Chinese Yuan / US Dollar / Gold Review: Forex US Dollar rates continue weaker vs. Yuan

The US dollar was lower against other major currencies early in Asian trading hours Monday as the sell-off that began Friday continued.

This week, currency markets are likely to watch for further trouble in the US housing market and for US corporate earnings reports that might show a more widespread slowdown in the US economy.

At 9.50 am here (2350 GMT Sunday), the dollar was at 121.33 yen, down from 121.59 yen in late trading in New York Friday. The euro was at 1.3839 dollars, up from 1.3833 in New York.

The US dollar was sold heavily Friday on continuing concern about the sub-prime mortgage market in the US, which pushed the US 10-year bond yield down to 4.95 percent.

This lifted the euro to a new record high of 1.3843 dollars, sterling to a new 26-year high of 2.0587 dollars and the Australian dollar to a new 18-year high of 0.8834 dollar.

St Louis Federal Reserve president William Poole commented Friday that the fall in the value of the US dollar would increase inflationary pressure, but that it was not a decisive influence. Poole also said that losses in the non-prime mortgage market were large enough to affect home building and consumer spending.

The Chinese central bank's decision Friday to increase its lending rate by 27 basis points to 6.84 percent and its deposit rate by 27 basis points to 3.33 percent is seen as having little effect on currency markets. The increase is meant to counter inflation, which was running at an annual rate of 4.4 percent in June.

The Chinese central bank also cut the rate of withholding tax on interest from deposits to 5 percent from 20 percent in order to increase returns from bank deposits and take the steam out of the Chinese stock markets.

In a move that could trim the trade gap with the United States, China revalued its currency higher against the dollar Thursday and said it would no longer have the yuan tied to a fixed rate against the U.S. currency.

The move, while small at this point, could be the first step to reduce competition for some U.S. companies from lower-priced Chinese imports.

A stronger yuan could also increase the sales U.S. exporters get from business with the world's largest country, one of the fastest growing consumer markets. U.S. exporters could keep their prices the same in U.S. dollars, thus lowering the price in yuan and spurring increased sales. Or they could keep prices in yuan level, and bring in a greater amount of dollars.

Reuters reported that U.S. Treasury Secretary John Snow praised the move in a meeting with reporters Thursday morning. Both the administration and members of Congress have been calling on China to end its fixed dollar-yuan peg. There is legislation before Congress that threatens trade sanctions on China if the yuan did not start trading freely in currency markets.

"This is a good first step, albeit a baby step," said .S. Sen. Charles Schumer, D-N.Y., one of the authors of the legislation, at the start of a hearing of the Senate Banking Committee. "It is smaller than we had hoped, but to paraphrase the Chinese philosophers, a trip of a thousand miles can well begin with the first baby step. If there are not larger steps in the future, we will not have accomplished very much. But after years of inaction, this step is welcome."

Federal Reserve Chairman Alan Greenspan, who was giving his semi-annual testimony to the banking committee, said he basically agreed with Schumer.

"It's the type of step you would want to take when you've had a decade-long fixed structure," said Greenspan. "I think they've been cautious and admirably so."

On the downside for American citizens, it could lead to increased prices for Chinese-made goods such as apparel and electronics. But economists doubt that with a change in valuation as small as Thursday's move that prices will increase.

"The change is pretty slight but very significant because of the fact that they did allow it to revalue. Now speculation is that this will pave the way for further valuations down the road," said Ezechiel Copic, currency analyst for MG Financial Group.

The fixed rate between the yuan and the dollar has been blamed for the soaring trade gap between China and the United States, as it kept Chinese-made goods cheap here.

The trade gap between the United States and China was $72.5 billion the first five months of this year, by far the largest gap of with any trading partner. It was more than the U.S. gap with Japan and OPEC combined during the same period.

Jay Bryson, global economist for Wachovia Securities, said that there is still more unknown than known about the way the new valuation system will work. He doesn't expect it to cause an immediate impact on the economics of that trade, but he said it opens the door to further strengthening of the yuan.

"Will the yuan be 30 percent stronger vs. the dollar a year from now? I doubt that. Could it be 10 percent stronger? Yeah, that's reasonable," he said. "It will help somewhat people who compete against Chinese exporters. It doesn't mean textile jobs will come back to North Carolina, those jobs are gone. But it might help a manufacturer who is still here."

U.S. stock futures soared immediately after the statement from People's Bank of China just after 7 a.m. ET Thursday. But an hour later much of those gains had evaporated after traders had a chance to examine and weigh the statement.

The statement said China will immediately value the currency at 8.11 yuan, down 2 percent from the 8.28 rate previously. It also said it will now peg the yuan against a "market basket" of numerous currencies, although it will keep the yuan in a tight band rather than letting it trade freely. But the central bank did promise that the exchange rate band would be adjusted when necessary according to market developments as well as economic and financial situations.

Reuters quoted another statement from the bank as saying any sharp swing in the yuan's exchange rate would hit China's financial system, and therefore would not be in Beijing's interest.

The U.S. Congress had been threatening to impose stiff trade sanctions on Chinese imports if it did not allow more market-based valuation of the yuan. The move by the Chinese reduces the threat of that kind of trade war, which is one of the factors that likely lifted futures early, said Bryson.

"Obviously they're getting a lot of flak from Congress and the Europeans as well. It was going to happen at some point anyway. It probably happened sooner than it would have if Congress and the administration hadn't said anything," said Bryson.

But University of Maryland Professor Peter Morici, a vocal critic of the Chinese government's policy on currency, said this move doesn't suggest any significant change in the economics of trade is on the horizon.

"This is a fig leaf. It's an attempt by the Chinese to do the least amount possible," said Morici, who estimated that the yuan is about 40 percent undervalued because of the trading restrictions.

"Even a pace of 10 percent change a year will get us there too slowly," he said. "(With this change) China will continue to have very large trade surpluses and cause damage to industries that compete with Chinese companies."

A survey conducted in June by Baruch College's Zicklin School of Business of nearly 200 chief financial officers who belong to Financial Executives International found only a fraction thought a yuan revaluation would have a large impact on their business, and of those who saw a change, they were equally split whether it would represent good or bad news.

The survey found 5 percent who expected a significantly positive impact and 6 percent said the impact would be significantly negative, while 39 percent saw no impact on their companies. Those surveyed include executives at both large and small and both public and privately held companies.

Sydney 9.50 am (2350 GMT Sunday)

US dollar

121.33 yen

1.2007 sfr

Euro

1.3839 usd

167.89 yen

1.6611 sfr

0.6733 stg

Sterling

2.0559 usd

249.37 yen