China undervalues its currency in order to gain competitive advantage around the world. Everyone understands that and it needs to change, but the question in the United State is how to effectively change it. The Obama administration is taking the gradual approach:

The Obama administration on Tuesday declined to label China a currency manipulator after seeing recent increases in the value of the yuan compared to the dollar.

The decision angered some manufacturing groups, which have accused Beijing of artificially holding down the value of its currency to gain trade advantages. A cheaper yuan makes Chinese goods less expensive when they are shipped to the United States. It also makes U.S. goods more expensive in China. Both could increase the U.S. trade deficit with China, which is on pace to hit a record high this year.

The Treasury Department said the yuan has appreciated 12 percent against the dollar in the past 18 months, after adjusting for inflation. In addition, the department said in a semi-annual report that China promised at two high-level meetings last month to make the yuan’s exchange rate more flexible.

Still, yuan is “substantially undervalued” and its appreciation “is insufficient and more progress is needed,” the report noted. The department will “press for policy changes that yield greater exchange rate flexibility” and “level the playing field.”

This will likely end up being a campaign issue as Mitt Romney and other GOP candidates are hammering Obama over China. But progress is being made.

The United States is losing patience with China as the Chinese move slowly on their currency policy. Many in the US believe correctly that the Chinese are propping up their exports, and hurting US imports, by undervaluing their currency. Larry Summers visited China but no progress has been made . . . at least in public statements.

China rejected pressure over currency Tuesday amid a visit by two high-level U.S. envoys, saying Beijing will set the pace of exchange rate reforms.

Currency has re-emerged as an irritant in U.S.-Chinese relations as American leaders face pressure to create jobs ahead of November elections. Lawmakers who want possible trade sanctions on China set aside complaints as the two governments worked together to end the global crisis but are renewing their demands.

“Exchange rate reform can’t be pressed ahead under external pressure,” said Jiang Yu, a foreign ministry spokesman.

The Chinese don’t want to ;look like they are bowing to pressure, so we all need to go through this diplomatic song and dance. Eventually, a change has to be made.

After months of subtle pressure from the United States and other nations, China has signaled a willingness to adjust its currency policies.

China’s central bank announced on Saturday evening that it would allow greater flexibility in the value of the country’s currency, in the clearest sign yet that China will allow the renminbi to appreciate gradually against the dollar.

The People’s Bank of China said that the Chinese economy was strengthening after the global financial crisis and that it was “desirable to proceed further with reform” of the currency, known as the renminbi or yuan. The announcement comes a week before world leaders gather in Canada for the Group of 20 and Group of 8 summit meetings. A growing number of countries have been calling for China to let the renminbi appreciate, including not just the United States and European nations, but India, Brazil and Singapore in recent weeks.

This is big news. For years China has kept its currency artificially low vs the dollar. Now we might see an adjustment that let’s the market have more of an impact on the value of the currency, which can help with the China/US trade deficit.