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Q&A: China's currency moves

By Kevin Voigt, CNN
China currency moves could increase the buying power of the yuan against the dollar.
China currency moves could increase the buying power of the yuan against the dollar.
  • NEW China's yuan moved up 0.42 percent on Monday
  • Markets and countries greeted China's currency announcement warmly
  • Still, critics are waiting for the government to release details on its plans
  • Companies who sell to China stand to gain from the move
  • Customers of Chinese goods and services could see higher prices

(CNN) -- China's announcement Saturday that it will resume a policy of exchange rate flexibility has been greeted warmly by the markets and countries that do trade with the world's most populous nation.

The move could decrease building tensions between Beijing and Washington, where anger is building over China's growing trade deficit with the U.S. and the migration of jobs to the Asian giant's deep pool of low-cost labor. Here's a closer look at the issue:


As part of its admission to the World Trade Organization in 2001, China pledged to gradually eliminate its peg to the U.S. dollar. In July 2005, China increased the value of the yuan by 2.1 percent and allowed small moves in value up or down based on a basket of international currencies. From 2005 to 2008, the currency strengthened by 21 percent to 6.83 yuan from 8.28 yuan to the dollar.

But in July 2008, China's central bank began pegging its value back to the dollar.

Why does the U.S. care about China's currency?

China's peg to the U.S. dollar threatened to become the fuse that ignited a trade war between the two economic powerhouses.

Rhetoric was strong between the nations earlier this year, when there were threats the United States could label China a currency manipulator and subject to possible sanctions.

"One, it gives their exports a subsidy ... two, it makes it much more expensive for Americans to sell their goods in China," Patrick Mulloy, a member of the U.S.-China Economic and Security Review Commission, told CNN. "And the third thing, and I think most important, it gives an incentive for foreign companies to move their manufacturing -- and their R&D (research and development) now -- to China."

Tensions were diffused after a visit by U.S. Treasury Secretary Timothy Geithner in April in which he reiterated China's right as a sovereign country to determine the value of its currency, yet maintained that it was in China's interest to let its currency appreciate.

Yet suspicions remain high on Capitol Hill. U.S. Senator Charles Schumer called China's plans "vague" said he would continue ahead with legislation aimed at penalizing China.

Asia markets climb on China currency plans

Why did China re-establish the peg to the U.S. dollar?

In 2008, Chinese exporters were hard hit by the financial crisis as demand from its main customers -- companies and consumers in the United States, Japan and Western Europe -- shrank. Holding the currency firm cushioned the blow for Chinese companies.

China's central bank said in its statement Saturday that "the stability of the RMB exchange rate has played an important role in mitigating the crisis' impact, contributing significantly to Asian and global recovery, and demonstrating China's efforts in promoting global rebalancing."

Why is China doing this now?

In its Saturday announcement, the People's Bank of China, China's central bank, said "the gradual recovery of the global economy and upturn of the Chinese economy has become more solid with enhanced economic stability," so it is now "desirable ... to proceed further with reform of the RMB exchange rate regime and increase the RMB exchange rate flexibility,

The announcement was a canny move by the Chinese government, because the currency issue was sure to be high on the agenda for the U.S. and other countries at the G-20 summit in Toronto this week. There is also speculation that if the euro continues its depreciation, there is a chance that the yuan, too, could see its value decline.

China's currency move: Why now?

Does this mean the yuan will suddenly rise in value?

No. China state bank announced Saturday it would resume a policy of flexibility with the yuan, but hasn't revealed exactly how much.The bank released a statement on Sunday clarifying that there would not be a substantial increase in the yuan.

On Monday, the value of the yuan was allowed to crawl up 0.42 percent -- it's biggest one-day gain since China's move to revalue the currency in 2005.

What we're seeing is a resumption of the policy started in 2005 but stopped two years ago, which allowed slight ups and downs in value on a daily basis. So instead of being moored to the dollar, the yuan will once again be allowed to float slowly away on its own.

What will it mean for Chinese consumers?

The move will help curb inflation and, in theory, allow Chinese consumers to spend more, helping boost domestic consumption if the yuan appreciates. It would also give the government more tools to combat inflation in China.

What will it mean for Western companies in China?

Companies that sell products in China would stand to gain by the increased buying power of Chinese consumers. For companies that harness the Chinese labor force, it would likely add to the cost of doing business in China -- costs that will likely result in increased cost of Chinese products in the U.S. and elsewhere.

The big winner will likely be companies that sell oil, gas, iron ore and other commodities to feed China's ravenous growth rate, which despite still grew by 8.7 percent in 2009 the global recession.

China 'steals U.S. thunder' ahead of G-20

What does this mean for investors?

Some analysts believe it will also strengthen neighboring currencies in Asia, as well as currencies of Canada and Australia -- which have strong mining and oil industries and could most stand to gain with increased Chinese spending power.

Also this could wet short-term investor appetite for taking on riskier investments.

Is there a difference between the 'yuan' and 'renminbi'?

No. Renminbi means "the people's currency" in Chinese. The yuan is the unit of currency. They are used interchangeably.

CNN's John Vause contributed to this report