India Debunks the Currency Hawks

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Perhaps the most common refrain from the folks in Congress and the punditocracy who are demanding a drastic appreciation in China's currency (the RMB) is that the revaluation is absolutely necessary to reduce the "dangerous" US-China trade deficit.  These currency hawks' underlying reasoning is simple: China's allegedly undervalued currency makes Chinese imports to the US cheaper and American exports to China more expensive, thus creating a woefully-distorted bilateral trade imbalance as compared to a situation in which both the RMB and USD "floated" based on market conditions.  (See here and here for examples of this rhetoric.)

Assuming for a moment that the RMB is significantly undervalued, and that the bilateral trade deficit (or any trade deficit) is a problem for the US economy, there remains a very serious question of whether any sort of RMB appreciation, based on market factors or otherwise, will actually affect the US-China trade balance.  The currency hawks certainly think so (it's their raison d'etre), but many scholars (and your humble correspondent) disagree, pointing to the recent history of the RMB and the US trade deficit, the past experiences of Japan's currency appreciation versus the dollar, and, of course, lots of economic analysis and modeling of structural factors in both the US and China - all of which strongly argue against the theory that RMB appreciation is some sort of "silver bullet" for the bilateral trade deficit.  Indeed, a very interesting new study released by the Centre for Economic Policy Research provides even more such evidence (and a lot of other good stuff).

Unsurprisingly, currency hawks like Paul Krugman have brushed these sound criticisms aside, arguing that they fail to capture current market realities (or something).  A story in Thursday's Wall Street Journal, however, provides very strong support for the currency skeptics' arguments about the disconnect between nations' currency policies and their bilateral trade balances - this time from what is arguably China's largest competitor, India. 

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