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China Cuts Currency Link to U.S. Dollar

After months of lobbying by its trading partners, China on Thursday cut its currency's link to the U.S. dollar and raised its value by about 2 percent in a move that could make Chinese exports more expensive and make foreign assets cheaper for China to buy.

The government's increase of the state-set exchange rate of the yuan could give a respite to foreign companies that are trying to compete with an avalanche of low-cost Chinese goods.

But Chinese companies also could get a break as prices of imported oil and other raw materials fall. And a stronger currency could prompt more takeover bids by China like those launched recently for U.S. oil company Unocal Corp. and appliance maker Maytag Corp.

But by dropping the U.S. dollar link and switching to a more flexible system based on a basket of foreign currencies, the Chinese have opened the door to a further, gradual rise in the yuan's value.

The government announced the change to an exchange rate of 8.11 yuan to the dollar in a surprise announcement on state television's evening news. That raised the value of one yuan by about one-quarter of one U.S. cent to 12.33 cents.

The effect on U.S. financial markets was immediate: The dollar fell against other major currencies and yields on U.S. Treasury securities rose. If that rise in interest rates is sustained, it could make it more expensive for U.S. consumers to finance purchases of new cars, homes and other big-ticket items. A stronger yuan could also encourage domestic spending, making China's economic growth less dependent on exports

China's decision to base the yuan's value on a basket of foreign currencies such as the euro or Japanese yen could see the yuan rise in value as the dollar weakens against those currencies, dragged down by mounting U.S. budget and trade deficits.

Beginning Friday, the yuan will be limited to moving within a 0.3 percent band each day against a collection of as-of-yet unnamed foreign currencies, the government said. But the officially announced price at the end of each day will become the midpoint of trading for the next day, which could let the yuan edge up incrementally.

Malaysia also announced Thursday it was dropping its own policy tying its currency, the ringgit, to the U.S. dollar and would adopt a currency basket arrangement similar to China's.

Hong Kong said it would keep its currency peg to the U.S. dollar, making it the only Asian economy left with such a link.

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