After years of pressure to adopt a more flexible currency regime, China took a major political leap last week and a small economic step. After rigidly pegging its currency to the dollar for more than a decade, China’s central bank announced that China’s currency, the yuan, would be revalued by 2.1 percent against the dollar.
China’s central bank also declared that the yuan would be permitted to fluctuate up or down by a maximum of 0.3 percent per day, as measured against a basket of currencies. The political leap derives from the fact that China not only revalued but also agreed to adopt a much more flexible currency regime. The small economic step comes from the fact that China initially increased the value of its currency, which most economists believe is undervalued by between 15 and 30 percent, by a relatively minuscule 2.1 percent. For all practical purposes, a change of that magnitude would have virtually no effect on the rising structural trade imbalances that afflict both China and the United States.
The currency move precedes Chinese President Hu Jintao’s visit to the United States scheduled in September. However, if Mr. Hu expects the tiny 2.1 percent revaluation to quell the disturbing increase in protectionist sentiments in the United States, he is badly mistaken. Misguided bipartisan legislation sponsored by Democratic Sen. Charles Schumer of New York and Republican Sen. Lindsey Graham of South Carolina calls for applying massive across-the-board tariffs of 27.5 percent on Chinese imports. Schumer-Graham would represent the largest tariff increases since the Smoot-Hawley disaster exacerbated and prolonged the Great Depression during the 1930s. Mr. Schumer reacted to China’s move by calling it “the first baby step.”
Arithmetically, China’s new daily trading band of 0.3 percent could generate a cumulative revaluation of 20 percent within two months. However, signaling that it did not intend for the yuan to undergo a major revaluation over the short term, China made clear that it intends for its currency to remain “basically stable” following the initial revaluation.
The structural trade imbalances are reflected by America’s accelerating current-account deficit, which threatens to reach 8 percent of gross domestic product (GDP) this year, and by China’s soaring current-account surplus, which could rise to 8 or 9 percent of its GDP in 2005. Moreover, the 2.1 percent revaluation would probably not have a perceptible impact upon America’s trade deficit with China, which totaled $162 billion last year and has been rising at the rate of $1 billion per month this year. If a 12.4 percent overall real depreciation of the dollar between early 2002 and last month could not prevent America’s trade deficit from increasing from $363 billion in 2001 to $666 billion over the past 12 months, China’s 2.1 percent revaluation against the dollar and any comparable changes in Asia would not matter a bit.