The thinking that a Chinese contraction engineered by higher interest rates alone, without the benefit of the deflationary effect of an appreciation of the currency would need sharper contraction and would cut imports more drastically, also worsening the current account surplus, is neither static nor simple. Chinese macroeconomic management has been typified in the past by blunt and sharp contractions in response to overheating. The activation both in terms of their effect on Chinese peoples’ welfare and wasted economic potential. And Mr Fung should take a reality check. And losing 2 (or 6) per cent of income is 2 (or 6) per cent of income (with its associated impact on employment concomitant effects on China’s partners) whether it comes off a 10 per cent or a 2 per cent growth rate.

However, if one look at what is beyond the theories for a static expansion and contraction case and work in the real dynamic world where a “contraction” may mean a fairly soft or moderate landing as opposed to an absolute reduction in output, the above argument may look a bit shaky.

What does a contraction in China mean by all intent and purpose? It should ideally be a growth from 12 to 10%. Nevertheless it is still a 10% growth, and as a result, China still will increase imports much more.

At the same time, the external demand is not necessarily growth in pace of the 10% economic growth in China, means external demand for China’s exports may actually grow much slower than its imports, even in that scenario of a contraction.

The upshot is that it is not convincing to use the simple and conventional static thinking on current account to the exchange rate policy indiscreetly. One has to consider the specific case at hand here.

I agree the world cannot afford trade or currency wars between the US and China caused by Washington inability to resolve their mismanaged economy including re-regulation of Wall Street.
However, Washington needs to become aware that its perception of reality is not shared other nation states and boundaries need to be wisely set.

The issue of “good national policy for China..” and “letting America having a win..” are concerns requiring more thought and discussions.

ECONOMIC THEORY AND CHINA

Our present Global Financial Crisis (GFC) with its US epicenter is the result of contra-factual market fundamentalism, crony capitalism and corruption.
China is successfully managing their transition into an industrial economic superpower based on experimentation and pragmatism by ignoring popular western advice.

The GFC has shifted our paradigm and the following commentaries suggest we need to re-consider our assumptions:

Get the Yuan Right, Prove Pundits Wrong
Andy Xie
http://english.caing.com/2010-04-12/100134074.html

Quote
“In the past, Wall Street forecasters have had trouble getting big calls right. Indeed, over the past two decades Wall Streeters have missed three of the biggest calls: the East Asian Miracle, the Internet Revolution, and Financial Innovation, i.e., derivatives. All three mega-trends had considerable substance. But U.S. financial markets misread implications of these trends”.
Unquote

Institute for New Economic Thinking
Founded in October 2009 with a $50 million pledge by George Soros
http://ineteconomics.org/

William White, Former Chief Economist Bank for International Settlements
Richard Koo, Chief Economist Nomura Research Institute
George Soros, Chair Soros Fund Management LLC
Joseph E. Stiglitz, Professor of Economics Columbia University

In summary
“Economic theories are a system of beliefs that the neo-liberal ideology has prejudiced US and other Western Central Bankers from being receptive to early warnings of growing bubbles etc. The Anglo-Saxon neo-liberal economic theory does not possess the insights or the mathematical models to describe the real world and some of the insights from the Austrian schools do.
US and Western Central Bankers continue to apply contra-factual neo-liberal practices in their attempts to mitigate the GFC without solving the underlying debt problem”
End Summary

LETTING AMERICA HAVING A WIN

The core US geopolitical belief system is founded on their perceived ability to create the reality and narrative for the rest of the world based on their control of International Institutions (UN, World Bank and IMF) as well as asymmetrical advantages in the Media, Financial System and Military bases and Technology.

How can we be re-assured the US will recognize they are in denial by pandering to their ill considered demands that are inappropriately motivation?

Get the Yuan Right, Prove Pundits Wrong
Andy Xie
http://english.caing.com/2010-04-12/100134074.html

Quote
“But acting on the currency first, especially in small steps, would further inflate China’s property bubble and inflation, potentially leading to a major economic crisis in two years. A small increase in the yuan’s value would fail to resolve two pressing problems: inflationary pressure at home, and political pressure from the United States. Moreover, a small appreciation would attract hot money, stoking inflationary pressure.
Imported goods’ share of consumption is too small in China for a small currency appreciation to affect the consumer price index. At the same time, a minor appreciation would fail to placate U.S. interest groups, some of whom are demanding a rise in yuan value of one-third or more. Some argue it should double in value. Indeed, a slight appreciation would merely exacerbate existing problems by emboldening U.S. supporters of a stronger yuan to demand even greater appreciation”.
Unquote