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Cheering China's baby steps
Sure, its yuan move is tiny and oblique but progress on the economic front is still encouraging.
July 22, 2005: 9:57 AM EDT

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NEW YORK (CNN/Money) - So the Chinese have taken a mere "baby step" toward breaking their currency peg to the dollar and letting their currency float freely, but is this so bad and why should we expect more?

Think back to when your baby took its first steps. Weren't you thrilled? Didn't you applaud? And if your baby didn't start walking till it was five or six -- maybe this is the better China analogy -- weren't you relieved? Now the question is how quickly baby steps turn into strides: more frequent moves, wider currency bands, fewer currency controls.

In fact, taking a baby step by dropping the formal dollar peg and adopting a "managed float" system with the yuan tightly-tethered to a basket of currencies (still heavily dollar weighted) makes sense for China. There have been far too many examples of bold and abrupt currency changes that blew up in the face of the global financial system. (Can you say "Thai Baht"? Its depreciation set off the downward currency spiral that kicked off the Asian crisis of 1998.)

Let the Chinese feel their way along here and gradually develop the system. Let traders overreact to tiny shifts. Let them get their floating-exchange-rate feet under them first.

The real fundamental question is what this does to the economy -- in China, the U.S. and the world? The U.S. needs to see some shift in exports and imports where we sell more to them and they sell less to us -- or at least where the prices of Chinese goods are higher so U.S. producers can compete (are there any U.S. manufacturers left out there or has the last one turned out the lights?) For China the fear will be that even a tiny shift in trade will hurt their factories and since they have millions of people clamoring for jobs this is a pretty important question for them, too.

On the political front, Treasury Secretary John Snow called this "a very positive development." At least he can now go home and say to President Bush, "See boss? They finally listened!" Leading China battler Sen. Chuck Schumer called it a step in the right direction, but the anti-China forces will not be so kind for long. They will want to see more steps soon or they will call this a cynical attempt to manipulate global trading partners without making needed changes. Hard to argue with that.

At the very least, though, note economists at BMO Nesbitt Burns up in Toronto (and remember, Canadians know a thing or two about currencies), this should prevent the U.S. Treasury from branding China a currency manipulator in October.

And it remains to be seen if China is going to take any more steps on other fronts to show it is serious about being a grown-up, an adult, in the global trading system, like seriously cracking down on rampant rip-offs of intellectual property. Need more than baby steps there.

As many noted yesterday following China's announcement there are big implications for U.S. Treasury bonds, i.e., fewer China bond purchases and higher U.S. bond yields (and folks, that means higher mortgage rates and that could have implications for the U.S. housing market).

As the BMO Nesbitt Burns economists sagely note, however, "it is decidedly not in China's interest to spark sharply higher U.S. interest rates that could cool the enthusiasm of U.S. consumers to spend."

In other words, higher rates that keeps us from buying boatloads of Chinese goods ain't good news for Chinese companies or workers.

Also bear in mind, the fact that the Chinese own hundreds of billions of dollars of U.S. bonds means they too are vulnerable to rising rates, or yields on those bonds. Remember, higher bond yield means lower price and if yields rise that means losses for the Chinese government on its bond holdings.

One more thought from Nesbitt Burns: "What this move could hopefully do is to try to balance the need to help encourage Chinese ... Asian ... consumers to spend more, while not crushing spending in the United States."

Wow. Chinese spend more? That's a vision of more juice for the global growth engine. Like so many parents, we all have big hopes for our babies when they start walking.

And we all know that most babies love walking once they start and are eager to skip and run. Let's hope China, a billion dollar baby, stays on course.

_____________________________________

-- Kathleen Hays is economics correspondent for CNN and contributes to Lou Dobbs Tonight. You can read more of her columns here.  Top of page

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