Thursday, May 19, 2005

The Economist on Yuan Revaluation China's currency: "...even if China does revalue, it will not be the salvation that American politicians are praying for. First, it is highly unlikely that the yuan will be allowed to rise very far; even optimists expect a revaluation only in the range of 3-10%, which will still leave the currency seriously undervalued.

Moreover, the effects of a relaxed peg on America's current-account deficit will be extremely modest. China accounts for less than one-tenth of America's trade, so even a 10% revaluation would only reduce the trade-weighted value of the dollar by 1%-not enough to produce any noticeable change in America's current account. Nor is it clear that even a big revaluation would help much. Morris Goldstein of the Institute for International Economics estimates that even a 25% revaluation would reduce the current-account deficit by less than 5%.

Nonetheless, China seems to be preparing the way for a slightly freer currency. This week it allowed some foreign currencies to be traded against each other for the first time in China. This is widely seen as a preparation for reform of the tightly controlled currency regime. And if a revaluation seems unlikely to please America's protectionist politicians, it should nonetheless help to correct the imbalances caused by the gaping American current-account deficit, if only by weaning America's spendthrift consumers-and government-off cheap Chinese credit. If the hour of reckoning is not quite at hand, it seems only a matter of time before China's financial system, and America's borrowers, begin to grow up."

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