China Drops Yuan's Dollar Peg,
Will Let Currency Float in Band
By MICHAEL M. PHILLIPS Staff Reporter of THE WALL STREET JOURNAL
China announced suddenly its long awaited change to its currency policy, saying it will no longer peg the yuan to the U.S. dollar but instead let it float in a tight band against a basket of foreign currencies.
The yuan has been strengthened, effective immediately, to a rate of 8.11 to the U.S. dollar -- compared to the 8.28 it has been set at for more than a decade. The new trading regime will begin Friday, the government said in an announcement on state television.
The yuan will now be allowed to trade in a tight 0.3 percent band against a basket of foreign currencies, the government said. It didn't say which currencies.
It said the central bank would announce the yuan's closing price each day, and that rate would be the midpoint of the next day's trading band.
The U.S. Treasury has been pushing for the Chinese move and had no immediate comment.
Carl B. Weinberg, chief economist of High Frequency Economics, issued a report saying he estimated the complex change as a 2% revaluation against the dollar -- well below the 10% called for by some analysts and American policy makers. Mr. Weinberg wrote that it "is unlikely to affect the U.S. trade deficit with China ... or any of China's trade flows or economic conditions at all." Mr. Weinberg called it "a nice token move, but it is no economic knockout."
The resolution of the yuan problem removes one of the main thorns in U.S.-China relations. But others remain. Earlier this week, the Defense Department issued a harshly worded report suggesting China was on the way to becoming a military rival to the U.S. On the trade front, the U.S. continues to press China to crack down on rampant copyright and trademark piracy, followed by ongoing friction over the textile and apparel imports. The U.S. also has issues with China's military buildup, its human-right record, and its lack of freedom of worship, all of which will be touched on when Deputy Secretary of State Robert Zoellick travels to Beijing in early August for the first in a series of "strategic dialogues" between the two countries.
China's policy of tying its currency to the U.S. dollar has long been a flashpoint in the administration's international economic policy, with Mr. Bush and his economic team trying to balance diplomatic prudence towards a growing world power with fierce domestic pressure from workers and business executives who blame Beijing for their woes.
The Chinese yuan first appeared on the Bush administration's radar screen shortly before the Sept. 11, 2001, hijackings. Then-Treasury Secretary Paul O'Neill traveled to China, ready to press the Chinese to float the yuan. Mostly it was a reflection of his economic philosophy; economies work better when key ingredients, such as the exchange rate, are set by the markets, he felt. After closed-door discussions, Mr. O'Neill left persuaded that the Chinese authorities already intended to move in that direction -- at their own pace.
"I'm convinced they'll take whatever actions are appropriate, and it's not something we can really help them with," Mr. O'Neill said.
The issue quickly became swamped by the uproar that followed the Sept. 11 attacks, and Treasury focused its energy on tracking down the finances of alleged terror groups.
A year later, Chinese Finance Minister Xiang Huaicheng ruled out the possibility that China would switch to a floating exchange-rate system any time soon. "Personally speaking, the direction of our currency system is toward the floating system. But in the foreseeable future, it is impossible to fully liberalize the currency system," Mr. Xiang said in the joint press conference in Washington after meeting with Mr. O'Neill.
The Treasury secretary seemed unconcerned that China's position on the currency would sully U.S.-China relations. "Do I see it as the complication? The answer is no," Mr. O'Neill said, according to press reports at the time.
Factory Owners Persisted
But American factory owners refused to let the matter drop. During the early years of the Mr. Bush's first term, the National Association of Manufacturers had pounded the administration over the general strength of the U.S. dollar. As the greenback slipped, however, and John Snow took over from Mr. O'Neill, they shifted their focus to Asia. In early 2003 NAM and its allied companies launched a campaign to get the White House and Treasury to put pressure on China and other Asian nations to stop keeping their currencies artificially weak against the dollar. In NAM's view, China, which had held the yuan at 8.28 to the dollar since 1994, was cheating on the exchange rate to steal markets from U.S. firms.
"The first thing is for the U.S. to begin expressing its concern and displeasure over the fact that other countries are keeping their currencies from adjusting," Frank Vargo, the association's vice president, said as the group unveiled its lobbying campaign.
Mr. Snow adopted a quiet approach, in part for fear that rushing China along towards a free-floating currency could damage its already weak banks. Lawmakers, business executives and Democratic presidential hopefuls, however, focused their fury in China.
Mr. Snow visited China in early September 2003. Even before he arrived in Beijing, the Chinese central bank issued a release saying, "We will keep the yuan stable according to the current policy," while a government-owned newspaper complained about "international browbeating."
The administration clearly felt that it couldn't appear too passive. "The establishment of flexible exchange rates, of a flexible exchange-rate regime, would benefit both our nations as well as our regional and global trading partners," Mr. Snow told reporters in Beijing. "That's really our central point -- that floating rates, market-based, flexible exchange rates create the signals for a well-functioning flow of resources on a global basis. There ultimately is no substitute for that."
