Some in the United States believe that letting the Chinese yuan find its true value in the foreign exchange market will deliver a quick boon to America’s economy. Perhaps. But there’s reason for doubt.

Embedded in the optimists’ notion is the presumption that the yuan is undervalued by way of Beijing’s “manipulations,” otherwise known as a peg of one dollar to 8.28 yuan that’s prevailed since 1995. Opening up this corner of forex to the light of free trade will satisfy certain members of Congress and more than a few industries that have previously taken it on the chin in competing with the Middle Kingdom. We’re all for free trade and fair prices, to the extent forex can actually deliver on such promises, but one should always go into such constructs with eyes wide open.
That starts with recognizing that there may be a few downsides looming in a sudden upward revaluation of the yuan, at least from the perspective of the U.S. Consider the possibility that if this currency strategy comes to fruition, a result may be that one of the main sources of U.S. imports these days will effectively raise its prices by strengthening its currency. Given the Federal Reserve’s growing concern with inflation, one might reasonably wonder if revaluing the yuan upward, under pressure from the U.S. government, and thereby adding that much more pressure to already rising import prices passes the smell test as enlightened economic policy at this juncture.
Enlightened or not, the powers that be in Washington want a stronger yuan. Reuters reports that the U.S. Treasury seems to be moving China’s central bank forward in terms of favorably reviewing a revaluation scheme. A meeting between Chinese officials and the representatives from Treasury is the catalyst for such thinking in the latest news cycle. “[The Chinese] have made continuous, steady progress on the necessary reforms to introduce flexibility,” Treasury spokesman Tony Fratto said today. “They’ve made continued progress on their ability to do that. Along that continuum they’ve made sufficient progress to introduce flexibility now. And yes, this meeting furthered that.”
Treasury Secretary John Snow weighed in on the subject as well, advising, “I don’t have a timetable for it, but I’m encouraged that the Chinese have made enormous strides to put in place improvements to their financial system that will” pave the way for the yuan to become more flexible, Snow said, according to Bloomberg News.
Sounds like they’re reading from a talking points memo. But whether the comments are inspired or not, the philosophical assumptions for thinking that a floating yuan is a short-cut to curing America’s various macroeconomic ills is misguided. Or so asserts Steven Hanke, a professor at Johns Hopkins University and a longtime observer of forex, in an op-ed piece in today’s Wall Street Journal. Similar currency schemes were tried with the Japanese yen in the 1980s, and with little to show for it, Hanke advises along with his co-author Michael Connolly, a professor at the University of Miami.
“The clamor for a yuan revaluation is loud. At one time or another, everyone from President Bush to the G-7 has had a hand in the noisemaking,” Hanke and Connolly write. “But the yuan quick fix might just be neat, plausible and wrong.” What’s more, killing the peg probably wouldn’t shrink the U.S. trade deficit, they warn, the true motivation for trying to get China to revalue. “After a yuan revaluation, the U.S. demand for foreign goods would simply be shifted from China to other countries.”
Free markets, in short, can be a double-edged sword. Perhaps someone should tell the folks in Treasury, and the U.S. Congress.