The US government will soon take a final call on whether to label China a ?currency manipulator?. If the US government does take this unprecedented step, it will likely follow it with sanctions on China. This could trigger a bigger trade war between the world?s two most important economies. Of course, there is plenty of evidence which clearly suggests that the yuan is undervalued. By definition, that would require intervention and manipulation by the Chinese central bank. Needless to say, such a strategy has helped China boost its exports and led it to amass a huge trade surplus, not just with the US but also with a lot of other economies, large and small. Still, there is good reason to argue that the US should not try and use political pressure to force the Chinese to revalue their exchange rate. The trade war that is likely to follow will be damaging to the global economy that is just about recovering from a protracted slowdown. As we have argued in these columns before, it is increasingly in China?s self-interest to allow an appreciation of the yuan.
China?s economy has recovered smartly from the global slowdown. In fact, there are genuine concerns about asset price bubbles, overheating and inflation in the economy. The single best way to tackle these would be to let the yuan appreciate. Remember also that it is impossible to have free capital flows and a fixed exchange rate and yet retain independence of monetary policy?the impossible trinity. China should give in on the exchange rate front and acquire more flexibility on the monetary policy front. There is also a longer-term structural issue that has emerged after the global economic crisis?China needs to begin consuming more, and countries like the US need to consume less, to maintain a balance in the global economy. Again, it is in China?s interest not to be over-dependent on exports. The economics of the matter, even from the Chinese perspective, is in favour of an appreciation of the yuan. Nationalist political pressures in China and the US make the issue more complicated than it otherwise might be. At this stage, it is in everyone?s best interest that politics not derail a necessary adjustment. There is much at stake for countries other than the US and China in this adjustment. India and other emerging economies also suffer because of China?s undervalued exchange rate. Everyone will welcome a revaluation of the yuan without the messy politics.
