Unfortunately, policy adjustments in the following months reinforced impressions in the opposite direction. On June 13, the US Congress announced a bill to promote renminbi appreciation. And on June 26-27, the G20 leaders held a summit in Toronto, Canada. There was widespread expectation that leaders of other countries would exert pressures on China to appreciate its currency at the summit. And then on June 19, PBOC rushed to announce its decision to increase exchange rate flexibility.

In the following three months, however, renminbi exchange rate did not show any clear sign of appreciation. It appreciated by less than 0.5 per cent between June 19 and September 8. It is understandable that international pressures rose again in recent weeks. Larry Summers, chairman of the US National Economic Council visited Beijing, from September 8. One question he brought with him to China was probably why had the renminbi not appreciated more significantly? The US Congress scheduled a hearing on the same subject on September 15. And then the renminbi started to appreciate rapidly from September 10.

Taking a positive perspective, policymakers willingness to adjust the policy in order to avoid a worst-case scenario is encouraging. But the timing of the adjustment is really problematic. After the stabilisation of global financial risks, it was a consensus view that 2010 would be a year of trade protectionism. The schedules of the G20 summit and the US Congress were hardly a secret. If policymaking had been forward-looking, China didn’t need to wait until the last minute to adjust its policy.

There were probably two reasons why the renminbi didn’t appreciate more rapidly earlier on. First, the risk of a double dip for the global economy increased in the wake of European sovereign debt crisis. And, second, domestic opposition to currency appreciation from the export sector was very strong, especially because it was linked to potential job losses. But this last point was significantly overstated. One department of the Chinese government did a stress test at the beginning of the year and concluded that greater than 3 per cent appreciation of renminbi could destroy the export sector and cause widespread job losses. This was simply not consistent with China’s own experience, especially that during 2005-2008 when renminbi appreciated by an average of 7 per cent a year.

Currency adjustment could be postponed no further. First, the structural imbalance problem has become worse. For the past seven years the government has been trying to rebalance the economy and improve the quality of growth. But it has achieved little. The principal reason is because the government relied mainly on administrative measures, not changes to the incentive structure. Distortions to factor prices, including distortion in the exchange rate, were fundamental causes of the imbalance problem, including too many exports and an underdeveloped service sector. Second, the declining effectiveness of capital account controls is affecting independence of the monetary policy. Increased exchange rate flexibility is critical for regaining independent monetary policy. And, third, without the proper adjustment of the exchange rate policy, the risk of a trade war has become imminent, and that could potentially damage the Chinese economy.

The US and China are now the world’s two largest economies. Policy games between them are likely to become a common phenomenon. Certainly China does not need to let itself be pushed around by the US. But at times compromise is important, and is also the best way of protecting our own economic interest. We should make every effort to robustly refute some of the Amercian accusations. But it is equally important that Chinese policymakers have, as their reference point, a general equilibrium framework, not hijacked by particular interest groups, and also a forward-looking perspective. If the Chinese government always responds at the last minute, it certainly will not help with its image among its own people. It would also not help in the next round of policy games with the US and other countries.

Yiping Huang is professor of economics at the China Center for Economic Research at Peking University and in the Crawford School of Economics and Government in the Australian National University.