The next day, President Bush himself chimed in, telling an audience of business people in Kansas City, Mo., "We don't think we're being treated fairly when a currency is controlled by the government. We believe a currency ought to be controlled by the market, it ought to reflect the true values of the respective economies."
The sharpened rhetoric won the administration a short reprieve from the NAM, which praised both Messrs. Snow and Bush. "But we were not satisfied at the Chinese government's response to these appeals, which suggests continue delays in correcting the problem," Jerry Jasinowski, NAM president, said after Mr. Snow returned from China.
And trade hawks on Capitol Hill seized the moment to exert their own pressure on both China and the Bush administration. Just days after Mr. Snow left Beijing, Sens. Chuck Schumer (D., N.Y.), Lindsey Graham (R., S.C.) and others introduced a bill that would impose a whopping 27.5% tariff on Chinese goods entering the U.S. -- the amount the senator said was necessary to counter the advantage conveyed by the undervalued yuan.
"The time for diplomatic niceties has passed," Sen. Schumer told Mr. Snow at a Senate hearing. "The administration needs to grow some backbone and take a firm line with the Chinese on the currency issue."
The administration maintained the rhetorical pressure for a few months. Mr. Bush raised the subject with Chinese President Hu Jintao at an economic summit in Bangkok in October 2003. Other senior administration officials joined the chorus. But Treasury, if not the White House, was careful not to promise that a rising yuan would reduce the U.S.-China trade deficit or create American jobs. Instead, Treasury officials argued that such a move would be good for China and give it more control over its own monetary policy. And the administration declined to label China a currency "manipulator" in its semiannual report on currency practices around the world.
"By letting China off the hook, the Bush administration has made itself an accessory in the economic crimes being committed against our workers," Sen. Joe Lieberman (D., Conn.), then running for president, said at the time.
'Coalition of the Raging'
The political heat led Robert Kapp, president of the U.S.-China Business Council, a group representing American companies with investments in China, to label those lobbying for a get-tough policy the "Coalition of the Raging."
The Chinese, in the meantime, continued to promise reforms in the vague future. "With the role of the market becoming increasingly important, the exchange rate Šwill be finally determined decisively by the market forces and have great flexibility," Zhou Xiaochuan, governor of the Chinese central bank, said in October.
During 2004, the administration toned down the rhetoric, and emphasized its decision to send a team of technical experts to help Beijing pave the way to a flexible exchange rate system. The idea was to keep the issue low key and professional, while the Chinese took steps to strengthen their banking system and otherwise prepare for a freer movement of capital across their borders. Mr. Snow appointed a special envoy to China.
In February, the U.S. and its major allies in the Group of Seven issued a statement pointedly urging China to make its currency more flexible. It was an intentional effort on the part of the U.S. to shift the yuan issue into the international arena, so the Chinese wouldn't feel that any policy change amounted to a humiliating surrender to U.S. bullying.
"That was part of a broader effort to make it clear this is a bigger issue than just the bilateral relationship between the U.S. and China," recalls Treasury spokesman Tony Fratto. "It's a global issue."
The discontent in Congress, fueled by unease among manufacturers and their employees back home, would not subside, however. In April 2005, the Schumer-Graham tariff bill won overwhelming support in a procedural vote, a sign that the Senate might be prepared to lend its support to the idea of punishing China with high import duties. A vote on the full bill was scheduled for this month.
The protectionist sentiment on the Hill alarmed the president's economic team, and administration officials ratcheted up their rhetoric once again. "We're pressing China Š for floating her currency, so we can have free and fair trade with China," Mr. Bush told a group of newspaper editors.
Senior U.S. officials took the opportunity to announce that China had done enough preparatory work, and that the time to act had arrived -- a significant shift in tone. Even as they tried to fend off protectionists on the Hill, they used the threat of congressional action to prod China to loosen the yuan's links to the dollar. "We're not happy with the current situation," one Treasury official said then. The Chinese "need to find the political will to move."
The administration never specified exactly what steps it wanted China to take, except to say that they should be of a "manner and magnitude" sufficient to signal a move towards flexibility. Mr. Snow was careful to say that he did not think China should immediately cut the yuan completely loose of its moorings. A significant revaluation might have been an acceptable start to the U.S., or a peg to a basket of foreign currencies. Even a wider trading band or a gradual crawl upwards might have won U.S. support.
This summer, Mr. Snow became increasingly convinced that the Chinese were on the verge of taking action, although he still didn't know when or how Beijing would move. "I believe that our longstanding efforts are beginning to come to fruition and we are making progress toward achieving this goal," Mr. Snow said.
As the date of a new vote on the Schumer-Graham tariff bill approached, Mr. Snow and Federal Reserve Chairman Alan Greenspan persuaded the senators that the Chinese were more likely to act soon if the Senate stepped back from its brinkmanship.
The senators agreed in July to withdraw their request for a floor vote. "If we can get there by persuasion and accommodation, so much the better," Sen. Schumer told reporters.
Write to Michael M. Phillips at michael.phillips at wsj.com