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June 27, 2017

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China bashing over yuan must stop

I'll say it at the outset: Focusing on the yuan-dollar rate is a serious distraction, and it's time for the U.S. to back off from bashing China over problems that are born mostly at home.

Let's start with the source of all the misdirected attention. On June 20, the People's Bank of China bowed to American pressure and said it was abandoning the peg of 6.83 yuan to the dollar. Now the bank will vary the exchange rate at the beginning of each trading day, as well as widening the range of variation to plus or minus 0.5 percent.

But the PBC is concerned about re-introducing the one-way bet that prevailed between July 2005 and July 2008: that the currency steadily rises as it did at about a 6 percent annual rate. This led to massive inflows of hot money that threatened a loss of monetary control while impeding the forward market in foreign exchange.

China's central bank is again in a difficult situation. The U.S. Congress, led by New York Senator Charles Schumer, again is threatening to impose punitive tariffs on imports from China unless the yuan appreciates. Thus China's ritualistic de-pegging exercise to defuse American pressure.

Yet any gradual appreciation, or even the threat of it, will restart the hot-money inflows. Moreover, any sharp appreciation won't defuse the situation because it will be unlikely to reduce China's trade surplus, mainly the result of that country's high savings rate.

False Belief

Unfortunately, what lies behind this unnecessary political crisis is a widely held but false economic belief: the idea that the exchange rate can be used to control any country's trade balance, which is the difference between its saving and investment rate. Instead, the problem is a saving deficiency in the U.S. — with very large fiscal deficits and low personal saving — coupled with surplus saving in China.

To correct the trade imbalance between the two countries, these fundamentals must be jointly altered by changes in public policies.

Nobody disputes that almost three decades of U.S. trade and net saving deficits have made the global system of finance and trade more unstable. Dollar debts outstanding have become huge, and threaten America's own financial future.

Because the United States' main creditors in Asia — Japan in the 1980s and 1990s, China since 2000 — rely heavily on exports, the transfer of their surplus savings to the U.S. entails that they run large trade surpluses in manufactured goods.

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