The Financial Times has a good article on US-China trade relations (find it through Google News if you are not a subscriber). The thrust is this: things are messy. The miniscule movement of the yuan since it was unpegged from the dollar two week ago suggests that the Chinese government took action more to mitigate concerns before the G20 summit than out of a genuine desire to strengthen the currency. At the same time, foreign businesses in China are becoming increasingly disgruntled with heavy-handed Chinese industrial policy. Wages are rising in the Chinese labour market, and with profit margins consequently diminishing for corporations, there is less tolerance for widespread government belligerence and exploitation from Chinese business partners.

The Chinese government also faces internal conflicts. Influential exporters wish to keep the yuan artificially low, and have been supported by the Commerce Ministry in efforts to limit the scope of appreciation. The State Council, however, approved the revaluation perhaps because it is looking past the short term interests of the exporters and towards a necessary restructuring of the Chinese economy. The export industry, though now recovered, was damaged during the recession by a drop in overseas demand. This revealed China’s exposure to what it fears most: dependency on others.
With the Chinese middle class growing and the importance of skilled labour increasing, it only makes sense for China’s economy to transition from being export-based to focusing more on domestic consumption. Were the yuan to float freely, this process would happen naturally as wages would rise and the domestic market would become more lucrative. Beijing is instead trying to keep everyone happy but allowing the yuan to merely inch upward. Hence, the yuan, still undervalued, continues to draw the ire of foreign governments and their beholden interests.

Paul Krugman thinks the US should threaten sanctions, which as I’ve said before is the last thing that will change Beijing’s mind. Even now the government is insisting to domestic audiences that foreign pressure had nothing to do with revaluation. A genuinely market-based yuan would defend Beijing from this criticism by taking the political element entirely out of the equation at the same time that it makes China economically self-dependant. But export interests still have the ear (and indeed the funding) of the government, which paradoxically leaves it more vulnerable to crises in China’s biggest export market, Europe. Continued micromanagement of the vast and increasingly complex Chinese economy will lead to mistakes which will threaten the social stability that Hu Jintao and company hold so dear.