Posted on: Monday, December 24, 2001

U.S. dollar out of favor in China's illegal market

By Paul Wiseman
USA Today

BEIJING — The illegal money changers here have never seen anything like it: China's currency, the yuan, this fall muscled aside the U.S. dollar in illegal trading.

The Sept. 11 terrorist attacks undermined confidence in the United States. And for the first time ever, the yuan's illegal market rate topped the official government rate of 8.28 for each U.S. dollar.

The yuan has faded a bit from earlier this fall. But it is still strong enough to signal that the Chinese government is undervaluing the yuan — a sharp reversal from years past when Beijing had to prop up its currency.

The unprecedented development threatens to delay the Chinese government's plans to ease tight restrictions on currency trading. Beijing's reluctance to let the yuan float more freely is angering Japan, which says a cheap yuan gives Chinese exporters an unfair advantage in world markets.

The yuan's strength on the street reflects more than the dollar's weakness. Foreign investment is pouring into China, and the country is running a big surplus in trade. If the yuan traded in worldwide currency markets, it would almost certainly rise sharply — maybe as much as 50 percent, says Chi Lo, economist with Standard Chartered Bank in Hong Kong.

But Beijing doesn't allow the yuan to trade and instead has effectively tethered it to the U.S. dollar at a fixed rate. The illegal market — and some informal offshore markets that let investors bet on the underlying value of the Chinese currency — offer a reality check on the official rate. Right now the signal they are sending is clear: The yuan should rise.

The new respect accorded to the yuan is a sign of China's perceived economic strength. But Chinese officials aren't gloating. The upward pressure on the currency is causing:

• Friction with Japan. Tokyo, already waging a trade war with Beijing over cheap Chinese imports, is pressuring China to revalue the yuan upward.

• A quandary over controls. Chinese officials want to let the yuan trade more freely and were expected to begin loosening their grip on the currency. Now their push to liberalize has been slowed.

"If they let go of controls, a rising (yuan) would add to the economy's deflationary pressure and hurt exports already suffering from weak global demand," says Standard Chartered's Lo.