Since September when I speculated that a yuan revaluation was imminent, China’s currency has appreciated by 1% or at an annual rate of 4% against the US dollar. However, the current rate of 7.82 yuan/dollar is still too high and has done nothing to reduce the China-US trade balance.

A high-level delegation to Beijing from the United States led by US Treasury Secretary Henry Paulson and Federal Reserve chairman Ben Bernanke will meet with their mainland counterparts Thursday for two days of talks aimed at resolving trade disputes.

There is no doubt that China will face additional pressure to increase the pace of the yuan’s appreciation. China is hesitant to allow its currency to float more freely due to the pain that it would cause to its export sector and the inability for its capital markets to manage a more flexible yuan. Instead China would prefer seeing its currency rise gradually at 5% or so a year giving ample time for exporters to adjust to a stronger yuan and for additional reforms to be carried out in the financial sector.

The problem is that the US will not be patient enough to wait for the yuan to gradually appreciate, while its trade deficit remains high. You can bet that the US will retaliate with significant tariffs on Chinese goods if this is the case. This would be the worst situation for China since its export-led economy would struggle. If instead China revalues its currency by the tariff rate, then it could combat weakness in exporting with lower import prices and less US dollar reserves buying which could be used to stimulate the economy.

Therefore, I expect that the yuan’s appreciation that we have witnessed in recent months to pick up through a faster crawl and/or by a surprise revaluation announcement. My forecast is that the US dollar will be trading at less than 7 yuan by the end of 2007.