The Dollar and the Dragon

CAMBRIDGE – For several years, American officials have pressed China to revalue its currency. They complain that the undervalued renminbi represents unfair competition, destroying American jobs, and contributing to the United States’ trade deficit. How, then, should US officials respond?

Just before the recent G-20 meeting in Toronto, China announced a formula that would allow modest renminbi appreciation, but some American Congressmen remain unconvinced, and threaten to increase tariffs on Chinese goods.

America absorbs Chinese imports, pays China in dollars, and China holds dollars, amassing $2.5 trillion in foreign-exchange reserves, much of it held in US Treasury securities. To some observers, this represents a fundamental shift in the global balance of power, because China could bring the US to its knees by threatening to sell its dollars.

But, if China were to bring the US to it knees, it might bring itself to its ankles in the process. China would not only reduce the value of its reserves as the dollar’s value fell, but it would also jeopardize America’s continued willingness to import cheap Chinese goods, which would mean job losses and instability in China.