I want to make two quick comments other than saying thanks for sharing your insights.

First, I have to admit that citing the export share of GDP is not exactly a scientific approach, as Guy de Jonquieres pointed out. This, however, is a common measure for openness in trade and policy literature. While exports are not all value-added, its share of GDP does show the degree at which the economy is exposed to the outside world.

Second, I always admire Don Hanna’s calm analysis, even at crisis times. I take everything said on why China should appreciate the currency, which is the case I always make in China whenever possible. However, I think wars or trade wars happen often not as a result of calculation by rational people. I am sure Chinese officials are considering all options. But if the Treasury names China a currency manipulator and the Obama administration starts some sort of protectionism measures, I don’t think the Chinese officials have much of a choice. This is why I think Krugman’s comments are not helpful (though his suggestion that renminbi should appreciation is valid).

As we all know perfectly well, future developments will be dependent on politics as much as on economics. I am sure the officials at the PBOC and Treasury share some common analyses of the issue. But politics is simply beyond their control on both sides of the Pacific.

Enjoy debating!

1. The US external deficit, is the US having external trade deficit with China? Or is China the largest and for how long it has been as the largest?

2. If China is currency manipulator then it must have devalued its currency against the $US which its currency pegs into. Has China devalued its currency in recent years? Against the $US?

3. Isn’t the US a currency manipulator? Haven’t we often heard the US authorities say or have said that they want or wanted strong or weak $US? What do they mean or have they meant? Not a currency manipulator?

4. PPP and currency valuation: it is a general knowledge that most developing countries’ GDP is higher in PPP, as opposed to their market currency. Does it mean their currency is undervalued in market terms?

5. The US has been blaming others for its external deficits, that is because they trade with others. Who should it blame for its out of control budget deficits?

6. Why balances, as opposed to imbalances should be the norm? Just think about savings and borrowings, consumptions and investments, why should any unit except the world as a whole be always balanced at all time? Is that good or bad for the living standards and welfares of the world?

7. Why does the US argues for free trade sometimes and say a different thing some other times? Isn’t it political economy at the world scale?

8. Why has the US had the lowest and sometimes negative saving rate? Did any other countries force it to do that? Whose fault is it?

I welcome the comments by Don Hanna. He notes the need to find an intelligent way out of the policy problem. It in NOT a prisoner’s dilemma (which has some quite specific characteristics that do not apply here). Communications and rationality do provide a way out along the lines Hanna suggests, provided national pride is not given undue weight in the calculations of costs and benefits.

I also agree with Guy de Jonquieres about the limited effect of exchange rates on the price of exports with a high import content.

When I heard or read about Krugman’s talking about the Chinese currency versus the $US, I have always been reminded by a remark by Frank Milne (hope it is correct) once at his lecture of microeconomics at the graduate/masters level: economic policies can kill at a mass scale – look at what happened in China during the great leap forward and how many people died as a consequence!

Now Krugman, a winner of the Nobel Prize in Economics, is making his prescriptions to real economic problems and doing his economic advices to the US and possibly to some others.

It will be interesting to anticipate what his advices will result in, even for the Americans whom he tries or intends or has said or is said to help.

If that’s the case, the argument for reaching an accommodation on the issue so as to safeguard a broader relationship is huge. Nationalismis is intolerant and irrational. If it comes to dominate discussions, China, the US and the world will suffer.

Of course there are myriad reasons for the persistence of China’s trade surplus, and, yes, US manufacturing jobs were lost for reasons that go beyond the nominal value of the yuan. But, neither of these conditions is an argument for maintaining a fixed exchange rate. They simply imply that the consequences of altering the exchange rate will be lower than some assume.

There are two reasons for China to return to the limited fx flexibility it adopted in 2005. The first is internal, the second external.

As Krugman points out, China has both a trade surplus (yes, a smaller one than in 2008, but one that is forecast to grow as a share of GDP this year) and rising inflation (by my calculations inflation is running above the newly announced 3% target for this year). Why? Because real demand is rising too rapidly–11% in Q4 according to the People’s Bank, a rate that exceeds the estimates of sustainable growth for China I’m aware of. And because the real exchange rate, inclusive of factor price and structural distortions is undervalued.

China has a choice–allow the higher inflation to erode both the real exchange rate and real demand–or appreciate the nominal exchange rate and tighten fiscal and monetary policy. It’s already doing the latter two. Why not the first?

The failure to allow some of the real exchange rate adjustment to come through the nominal exchange rate looks lamentable in the face of the second reason for acting: the growing chorus of calls for adjustment coming from trading partners. Some of those calls would still were China to step back a bit from its de facto exchange rate peg.

Paul Krugman is calling for the US to name China a manipulator to force up the costs to China of maintaining that peg. He says explicitly that he sees the chances of a trade war as low. Yiping Huang’s response is that China will retaliate by becoming more recalcitrant. That doesn’t fit well into a cool assessment of costs and benefits. It smacks of petulant nationalismon China’s part.

Or of clever gamesmanship. Threatening to do something that is against your own interests–as perpetuating a trade war with a country with which you have a trade surplus clearly is–only makes sense if the other side views you as sufficiently irrational so as to actually carry out your threat.

But isn’t a trade war a cost to the US, too, and, therefore, not a credible threat unless the US, too, is irrational? Not, if officials believe that on the margin China’s threat to dump US Treasuries is blunted by the liquidity trap and that the surfeit of underutilized resources in the US will allow domestic production to substitute more easily for Chinese imports than would be the case in normal times.

So for China, the obvious question is why risk all this external opprobrium when domestic conditions warrant a change? Why not step back a bit from the exchange rate, putting more of it’s movement in the markets hands?

Nationalists on both sides of the Pacific would then have to blame the exchange rate on the market. One thing about the market, though, it’s not prideful or nationalistic!

That said, I am doubtful that a 40 per cent revaluation would be anything like as damaging to China’s exports and growth as Yiping Huang suggests. Exports do not, as he states, account for a third of China’s GDP. This is a common misconception that arises from comparing apples with pears. Exports are gross sales; GDP is value-added.

In 2007, their peak year, exports’ true contribution was probably around 18 per cent of GDP and 20-25 per cent of growth. That is because so many of China’s exports are still “processing trade” and involve the final assembly of imported components into finished products. The local value-added from such activity is often very low, particularly in electronics products, one of the fastest-growing export sectors, where it is as little as 15 per cent. As a result, much or most of the impact of a revaluation on export prices would be offset by a decline in import prices in local currency terms. Furthermore, Chinese manufacturing has exhibited impressive sustained productivity gains, which are likely further to soften the impact of a revaluation.

In reality, exports and the exchange rate are not primarily an economic issue in China: they are much more a political one. They generate a lot of jobs in prosperous and politically powerful coastal provinces which have strong voices in Beijing and are obviously keen to avoid any threat to their well-being. That is what the increasingly obvious in-fighting about the exchange rate is really about.

Finally, casting the debate purely in terms of revaluation is missing the main point. What really matters, or should matter, is not the “correct” level of the exchange rate (which is anyone’s guess); It is the cumbersome mechanism used to maintain it, which involves massive intervention at huge cost to the economy and the financial system. For an admirably clear explanation, see Nick Lardy’s paper on financial repression in China, available on the PIIE website. That is what China’s foreign critics should have in their sights.