After a period of tension between the US 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 yuan resume its slow but steady upward march. We can now expect the yuan to begin appreciating again, very gradually, against the US 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 yuan as a significant factor in US unemployment, will be disappointed by gradual adjustment.
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.
In fact, both sets of critics are wrong. China was right to wait in adjusting its exchange rate, and it is now right to move gradually rather than discontinuously. The Chinese economy is growing at potential: Forecasts put the prospective rate for this year at 10 percent; the first-quarter flash numbers, at 11.9 percent, show it expanding as fast as any economy can safely grow.
China successfully navigated the crisis by ramping up public spending. As a result, it now has no further scope for increasing public consumption or investment.
To be sure, building a social safety net, developing financial markets and strengthening corporate governance to encourage state enterprises to pay out more of their earnings would encourage Chinese households to consume. However, such reforms take years to complete. In the meantime, the rate of spending growth in China will not change dramatically.
As a result, Chinese policymakers have been waiting to see whether the recovery in the US is real. If it is, China’s exports will grow more rapidly. If its exports grow more rapidly, they can allow the yuan to rise.
Without that exchange-rate adjustment, faster export growth would expose the Chinese economy to the risk of overheating. However, with the adjustment, Chinese consumers will spend more on imports and less on domestic goods. Overheating having been avoided, the Chinese economy can keep motoring ahead at its customary 10 percent annual pace.
Evidence that the US recovery will be sustained is mounting. As always, there is no guarantee but the latest data points in this direction.
As the increase in US spending on Chinese exports will be gradual, it also is appropriate for the adjustment in the yuan-dollar exchange rate to be gradual. If China recklessly revalued its exchange rate by 20 percent, the result could be a sharp fall in spending on its goods, which would undermine growth.
Moreover, gradual adjustment in the bilateral exchange rate is needed to prevent global imbalances from blowing out. US growth will be driven by the recovery of investment, which fell precipitously during the crisis.
However, as investment now rises relative to saving, there is a danger that the US current-account deficit, which fell from 6 percent of GDP in 2006 to barely 2.5 percent of GDP last year, will widen again.
Yuan appreciation that switches Chinese spending toward foreign goods, including US exports, will work against this. By giving US firms more earnings, it will increase corporate savings in the US and reconcile recovery in the US with the need to prevent global imbalances from again threatening financial stability.
Chinese officials have been on the receiving end of a lot of gratuitous advice. They have been wise to disregard it. In managing their exchange rate, they have gotten it exactly right.
Barry Eichengreen is a professor of economics and political science at the University of California, Berkeley.
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