In its semi-annual report to Congress, the Treasury Department once again failed to officially label China (or any country for that matter) a currency manipulator. No surprise there. While it’s self-evident that China manipulates the RMB (via the peg with the US Dollar), the political implications of such a label prevent it from being used except in the most extreme cases. Nonetheless, there is mounting pressure on China, both domestic and international, to “adjust” the peg and allow the Yuan to move closer to its fundamental value. Most of the international pressure has been soft, coming in the form of roundabout pleas for China to allow the Yuan to float “for the sake of global stability.” Said one US Senator weakly, “I hope that with strong leadership from the United States, the G-20 nations and our international institutions will undertake what has been missing — a focused, sustained and meaningful multilateral engagement to address currency manipulation and current imbalances.” At the same time, some of this rhetoric has recently been translated into action. Last month, the Obama Administration enacted a 35% tariff on Chinese tire products. Other countries have also begun to raise concerns about Chinese dumping, and bringing their cases to the WTO for good measure. Many of these countries are in fact suffering more than the US. Since the Yuan is effectively pegged to the Dollar, the decline of the latter has been mirrored by the former. Since many other currencies of developing countries are also fixed, this leaves only a handful to absorb the shock. For example, the Euro and Yen have both risen about 15% against the RMB over the last year, in line with their appreciation against the Dollar. The handful of floating currencies in the region, such as the Korean Won, Indian Rupee, Malaysian Ringhit, etc. have also faced strong upward pressure. For them, it is not so much the weak Dollar that they fear so much as the weak RMB, since China is a direct competitor to all of them. 
More importantly, there are now voices within China’s ruling Communist party that have also begun to press for a stronger Yuan. The Nationalist camp, for example, is pressing for China to make the Yuan a more prominent currency on the international trade scene. While such doesn’t inherently require a floating currency (in fact, all of the trade/swap agreements involving Yuan are based on fixed exchange rates), a loosening of capital controls and liberalizing of financial markets would probably bring about a stronger Yuan.
The other group pushing for a stronger Yuan is doing so on more fundamental, economic grounds. Just-released 2009 Q2 GDP data showed prelimenary growth estimates of a whopping 8.9%! Not bad, especially when you consider that the rest of the world remains mired in recession. Chinese economists largely ignore the political implications of the notion that this growth probably came at the expense of the rest of the world, and focus instead on the economc implications. First is that the economy remains hopeless dependent on exports to drive growth, which can only be remedid through a stronger Yuan. Second, it heralds the coming of inflation. Many foreigners continue to pour “hot money” into Chinese asset markets hoping to reap the upside from both asset and currency appreciation. In response, “Analysts say China could let the yuan appreciate to help restrain inflation, since a stronger yuan would reduce the cost of imports. But some caution that Beijing tried a similar strategy in early 2008, but didn’t achieve great success in containing inflation or stemming the inflows.” While analysts don’t expect the Bank of China to allow the RMB to rise until after the Chinese New Year in January, investors are pricing in incremental appreciation every month beginning with the next. In fact, futures prices already reflect the expectation that the RMB will rise 3% over the next twelve-months. My bet is that this will be kicked off by another one-off appreciation, in the same vein as July 2005. Now as was the case then, China needs to make up for lost time. 
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