Reconsidering Revaluation

China's economy has grown dramatically in the last decade: it is more than twice as large as it was ten years ago. This spectacular rise means that Beijing can influence the global economy today in ways that would have been unimaginable in the 1990s -- a development that has led to widespread concerns in the United States. Many officials in Washington and small U.S. manufacturing companies allege that Beijing has deliberately undervalued its currency and manipulated markets in order to promote the growth of its exports.

Consequently, many U.S. politicians are clamoring for action to redress China's growing annual trade surplus with the United States, which currently stands at $250 billion. They assume that increasing the value of the yuan against the dollar will simultaneously decrease Chinese exports to the United States by making them more expensive and boost U.S. imports to China by making them cheaper. As the 2008 presidential election approaches, the U.S. Congress is actively discussing protectionist legislation and new tariffs that would punish China if its currency does not appreciate faster than the current rate of five percent.

But revaluation -- no matter how vehemently it is advocated -- is unlikely to achieve the desired result of reducing the U.S. trade imbalance with China. Taxation reform, the restructuring of the corporate and banking sectors, the gradual opening of capital accounts, and the encouragement of domestic consumer spending would each have a more measurable and lasting effect on China's current account surplus. There is also scant reason to believe that Beijing will accept the large-scale revaluation of 20 percent or more sought by certain members of the U.S. Congress. Such a policy could result in fewer exports, lost jobs, and capital flight to other emerging markets with cheaper labor costs, not to mention increased currency speculation and exchange-rate losses on hundreds of billions of dollars worth of U.S. Treasury debt now held by the Chinese government.