The Marshall–Lerner condition shows that devaluation of US dollar may not immediately improve U.S.'s balance of payments.

Persistent US efforts to pressure China on the RMB exchange rate are damaging trade ties between the two countries.

In testimony to a US Senate Committee on September 19, Treasury Secretary Timothy Geithner said the pace of Chinese currency appreciation is too slow, and called on China to allow a significant and sustained appreciation of the yuan.

With growth slowing and unemployment increasing, earlier this year the Obama government put forward a plan to double exports. In practice, this meant imposing protectionist measures to boost US competitiveness.

The United States thinks it can improve its balance of trade by demanding China revalue its currency – in other words, by devaluing the dollar. But is this really going to solve the deficit problem?

The Marshall–Lerner condition, named after economists Alfred Marshall and Abba Lerner, shows that devaluation may not immediately improve its balance of payments. For devaluation to have a positive impact on the trade balance, the sum of price elasticity of exports and imports must be greater than 1.

But it will not be easy for U.S. to meet this condition.

Most US imports from China are necessities, like textiles, clothing and home appliances. Because of the global shift of manufacturing, the U.S. no longer has the capacity to produce these goods. If the U.S. cuts imports from China, it will have to import the same goods from other countries, so its trade deficit will remain the same.

The U.S. wants to boost its exports to China. But cold-war prejudice means it is unwilling to sell many high-tech goods to China. Instead the U.S. wants to sell China its agricultural produce. But China is unlikely to sacrifice the interests of its own farmers to balance the books with the U.S.

China's trade with Australia, South Korea and Southeast Asian countries has frequently been in deficit in recent years. This is another indication that the United States may be wrong to blame its deficit on the Chinese exchange rate.

In the United States, service industries account for more than 70 percent of the economy, but Chinese exports to U.S. are mainly manufactured goods. Given these figures, it is hard to see how RMB appreciation would cut US unemployment. As the world's largest developing country and the largest developed country, trade between China and the U.S. should be largely complementary, but Americans don't seem to grasp this point.

The media have reported extensively on the popular mood in America against the "made in China" label. And the US government has placed hurdles in the path of a range of Chinese products. But as limited measures have failed to ease the deficit, the U.S. has switched to pressing for a RMB revaluation that would hit Chinese exports across the board.

But even Geithner doesn't believe RMB appreciation will solve his country's deficit problem. He emphasized the importance of internal economic strength and said the U.S. should take action to boost its own economy.

(This post was first published in Chinese on September 19, 2010 and translated by Ma Yujia.)