Even if one were to agree that without a significant rise in the renminbi, the Chinese economy would continue to overheat, there is no unanimity over what the "fair value" is for the nominal exchange rate. However, there is a danger that if the capital account were to be fully liberalised, this may result in Chinese savings heading abroad, and causing the devaluation to be very small.

The Chinese would be reluctant to play roulette with the exchange rate, which has been a source of stability for the last decade.

The second argument is that China would enjoy a rise in real exchange rates that comes with its gradual economic catch-up with the more industrialised economies. However, the real exchange rate can rise by just ensuring that the inflation rate remains higher than the trading partner, and may not have to move on exchange rates. This was a strategy that Japan used during the Bretton Woods years of fixed exchange rates.

The third argument that the exchange rate is deliberately undervalued does not make sense. Even a major revaluation of 25 per cent against the dollar would scarcely make any difference to the US economy.

China accounts for 10 per cent of total US trade. Hence a 25 per cent revaluation would lead to a 2.5 per cent devaluation of the dollar, which would be a drop in the ocean relative to the current dollar rout.

In order to bring the US current account deficit to 2-3 per cent of GDP from the current 6 per cent would need a whopping 33 per cent devaluation in the relative value of dollar. Hence, China and Asian currency adjustments would not make any difference.

China's trade surplus with the UShas been offset by a growing trade deficit with the rest of Asia. Asian countries are increasingly sending their goods to the US via China. China has a huge cost advantage in manufacturing, which would not be dented by any such adjustments.

Chinese manufacturing wages averaged less than $800 per annum in the second half of the 1990s, whereas those in the US averaged around $29,000 per annum during the same period.

The fourth argument makes some sense, but if capital controls were removed, it would create huge exchange rate uncertainties. Such changes could result in a financial market crisis like the ones that hit Mexico in 1994 and Thailand in 1997. It seems that the consensus favours revaluation, but all the arguments are only superficial and somehow mask an underlying US protectionist manifesto.

Now let's take a look at the conventional wisdom on the Chinese revaluation story and determine if this makes sense. There are a few myths.

One is that China has gained manufacturing jobs at the expense of other countries. This is not factually true. China may not have lost as many jobs in the manufacturing sector as like some other countries, but there has been no net job gain.

China's domestic restructuring has given rise to massive gains in the private sector, which has offset huge job losses in the State-owned enterprises.

It is believed that China's bilateral trade position vis-à-vis the US proves that its exchange rate is undervalued. As mentioned earlier, this is not true as the overall trade position is of a very modest surplus. Its gains against the UShave been offset by losses against other Asian countries and commodity producers.

Overall, China's trade surplus has fallen, not risen, in recent years. Currency stability has brought about some potential benefits. Chinese did not revalue when it would have benefited them during the Asian crisis.

China has averaged a growth of 9 per cent p.a. Its share of global exports has risen from 1.2 per cent to 7.3 per cent. The infant mortality rate has fallen and literacy rate has risen from 80.5 per cent to 90.9 per cent.

Another myth is that a rise in China's nominal exchange rate will permanently remove competitive imbalances.

This is also not true, as China has demonstrated during the Asian crisis that it is capable of making the necessary adjustment and remain competitive even though the relative exchange rate changes against them.

Another myth is that the renminbi's value is the only stumbling block in sorting out the world's current account imbalances. This is not true as China accounts for only 13.7 per cent of imports by the US and 4.1 per cent of exports.

Hence, even if a significant revaluation does take place, unless US domestic demand growth slows down, the US current account deficit would only begin to widen all over again.

So, if a revaluation is not a viable solution and the dollar's status as the world's reserve currency starts slipping, what alternate strategy can China adopt?

China could consider a free float that is associated with inflation or a money supply target. Another solution could be that it widens the bands and lives with some uncertainty. This may not be a good alternative, as this would aid a build-up of speculative forces.

China could also adopt a currency basket reflecting China's main trading partners.

The US trade accounts for only 17.7 per cent of China's trade. The table shows China's trade partners.

China could look at move to a peg against the euro, if commodities are increasingly priced in euro rather than dollar.

This would create a problem for Asian countries, which are pegged against the dollar. If nothing changes, this move would increase uncertainty over pricing.

Another solution could be the formation of an Asian Currency Union on the lines of Eurozone.

It is unlikely that Asian currencies would be replaced by a new single currency, but it might be easier to link all the currencies permanently to another currency.

Summary

Chinese revaluation would have very little impact on global economic imbalances. Western policy makers are just using China as an excuse.

Any proactive change in China's foreign exchange regime should be seen in light of dollar developments.

The strongest case of change in regime would come from concerns that the dollar no longer offers the best qualities as the reserve currency.

(The author is Senior Manager, Corporate Treasury Sales - Western India for HSBC. The views expressed herein are his own and not necessarily those of his employer.)

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