China Deals Fall, China Currency Rises

China Travel Services

NEW YORK - A day after the demise of two deals by Chinese companies to take over American companies, China announced it would allow its currency to appreciate—a move the Bush Administration had hounded China to take.

As anti-China sentiment has ballooned in Congress—with many legislators insisting that in the name of free trade, America's Unocal (nyse: UCL - news - people ) mustn't be sold to the highest bidder, Chinese oil giant China National Offshore Oil Corp. (nyse: CEO - news - people )—China said it would immediately adjust its exchange rate. Appliance maker Haier Group also dropped its bid to buy America's Maytag (nyse: MYG - news - people ).

China's currency has been fixed at 8.28 yuan to the dollar for years. China said that effective immediately, the rate will go up by 2% to 8.11 yuan to the dollar and that China will drop the dollar peg. Instead, China will move to a managed float of the renminbi, pegging the currency's value to a basket of currencies. In an effort to limit the amount of volatility, China will not allow the currency to fluctuate by more than .3%.

"It is basically making a small move," says Andy Xie, managing director of Morgan Stanley (nyse: MWD - news - people ) in Hong Kong. "The market was expecting a lot more."

The United States has been pushing China to allow its currency to appreciate for more than a year, but China's leaders resisted. In part this is because the lower exchange rates make China's goods cheaper abroad and boosts China's exports. Also, this is because Chinese leaders prize economic and political stability and feared a currency change would destabilize China's shaky financial system. Indeed it might.

"This is a highly unstable situation for China," Xie says. "It is a high-wire act."

Hot money has flowed into China, anticipating that China would revalue its currency upward by 10% or more. Economists say the currency is undervalued by at least 30% against the dollar. This, of course, is because the value of the dollar has dropped against major currencies—particularly the euro—in recent years. The dollar-renminbi exchange rate has been unchanged for years.

The currency move is likely an effort to repair fraying U.S.-China relations ahead of President Hu Jintao's planned visit to the United States in September.

China watchers are concerned that many Chinese and Taiwanese companies could watch their razor-thin profits disappear as a result of the revaluation. Large American companies like Wal-Mart (nyse: WMT - news - people ), which import billions of dollars' worth of goods from China, are also unlikely to favor the move, which makes their Chinese purchases more expensive in dollar terms. The revaluation may make Chinese-made goods more expensive for American consumers.