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Comment (June 27, 2005)

Comment on Mr. Gyohten's "Japan's Stance Toward the U.S. and China" regarding China's Currency Revaluation

James P. Dressler (University of Southern California)

In his recent article on the GLOCOM Platform ( essays/20050523_gyohten_japan), Mr. Gyohten discusses China's currency conundrum and asserts that in spite of U.S. pressure on China to appreciate its currency "the Chinese government is unlikely to yield to the U.S. demand, although it might be willing to make the currency system a little more flexible." Mr. Gyohten expresses his belief on what will most likely happen, but he does not engage in an in depth analysis of the Chinese currency issue.

I agree with Mr. Gyohten's assertion that China will not allow a full and immediate appreciation of their currency. In fact, I believe that a more flexible exchange rate system, rather than a drastic adjustment of the currency value, is desirable for China as well as the rest of the world. Before making any conclusions, let us review both sides of the yuan revaluation issue.

Arguments For Revaluation

U.S. Treasury Secretary John Snow is the most vocal advocate for Chinese currency reform. Snow recently penned an opinion piece in the Wall Street Journal that outlined his rationale. Snow claims that addressing global imbalances is the shared responsibility of the world's major economies and that the international economy performs best when large economies embrace free trade, free flow of capital, and flexible currencies. Snow wrote in the Wall Street Journal, "China's rigid currency regime is highly distortionary and poses risks to China's economy—sowing the seeds for excess liquidity creation; asset price inflation; large speculative capital flows; and over-investment. It also limits the ability of China's neighbors to follow independent, anti-inflationary monetary policies because of competitive considerations relative to China." As such, the U.S. must also worry about the spread of undervalued currencies throughout Asia.

However, Mr. Snow doesn't portray an immediate yuan appreciation as a panacea for the U.S.'s ailments. Instead, Snow writes, "…a flexible system will provide China with a more sophisticated array of political tools that will prove much more effective in achieving price stability and the ability to adjust to shocks." Many economists argue that a stronger yuan will benefit China in the long run by keeping inflation in check and promoting the efficient allocation of resources.

Mr. Snow isn't calling for China to immediately allow its currency to float freely and be subjected to the full force of the market. In fact, Snow believes that the Chinese banking system is ill prepared for such a move and that floating the yuan at the time would be a mistake. Rather, Snow believes that China should take intermediate steps that include allowing the yuan to trade within a wider band or pegging the yuan to a basket of currencies instead of only the U.S. dollar. These steps would signal Chinese goodwill and strengthen the bond between the two countries.

According to a study by the Asian Development Bank, a revaluation of the yuan would help cool China's overheated economy. This study concludes that a revaluation of 10% could considerably stabilize China's economy by suppressing inflation and reducing investment and GDP growth. A 20% revaluation nearly halves GDP growth and risks a hard landing for the Chinese economy.

Snow closes his opinion piece with the following, "The current system poses a risk to China's economy, its trading partners, and global economic growth."

Arguments Against Revaluation

Many developing, and even some developed, countries do not fully float their currency. Nations are sovereign and have the right to implement whatever currency regime they see fit. Indeed, a nation's currency practices are not specifically regulated by any international agreement. Therefore, China should be free to choose the currency regime it feels is in its best interest.

Referring once again to the study by the Asian Development Bank, a revaluation of the yuan would have a limited impact on the U.S. trade deficit. A 10% and 20% yuan appreciation would improve the U.S. deficit by $3.62 billion and $7.87 billion respectively. These numbers may seem quite large, but they are merely a small fraction of the $617 total U.S. trade deficit. Upon a yuan revaluation, U.S. consumers would simply find the next lowest priced exporter and buy from them. The "bad man" image of China would shift to the country with the next lowest labor costs, and U.S. Federal Reserve Chairman Alan Greenspan readily admits this effect. Consequently, a yuan revaluation is unlikely to improve the U.S. trade deficit.

There is also concern that a yuan appreciation would create joblessness and financial instability in China. According to an article in the Wall Street Journal, there is no such thing as a perfect balance in an inherently dynamic international economy, and interference from politicians usually slows down trade and investment and exacerbates global poverty. Stanford economist Ron McKinnon cites the appreciation of the Japanese yen from 360 to 80 to the dollar from 1971 to 1996 as a failed example of U.S. intervention. Following this strong appreciation of the yen, the U.S. trade deficit and the Japan trade surplus continued to grow instead of shrink. Additionally, Japan experienced strong deflationary pressures that damaged their economy. A similar deflationary fate and economic slump could befall China following a yuan revaluation.

Additionally, China is still a fragile economic and political system and would not be able to adequately handle the volatility of a floating yuan. The Chinese banking system needs significant reform before any floating currency system can be effectively implemented. Reforms are currently underway, and remaining inefficiencies will be addressed by competitive pressures from foreign banks which will begin to operate in China at the end of 2006.


China has repeatedly said that they will reform their currency system, which should lead to the revaluation of the yuan, and there is solid reason to believe them. However, it is clear that China will proceed with reforms at its own pace. China is currently spending hundreds of millions of dollars to upgrade its computer and financial systems and train thousands of bankers and bureaucrats in international finance techniques. This is evidence that China is laying the groundwork for the big transition from a fixed currency to a more freely traded currency.

China is a proud nation and does not want to give the impression that it is kowtowing to U.S. demands. In complex matters like currency revaluation, prudence nearly always triumphs over rashness. China will most likely revalue their currency in the near future, but the U.S. must be patient. It would be a fiasco for the U.S. to brand China a "currency manipulator" and spark a trade war where the economic and political consequences would be disastrous for both countries. America's cantankerous attitude towards China suggests the U.S. is suffering from the challenge of integrating China into their economic system. Rather than drive a wedge between one another, the U.S. must develop and implement a comprehensive strategy for dealing with China's rise as an economic power.


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Connolly, Michael and Hanke, Steve H. "China Syndrome." Wall Street Journal. 09 May 2005.

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