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Solidifying a new G2: China and the United States should stabilize the yuan/dollar relationship.

Article Excerpt
Tensions between the United States and China escalated recently when the new U.S. Secretary of the Treasury, Timothy Geithner, suggested in mid-January that China might be designated as a "currency manipulator." This prompted Premier Wen Jiabao on January 29 to mount a vigorous defense of China's existing exchange rate policy at a high-level meeting of world leaders at Davos, Switzerland. Mr. Wen pledged to keep the renminbi at a "reasonable and balanced level."

There is a good economic rationale for China's wanting to keep the yuan/dollar rate stable. First, as long as the fixed rate is credible--as it was between 1995 and 2004 at 8.28 yuan per dollar--it serves as an effective monetary anchor for China's internal price level. After inflation had exploded to more than 20 percent per year in 1993-1995, the fixed rate anchor helped China regain price-level stability. Second, the big fiscal stimulus, which Premier Wen is now contemplating, would be most effective if China's exchange rate were kept stable--as it has been since last July.

MONETARY CONTROL: LOST AND THEN REGAINED

However, China bashing, that is, mainly U.S. pressure to appreciate the renminbi, had become intense by 2004. To deflect American protectionist threats, the Chinese authorities began, as of July 21, 2005, to allow the renminbi to appreciate slowly--about 6 percent per year against the dollar. But...

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