In the WSJ, Daniel Rosen writes:

U.S. and Chinese officials are preparing to gather next week for the latest round of their Strategic Economic Dialogue, and as in the past yuan appreciation will be a critical agenda item. In one of those accidents of history, Treasury Secretary Hank Paulson may make progress on this issue thanks to an entirely unintended helping hand: the mounting dollar cost of raw materials critical to China's growth.

This may seem counterintuitive when China's exporters are already hurting from the yuan's recent appreciation. In real, trade-weighted terms the yuan has moved less than 10% since July 2005, while nominally rising 19% against the dollar over the period. Low-end manufacturers confronted with yuan appreciation -- along with higher wages, environmental compliance costs and greater quality supervision -- are setting sail for cheaper labor in Vietnam, Cambodia and elsewhere. Forecasting China's exchange rate policy this year, many economists assume that the clamor of suffering exporters will force Beijing to abandon the course of currency strength.

But China's government has to deal with a multitude of competing interests, including as many importers as exporters. And many importers suffering from soaring commodity prices are larger and more politically connected than the sock and underwear peddlers threatening to join the China-Vietnam Business Council. While China's foreign-invested enterprises are the linchpin of the export economy, running a $136 billion surplus in 2007, the state-owned enterprise sector ran a $46 billion trade deficit. These powerful state firms are the country's most confirmed importing lobby, and they are also crucial supports for China's economy.

To read more:

http://online.wsj.com/article/SB121322110063065821.html?mod=djemEditorialPage