One of the charges levelled against China is a "beggar-thy-neighbor" policy: keeping its currency artificially cheap, effectively subsidizing its exporters (while penalizing importers). Last week's meeting between Presidents Hu Jintao and Bush provoked a comment from the latter: "There has been some appreciation in the currency. We would hope there would be more appreciation in the currency."
Some review: a currency peg is when one country fixes the conversion between its own and a foreign currency at a given value. It is said to be following a fixed exchange rate policy in contrast to a flexible or floating exchange rate policy. A domestic currency appreciates when the rate at which one unit converts to a foreign currency goes up (conversely, when it takes fewer units of a domestic currency to buy one unit of a foreign currency). A depreciation is the reverse. The real exchange rate, is the market value adjusted by relative inflation (the difference between domestic inflation and inflation in the country holding the foreign reference currency). The idea is that domestic inflation at given market exchange rate is equivalent to an appreciation of the domestic currency. Depreciation accompanied by the same rate of inflation yields an unchanged real exchange rate.
So now we are ready to consider the question: is the yuan undervalued? Most economists would agree: yes, but not by a lot. Certainly not by magnitudes of 27.5% called for by some US Congressmen. (Though revaluation of yuan by that magnitude would do wonders for the Philippines' trade surplus with that country. Whether that's economically desirable is doubtful.)
Since the mid-1990s China has been on a currency peg; based on ADB data, the yuan/dollar exchange rate has fluctuated within a narrow band of 8.3 to 8.28. Using inflation rates in China and the US from 1996-2005, the yuan has only depreciated in real terms by less than one percent. Finally, overall trade surplus of China is only 2.6% of GDP, around the same level as in 2000.
More arguments against the undervalued-yuan claim here. Brad Setser also has plenty of discussion on the China-US imbalance.
It seems that some elements of the US Congress have become very adept at the "blame-thy-neighbor" policy. China-bashing bandwagon, anyone?