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China Ends Fixed-Rate Currency
China's decision to revalue the yuan drove the Japanese yen up against the U.S. dollar, and U.S. Treasury bonds fell. The USX China Index, which includes Chinese companies listed in the United States, rose by more than 3.5 percent.
Under the new system, the basket of currencies used to set the value of the yuan would be known to only Chinese authorities, though it is widely expected to include the euro and the Japanese yen.
Widening the band in which the yuan trades allows China to adjust to the foreign investment inflows that have been pouring into the country. Such investment, combined with China's swelling export earnings, has pushed the country's foreign exchange reserves beyond $600 billion, sowing worries about over-investment and inflation.
"China needs a flexible exchange rate to take off speculative pressures," said Jonathan Anderson, chief economist at UBS Investment Research in Hong Kong.
Anderson and other economists have for months predicted that the move would come in the summer, when markets are quieter. In the short term, however, the change could actually encourage speculation, as investors bet on the possibility of another bump up in the value of the yuan.
A desire to alleviate tensions with the United States also appears to have affected China's timing, analysts said. The currency change comes as Congress considers trade sanctions against China and just weeks ahead of a planned September trip to Washington by Chinese President Hu Jintao. It also lands as the state-owned Chinese energy company Cnooc Ltd. seeks to buy U.S.-based Unocal Corp. -- an effort that has stoked national security concerns in the United States.
But the most consistent irritant in the U.S.-China trade relationship has been the value of the yuan. Beijing has said repeatedly that it plans to float its currency eventually while insisting it would not cave to foreign pressures. China's leaders probably settled on the new policy weeks ago, analysts said, then timed the announcement for maximum political effect in Washington.
On Capitol Hill, China's alleged currency manipulation is often cited as a reason for China's $160 billion-plus trade surplus with the United States. But many economists disagree, noting that if Chinese-made T-shirts, furniture, toys and air conditioners increase in price as a result of a revalued yuan, U.S. workers would not gain any jobs. Rather, the business would shift to factories in other low-cost countries, such as Mexico and Thailand.
"This will have very little impact on the trade deficit," said Fred Hu, a managing director at Goldman Sachs in Hong Kong.
For China, the move toward a more flexible currency carries potential perils. Anything that could dampen export growth is sensitive at a time when China's coastal factories are creating jobs to offset those lost by the demise of bankrupt state-owned factories.
"The yuan appreciation will add to their difficulties and force them to lay off more workers," said Yu, the East China Normal University economist.
China has been loath to remove controls on the movement of money, cognizant that a surge of speculative investment into real estate followed by a hasty dash for the exits delivered Asia's last financial crisis. China avoided the devastation in large part because of its fixed currency and strict capital controls -- a policy that then drew words of gratitude from the United States.
"This a cautious move," said Zhong Wei, a finance expert at Beijing Normal University. "This is more like a political stance than real currency reform."
Staff writer Paul Blustein contributed from Washington. Special correspondents Eva Woo and Jason Cai also contributed to this report.