Observers assume the Chinese will move to allow the yuan to float, but they'll do it in their own time, writes Jasper Becker, in Beijing

As China strongly resists pressure from the US to allow its currency to float, the similarities with Japan in the 1980s are being made.

Sooner or later, China will give in, as Japan did with the Plaza Accord, and allow its currency to revalue against the dollar.

China has been loudly denying this since US Treasury Secretary Mr John Snow paid a visit to Beijing earlier this month. It claims the US pressure is just to do with President George W. Bush's election campaign.

"Making China the scapegoat can perhaps help some US politicians score cheap political points, \ it has nothing to do with the solution of their real problems," China Daily said.

"The high-pitched but groundless US objections against China's trade policies do not bear scrutiny," argues the People's Daily.

"China's soaring exports were largely fuelled by drastic trade reforms, dynamic private and foreign-funded enterprises, and an abundance of cheap and skilled labour instead of an undervalued currency."

In the US, some analysts claim the yuan, also known as the renminbi, is undervalued by as much as 40 per cent, helping Chinese manufacturers destroy jobs by flooding the United States with low-cost products.

The Bush administration, which has seen 2.7 million jobs disappear, is trying to step up the pressure on China to speed up access to goods and services, spelt out in the deal which allowed China to finally join the World Trade Organisation 18 months ago.

US lawmakers from industrial states are even pushing for legislation that would threaten China with higher tariffs if it refuses to let its currency float at market rates.

Behind bluster from both sides and the trans-Pacific tensions over jobs and market access, the two countries are not as far apart as it might seem.

It is clear something has to give. China is running a $100 billion (€87 billion) a year surplus with the US, which is as big as Japan's.

In June, China had foreign currency reserves of $365 billion and, in order to keep the yuan stable at around 8.28 to the dollar, China's central bank has to keep buying surplus dollars and reinvesting them abroad.

In practice, this means buying US Treasury bonds. China's holdings of US Treasury bonds rose to a record $122.5 billion last month, far more than any other country apart from Japan. Together, Japan and China hold 41.9 per cent of the $1.3472 trillion debt the US government owes the world.

This is unsustainable in the long run and it also means the Chinese government has to keep printing hundreds of billions of yuan. As Chinese banks keep lending like crazy, this is helping to keep the economy growing at more than 8 per cent year.

The central bank tries to control the potential inflationary effects of this helter-skelter expansion of the money supply by borrowing back much of the extra yuan but it is not an easy trick to pull off.

In the mid-1990s, when Beijing printed too much money, it led to a destabilising bout of runaway inflation.

This time, China is trying to avoid this by effectively exporting deflation to the rest of the world. This is helping to keep inflation under control, encouraging record low interest rates in the US and Britain.

This also explains why the rest of Asia grew by a meagre 3 per cent in the first half of 2003 but China recorded 9.9 per cent real gross domestic product (GDP) growth in the first quarter. It probably would have fared better in the second quarter had SARS not stalled the economic engine.

Even so, domestic demand is increasing at an annualised rate of 14 per cent and imports are up by 50 per cent as China sucks in ever-growing quantities of oil, minerals, timber and other raw materials.

Domestic car sales have tripled and a construction boom is under way.

The amount of residential floor space under construction has grown by a third in the past 12 months. China is already the world's biggest steel maker and capacity will probably grow by 40 per cent in the next two years.

Many people believe a crash is only round the corner.

Overall, China is running only a small trade surplus. Many of its imports are parts that it assembles from Taiwan, Japan or other countries to make goods whose final destination is the US.

Changing the value of the yuan to make Chinese labour more expensive is unlikely to protect jobs in the US, although it might make a difference to some manufacturers, such as textile factories, trying to hang on in Taiwan or South Korea.

"Since the eruption of the 1997 Asian financial crisis, the stability of the exchange rate has not only enhanced China's economic and financial stability but also contributed to the financial and economic stability in the Asian region and the world," China's Minister for Finance Mr Jin Renqing claimed last weekend.

Behind the soothing talk of financial stability, Chinese officials also face the political imperative of creating new jobs at home. Tens of millions of jobs have been lost in the reform of China's bloated state sector during the past decade, leaving some 30 million unemployed in China's cities. In addition, there are up to 200 million underemployed in the countryside.

Just to keep standing still, China needs to create 15 million new jobs a year.

"The market-based, single, managed floating exchange regime as adopted by China complies with China's fundamentals," Mr Jin also maintained.

China's fundamentals include a staggering burden of bad loans and uncovered pension and social welfare liabilities which, at more than $500 billion, rival Japan's better-known debt burden.

It will take many years for China's four main state banks to shuffle off the crisis of non-performing loans. Many say Beijing has yet to begin in earnest. This means that China can only move slowly to lift the curbs on capital flows or risk seeing Chinese savers quickly pulling their money out of the shaky domestic banking system.

"There is no strong reason to have any kind of sudden changes," Mr Zhou Xiaochuan insisted in Hong Kong last week although he added that "We're always going forward, making new changes."

Most observers assume China will move to allow the yuan to float, but slowly, and it will take small steps to allow Chinese to use their foreign currency savings and take money out of the country.

This month, for example, China allowed individual tourists to apply for visas to Hong Kong and allowed each to take out 20,000 yuan (€2,100) instead of 8,000 yuan.

UBS forecaster Mr Jonathan Anderson thinks that, at best, China will widen the yuan dollar band by one to three percentage points in the immediate future as a result of US pressure.

Full convertibility of the yuan remains the official goal of the Chinese government but the timing remains hard to predict. Some believe China will reach full convertibility by the time it hosts the Beijing Olympics in 2008.