After several years of resisting outside demands to allow the yuan renminbi to appreciate in value against other currencies (especially the U.S. dollar), it looks as if China has decided to allow just that - for its own internal reasons instead of external pressure.

Inflation in China seems to be the driving force behind the rising yuan at the moment.

Let me see if I can explain how this works for those of us that are economists...

China has a growing export economy. What that means is that many workers get paid for making things that never hit the store selves in China. Their local economy gets pumped up with more and more money, but there's not that much more to buy, since they put what they made on a boat and sent it to London or New York. The result is that prices go up for them, locally. If the yuan gets stronger against currencies like the dollar, exports become more expensive in those overseas countries that are buying them. So the rate of exports slow down. Businesses that were making goods for export start making stuff for local consumption instead (or simply lay some of their people off), and inflation goes down. That's the theory.

Channel News Asia recently reported that four out of five Chinese wanted reduced inflation in 2008. Inflation, according to that story, is at 6.9%. But other sources put inflation into the double digits. And China's inflation rate has hit grocery items the hardest.

On Thursday, January 3rd, the yuan jumped dramatically. Fellow blogger Louis Navellier had this to say about the yuan:

On Thursday, the Chinese government backed up its recent words with actions when it allowed the yuan to appreciate against the U.S. dollar at the fastest pace since China ended its peg to the U.S. dollar in mid-2005. Specifically, the Chinese yuan rose 0.37% to a new high of 7.3175 to the dollar ($0.1367), up 13% from a pegged rate of 8.28 ($0.1208) in 2005. Win Thin, the senior currency strategist at Brown Brothers Harriman, called this "a huge move," adding that it was not a "response to outside pressure, but rather to help China's domestic situation and fight inflation."

The yuan has gained strength in each of the last four quarters. It gained 1.1% in the first quarter of 2007, 1.5% in the second quarter, and 1.4% in the third. But in the fourth quarter of 2007 the yuan jumped substantially more - 2.6%

Belinda Cao, writing for Bloomberg, says that she expects the yuan to continue to increase in value. According to Cao, "The median estimate of 28 analysts surveyed by Bloomberg News is for a yuan rate of 6.89 per dollar by the end of 2008. Forward contracts show traders are betting on a 9 percent advance in the yuan to 6.6720 in the next 12 months." That lines up with a recent article by Caijing.

At the moment the yuan is trading at 7.27CNY to one US dollar.

Not everyone agrees with the 28 Bloomberg analysts. A story in Sunday's NY Times quoted Ed Yardeni, president of Yardeni Research in Great Neck, N.Y. "Those people who are waiting for the dollar to crash should wake up and smell the coffee, because it has already happened," he said. He predicted that the U.S. dollar would strengthen in 2008.