BEIJING/WASHINGTON - President Barack Obama has promised to raise the issue of the yuan's exchange rate during his visit this week to Beijing, putting the spotlight on a major bone of contention which has the potential to shake currency markets and diplomatic ties alike.

In an interview with Reuters in Washington, Obama put the question of the yuan in the broader context of a shared need to iron out imbalances in the world economy -- including China's huge savings -- in order to ensure sustainable global growth.

They have a huge amount of U.S. dollars that they are holding, so our success is important to them. The flip side of that is that if we don't solve some of these problems, then I think both economically and politically it will put enormous strains on the relationship, he said.

As Obama spent his first full day in China on Monday, a Commerce Ministry spokesman rebuffed calls for the yuan to appreciate. The spokesman, Yao Jian, restated China's long-standing policy that the yuan should be kept stable, arguing that the exchange rate had little to do with the trade imbalance.

WHERE THINGS STAND NOW

China says it manages the yuan's exchange rate against a basket of currencies, but if there is a basket, the dollar is far and away the heaviest component.

The history of China's managed float regime divides neatly into two parts: July 2005 to July 2008, when the yuan gradually rose 21 percent in a crawling peg to the dollar; and July 2008 to the present, when the yuan has been virtually repegged at about 6.83 to the dollar.

U.S. critics complain that China is thwarting normal market adjustments that would push up the value of the currency to reflect China's rapid growth and thereby make its products more expensive for foreigners.

China says that a stable exchange is an important help for its beleaguered exporters and that it also promotes stability in the global economy.

Zhang Yuyan, who heads the Institute of World Economics and Politics at the Chinese Academy of Social Sciences, said on November 5 that the yuan's de facto dollar peg to the dollar was unsustainable in the long run, but Chinese academics were deeply divided on what should replace it.

There are several options. One is to peg it to a basket of currencies; another option is a big one-off revaluation, Zhang said. There is no perfect option.

IS THIS JUST AN ISSUE FOR AMERICA?

The International Monetary Fund has urged China to permit more exchange rate flexibility as an important part of efforts to rebalance global growth and as a way for Beijing to gain more autonomy in setting monetary policy.

IMF Managing Director Dominique Strauss-Kahn reiterated that point in Beijing on Monday.

In unusually direct comments, European Central Bank President Jean-Claude Trichet said on November 5 that a stronger yuan would be welcome for the sake of the global economy.

Even Brazil, a fellow emerging market giant, broke ranks earlier in November and criticized China's quasi-fixed exchange rate.

But Ma Delun, a vice-governor with the People's Bank of China, said on November 10 that external pressure to let the yuan rise was not that great and stressed the need to give the country's exporters a helping hand.

WHAT WOULD HAPPEN IF CHINA LET ITS CURRENCY APPRECIATE?

Theoretically, the cost of Chinese-made products would rise for consumers around the world. If prices rose sufficiently, other countries' goods might displace those China now makes.

Some in the United States hope that domestic firms which now say they cannot compete might decide that they can boost their share of export markets, cranking up production and hiring.

In practice, though, the yuan's 21 percent rise from 2005-2008 barely registered on the price tags of Chinese goods abroad, as buyers -- often foreign firms like Wal-Mart -- demanded that costs be kept down and their suppliers were able to oblige, thanks in part to productivity gains.

Many economists see China's trade surplus as a function of its cheap capital and over-investment, which generate excess production that is cleared through exports.

The implication is that deeper reforms to China's economy such as building up a social safety net, and not just yuan appreciation, are necessary to stimulate domestic demand and rein in its yawning trade surplus.

(Reporting by Simon Rabinovitch and Glenn Somerville; Editing by Alan Wheatley)

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