Chapter 7: Why Revaluation of the Yuan will not Work
INTRODUCTION The controversy over the US trade deficit with China has become ideological and has turned ugly. In particular there is a heated debate about whether or not revaluation of the yuan will work, in the sense that it will eliminate or at least reduce the US trade deficit with China. For example, a Nobel Prize winner, Joseph Stiglitz, thinks that revaluation will not work but another Nobel Prize winner, Paul Krugman, says that it will. Robert Mundell, a Nobel Prize winner himself, agrees with Stiglitz by arguing that “there’s no evidence that exchange rates correspond with trade balances” and that “the US arguments in this regard are intellectually weak” (Dukes, 2005). Fatas (2010) casts a big shadow of doubt on Krugman’s argument that trade imbalances cannot be corrected without an exchange rate change, as he (Krugman) “almost implies that current account imbalances are always the result of exchange rate misalignments”, which is such an extreme position. Fatas argues that while the current account may react to changes in the exchange rate, changes in saving and investment (which is what matters for the current account) are driven by many other factors. Krugman’s argument is that an increase in Chinese consumption will not reduce China’s current account surplus unless this consumption translates into imports, and for this to happen “we need a relative price change”. Fatas puts forward the view that “the Chinese will have to get used to consume more, Americans will need to understand that they need to save...
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