As for ChinaWatcher’s comments, let me say at the front that I do think exchange rate policy is an important part of the global imbalance problem. But I think the structural problems, especially those in China and the US, are more fundamental. Therefore, it would be much more effective attacking the problem directly, with exchange rate policy reform being a part of the reform package. Finger-pointing at renminbi (RMB) exchange rate policy is neither good politics nor good economics.

But let us first take a step back. What are the so-called “legal” rights or obligations. The IMF “laws” do not have any specific requirement with regard to exchange rate regimes, unless we are talking about something else here. Under the Bretton Wood System (BWS), all member countries were required to state par values of their currencies against gold (or effectively against US dollar) and then defend them. Obviously this was typical fixing exchange rate regime. IMF only amended its articles in 1976 to allow member countries to adopt flexible exchange rate regimes, after delinking of US dollar from gold in 1971 and most industrial countries switched to floating rates in 1973. But in the wide world today, there is no “legal” form of exchange rate. There are all sorts of exchange rate regimes, from complete fixing (dollarisation, monetary union, pegging) to complete floating, with most somewhere in between of these two extremes. They are all legal.
(POINT NUMBER ONE: PEGGING IS NOT EXACTLY ILLEGAL)

IMF article IV is about current account, NOT about capital account or exchange rate regime. China realised current account convertibility in 1996. Of course it can be debatable how rigorously China implemented its policies during the past decade or so, but it is not the key concern here. IMF ALLOW countries to adopt capital account control measures when needed, although recently it is more encouraging on free capital flows.

Many IMF staff and ex-staff have done empirical analyses trying to nail down the correlation between exchange rate regimes and current account imbalances. Their findings? Nothing whatsoever! There is no strong evidence that flexible exchange rate regime is associated with more balanced current accounts or even faster adjustment of the current account imbalances.

The issue of currency misalignment is even more controversial. There are generally three approaches applied for estimation of RMB misalignment: purchasing power parity (PPP), Behavioral Equilibrium Exchange Rate (BEER) and Fundamental Equilibrium Exchange Rate (FEER). FEER is not insightful. Essentially it is calculated from current account surplus or deficits using some import and export elasticity estimates. So by definition, if you have current account surplus, your currency is undervalued. BEER uses world average relationship between exchange rate and structural variables to infer a currency’s misalignment. Obviously if a country is not a world average, then the estimation results may be questionable. And finally PPP method looks at the actual purchasing power. Studies based on this method used to suggest 20-50% undervaluation of RMB. But since the World Bank revised down China’s PPP-based GDP by 40% a couple of years ago, the estimated undervaluation disappeared immediately.
(POINT NUMBER TWO: NOBODY KNOWS HOW MUCH RMB IS UNDERVALUED)

Of course, if the old club (such as G7) is able to engineer another “Plaza Accord” like it did to Japanese yen and European currencies more than 20 years ago, then China’s current account surplus might disappear (assuming RMB rise by 50-100 per cent within three years). But that would really hurt the Chinese economy. As an emerging market economy China will need time to prepare its system to be able to withstand large shocks like those. Like policymakers in the US or Europe, Chinese policymakers have to pay very close attention to domestic economic and political conditions as well as international factors.

But even if China successfully eliminated its current account surplus, would that reduce America’s current account deficits? Not likely. If China lost competitiveness due to sharp appreciation, other emerging economies like India, Pakistan, Bangladesh, etc, would step in to fill the vacuum. US trade and current account deficits are not likely to narrow significantly, unless it also pursues its own reform agenda, but its main partners would change. In short, US is simply not competitive enough to rebuild those consumer goods industries that are already big and competitive in the emerging world. Between mid-2005 and mid-2008, China’s RMB appreciated by 23% against the dollar and by 17% on real effective terms, both China’s surplus and America’s deficits widened during the same period. 
(POINT NUMBER THREE: MODEST RMB APPRECIATION DOES NOT GUARANTEE REDUCTION OF IMBALANCES)

I think the more fundamental solution to the problem lies in structural reforms in both surplus and deficit countries. In China, factor market liberalisation shall be critical in solving both internal and external imbalances. Exchange rate policy should be a part of the package. But the US also faces big structural reform tasks. Simply pointing fingers at the others is not going to solve America’s own imbalance problem fundamentally. Did sharp rise of Japanese yen in the late 1980s cure America’s imbalances? No. IMF made lots of mistakes during the past decades. But one biggest mistake was that it never advised the US on structural reforms. IMF spent so much time around the world advising more than 100 member countries on structural reforms. But one of the biggest structural problem slipped away under its eyes. It was a true tragedy. And now we are all in this mess.
(POINT NUMBER FOUR: STRUCTURAL REFORMS IN BOTH CHINA AND US OFFER MORE FUNDAMENTAL AND EFFECTIVE SOLUTIONS TO THE GLOBAL IMBALANCE PROBLEM)

It is Chinese leaders, not trading partners, who consistently misstate this issue. The exchange rate is the legitimate concern of trading partners. If China were a responsible trading partner it would recognize this, acknowledge its international obligations until IMF Art. 4, and take remedial steps.

The other steps that must be taken to rebalance the Chinese economy – strengthening the social safety net, investing in education, rural development, etc – are of course China’s internal choices. But exchange rates – and other subsidies to exports – can never be a matter of internal choices.

No one should be criticized for standing up for his legal rights, and no one should be excused from fulfilling his legal obligations.

If that argument is correct, then what about the different experiences of trade deficits and surplus over the last 30 years? Are the directions of the causes and effects positively related as the way Huang argues?