After pegging its currency to the US dollar (a policy not without some irony) for almost exactly 10 years, the People's Bank of China announced this morning that it would allow the yuan to float against "a basket of currencies". It immediately reduced the exchange rate with the dollar from 8.28 to 8.11; inverted, this means a single yuan, formerly worth 12.1¢, is now worth 12.3¢, an increase of 2.1%. The float will be "managed", so presumably abrupt, large increases will be discouraged through intervention. This change took effect at 7:00PM in Beijing, after the close of Chinese markets. Importantly, the yuan is traded only in China, during China's trading hours. It does not trade in Western markets. So the "official" rate governing transactions in goods and services that take place in Western markets which are priced for value July 21 remains 8.2765. This is the rate that appears, for example, on the New York Fed's schedule of "Noon Buying Rates" that is dated today, July 21. The new rate will appear on quote sheets for tomorrow, July 22. Each day, the People's Bank of China will announce a rate at the close of Chinese trading which will apply for the following Chinese business day, a practice similar to the form of this announcement.

News stories cited pressure from governments in some major regions of the world as a reason the Chinese chose to act. The share of Chinese goods in world markets is growing rapidly, and there have already been efforts toward protectionism. The US, for one, continues to struggle to form a policy over Chinese textiles. The rapid inroads being made by Chinese goods are readily apparent in the table below.

It is perhaps no coincidence that the Chinese action was taken on the same day as the release of June trade data by Japan. Japan's trade surplus shrank to ¥873 million from ¥1.141 billion in June 2004. Some 45% of the deterioration involved trade with China. Chinese imports are now 21.0% of total Japanese imports, up a percentage point in market share over the past year and up 2.7 percentage points from the average for 2002.

Other markets feel the same kind of penetration: in the US, imports from China were 14.1% of the total in May, up 1.4 percentage points from a year ago. In the Euro-Zone, the gain in share was 1.2 percentage points. Both of these regions are seeing a steep uptrend in the inflow of Chinese goods.

This has not been all bad. As we've noted here earlier this week, one of the offsets to rising energy costs has been falling textile and clothing prices. Clothing has been ever more cheaper in many parts of the world, a boon to lower-income nations as well as those that are better off. Hopefully, this will not all disappear with this action, but the policy change should help rebalance global trade. Further, perhaps the Chinese believe that this will help them with the politics that are involved in their recently proposed direct investment transactions in the US and elsewhere.