Gradual appreciation

In 2005, China ended the direct peg of its currency to the U.S. dollar in favor of a “limited float” against a basket of currencies. The yuan gradually appreciated over the next few years, but the U.S. consistently pressured China to allow the currency to strengthen further, arguing it remained highly undervalued.

However, It shows the U.S. dollar/Chinese yuan (USD/CNY) pair hit a wall in July 2008 as the world economic meltdown hit full stride. The pair has since traded mostly in a tight range between 6.8 and 6.9.

The U.S. Treasury Department is required to release two reports a year, one in April and one in October, highlighting potential foreign exchange conflicts. In these reports it can name countries it believes are manipulating their exchange rates. Under U.S. law, if a country is designated a “currency manipulator,” the Treasury Department is required to attempt to resolve the issue through diplomatic means. If that process fails, measures to correct the imbalance can go so far as the implementation of trade tariffs; the confrontational scenario in this case could result in U.S. import duties on Chinese goods.

China was the U.S.’s second largest trade partner behind Canada according to Census Bureau data through November 2008. The U.S. imported $313 billion worth of Chinese goods in 2008 through November, nearly five times the amount it exported, leading to an imbalance to the tune of $246 billion dollars.

This imbalance has prompted some to apply the “manipulator” label to China. By keeping the value of its currency relatively low — unfairly low, according the manipulation camp — China can keep its exports to the U.S. cheap and make the goods they import from the U.S. more expensive.

Questions remain whether this is the right time to pursue this issue with China, claiming there are currently many more pressing issues facing the world’s economies. While the U.S. fights through the most serious economic downturn since the Great Depression, China’s economy, which has been growing steadily in recent years, has also taken a turn for the worse. Asking a country known for its protectionism to loosen its stance on its currency as it faces a steep economic downturn may yield few results.

According the national Bureau of Statistics of China, GDP growth contracted from 9 percent in Q3 2008 to 6.8 percent in Q4, and came in at 9 percent for the year as a whole. By comparison, China’s GDP growth in 2007 was 13 percent, which was a 1.1-percent increase from 2006. Industrial production grew 12.9 percent in 2008, a 5.6-percent decrease from 2007. And even though China’s exports grew to $1.4 trillion in 2008, a 17.2 percent increase over 2007, Q4 import growth was sharply lower than the rest of the year, growing only 4.3 percent.

Although the Chinese government is attempting to insulate its import sector by selling the yuan and buying U.S. dollars, in the current global economic climate, it may have little effect.

“The downturn in all the other major economies that buy Chinese exports is basically stifling any exchange rate positives,” says Brian Dolan, chief currency strategist for New York-based forex trading firm GAIN capital.