Yesterday, the Chinese government announced it was ready to revalue the yuan vis-à-vis the US dollar and other currencies after an 18-month hiatus, this according to the People’s Bank of China’s third quarterly report. The exchange rate will be guided in a “proactive, controlled and gradual manner and based on international capital flows and movements in major currencies,” the report said.

Paper money (which is no longer backed by precious metals) is a stable domestic means of exchange that has legal tender. Its stability is regulated by monetary supply established by central banks, which usually try to maintain a growth rate that reflects that of the economy to avoid inflationary pressures. The same is not necessarily true for foreign currency exchanges, which are theoretically governed by international monetary rules.

When the new US administration took office in January 2009, it tried to get China to change its foreign exchange policy. Soon enough, US Treasury secretary Timothy Geithner accused China of manipulating its currency’s rate, provoking People’s Bank of China Chairman Zhongnanhai to respond with vehement denials. This in turn prompted US President Obama to repudiate what his treasury secretary had said. Still, Geithner’s remarks about the yuan being undervalued did stir an economic and political hornet’ nest.

Pressures from the US government to have the yuan re-valued would have further weakened the US dollar, and badly affected the world economy.

This is of special concern to China because of its huge foreign currency reserves in US securities and treasury bills: an estimated US$ 1.2 trillion out of  US$ 2 trillion.

Beijing is already paying a hefty price for this because of US dollar devaluation against other currencies but especially the yuan.

Any sudden jump in the yuan could have unbearable consequences for the mainland, and force Beijing to sell off US securities to resist renewed US pressure for revaluation, with unimaginable consequences for the world economy.