ECB's Trichet fails to convince China to let the yuan float

Foreign manufacturers, including many from the European Union and the United States, argue that China's fixed-yuan policy gives China's manufacturers an unnatural, unfair competitive advantage, as the currency peg keeps China's exports cheaper than what they would be under a market-based currency system.

Wen disagreed. "Some countries are now calling for yuan appreciation while imposing trade protectionism on China, which is unfair and actually limits China's development," Wen said at a briefing in the city of Nanjing, Bloomberg News reported Monday. He added, in the financial crisis, "a stable yuan is helpful to the development of the Chinese economy and the world's economic recovery."

Europe, particularly the euro-zone, will face even more of a price disadvantage than the U.S versus China, due to the euro's appreciation versus the dollar. As the euro strengthens versus the dollar, China's goods become even cheaper in the euro-zone; since January, the euro has strengthened about 8% versus the euro.

Economic Analysis: Right now, China's sees few positive developments from letting the yuan appreciate, and since the U.S. and E.U. have little leverage against the Asian economic giant, don't expect a policy change. The main drawback for China from its fixed-rate system? An increase in inflation, assuming a continued dollar slide, which would push up commodity prices. But right now China is not that concerned about inflation – it will tolerate 4-5% inflation if it can return to 10% GDP growth, hence the downsides are few.

However, had the U.S. kept its federal budget balanced during the past decade, Congress would be in a position to pressure China with a retaliatory tariff: however, due to the U.S. budget deficit and the enormous amount of U.S. public debt China holds, no Congressional action is likely. The above underscores the strategic disadvantage the U.S. placed itself in, as a result of a 2001 federal income tax cut that instantaneously turned a budget surplus into a budget deficit. In a nutshell, it was one of the worst U.S. public policy changes in decades.