As 2010 comes to an end we’ve had two themes banging on in the background…

Sovereign Debt and China’s undervalued Yuan.

And as 2011 rolls in it doesn’t look like either problem will be resolved anytime soon.

As central banks continue to lend and governments overspend, you can expect the sovereign debt saga to drag on well past 2011.

And the undervalued Yuan?

China may force its economic might on the world. But you can bet the Christmas Ham that America will continue to push for a Yuan level that suits them rather than the Chinese.

But the U.S. is kidding itself thinking that a higher valued Yuan will solve all of its economic problems.

So why are government officials still calling on China to let the Yuan appreciate 30%, or even 40%?

Chinese officials have let the Yuan gain 2.4% against the U.S. dollar this year. Yet, that’s still not enough for some American politicians.

There aren’t a whole lot of outspoken Chinese officials. But, there is one or two suggesting that a stronger Yuan will benefit the Chinese economy. The CEO of Lenovo – a computer manufacturer – has said a ‘…stronger Yuan will boost the purchasing power of the Chinese.’

And he’s right. But most importantly it’ll benefit the Chinese middle class too. This just happens to be the target demographic for American corporations. Those that want to sell their iPods and other lifestyle gadgets.

Letting the Yuan appreciate in a free market system could assist China to move demand from the manufacturing sector to the service sector. It may even achieve balanced economic growth.

Heck, a higher valued Yuan would mean lower import costs to China. This would help reduce its trade surplus. And it could lead to slower growth and much lower inflation.

If these are just a few of the benefits to the Chinese economy, why are officials refusing America’s request to surrender?

It could just be that China was paying attention all those years ago when Japan signed the Plaza Accord in the 1985.

What’s that?

Back in the mid eighties, America was in the middle of a recession. And there seemed to be no end in sight. You could argue it’s pretty similar to the situation they’re in now. That was when the country had a massive trade deficit with Japan. Sounds familiar doesn’t it?

The United States, requested that the other countries in the ‘G5’ nations – France, Germany, Japan and United Kingdom – sign an agreement that would weaken the U.S. dollar against those currencies.

So, why would the U.S. want to weaken its currency?

Funnily enough, the whole idea of the Plaza Accord was to pull the country out of a recession and reduce the massive trade deficit with Japan, and the other G5 nations.

China must have been paying attention. Because this is the very reason for not weakening the Yuan.

For the other three countries that took part, it worked well. The U.S. was pulled out of the recession and its trade deficit with the remaining G5 members was reduced.

You see, at the time the Plaza Accord was signed, America’s trade deficit with Japan was about USD$43 billion. And you guessed it, not only was the deficit not reduced, but it ballooned out to USD$59 billion by 1993.

But for Japan, the outcome wasn’t what everyone had hoped for. Just after the agreement was signed the Yen began to climb against the U.S. dollar.

One of the biggest problems was that of the trade deficit reduction. And the structural implications around what imports Japan could accept. Let’s just say not a whole lot of American goods met the requirements.

In a frantic attempt to weaken the Yen, the Japanese central bank lowered interest rates to offset the rising currency. Of course, these moves by the central bank weren’t the only cause. But it can be argued that these decisions added to the property bubble and what later became known as Japan’s ‘lost decade’.

There’s a chance China could be using the Plaza Accord and the outcome for Japan as an excuse to not let the Yuan appreciate. Senior economists in China have said that the ‘lost decade’ occurred because of the Bank of Japan’s own bad decisions.

Either way, it doesn’t matter.

China has seen that America will do only what it is in the best interests of America.

The good news for China is that its economy should pass America’s in about 15 years.

China can afford to take its time ensuring its own economy is looked after before any other.

And right now letting the Yuan appreciate beyond the central bank’s control is not in the best interest of Chinese officials.

Shae Smith
Assistant Editor
Money Morning