This is the timely question being asked today by Stanford's Ronald McKinnon. Along with Stephen Roach, Andy Xie and the rest of the Morgan Stanley set McKinnon has one clear message: hold out against Rinban Revaluation.
These days, even the most casual shopper must be impressed by the number of made-in-China labels on clothes, bicycles, toys and electronic gadgets. China is the only truly booming part of the world economy. But this surge in exports has provoked complaints in the older industrial economies that Chinese goods are too cheap.
China's burgeoning trade surpluses have been linked to its fixed exchange rate. The renminbi has been stable at 8.3 to the dollar since 1994. Many economists and commentators have suggested that the Chinese currency should now be allowed to strengthen; then, once China cleans up its banks, liberalises its financial markets and scraps its exchange controls on capital movements, the renminbi should be allowed to float - presumably upwards.
One has only to look at the history of the postwar Japanese economy to realise that this is bad advice.From the 1960s to the mid-1990s, the rapid expansion of Japanese exports of steel, cars, machine tools and semi- conductors - culminating in large net trade surpluses - upset European and US industrialists. The angst was even greater among western trade unionists. Trade disputes were usually resolved by Japan's formally agreeing to "voluntary" restraints on the export of such goods and an implicit agreement to let the yen appreciate. Indeed, until Robert Rubin announced America's strong dollar policy in April 1995, US Treasury secretaries and influential pundits used to hector the Japanese to let the yen strengthen. And the yen rose - albeit erratically - from 360 to the dollar in 1971 to about 116 today.
This massive appreciation failed to eliminate Japan's trade surpluses, which simply reflect its higher propensity to save. In 2002, Japan and China both had "surplus saving" of 2 to 3 per cent of their gross national product, while the US has a current account deficit of 5 per cent of GNP. In open economies, the ongoing current account surplus is determined by a nation's net saving propensity, not by exchange rate changes. The exchange rate eventually determines domestic inflation or deflation. Thus the strengthening of the yen during the 1980s and 1990s imposed deflationary pressure on Japan's slumping economy, while forcing nominal interest rates towards zero.
Source: Financial Times