When the Chinese government recently said it was going to let its currency, the yuan, float, the knee-jerk reaction among U.S. investors was enthusiastic. A stronger yuan, they reasoned, meant that there would be fewer trade problems between China and the West, that it would be easier to tame inflation, and that it would help to rebalance that country's economy.

But Gary Shilling, the economist credited with predicting the subprime mortgage crisis and the subsequent slowdown of the U.S. economy, says not to believe the headlines. Shilling says that there is no way China's government will give the yuan complete free rein to trade against the dollar.


Yuan to Stay Under Chinese Government Control


Shilling, the president of A. Gary Shilling & Co., stopped by the offices of AOL's DailyFinance recently and, in the first in a series of interviews on the economy, argued that as China tries to convert itself to an economy driven by domestic demand rather than by exports, the yuan is going to remain very much under the control of the Chinese government.

"This isn't a free float by any stretch of the imagination," says Shilling.

And what if the Chinese actually did allow its currency to appreciate? It would not rise against the dollar, says Shilling, but instead fall as the Chinese looked for safer markets to invest their currency. Shilling argues that the problem is that China is a "stop and go" economy and right now, after years of rapid growth, the government wants to cool off its economy. One way to do that is by allowing the yuan to appreciate.

China, of course, suffered from the collapse of its consumer economy in 2008 when its exports evaporated, but it has rebounded well from that situation. Now, the country, in which consumers save 30% of their incomes, has a serious problem trying to grow its domestic markets.

Did China Make a Mistake?


So, was China's decision to loosen the yuan's peg to the dollar a mistake? Shilling says the move could have serious unintended consequences. He says "hot money" will now come into China, a result the country doesn't want as it tries to cool its economy. He also says that because China's economy is only partly market regulated, and mostly run by the government, Beijing now has some tricky decisions to make.

On top of all this, China has a real estate bubble that's ready to pop. Prices have been going up 10% to 20% per year, and the cost of an apartment in Shanghai or Beijing is now 25 times the income of an average urban family, an inequality that will be difficult to resolve.



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