“Hail to the Chief!” sang the Chinese as they shook hands with the Secretary of the Treasury, Timothy Geithner in Beijing upon his unexpected visit enroute to Washington from New Delhi. They want to let their currency, yuan, fluctuate. And this is a good sign. China does not want war, of any kind, economic or military. They fully seem to understand that if they do not act on their currency policy, the United States and the rest of the G7 can. They may just as well control the process by cooperating rather than provoke confrontation only to lose control.
Gradually expanding the band within which a pegged currency fluctuates is how any country is supposed to, per the textbook, eventually let its currency freely float in the winds of the market forces. Similar to the Fed’s debate about the inflation targeting, a country without an independent monetary policy, with capital controls and a pegged currency must, under ideal circumstances, create economic conditions to rely on when and how it wants to change its money supply and remove capital controls to let its currency float by targeting a gradually expanding range within which the currency’s exchange rate against other currencies changes. And China is exactly doing that. Inflation targeting for the United States is equivalent to China’s exchange rate targeting.
The interesting point of examination of China’s currency policy would be its target range: what is the low and what is the high? It appears that China is targeting a range between about 5.50 yuan to a dollar and 6.50, effectively implying that any value lower than 6.50 yuan to a dollar is not in the best interest of China.
In this bilateral dance with China, the same applies to the United States on its debt management and dollar exchange rate. The United States can buy back its debt (prices will rise, yields will fall) and control the pace of the devaluation of the dollar, rather than wait for foreigners and the Wall Street herd do it for the government, only to lose control.