In this regard, the Bush administration has taken note of the shift in Beijing's position on the value of its currency, which has been pegged to the US dollar for the past ten years at a rate of 8.28 yuan to US$1. This circumstance has led to charges that Chinese manufacturers enjoy an unfair competitive advantage by undervaluing the yuan by 20-45%, which is at least in part to blame for the woes of the US manufacturing sector. However, a number of top Chinese officials now have indicated that establishing a market-driven trading system for the yuan has become a top priority.

Under the Omnibus Trade and Competitiveness Act of 1988, the US Treasury Department must submit a report on international exchange rates twice per year. And if the department finds that a country has significantly harmed US trade through foreign exchange rate manipulations, then the treasury secretary is required to conduct "expedited" negotiations to change the practice. However, in its latest report, which was released on April 15th, the US Treasury Department said that neither China nor any other country had systematically manipulated its currency in the second half of 2003.

Still, the Treasury's report notes that China's bilateral merchandise trade surplus with the US grew to US$70 billion in the second half of 2003, up from US$60 billion in the second half of 2002. At the same time, the report recognises that more than 50% of China's exports come from foreign-funded operations that use the country for final assembly and processing.

The Treasury report states that while a number of economies continue to use pegged exchange rates and intervene in foreign exchange markets, a peg or intervention does not in itself satisfy the statutory test. For the purpose of assessing whether an economy is manipulating its currency, the Treasury undertakes a careful review of the individual trading partners' exchange rates, external balances, foreign exchange reserve accumulation, macroeconomic trends, monetary and financial developments, the state of institutional development and financial and exchange restrictions. In other words, isolated developments in any one area do not typically provide sufficient grounds to conclude that there is exchange-rate manipulation.

The Treasury report notes that because of China's exchange-rate peg, balance of payments inflows are absorbed by the Chinese central bank and reflected in an increase in Chinese reserves. As a result, China's official foreign exchange reserves grew by a net US$57 billion during the second half of 2003 to reach US$403 billion, up 16% over the country's foreign exchange reserves at the end of June 2003. This accumulation of foreign exchange reserves has created monetary pressures that fuel domestic credit growth and inflation. China's real gross domestic product (GDP) officially increased 9.1% in 2003, with official fourth-quarter growth coming it at 9.9%. The Treasury report also points out that China's capital controls are largely asymmetric, restricting outflows more than inflows, and hence provide upward pressure on the currency's value.

The report observes that the Bush administration has urged China to move as soon as possible toward greater exchange-rate flexibility. A regular dialogue between senior financial officials from the Group of Seven (G-7) industrialised countries and senior finance officials from China has been established. Yet the report goes on to say that China will need to lay the groundwork for floating its currency. It states that Beijing has already taken a number of steps to prepare for a flexible exchange rate regime, having re-capitalised two of its four largest state-owned financial institutions in December 2003 and continued to write off non-performing loans.

In addition, the report acknowledges that Beijing has liberalised foreign direct investment (FDI) outflows, is preparing for renminbi trading in Hong Kong and has allowed insurance companies to invest a portion of their portfolio in foreign assets. China also is preparing to allow limited investments in securities traded on foreign markets.

US Treasury Secretary John Snow will meet with Vice Premier Huang Ju in Washington in the next few months to discuss the undervaluation of China's currency. Yet the Bush administration has backed off from its earlier demands that China should float its currency. Not without good reason, it should be added. Most economists do not believe that floating China's currency would do anything to reduce the US trade deficit with China. Nor would it be likely to restore lost American manufacturing jobs. Moreover, the yuan's appreciation would damage those US firms that produce in China for the US market.

However, it has become increasingly likely over the past few months that Beijing might appreciate the yuan a bit and peg the currency's value to a basket of major currencies, including the US dollar, the euro and the Japanese yen. Off the record, most US officials believe that this would be the most desirable outcome at this time.