How it all started

The question of a Chinese revaluation was first raised in the G7 meeting in September 2003 in Dubai. A communiqué from the conference was widely interpreted as a challenge to countries with fixed exchange rates, China in particular.

The initial Chinese response was to reject foreign pressure and interference in sovereign decision making. After all, China’s balance of trade is roughly in balance. That they have a high and rising surplus with the U.S. is not their problem — it’s the U.S.’s problem for overspending on consumption goods and not saving enough. Because China uses the U.S. dollar as a reserve currency, to re value the renminbi by 10 percent automatically reduces their reserves of about $650 billion by the same proportion, or $65 billion. This is about 10 percent of one year’s GDP, and it’s a one-time reduction in the national wealth.

Some people want China to revalue by the 40 to 50 percent necessary to make an actual dent in the surplus with the U.S., which is running at a rate of $13 to 15 billion per month. In the absence of real progress on the revaluation, the U.S. Congress recently passed a proposal to consider a 27.5 percent tariff on all Chinese exports to the U.S., since the fixed rate renminbi constitutes “currency anipulation” to the detriment of a trading partner.

The Treasury hasn’t named China as a manipulator since 1994, and clearly doesn’t want to do it today, either, considering the U.S. is in some form of “negotiation” with China on the issue. Congress thinks the Treasury is being hoodwinked by the Chinese and led down the garden path — and it may be right.

But restraints on free trade are always and everywhere a bad thing. A pegged currency may result in misallocation of resources, but so does an economy whose businesses are insulated from competition. The same result — a reduction in Chinese exports to the U.S. — can be achieved by the imposition of an export tax within China, which is a market-based solution and has the added benefit of generating tax revenue in a poor country.