Yuan Revaluation

The financial press has been rife with talk about a Chinese revaluation of the yuan over the past week or two. To cap that off, yesterday the US Treasury effectively gave China a 6-month warning to change its exchange rate or else. The yuan issue is clearly high on many people’s list of Things to Pay Attention To these days.

This week The Economist gives an excellent summary of the situation and potential problems, both with keeping the peg and with removing it. The piece makes one point in particular that I think has received inadequate attention: a change to the dollar/renmimbi exchange rate will not by itself cause any significant improvement in the US’s current account deficit. The US current account deficit will not fall until consumption, either by individuals or the US government, starts to fall relative to income.

Brad Setser muses about the issue in a typically thoughtful post. A particularly good question that Brad poses is this:

I don’t understand why the Administration has not worked harder to build the case that China needs to adjust its peg for the sake of the multilateral trading and global monetary system inside the IMF. The US is not the only country with a beef with China: this is an example of an issue where a serious, hard-headed multilateral approach might have better served US interests.

…[A]part from the Article IV process, there are a range of things the Administration could have asked the IMF to do.

Why hasn’t the Administration spend more time asking the IMF to do more work on optimum levels of reserve accumulation, to set a benchmark for evaluating China’s reserve accumulation? Both Goldman Sachs and the World Bank have done some interesting work on this topic. Why hasn’t the Administration done more to put the responsibilities that go with the right to choose your own exchange rate regime on the global agenda… [or] demand that the IMF study whether China’s current levels of intervention go against its IMF commitments?

I think that the answer to Brad’s question is that the Bush administration has once again allowed ideology to trump good policy. I agree with Brad that it would have been more effective to build a multilateral consensus on the China issue, but as we’ve seen time and time again, the people who actually make policy in the White House (e.g. Cheney and Rove) seem to instinctually want to do everything as unilaterally as possible – even when it is clearly not in the US’s best interests to do so.

And now the Bush administration is setting things up for a battle of wills with the Chinese government later this year. The worst part about it, though, is that I have very little confidence that the Bush administration has thought through what will happen if and when China stops propping up the dollar, or how to respond to events that might follow such a change in the exchange rate.