China let the yuan rise to a record level versus the dollar Friday, Bloomberg News reported, in a sign Beijing may be modifying its currency stance in order to regain control of inflation.

The yuan strengthened to 6.9907 yuan versus the dollar Friday, its strongest level since the Chinese Government moved from a fixed or "dollar pegged" currency rate to a system that limits the yuan's currency appreciation to about 5% per year.

China has kept the yuan artificially low -- or not set by free-market, foreign exchange forces -- in order to stimulate economic growth and protect its young economy. The low yuan keeps the cost of Chinese exports low -- a major factor in both China's record trade surplus with the United States and its surging manufacturing export revenue. Critics charge that the low yuan gives China an unfair advantage versus foreign manufacturers: many of these producers, among others, argue that the yuan would appreciate to 5 or even 4.5 yuan to the dollar if allowed to float freely.

Inflation pressures

Up until now, China has been able to turn aside foreign pressure to let its currency appreciate faster by arguing that foreign nations should seek local solutions to their trade problems, and not interfere with a domestic Chinese economic matter. In response to U.S. criticism in particular, China has said the way for the United States to reduce its trade deficit is for U.S. consumers to save more and consume less.

However, the global growth and commodity price boom that China's surging economy and cheap-yuan-based exports have helped create may have finally come home to roost for the world's third largest economy, according to economist David H. Wang. Inflation in China is running at an 8.7% year-over-year rate through February 2008, Wang said, a rate not conducive to sustainable, sound economic growth.

Moreover, a considerable portion of that inflation is caused by the low value of the yuan itself, Wang said. That's because as the dollar falls, the cost of goods imported into China -- including commodities -- rises, as well, increasing China's inflation.

A 'commodities shock'

Economist Glen Langan said the yuan-dollar/inflation nexus was not much of a concern for China earlier this decade, when the price of oil was increasing at the 'now modest rate' of 10-15% per year. However, with the tripling of the UBS Bloomberg Constant Maturity Commodity Index of 26 commodities in the last six years -- China's present currency policy means "it's getting inflation pressure on almost all fronts," Langan said.

Further, Langan said China's decision to let the yuan appreciate faster is further evidence for him that the world's economic powers are "starting to recognize that global commodity demand could outstrip supply," leading to unheard-of price increases in grain commodities, minerals, and of course, in crude oil. Langan calls that worst case scenario a "commodities shock." China's faster currency appreciation would be a good, first step to avert that commodities shock, he said, a policy that would also lower China's inflation.