In a shift that could lead to a reshaping of the global economy, China's government has loosened the tether on its currency, signalling the determination of the country's leaders to make the yuan a rival to the U.S. dollar.
Starting Monday, the People's Bank of China will allow the value of the Chinese currency to rise or fall by 1 per cent from the price it sets at the start of each trading day, compared with 0.5 per cent previously. The change was announced late Friday on the central bank's website and is the first change in the yuan's trading range since 2007.
Assuming the value of the yuan rises against other currencies, China's growing middle class will be left with greater purchasing power to buy foreign goods, which could provide a jolt of energy to struggling economies in Europe and the United States. The new policy will also alter the tenor of international forums like this weekend's upcoming gathering of finance ministers from the Group of 20, where China is regularly criticized for manipulating the value of its currency.
But above all, the announcement reinforces China's pledge to allow the yuan to circulate freely on international markets by 2015.
The country's leaders have long promised more free-market-oriented policies, but haven't always followed through with action. The implications of Beijing following through on its promise to embrace a freely traded currency could be profound.
With ready access to the currency used by the world's second-biggest economy, investors could move away from the U.S. dollar, the de facto world reserve currency since the end of the Second World War, causing U.S. interest rates to rise. Currently, commodities are priced almost exclusively in dollars. In time, that could change, as traders and companies gain confidence in the yuan as a means of global exchange.
"This is a major step," said Gregory Chin, a senior fellow at the Centre for International Governance Innovation in Waterloo, Ont., who worked on China as a senior Canadian government official, including at the embassy in Beijing. "Can you imagine what the world might look like in 2015?"
The currency issue has plagued relations between China and the United States for much of the past decade. American manufacturers say their Chinese competitors get an unfair advantage from a currency that officials in Beijing ensure stays artificially cheap. Year after year, congressmen threaten retaliatory trade sanctions, and Mitt Romney, the likely Republican nominee for president, has promised to get tougher on China.
For the Obama administration, the diplomatic trick has been applying pressure over a currency whose value it says is "misaligned," while avoiding an all-out trade war with the world's No. 2 economy.
One U.S. tactic has been to enlist partners in the G20 to lobby China, a role Canada has willingly embraced. Finance Minister Jim Flaherty and Bank of Canada Governor Mark Carney regularly echo U.S. complaints, saying China's unwillingness to allow the yuan to appreciate is preventing a rebalancing of the global economy to more consumption in China.
China's currency controls also put pressure on the Canadian dollar, which has surged to par with its U.S. counterpart, dealing a serious blow to the competitiveness of Canadian exporters. With the economies of Europe and the U.S. stagnant, international investors are seeking more profitable places to put their money. China is a natural, except the government limits the amount of yuan in circulation so it can control the exchange rate. That increases the demand for Canadian assets.
All these issues are set to be taken up anew this weekend in Washington, where ministers and central bankers are set to convene for the G20 gathering and the annual spring meetings of the International Monetary Fund and the World Bank.
Many analysts said the timing of China's currency announcement likely was linked to this week's summitry. China has a history of attempting to head off criticism with a timely press release, and just last week IMF managing director Christine Lagarde said she was concerned that China wasn't doing enough to encourage domestic demand.
China's latest move appeared to yield favourable diplomatic results. Ms. Lagarde issued a statement on the weekend, calling the central bank's announcement an "important step."
Critics such as Canada and the United States could be harder to appease. Ben Rhodes, a White House national security adviser, said the Obama administration was closely studying China's latest move. "They have made some progress," Mr. Rhodes told reporters in Cartagena, Colombia, where President Barack Obama was attending the Summit of the Americas. "We'd like to see more movement."
Mr. Chin agreed that Friday's announcement likely was meant as an olive branch for China's critics, but he said it also reflects a recognition by China's leaders that the time has come for them to rely less on exports for economic growth and more on the demand of their own people.
"The previous growth model is running its course," he said. "They know they need to make a shift. The question was always getting the right conditions."
China is speeding up the internationalization of the yuan, a process that the government began tentatively a couple of years ago with some pilot projects that allowed some of its currency to circulate in Hong Kong. Earlier this month, regulators said foreigners could buy up to $80-billion (U.S.) in Chinese stocks and bonds, an increase from $30-billion, and also raised limits on using yuan held in offshore accounts to make investments in China.
The yuan ended trading last week at 6.3030 to the dollar, an increase of about 8 per cent since June, 2010, when the government ended a nearly two-year peg to the U.S. currency. After keeping the yuan's value stable for a decade, authorities allowed it to strengthen by 21 per cent between July, 2005, and July, 2008.
China's currency has held steady lately as the country's economy slows from its previous break-neck pace. Officials in Beijing have said publicly that the yuan has found its "equilibrium" value against the dollar, an assertion that is dismissed in Washington, where the Obama administration continues to assert that the yuan is undervalued. The wider trading band could test Washington's claims, as some economists say the looser controls could result in the yuan's value falling rather than rising.