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China to let yuan rise, all the world’s economic problems solved

Or so you might think, based on what China’s critics have been claiming up until China’s latest announcement.

For nearly the past two years, China peg its currency, the yuan (also called the renminbi), to the US dollar. On Saturday the Chinese central bank revealed that it would end this policy.

Prior to this move, critics – mainly found among American politicians and economists - had alleged that China’s currency policy was a major source of the “global imbalances” in the world economy. China’s currency, they said, was being held artificially low. Remove this control, let the yuan appreciate, and wonders of wonders will occur: China would focus on selling to domestic consumers rather than exporting to the world, while the US would now have a more competitive currency and would see its trade deficit fall, as imports would be more expensive and exports cheaper. The imbalance between the US and China – claimed to be the source of the world economy’s woes – would be addressed.

Well, all I can say is, don’t hold your breath for the promised miracles to appear. And not just because China said its appreciation in the yuan would be gradual.

As I pointed out in an earlier post, the attacks on China for its currency policy have been misguided. Of course, a higher yuan to the dollar would benefit the US’s trade with China. But adjustments don’t happen automatically, just because of exchange rates. If Chinese imports into the US are more expensive, then it is likely they will be replaced by cheap imports from other emerging markets, like Vietnam. If there are no obvious substitutes, US consumers will pay higher prices. And reorienting US companies to produce in product areas they thought were hopelessly uncompetitive in versus imports does not just happen overnight. On the China side, US imports will cheaper, but they still won’t necessarily be the most competitive, so don’t expect an explosion of US exports to China.

What gets missed out in all of this talk about currencies and global imbalances is that different economies are more productive than one another. China has been succeeding in world trade, but not because its currency has been relatively cheap, but because its industry is more productive than others. Likewise, a shift in currencies is not enough to create lots of jobs in US manufacturing.

China’s policy change was clearly timed in advance of the G-20 summit in Toronto at the weekend. In making this move, China will now probably avoid being the center of criticism. Indeed, by taking itself out of the equation, China will, over time, expose how its currency really has not been the problem. The Western powers will have to now confront their own home-grown weaknesses – primarily, a lack of dynamism in productive industry – or otherwise find a new scapegoat.

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