In Defense of a Stable Yuan

WSJ:

Contrary to widely held beliefs in both China and the U.S., a discrete appreciation of the yuan against the dollar would not reduce China's trade surplus or America's trade deficit. A discrete appreciation of the yuan could have the perverse effect of causing investment in China to slump, as firms see China becoming a higher-cost area. This could drive up China's already high net savings rate, thus increasing its trade surplus with the U.S.

Mr. Geithner's accusations notwithstanding, China has other reasons for wanting to keep the yuan-dollar rate stable. First, as long as the fixed rate is credible -- as it was between 1995 and 2004 at 8.28 yuan per dollar -- it serves as an effective monetary anchor for China's internal price level. After inflation had exploded to over 20% per year in 1993-95, the fixed-rate anchor helped China regain price-level stability. Second, Beijing's four trillion yuan ($586 billion) fiscal stimulus package, launched in November and likely to grow even larger, would be most effective if China's exchange rate is kept stable -- as it has been since last July.

So what should Beijing be doing now? In order to buoy China's and the world economy while further correcting the festering trade imbalance between China and the U.S., fiscal expansion in surplus-saving countries like China is desperately needed. Because massive U.S. fiscal expansion (as it appears we will soon have) would enlarge the U.S. trade deficit, better to convince the Chinese that they should do most of the fiscal stimulating.

Comments

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China should withdraw from WTO and abandon the promise to late the Yuan float.