Yuan's peg to the dollar helps the US currency from freefalling and a gradual appreciation could be a long-term option

China still feels the pressure to revaluate the yuan although the United States has postponed the April 15 deadline for the Treasury Department to submit an annual report to the Congress.

Congressmen and women have signed up a letter calling for the department to label China a currency manipulator. Nobel Prize laureate Paul Krugman has written in two of his New York Times columns that the US government must take the case to the World Trade Organization and, if China does not succumb, to wage a trade war with it. Other critics are advocating other countries to join the US in putting the heat on China.

Relax, everyone. The US Treasury will not label China a currency manipulator in its upcoming report. Why? The simplest way for the US Treasury to force China to revaluate its yuan is to sufficiently lower the interests paid on the Treasury bonds or to simply stop selling the bonds to China; the fact that it has yet to do so shows that it doesn't want a revaluation.

Let's see how this works. In order to peg the yuan to the dollar, the Chinese central bank has to buy large amounts of dollar. This, however, will release equally large amounts of yuan in China that will inevitably lead to inflation if left unimpeded by the central bank. In reality, the central bank issues interest-bearing bonds to offset the excessive money supply. Now, if the US Treasury cuts the interest rate of its bonds below the rate paid on the Chinese central bank's offsetting bonds, the Chinese central bank will run a loss and may be forced to stop buying dollars. Once the sale of US Treasury bonds to China is halted, it will serve the same purpose and its effects will be more direct.

In fact, if the US stops selling its treasury bonds, a number of benefits could open up. First, as Krugman claimed, it prevents Chinese savings from depressing demand in the US. Second, it disciplines the US government in putting a clamp on its debt. Third, it does avoid a trade war that Krugman wanted. The inconvenient truth, however, is that the US Treasury needs cheap Chinese savings to finance a number of very urgent projects, such as its new healthcare plan.

It seems that some in the US want to have two good things simultaneously: an appreciation of the yuan and China's continuous supply of cheap money. This sounds like a deal too sweet to ask China to deliver.

But a more serious question is: Will a revaluation help the US economy even if China is willing to do so? Probably not, at least not in terms of moderate appreciation. Between July 2005 and June 2008, the yuan appreciated against the dollar by 21 percent on nominal terms, but China's exports to the US still increased and trade surplus surged from $100 billion in 2005 to $300 billion in 2008. A more drastic appreciation, say 20 percent as some would suggest, will likely have a strong effect, but that will also kill China's economic growth because exports were a strong growth factor between 2001 and 2008.