Why China is Right on the Renminbi

BERKELEYAfter a period of high tension between the United States and China, culminating earlier this month in rumblings of an all-out trade war, it is now evident that a change in Chinese exchange-rate policy is coming. China is finally prepared to let the renminbi resume its slow but steady upward march. We can now expect the renminbi to begin appreciating again, very gradually, against the dollar, as it did between 2005 and 2007.

Some observers, including those most fearful of a trade war, will be relieved. Others, who see a substantially undervalued renminbi as a significant factor in US unemployment, will be disappointed by gradual adjustment. They would have preferred a sharp revaluation of perhaps 20% in order to make a noticeable dent in the US unemployment rate.

Still others dismiss the change in Chinese exchange-rate policy as beside the point. For them, the Chinese current-account surplus and its mirror image, the US current-account deficit, are the central problem. They argue that current-account balances reflect national savings and investment rates. China is running external surpluses because its saving exceeds its investment. The US is running external deficits because of a national savings shortfall, which once reflected spendthrift households but now is the fault of a feckless government.

There is no reason, they conclude, why a change in the renminbi-dollar exchange rate should have a first-order impact on savings or investment in China, much less in the US. There is no reason, therefore, why it should have a first-order impact on the bilateral current-account balance, or, for that matter, on unemployment, which depends on the same saving and investment behavior.