Under the best circumstances, a transition from a fixed exchange regime to a flexible one is not easy. Within the context of China's unique political and economic environment, its top leaders face an especially difficult set of challenges that continue to conspire against a feasible exit plan for the yuan's de facto peg to the US dollar.

Authorities have exacerbated this dilemma by repeatedly promising not to adjust the currency under pressure by foreign powers (read: the United States) or by currency speculators (read: illegal hot money inflows). The record US trade deficit in November and China's record foreign exchange accumulation through the end of last year suggest such pressures are unlikely to evaporate in the foreseeable future.

Fortunately for mainland policy-makers, a conventional currency adjustment is not their only available path; a yuan peg to gold shines the way to a face-saving alternative.

Lest anyone get the wrong idea, this is not to imply China's leaders ought to ignore the failed history of the gold standard by adopting one of their own.

The idea is simply that China temporarily pegs its currency to gold to facilitate an exit from the insidious clutches of a de facto fixed currency regime and lay the foundation for an eventual transition to a fully floating one.

Gold is often dismissed as a potential monetary anchor for developing economies like China because of the pre-eminent role the US dollar plays in global trade and financing. A peg to the dollar minimizes currency risks for foreign lenders and direct investors, and facilitates capital inflows that are so essential for economic development in capital-poor countries.

This old shoe no longer fits, however, as reflected in China's bulging balance of payment surpluses and exploding foreign exchange reserves, which grew by US$206 billion (HK$1.6 trillion) last year alone.

China's use of band-aid administrative measures has provided a temporary respite from the continuing deluge of hard currency inflows. But a flexible currency is the only long-term solution for dampening dangerous foreign capital inflows, nearly half of which is illegal hot money breaching China's porous capital controls.

Meanwhile, the clock is ticking.

There are two key risks that mainland policy-makers face the longer they hold fast to the currency status quo.

Firstly, there are the massive foreign capital inflows causing economic distortions in China. Authorities have succeeded in neutralizing the worst visible symptoms of surging hot money inflows into the economy. Inflation, for example, began edging down four months ago.

But such success is likely to be transient because the underlying disease - that is, excess capital inflows - remains untreated.

Secondly, the longer authorities wait in moving to a flexible exchange regime, the riskier it becomes for China to liberalize its capital account.

Authorities have already started taking baby steps toward removing capital controls with the aim of facilitating hard currency outflows and, in turn, defusing pressure on the yuan.

Opening the capital account to relieve speculative pressure on a currency, however, is a dangerous expedient for a country with a weak financial sector - analogous to poking holes in a structurally flawed dike.

A peg to gold would immediately inject flexible market dynamics into the yuan's exchange rate with the dollar without risking the political and practical repercussions of conventional currency adjustment alternatives.

All that is required is for policy-makers to choose a yuan ratio that equals the current exchange rate of 8.28 against the dollar at the prevailing gold price. For argument's sake, let us assume gold is US$420. In that case, a ratio of 3,478 yuan to an ounce of gold, would result in an exchange rate that exactly matches the current pegged rate of 8.28.

Starting from the current exchange rate would help policy-makers avoid the political and practical risks of choosing the ultimate size of any direct revaluation of the yuan versus the dollar. From such a neutral starting point, the yuan/dollar exchange rate would adjust automatically based on the gold price.

As the gold price rises, the yuan/dollar exchange rate will appreciate, and vice versa.

Such exchange rate flexibility provided automatically by gold would serve an invaluable stabilizing function for the economy. When the gold price falls over some weeks or months, this is commonly interpreted as a sign of a relatively tighter US monetary policy, ie fewer US dollars are available for a given global supply of gold.

In response to changing global liquidity conditions, therefore, the gold price would produce exactly what the doctor ordered in the form of the required currency depreciation or appreciation versus the US dollar.

If China had fixed the yuan to gold before the Asian financial crisis, the resulting currency depreciation would have offset the painful deflationary pressures that rocked China's economy and forced policy-makers to implement such administrative measures as export tax rebates that still remain more or less in place today.

And China would have been insulated from the ire of trading partners, as any yuan depreciation resulting from a gold peg would have been the direct result of US monetary policy, as reflected in a gold price that went from a high of US$415 on February 5, 1996, to a low of US$252.80 on July 20, 1999.

After gold bounced around below US$300 for a couple of years from 1999-2000, an equally dramatic and inexorable rise in the gold price beginning in 2001 brought gold back above US$400 in 2003 and eventually to a high of US$454 on December 2, 2004, before settling back down in the range of US$420 recently.

This rise in the gold price, reflecting an enormous reflation of global dollar liquidity, would have resulted in an appreciating yuan, thus counteracting the pernicious effects of the speculative pressures that have fueled, and continue to fuel, a deluge of foreign capital inflows into the economy.

Consensus among the policy and business elites in Beijing has hardened around the idea that a flexible exchange rate regime is inevitable if China is to achieve its goal of becoming a great power again.

All of the easy answers for getting there, however, have vanished under the mountain of speculative capital inflows that continue to chase a red-hot economy and an undervalued currency.

The latest batch of academic and Wall Street models indicates the yuan is still undervalued by 15-30 percent.

Any of the conventional currency adjustment options that entail a small initial revaluation would merely fuel additional speculative inflows of foreign capital chasing the next inevitable revaluation.

A large one-time maxi-revaluation (of, say, roughly 15 percent) could theoretically eliminate speculative pressure and thus pave the way for a transition to a flexible exchange rate regime. But such a bold move entails the kind of political risk that China's new generation of leaders are not prepared to take.

The unconventional nature of the yuan peg to gold surely makes it similarly risky for policy-makers. But to dismiss this option because it is unconventional is to underestimate the risks that policy-makers face with any of their other conventional policy alternatives.

A peg to gold is not perfect, but it provides the least harmful option of many. Go on, China, go for the gold, or risk derailing your destiny as a once and future global great power.

Sam Baker is a China specialist and the director of Asia research at Trans National Research, a political and economic consulting firm to institutional investors