China&#39;s Massive Rebound Threatens To Break The Yuan Peg

China's stunning rebound from the financial crisis has sent the country's industrial production back to pre-crisis levels. October industrial production rose 16.1%, the fastest since March 2008. Power generation also grew at the fastest rate since March.

While both exports and imports continued to fall 13.8% and 6.4% respectively, China is clearly storming ahead with 8.9% GDP growth recorded in the third quarter.

The Chinese economy is growing far faster than that of the U.S., yet the fixed yuan-dollar exchange rate goes nowhere. China is also growing faster than most of the world, yet the yuan is actually falling in value against most currencies due to its peg to the falling dollar.

Thus China's latest momentum means that the pressure to break the yuan-dollar peg is like never before, both in terms of the underlying economic forces which should push the yuan up, and the very visible international political pressure from trading partners as well.

Hopefully the government will find current economic growth sufficiently strong to risk an upward adjustment to the yuan's exchange rate against the dollar, even if it causes some unemployment for export-oriented industries at the margin.

At a time when China is rapidly developing its domestic economy, an upward adjustment will actually bring down the cost of many necessary imported goods and help shift businesses towards serving the country's domestic market needs over simply serving the needs of foreign consumers. Thus it is in the long-term interest of the country and the nation's massive GDP growth means that it can weather some short-term pain in its export sector.

Sp they should just do it before the market can speculate further, and probably will soon (2010?).

A sudden yuan hike won't be that crazy, they've done it before. It will help ease some of the economic imbalances caused by the peg and will simply continue the course of yuan appreciation China began in 1994. While it won't be pretty, since it will fuel expectations for further hikes, there aren't any pretty options.

Yuan