When asked whether the value of the yuan will appreciate substantially in the near future, the answer should be based on the following two points: First, there should be a distinction between the pressure for appreciation and necessity for appreciation. Potential pressure to revalue the yuan does not mean that there must be a significant increase. Whether the value of the yuan should appreciate depends on the cost or the price. Second, in order to decide if the yuan should appreciate in value, we also need to take into consideration financial elements, China's industrialization process and long-term prosperity, as well as the country's contribution to global economic growth.

Considering its large population, scarcity of resources and low development level, China, especially the vast coastal areas, must develop processing trade based on foreign direct investment. This is the primary choice of the market and enterprises, not the decision of any government agency.

Choosing the processing trade-oriented model at the global level, China is substantially open to the outside world in terms of current dependency on foreign capital and world trade. The country has at least three effects on world economic growth. First, China is playing an increasingly important role in global economic growth. Second, China's contribution to the world's economic growth is becoming increasingly large. Although its national gross domestic product only accounts for 5 percent of the world's total, when taking into account the indirect association effect, China actually contributes about 15-18 percent of the world's economic growth in general. Third, countries throughout the world share the benefits of China's economic growth.

This growth is manifested externally in the following ways: First, cheap exported goods produced by this "world factory" create a large consumer surplus in all countries, particularly in the developed world. Second, China's demand for raw materials and intermediate products during its economic growth boosts the economy of those countries able to produce these imports. Third, a substantial absorption of foreign investment stimulates capital exports of developed countries and regions. High-speed expansion of these capital goods is also accompanied by hefty earnings. Fourth, the wealthy population of China, although small in number, consists of the major consumers of luxury brands produced in developed countries. Their overwhelming demand spurs a growth in the production of these goods. Fifth, China's foreign exchange reserves investment promotes international capital flow, as well as increases the dynamics of the world economy.

Therefore, on the occasion that the Chinese economy is becoming one of the growth engines of the world economy, a significant appreciation of the yuan under external pressure might deal a heavy blow to Chinese economy. If China cannot rapidly upgrade its labor-intensive industrial structure based on contract production, or if enterprises cannot respond by taking rigorous steps toward industrial upgrading, the country is very likely to face a long economic recession. Undoubtedly, China will pay a high price for this, and the world will also have to foot the bill.

The value of the Chinese currency is not the cause of the U.S. trade deficit. Statistics show that about 85 percent of the China-U.S. trade imbalance is generated by foreign-funded enterprises in China. China has tried its best to deal with the issue of the yuan appreciation rate. Prior to the Second Meeting of the China-U.S. Strategic Economic Dialogue, the Chinese side announced to widen the floating band of the yuan against U.S. dollar for daily spot trading on the inter-bank market from 0.3 percent to 0.5 percent as of May 21. Since China scrapped the yuan's peg to the U.S. dollar in July 2005, the yuan has appreciated in value, against the dollar, by more than 8 percent.

For the time being, in addition to speeding up the reform on the exchange rate system, China can also take several other measures to deal with the enormous pressure from mounting foreign exchange reserves and growing expectations on yuan revaluation.

For example, the government should loosen controls on consumption-related conversion of the yuan to local currencies in overseas markets and encourage Chinese enterprises to increase overseas investment, especially acquisitions of listed companies, brand assets and resource-based industries, as well as the introduction of high-caliber technical professionals. Restrictions on Chinese financial enterprises' investment in overseas currency, fund and stock markets should be removed. There is also the need to intensify the imports of foreign advanced technologies and equipment to facilitate the upgrading of China's traditional industries and creating indigenous brands with sharp competitive edge.

Special emphasis should be placed on expanding the free circulation of the yuan in areas of trade. The yuan should aim at a regional anchor currency, a status that will not change the current world currency standard but can help China offset the inflationary pressure from ballooning U.S. dollar reserves through increasing overseas holdings of its currency.