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China takes baby steps toward a free-floating yuan

NEW YORK (CNNMoney.com) -- China took steps Saturday to let its currency trade more freely, but investors and U.S. policy makers should not expect a large increase in its value.

Since 2008, China has pegged its currency, the yuan, to the dollar, keeping its value artificially low and making it tougher for U.S. companies to compete. Some economists think the yuan is undervalued by 20% or more.

The People's Bank of China said that in response to the global economy's continuing recovery, it will enhance its exchange rate's "flexibility," a statement observers interpreted as meaning that China will let the yuan gradually appreciate against the U.S. dollar. But don't expect big hikes: "The basis for large-scale appreciation does not exist," said the bank.

On Monday morning, despite a small uptick in the value of the yuan, the U.S. dollar was mostly unchanged against other currencies from where it traded Friday before the announcement.

The move comes one week before President Obama and other world leaders will gather will gather in Toronto for the G20 economic summit, at which China's currency policy will be in the spotlight. Representatives of several industrialized nations, including India, Brazil, the United States and European countries have previously asked China to allow its currency to float.

"We welcome China's decision to increase the flexibility of its exchange rate," Treasury Secretary Tim Geithner said Saturday. "Vigorous implementation would make a positive contribution to strong and balanced global growth."

Obama praised the move as a "constructive step that can help safeguard the recovery and contribute to a more balanced global economy."

While a stronger yuan -- and a weaker dollar -- is widely considered to be a good thing for U.S. manufacturers, it won't come without some pain for Americans.

China has been keeping the yuan cheap by buying massive amounts of U.S. dollars and Treasurys. If the yuan floated freely, China wouldn't need to buy as much. And that could mean higher interest rates on Treasurys, and thus higher borrowing costs for many U.S. homeowners and businesses.

It also could lead to a slide in the value of the dollar, which in turn could raise the price of imports, such as oil.

--CNN Wires contributed to this report To top of page

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