China allows the yuan to gain vs the dollar. A little.

Perhaps responding to my What's Up With the Yuan? post, China has just allowed to yuan to gain value against the dollar - just not very much, a mere .1%. This brings the currency's value to below 8 yuan to the dollar, which the NY Times notes is an important psychological threshold in its value (I had no idea). The last time the yuan was valued at this level was in 1994. Reacting to yuan's gain, some Asian markets dropped precipitously, anticipating further increases in the currency leading to a dampening effect on China's exports, which could have consequences for the entire regional economy. In recent weeks the dollar has been declining dramatically against the euro, pound, and yen as well, though it began regaining some value today.

What's up with the yuan?

There's been a lot of talk in financial circles lately about how China's currency, known as the renminbi (RMB) or yuan, is affecting the financial health of the US and world economy. But mostly the US economy, since we run such a large trade deficit with China, China buys so much of our debt, and both these issues only seem to be getting more serious. Fo eight years up until July 2005, China had pegged the value of its currency to the US dollar, and in consequence enjoyed an exchange rate extremely favorable to its exports. Even after loosening control over the yuan last year, China's leaders still kept it on a short leash, allowing it to climb about 2% vs the US dollar in July '05 followed by a similar rise more recently.

The consensus is that had the yuan / RMB been allowed to float freely, it would be worth vastly more against the dollar than it is today, and the trade deficit with the US would very likely be a lot smaller since Chinese goods wouldn't enjoy such a dramatic price advantage. So there's a lot of pressue on the Bush administration these days to push the Chinese leadership to improve the situation and further loosen their control, manipulation, restriction, call it what you will, of the yuan's value. And with that, I turn you over to someone who knows a lot more about this than me...

From US Treasury Secretary John Snow's May 10, 2006 Report on International Economic and Exchange Rate Policies:

"Strong growth in China and the region have helped propel the global economy. But greater exchange rate flexibility in emerging Asia is an irreplaceable component of the adjustment of global imbalances, and Chinese exchange rate flexibility is the lynchpin of currency flexibility in emerging Asia.

China's international economic and exchange rate policies are deeply concerning. The United States has been joined by the international community, including the G-7, the IMF, and Asian Development Bank, in vigorously encouraging China to implement greater exchange rate flexibility. In the final analysis, though, the Treasury Department is unable to conclude that China's intent has been to manage its exchange rate regime for the purposes of preventing effective balance of payments adjustment or gaining unfair competitive advantage in international trade. Thus, we have not designated China pursuant to the 1988 Trade Act. Let me share with you our reasons.

China is engaged in an historic transformation to a market system. To achieve the requisite economic rebalancing, China must make its currency regime more flexible, strengthen consumption and modernize its financial system – the three pillars of our policy engagement.

China's leadership has publicly committed to take these steps. President Hu, in a meeting with President Bush on April 20, stated that China does not want a large current account surplus and will act to reduce it. Premier Wen made this same commitment in his speech to the National People's Congress and also committed to allow more exchange rate flexibility. China's recent five-year plan places strong emphasis on consumption and rural development in order to spur domestic demand. China's Central Bank Governor laid out a five-point plan to reduce the surplus, including efforts to boost domestic demand, reduce China's high saving rate, accelerate removal of trade barriers, allow foreign firms greater access and achieve greater exchange rate flexibility.

Of course, words must be backed by action, and China is taking some action. On the exchange rate front, China abandoned its eight-year peg against the dollar last July, and the renminbi (RMB) has moved slightly higher against the dollar since that time. But given the close relationship between the RMB and the dollar and because the dollar appreciated last year across the board, China's currency on a trade-weighted basis appreciated by over 9 percent last year. China has also taken steps to create a deeper and more liquid foreign exchange market, allowing interbank foreign currency trading for the first time this year...

Let us be clear: we are extremely dissatisfied with the slow and disappointing pace of reform of the Chinese exchange rate regime. The RMB's appreciation has done little to curb China's large current account surplus or cool its fast-growing economy, which last quarter was at an over 10 percent annual rate. Further exchange rate flexibility is a key tool for tightening financial conditions amid ample liquidity, reinforcing the effect of recent monetary policy actions aimed at cooling economic activity. Thus, this slow pace is neither in China's self-interest nor in the interest of the world economy. With a still rigid exchange rate, China lacks effective monetary policy tools to avoid the boom-bust cycles it has experienced in the past. This is particularly important now that investment in China appears to be reaccelerating, increasing the risk of a hard landing.

For the last three years, the Treasury Department has made engagement with China one of its top priorities. This intensive engagement has first and foremost concentrated on exchange rate flexibility, but also on the other steps necessary to shift the sources of growth toward domestic demand and consumption, reform the financial sector and to build the foreign exchange market infrastructure. While the economic face of China changes rapidly each day, we are not satisfied with the progress made on China's exchange rate regime and we will monitor closely China's progress every step of the way.

It is important for China to understand that its exchange rate regime is not simply a bilateral US-China issue, but a multilateral issue. Chinese exchange rate practices affect the entire world. The IMF is the world's only multilateral institution with a mandate to consider exchange rates. Managing Director Rodrigo De Rato has called for strengthening IMF exchange rate surveillance in his medium-term strategy. Further, at the recent IMF/World Bank spring meetings, he developed a new mechanism for multilateral consultations to broaden the global discussion of imbalances. The IMF must take this mandate for leadership by encouraging real reform in the Chinese currency regime.

In conclusion, the entire international community must work together cooperatively to address global imbalances, but it is a matter of extreme urgency that China act immediately to increase the flexibility of its exchange rate regime before real harm is done to its own economy, to its Asian neighbors, and to the global financial system."

Finally, I leave you with an explanation from the all-knowing Wikipedia of the relationship between the terms "renminbi" and "yuan":

"The renminbi was first issued shortly before the takeover of the mainland by the Communists in 1949. One of the first tasks of the new communist government was to end the hyperinflation that had plagued China near the end of the Kuomintang era. A revaluation occurred in 1955 at the rate of 1 new yuan = 10,000 old yuan...

The base unit of the renminbi is the yuan. As with Chinese numerals, this character has two forms — a common simplified form and a formal form used to prevent alterations and accounting mistakes. One yuan is divided into 10 jiao, and one jiao is divided into 10 fen. So 3.45 yuan would be spoken of as "3 yuan 4 jiao 5 fen", as opposed to "3 yuan 45 fen". In colloquial usage, other names are frequently employed.

The largest denomination of the renminbi is the 100-yuan note. The smallest is the 1-fen coin or note. One of the more interesting things to note is that all denominations are available as banknotes. The fen notes are now rather insignificant, and the design has not changed since 1953.

The word yuan is the usual translation for the word dollar, and the abbreviation RMB¥ is sometimes written as CN$. Yuan in Chinese literally means round object."

So that's what's up with the yuan.