China severs currency's link to the U.S. dollar

updated 3:09 p.m. ET July 21, 2005

BEIJING - China dropped its politically volatile policy of linking its currency to the U.S. dollar but retained controls on its exchange rate, switching the link to a basket of foreign currencies in a move that could push up the price of Chinese exports to the United States and Europe.

China strengthened the state-set exchange rate of the yuan currency to 8.11 to the U.S. dollar from 8.277, where it had been fixed for more than a decade, the government said in a surprise announcement on state television's evening news. That raised the value of one yuan by about one-quarter of one U.S. cent to 12.33 cents.

China had been under pressure for years from its trading partners to let the yuan float or at least to raise its exchange rate. The United States and others said it undervalued the yuan by up to 40 percent, giving Chinese exporters an unfair price advantage.

The change Thursday appeared to be too small to satisfy the United States or other governments, which say inexpensive Chinese imports are threatening thousands of jobs.

"This is the start of a gradual appreciation process," said Frank Gong, managing director of JPMorgan Chase & Co. in Hong Kong. "It will help balance Chinese trade flows. Export volumes will come down. Import volumes will pick up. It will help reduce trade tensions."

Malaysia simultaneously announced it was dropping its own policy tying its currency, the ringgit, to the U.S. dollar and would adopt a similar arrangement.

Some U.S. lawmakers had threatened to impose retaliatory tariffs if China didn't adjust its yuan trading scheme.

The yuan will now be allowed to trade in a tight 0.3 percent band against a basket of foreign currencies, the government said. It didn't say which currencies.

It said the central bank would announce the yuan's closing price each day, and that rate would be the midpoint of the next day's trading band.

Chinese leaders have said for years that they eventually would let the yuan trade freely on world markets. But they said any decision would be based on China's economic needs, not foreign pressure.

Chinese officials said any abrupt change in its currency system would cause turmoil, hurting its fragile banks and financial industries.

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