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Asia-PacificJuly 1 2007

The miscalculation of posturing over currency misalignment

The US and IMF’s targeting of China’s currency has as much to do with playing to the political gallery as it does with economics.
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Determining the correct value of a country’s currency based on economic fundamentals is more of an art than a science. Economists could debate about it for weeks without coming to a conclusion.

When left to markets things go even further awry. Investor perceptions can leave currencies highly over- or under-valued for years while exporters and importers struggle – or benefit – from the consequences.

All this means that if the US congress and the International Monetary Fund (IMF) intend to get tough on exchange rate misalignment, it will be hard not to conclude that their actions are based as much on politics as on economics.

The US Congress by its very nature plays to the gallery and a proposed bill to counter China’s undervalued currency by imposing tariffs on Chinese imports is the stuff of great political theatre. It will probably fail to get on the statute book as wiser counsel in the US administration prevails.

The IMF, by contrast, should be free from political considerations and while it is true that there are gross distortions in the global economy, it is unclear whether the Chinese exchange rate is the key or only a driver of the imbalances. The US’s easing of monetary policy in recent years, an artificially low interest environment until recently, low savings rates and an undervalued dollar also play their part.

This makes the IMF’s new fourth principle in relation to exchange rates – “a member should avoid exchange rate policies that result in external instability” – highly contentious.

The Chinese view has always been that they intend to revalue the renminbi gradually but that they do not like to be pushed around. A potential clash between China and the IMF augurs badly for a steady and uneventful resolution of the situation.

Then there is the question of who else should be in the firing line? China is not alone in having an undervalued currency. Should as much attention be paid to other countries in the same situation or to nations such as New Zealand, which recently intervened to try and devalue its currency.

The IMF stance raises more questions than answers.

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Read more about:  Analysis & opinion , Asia-Pacific , China , Comment , Americas , US