Fundamental problems in the US economy need to be remedied; potential dangers for both nations loom if renminbi is revaluated

The renminbi exchange rate has once again become a target of the United States Congress. China-bashing, it seems, is back in fashion in the US.

But this latest round of disparagement appears stranger than the last. When the US Congress pressed China for a large currency revaluation in 2004-2005, China's current-account surplus was accelerating. Now China's current-account surplus is shrinking significantly due to the global recession caused by the US financial meltdown.

China's total annual surplus (excluding Hong Kong) now stands at $200 billion, down by roughly one-third from 2008. In GDP terms, it fell even more as GDP grew by 8.7 percent in 2008.

Back then, pegging the renminbi to the dollar pushed down China's effective exchange rate because the dollar was losing value against other currencies, such as the euro, sterling and yen. But currently, with the dollar appreciating against other major currencies in recent months, the relatively fixed rate between the dollar and the renminbi has caused China's currency to shore up.

Of course, there are now other sources of friction that did not seem as pressing five years ago. The US' internal and external deficits remain large, and its unemployment rate is extremely high. Someone needs to take responsibility, and since US politicians don't want to blame themselves, the best available scapegoat is China and its exchange rate, which has not appreciated against the dollar in 18 months.

But would a revaluation of the renminbi solve the US' problems? Recent evidence suggests that it would not. Between July 2005 and September 2008 (before the bankruptcy of Lehman Brothers), the renminbi appreciated 22 percent against the dollar. Yet the quarterly US current-account deficit increased - from $195 billion to $205 billion.

Most economists agree that the renminbi is probably undervalued. But the extent of misalignment remains an open question. The economist Menzie Chinn, using purchasing power parity (PPP) exchange rates, reckoned the renminbi's undervaluation to be 40 percent. But, after the World Bank revised China's GDP, in terms of PPP, downward by 40 percent, the undervaluation disappeared. Nick Lardy and Morris Goldstein suggest that the renminbi was probably undervalued only by 12-16 percent at the end of 2008. And Yang Yao of Beijing University has put the misalignment at less than 10 percent.

But assume that China does revalue its currency sharply, by, say, 40 percent. If the adjustment came abruptly, Chinese companies would suffer a sudden loss of competitiveness and would no longer be able to export goods. The market vacuum created by the absence of Chinese products could be filled quickly by other low-cost countries, such as Vietnam or India. Companies in the US cannot compete with these countries either. So no new jobs would be added in the US, but the inflation rate would increase.