The yuan appreciated 7 percent in 2007 versus an increase of 3.3 percent in 2006. The pace of appreciation has increased in the last few months and there is a growing belief that the yuan will see even greater gains in 2008. Foreign exchange reserves now total $1.46 trillion driven by the trade surplus which increased 52 percent through November.
We may like to believe that Treasury secretary Paulson was a persuasive communicator when he was in China last year, but the truth is probably closer to some simple economics. The Chinese economy is facing strong inflationary pressure. Food prices have increased double digits (18.2% yoy) and the latest numbers for November show an increase of 6.9 percent yoy. One way o reduce the inflationary pressure is to have the currency increase and buy more food imports. The increase will also slow growth for some of their export businesses. The appreciation will also stem some off the pressure for trade restrictions. Chinese manufacturing took a beating in bad PR in 2007.
Some have been arguing that this is a one way bet, but fighting managed floats when a country has great reserves can be dangerous if the government decides to punish speculators.
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