Recently the yuan has picked up its pace of appreciation against the U.S. dollar. Over the past week, the yuan has appreciated by 0.5% against the dollar and its current rate of 7.90 is the highest since its revaluation in July of last year. I believe this is setting up the stage for another revaluation before the end of the year.

Senators Charles Schumer and Lindsey Graham had planned to introduce legislation that would impose a 27.5% tariff on Chinese exports to the U.S. After meeting Treasury Secretary Henry Paulson they said they may delay pushing a vote for the time being. What could Mr. Paulson have said to them to have caused their shift in position? I believe the Treasury Secretary has received assurances from Chinese officials that they will soon revalue the yuan again.

China no doubt, understands the consequences of the proposed tariff. If it keeps the exchange rate fixed they would have to pay 27.5% of the value of its exports to the U.S. government. On the other hand, if China was to revalue its currency by 27.5% it would not have to pay tariffs to the government and the costs of its imports would decline by 21.4%. The impact on demand for Chinese goods under both situations would be equivalent. Obviously, China is better off revaluing.

China realizes that if they do not cooperate with the U.S. the legislation will eventually get passed and, therefore revaluing the currency very soon is their best option. I don’t expect the yuan to be revalued by 27.5%, but it will be more significant than the last revaluation.