China on Thursday took an important step forward in its move toward a market economy, announcing it would increase the value of its currency, the yuan, and abandon its decade-old fixed exchange rate to the U.S. dollar in favor of a link to a basket of world currencies.
The evening announcement on state television delivered China's first concrete move toward allowing the yuan -- also known as the renminbi -- to eventually float freely at the whim of global traders.
The move eased tensions between China and the United States on a key source of trade friction. The White House, pressured by manufacturers and vocal members of Congress, has lobbied China to raise the value of its currency, arguing that a low-priced yuan has unfairly kept Chinese goods artificially cheap.
The Chinese move was welcomed heartily by the Bush administration.
"They've put in place a mechanism that provides room for significant movement over time in the currency, and they've expressed a commitment to using market forces to let the currency move," Treasury Secretary John W. Snow said at a news conference. "I think today's developments are extremely positive."
China's most strenuous critics in the United States have demanded that Beijing increase the value of its currency by at least 10 percent. Sens. Charles E. Schumer (D-N.Y.) and Lindsey O. Graham (R-S.C.) have been pressing a bill that would impose across-the-board punitive tariffs of 27.5 percent against Chinese imports if China does not substantially raise the value of the yuan. Last month, the two senators delayed the vote after saying they had been assured by Snow and Federal Reserve Chairman Alan Greenspan that a Chinese revaluation was imminent.
The details of China's announced shift fell short of their demands. In a statement posted on its Web site, China's central bank said it would on Friday free the yuan to rise to 8.11 from its current 8.28 to the dollar -- an increase of about 2.1 percent. The bank also said it would allow the yuan to move within a trading range of 0.3 percent above or below the previous day's closing price, continuing its "managed float" policy.
The change garnered measured praise from Schumer: "It is smaller than we hoped," the senator said in a news conference. "But to paraphrase the Chinese philosophers, a trip of a thousand miles can well begin with the first baby step. And the fact that they have opened the door to future increases of 0.3 percent makes us feel and hope that this is not the last."
Analysts said Thursday's movement was probably only the beginning of a series of measures that will eventually allow the yuan to move in a broader trading band with other currencies and to float freely -- albeit not for several years.
"The new managed floating currency regime is just an interim system," said He Fan, an economist at the Chinese Academy of Social Sciences in Beijing. "There is a chance of a further widening of the band in the not-distant future, but it will go step by step."
Others suggested that Beijing was not likely to move again anytime soon. "I believe this revaluation will stay in place for the next 24 months," said Yu Nanping, an economist at East China Normal University in Shanghai.
In a sign of China's regional economic influence, Malaysia on Thursday followed with its own announcement that it, too, is allowing its currency, the ringgit, to float within a proscribed trading band. By contrast, Hong Kong announced it would retain its currency peg to the U.S. dollar.
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.