US-China trade war over yuan edges closer

China bluntly rejects US calls to revalue currency

The Chinese President has snubbed pleas from President Barack Obama for Beijing to revalue the Chinese yuan. It leaves relations between the so-called G2 at a fresh low, and raises fears of a trade war. Calls from the US Congress to formally label China a currency manipulator will intensify in the wake of the current failed round of talks.

Speaking on the fringes of the international nuclear summit in Washington, at which the two men met, President Hu Jintao reportedly told the American leader that an appreciation of the yuan would "neither balance Sino-US trade nor solve the [US] unemployment problem", and that the value of the yuan would be set primarily to suit domestic Chinese considerations.

China News Service reported that Mr Hu said China "is firmly committed to the direction of reforming the... exchange rate regime. This is based on the needs of China's own economic development." However, he added that "outside pressures will not advance reform". Mr Obama had urged the Chinese to put the yuan on a more "market oriented" footing.

Many in Washington accuse the Chinese of manipulating their currency to gain an unfair advantage in trade. America's trade deficit with China – $229bn (£149bn) – is the largest bilateral deficit in world history and the main "global imbalance" to destabilise the world economy going into the recession. Trade sanctions on China have been advocated by many members of Congress as well as leading economists such as Paul Krugman.

The US Treasury Secretary, Timothy Geithner, visited China for talks last week and seemed to receive some encouragement from his meeting with the Chinese Vice-Premier, Wang Qishan. Mr Geithner has delayed an official Treasury report labelling China a currency manipulator, though the latest war of words may make such a condemnation inevitable. The diplomatic mood music has turned less harmonious in Washington.

Intermittent skirmishes have been damaging US-Chinese economic relations since the recession pushed unemployment in the US higher. The Chinese commerce ministry has introduced a duty of up to 64.8 per cent on imports of US steel, in retaliation for a US move to impose an import tax on Chinese pipes.

Despite the uncharacteristically blunt language from the Chinese, many observers believe that China will eventually agree to allow the yuan to drift higher. Options include a one-off revaluation, possibly followed by a looser peg with the dollar, a strategy followed during 2005 to 2008. However the world trade recession – more severe even than the reduction in domestic national GDPs – forced the Chinese to devalue their currency again, the source of much of the current friction.

During the boom, Western consumers became dependent on a flow of cheap Chinese capital generated by China's trade surpluses with the advanced economies, to fuel their consumption boom and property bubbles, until the whole system became so unstable it collapsed.

Fixing the global imbalances is routinely identified in G20 communiqués and other high-level diplomacy as essential to rebalancing the world economy, and many believe the value of the yuan is the biggest obstacle to such a fundamental adjustment.