For many years, the Chinese government held the yuan at a fixed exchange rate of approximately 8.27 yuan to one U.S. dollar.
Many constituencies outside of China, including manufacturers, labor groups, government officials, money managers and economists, urged the Chinese government to allow the yuan to float freely against the world's currencies, allowing market forces to dictate the exchange rates.
It was believed that by maintaining an artificially undervalued exchange rate, China was protecting the lower price of Chinese exports.
These groups argued that a free-floating yuan would reduce trade deficits, improve access for foreign goods in China's growing markets and ultimately impact everything from wage rates to environmental protection to job security in the United States and elsewhere.
Indeed, the U.S. Senate considered a bill in April calling for a 27 percent tariff on all Chinese imports unless China revalued the yuan by at least 27 percent within one year. For years, China's government had resisted all economic and diplomatic efforts to effect this change, citing, among other things, its national sovereignty in determining how to value its currency.
On July 21, the Chinese government announced that it would finally allow the yuan to be revalued and unpegged from a fixed rate against the U.S. dollar. Initially, the yuan was to float within a very restricted, specified range of approximately 0.3 percent from the previous day's closing price. The price would be set by the People's Bank of China, against a basket of foreign currencies, instead of just against the U.S. dollar. A modest 2 percent increase was immediately allowed, with the possibility of daily revaluations.
Reaction to China's move was immediate and cautiously optimistic.
While most acknowledged that this tight range and small rate change was, itself, artificial, it was recognized that this constituted a long-anticipated first step. The real question was whether it was to be the first step, or the only step, on the road to a changed monetary policy in China. U.S. Treasury Secretary John Snow welcomed the move, as did Federal Reserve Chairman Alan Greenspan, hailing it as a ``good first step.''
Even Sen. Charles Schumer, D-N.Y., a strong voice for reform (and one of the sponsors of the proposed 27 percent tariff), praised the move, tempering his enthusiasm by pointing out that ``if there are not larger steps in the future, we will not have accomplished very much.''
Since that initial move to bring the yuan into step with the world's currencies, there has been much back-and-forth discussion but very little action.
In early August, the governor of the People's Bank of China disclosed the composition of the basket of currencies that forms the basis for valuing the yuan. While the U.S. dollar still plays a significant role, so do the euro, the Japanese yen and the South Korean won. This was followed by an amorphous statement by a Chinese official that China would further develop and perfect the yuan exchange system ``with a firm heart.''
Throughout August, September and October, there were many additional calls by the United States and other trading partners of China for further yuan revaluations, with reaction from the Chinese remaining fairly consistent.
``The exchange rate [will] continue to be set by the managed floating regime rather than by official revaluation,'' as announced by an assistant to the governor of the People's Bank of China.
There have been more recent comments outside China to perhaps force the issue a little. Treasury Secretary Snow recently stated that he planned to suggest to the International Monetary Fund that it take the lead in moving China toward further monetary reform.
Schumer has stated that unless more change is forthcoming, he might reintroduce legislation imposing a tariff on Chinese goods.
Whatever happens in the area of monetary policy will affect the U.S. and global economies. If the yuan remains stable and is not allowed to appreciate against foreign currencies, Chinese goods should remain relatively inexpensive compared to similar goods made outside of China.
Moreover, the demand for non-Chinese goods within China would continue to be negatively impacted by the relatively high value of the U.S. dollar and other currencies.
Naturally, it is assumed that with more active changes in the value of the yuan, including another upward revaluation, the opposite will occur, but companies should approach this analysis with caution.
As the yuan's value increases against foreign currencies, goods manufactured by U.S. companies in China will become more costly, and goods manufactured in the United States that require parts from China will also increase in price.
As recently as early November, the People's Bank of China confirmed that it was focusing on yuan reform, and that it would ``gradually push forward reform of the exchange-rate mechanism; establish a market-oriented, managed floating-exchange-rate system; and maintain the basic stability of the yuan at a reasonable and balanced level.''
So, as with most global economic issues, it will be important to monitor changes within China's monetary system in order to effectively plan both domestic and foreign business strategies.
Douglas Haas is an attorney at Benesch Friedlander, Coplan & Aronoff LLP in Cleveland.