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Why a More Flexible Renminbi Still Matters

CAMBRIDGE – One of the most notable macroeconomic developments in recent years has been the sharp drop in China’s current-account surplus. The International Monetary Fund is now forecasting a 2012 surplus of just 2.3% of GDP, down from a pre-crisis peak of 10.1% of GDP in 2007, owing largely to a decline in China’s trade surplus – that is, the excess of the value of Chinese exports over that of its imports.

The drop has been a surprise to the many pundits and policy analysts who view China’s sustained massive trade surpluses as prima facie evidence that government intervention has been keeping the renminbi far below its unfettered “equilibrium” value. Does the dramatic fall in China’s surplus call that conventional wisdom into question? Should the United States, the IMF, and other players stop pressing China to move to a more flexible currency regime?

The short answer is “no.” China’s economy is still plagued by massive imbalances, and moving to a more flexible exchange-rate regime would serve as a safety valve and shock absorber.

That said, the exchange rate has received far too much focus as a lightning rod for concerns over China’s growing engagement in the global economy. The link between the exchange rate and China’s pricing advantages in world markets is wildly exaggerated. At the same time, the exchange rate is by no means the most pressing macroeconomic problem facing China today.