China's growth should push up the value of the yuan over time, most economists say, but the pace of its journey will in the end be decided by the back-and-forth of politicians.
Beijing officials may be more inclined in the next few months to listen to Washington lawmakers' complaints that their currency policies are hurting manufacturers and jobs in other countries. Chinese President Hu Jintao will be in the global spotlight with this month's summit of the Group of 20 major economies in Seoul and a state visit to the U.S. planned for January. Diplomats say China wants to make sure those events go smoothly, without turning into shouting matches over China's exchange rate—concerns that would argue for continued appreciation of the currency, which has gained 2% against the dollar since September.
Yet there are signs that some officials within the Chinese government think that the yuan has already risen enough. Commerce Ministry spokesman Yao Jian said recently that Chinese exporters would face "pressure" if the yuan gains by more than 3% against the dollar this year. The Commerce Ministry and local governments from coastal regions, where much export-oriented manufacturing is centered, usually argue for exporters' interests in internal policy debates, analysts say.
Officials in the U.S. and other countries trying to influence China's currency policies are paying increasing attention to the internal Chinese debate among different interest groups. Strict exchange-rate and capital controls give government officials final say over the price of the yuan—and it's difficult for outsiders to tell how those decisions are made in China's closed political system.
"You can't tell from the outside, but all the time, just like in the United States, they're having huge debate about what policy course to take," U.S. Treasury Secretary Timothy Geithner said last month. "What we want to do is to maximize the incentives they have to let that process [currency appreciation] go as far as it needs to go."
In the first half of October, the yuan rose against the dollar at an annualized rate of more than 12%–the fastest since its spurt in the first half of 2008. It then gave up some of those gains in the rest of the month, in what observers called another sign of the central bank's desire to show markets that the currency can move down as well as up. What course the yuan takes in coming weeks will determine whether it makes the "significant" gains the Obama administration has said it wants to see.
Yet China's leaders have made clear that the fortunes of exporters–which employ millions of migrant workers–are very much on their mind. "Don't pressure China on appreciation of the Chinese yuan," Premier Wen Jiabao told European businesspeople in a speech last month. "Should the yuan appreciate by 20% to 40%, as demanded by some people, a large number of Chinese export enterprises will go bankrupt."
While the export sector is a powerful interest group influencing China's currency policy, it is not monolithic. Half of China's exports are simply the result of the processing and assembly of imported components, meaning that many exporters are also big importers. A rise in the exchange rate can lower their costs just as much as it pushes up the price of their product, meaning the net effect of a stronger exchange rate on such firms is often small. Their main interest is in avoiding volatility—so they don't lose money if, for instance, the yuan rate moves against them after they buy parts but before they are paid for the final product.
Firms that import from abroad to serve the domestic market also make up a big swathe of Chinese industry, and their interest in the exchange rate is the direct opposite of exporters'. China's steel industry, the world's largest, is a huge importer of iron ore from Australia and Brazil, and would see such purchases become cheaper with a stronger currency.
The existence of such "swing votes" helps explain how Chinese policy makers secured agreement for the recent rise in the currency despite continued opposition from exporters, said David Steinberg, a fellow at the Browne Center for International Politics at the University of Pennsylvania, who has researched lobbying on China's exchange rate. But key to such a bargain are other supportive policies to keep China's overall economy humming, so manufacturers' business isn't hurt too badly.
"If the domestic economy were to slow down, I think exporters would become highly concerned with the exchange rate and start lobbying for stopping the appreciation again," Mr. Steinberg said.
How the Chinese leadership would respond to such lobbying depends not just on their views on the economy, but also on the shifting currents of opinion on policy priorities. Ultimately, the argument over exchange-rate policy is less about lobbies and more of "a straightforward technocratic battle," said Edward Steinfeld, a political scientist at the Massachusetts Institute of Technology.
Currency policy is one of several issues where there's a divide between advocates of liberalization and those who prefer continued government control, he said. The People's Bank of China, the central bank, is generally seen as favoring market mechanisms, while the economic planners at the National Development and Reform Commission are thought to be more cautious.
It's in the context of the long-running struggle between these different schools of thought that pressure from abroad usually plays a role, analysts say. Advocates of currency appreciation have been able to argue that moving on the exchange rate will boost China's global image and help avert an even more damaging trade conflict. It's notable that China's June announcement of a more flexible exchange-rate regime came ahead of a G-20 meeting, as did the recent pick-up in the yuan's gains.
The current rethinking of policy priorities as China drafts its next five-year plan and prepares for a change in the top leadership could also influence the currency debate. If officials are serious about their expressed goal of reducing China's reliance on exports and making the economy more driven by domestic demand, it's possible there could be more consistent support for a stronger exchange rate in the future.