Is China's Currency Too Cheap?

While every shopper loves a good bargain, cheap imported goods don't always benefit a nation's economy. As the United States' trade deficit with China balloons to record levels, international debate is brewing over the way China values the yuan, its principal unit of currency.

This week, Chinese Vice Premier Wu Yi and other officials have traveled to Washington D.C. to discuss the yuan's valuation. The U.S. will argue that China must allow its currency to appreciate to natural levels, in order to help curtail the inflow of cheap Chinese goods. But China will say that it doesn't want to jeopardize its stable development with moves that might hurt its economy.

China's economy continues the rapid expansion it's shown over the past few years; in 2007, it's expected to grow more than 10%. And while China's growth has been good news for Americans, drawbacks to this story have also arisen in recent debates between U.S. and Chinese policymakers.

Many economists estimate that the yuan is undervalued by as much as 40%. This makes the Chinese-manufactured items at your local Wal-Mart (NYSE: WMT  ) and Target (NYSE: TGT  ) cheaper, giving China an unfair price advantage over domestic producers. Low-priced imports may appeal to you as a consumer, but they're not good for the U.S. economy, and they've allowed the trade gap between China and the U.S. to soar to record levels.

Even after they ended the pegged relationship between the yuan and the U.S. dollar in July 2005, the Chinese have continued to rack up a trade surplus, which now totals $232.5 billion. In order to reduce this trade gap, the yuan -- or renminbi -- must increase in value, according to some experts. However, Chinese leaders claim that letting the yuan rise will cause financial trouble for many of their businesses. On Friday, authorities in Beijing announced additional reforms that might eventually allow the yuan to appreciate, but U.S. policymakers still aren't pleased. They claim that the new measures are a start, but that the yuan needs to eventually begin trading freely on the international markets.

This week's strategic talks could have a big impact on the United States' future trade relations with China, which has become a major player in globalization. While it's imperative that the U.S. and China remain friendly trading partners, the Chinese may need to make some concessions about their currency's valuation. During the talks that began yesterday and continue today, U.S. Secretary of the Treasury Henry Paulson and Vice Premier Wu will examine both the opportunities and challenges they face as major trading partners. Hopefully, they'll be able to settle the growing economic friction between their two countries.

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Kristin Graham does not own shares in any of the companies mentioned in this article. Wal-Mart is a Motley Fool Inside Value pick. The Fool's disclosure policy loves John Woo films.

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