Some American critics say that the yuan is still at least 20 per cent undervalued [Getty Images]

The White House is set to decide whether to accuse Beijing formally of using its currency to gain unfair trade advantages against the US. Barack Obama faces a deadline on Friday that could test already fragile US-China relations.

Labelling China a currency manipulator would enrage the Chinese just as the US administration is looking for their help on major global initiatives.

On the other hand, failing to take a decision, or postponing it, could damage the US president's struggling Democratic Party in the lead-up to congressional elections on November 2.

Friday's deadline is part of a congressional requirement for the treasury department to prepare a twice-a-year report whether any countries are manipulating their currencies.

The yuan has been rising to new highs almost every day in recent weeks.

By late on Friday, the yuan was at 6.64 - its strongest rate against the dollar since the government set up the current currency regime in 1993.

In his remarks at a monetary policy conference on Friday, Ben Bernanke, chairman of the US Federal Reserve, did not directly mention the currency dispute with China.

But the side-effects of minting new dollars to pay for planned treasury-asset purchases are a weaker dollar.

Rising trade gap

Obama is under pressure to punish China for trade policies that US politicians say cost millions of manufacturing jobs in their country.

Many Americans are angry over a politically sensitive US trade deficit with China that has climbed to an
all-time monthly high of $46.3bn.

The US deficit with China alone rose 8.2 per cent in August to an all-time high of $28bn, surpassing the record $27.9bn set in October 2008.

Speaking hours before the Friday deadline, Yao Jian, spokesman for China's commerce ministry, said it was not fair to criticise his country's exchange rate policy simply by pointing to its trade surplus.

But American manufacturers contend that an undervalued currency gives China a trade boost by making Chinese goods cheaper in the US - and US products more expensive in China.

If the US designates China a currency manipulator, it would trigger negotiations between the two countries and could result in US economic sanctions against Beijing.

"A currency war would be very upsetting would create all kinds of unpredictabilty and slow growth," Nick Spicer, Al Jazeera's correspondent in Washington, said.

Domestic politics

The Obama administration, worried about high unemployment and losing ground to opposition Republicans in the November polls, wants to look tough on China.

That is especially true after ministers from around the world left last week's global finance meetings in Washington without resolving how to deal with differences over currency.

At the same time, US officials see Chinese co-operation as essential to US efforts to deal with the Iranian and North Korean nuclear standoffs, climate change and other difficult issues.

US politicians appear to have tired of White House attempts to strike a delicate balance with China.

The House of Representatives sent the administration and China a strong message last month by passing tough new legislation that would impose economic sanctions on countries found to be manipulating their currencies.

"Tensions between the US and China have been boiled down to this single issue, but this misses the point in the debate," Alistair Thornton, an economist with IHS Global Insight, told Al Jazeera.

"The Chinese savings rate is far too high, and consumption in the US is far too high."

Potential backlash

While Friday's deadline puts the Obama administration in a diplomatic and political bind, US officials do have options other than an outright declaration that China manipulates its currency.

The treasury department could postpone the report, which Obama, following the lead of his predecessor, George Bush, has done before.

It could also use strong words to criticise China without making a formal declaration of currency manipulation.

US-China ties have hit a low point recently, with the countries clashing over territorial disputes in the South China and East China seas, human rights as well as Taiwan and Tibet.

In the run-up to last week's finance meetings, Timothy Geithner, the US treasury secretary, urged China to make more progress in moving more towards flexible exchange rates.

Chinese perspective

China has allowed its currency to rise in value by about 2.3 per cent since announcing in June that it would introduce a flexible exchange rate.

Chinese officials say their gradual effort to revalue their currency is the best approach.

Allowing the currency to rise too rapidly, they say, would cost thousands of Chinese manufacturing jobs and destabilise the Chinese economy.

Differences over what exchange rates are appropriate to put the world economy back on course, have been intensifying in advance of a pair meetings of the Group of 20 leading economies in South Korea.

G20 finance ministers meet next week in Gyeongju to prepare for a summit of their leaders in Seoul on November 11-12.

Source: Al Jazeera and agencies