Currency Count in China

This column was originally published on RealMoney on Oct. 2 at 1:02 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

The Chinese yuan has appreciated on a slow but steady trajectory since July 2005. That was when authorities first decided -- at the importuning of U.S. Treasury officials and under pressure from market forces -- to relax the iron grip that had maintained an exchange rate of 8.28 per U.S. dollar for 10 years.

That rate of appreciation has accelerated in the wake of Treasury Secretary Henry Paulson's recent visit to China. This may be nothing more than a face-saving gesture on the part of China's leadership to a favored colleague of long tenure. (Paulson earned respect in China during his days as head of Goldman Sachs; he is still the new guy at the Treasury.)

However, it also may be more meaningful than that. As the yuan's dollar value closes in on that of the Hong Kong dollar, several issues arise.

Since 1983, the Hong Kong dollar has been officially pegged at 7.8 per U.S. dollar. Last year, the peg was widened to encompass a range -- from 7.75 to 7.85 -- which may have been done for the convenience of the Hong Kong Monetary Authority for all the economic significance of such a narrow trading band.

Also last year, the People's Bank of China officially declared that the value of the yuan would be set not in U.S. dollar terms, but in terms of a basket of internationally traded currencies. This facilitated China's decision to allow a modest appreciation in its currency, while blunting the appearance of giving in to U.S. pressure.

Two Systems, One Currency?

What happens next with China's two monies? One is pegged, the other officially floating (although so tightly managed as to be indistinguishable from an adjustable peg); one managed officially by the Hong Kong Monetary Authority , the other supervised by the People's Bank of China. One is something of a sideshow, while the other is a global main event.

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Jim Griffin is economic consultant and portfolio adviser to ING Investment Management and its Hartford-based unit, ING Aeltus, which manages institutional investment accounts and acts as adviser to the ING Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.