From Dean Baker (via Todd Tucker):
... the US doesn't have to "pressure" China to boost the yuan. Contrary to what you may have read in the paper, Washington is not helpless in this story.
Just as China can set a value of its currency against the dollar, the US government can set a value of the dollar against the yuan. The Chinese government currently supports an exchange rate at which the dollar can buy 6.8 yuan. This high value of the dollar makes US goods uncompetitive relative to China's. To make US goods more competitive, the US could adopt a policy through which it will sell dollars at a much lower price, say 4.5 yuan.
The difference in exchange rates would provide an enormous incentive for Chinese businesses and individuals to exchange their yuan at the Treasury rate rather than the official Chinese rate. While this may violate Chinese law, the enormous potential profits would make the law difficult to enforce. In a relatively short period of time, the US exchange rate is likely to become the effective market exchange rate.
Is there any precedent for this kind of battle of exchange rate pegs? It sounds like it could be worse than trade litigation. As Baker himself notes "this situation of warring exchange rates would lead to a period of instability and unnecessary hostility between the two countries."
