Market Comrades
Ceremonial gift-giving is an integral part of doing business in China. The value lies not so much in the gift (whose packaging is often more elaborate), but in the possibility of cementing a mutually beneficial relationship.</br></br>And so it was with last week's headline-grabbing announcement that China would revalue the yuan against the U.S. dollar. The modest gesture may make more possible a comprehensive economic dialogue between China and the U.S. in the interest of both nations.</br></br>The announcement on July 21 by the People's Bank of China that it would revalue the yuan, abandoning the 11-year-old peg of 8.28 yuan per U.S. dollar, caught financial markets by surprise. The jolt led market participants to gauge effects of current (and perhaps future) revaluations on currency values and interest rates. And, some U.S. political leaders claimed a victory in the campaign to blame Chinese "market manipulation" for external imbalances facing the U.S.</br></br>---</br></br>But there is a bigger story here. In the first sentence of the People's Bank's July 21 announcement, the bank states: "With a view to establish and improve the socialist market economic system in China, enable the market to fully play its role in resource allocation as well as put in place and further strengthen the managed floating exchange rate regime based on market supply and demand. . . ." [Emphasis added] The inherent conflicts in the phrase ("socialist market economic system," and "market supply and demand" with capital controls and a managed float) highlight both the central economic challenges facing China and the need for a comprehensive U.S. economic policy toward China.