Over the weekend, China announced a change in monetary policy, from maintaining a fixed exchange rate to the dollar at 6.82 yuan to a policy that allows the yuan to appreciate against the dollar. Estimates of appreciation in 2010 range between 3-5% and more in subsequent years.
As the yuan strengthens against the dollar, Chinese purchasing power of dollar-denominated goods will rise, improving the competitiveness of U.S. goods and services in China. It is hoped that this will preserve and increase jobs in the U.S.
A stronger yuan raises the prices of Chinese imports into the U.S., which should reduce demand. More exports to and fewer imports from China, if this scenario materializes, will reduce the large trade imbalance in China’s favor.
Yuan appreciation also helps Obama in the short run. Each stronger Chinese yuan can buy more dollars, thus facilitating China’s purchases of U.S. treasuries. In so doing, China can help finance Obama’s budget deficits and hold down U.S. interest rates.
Over the long run, the story could have a less happy ending. During the past decade, homeowners were helped by low interest rates but were foreclosed when rates rose. As China accumulates more U.S. debt, the day will come when its large holdings will give it substantial influence over U.S. domestic and foreign policy with the threat of national foreclosure. Fortunately for Obama, his one or two terms as president will be over and his successor(s) will have his problem on their hands.