The other side of the coin

Yuan: Some US congressmen want to slap duties on Chinese goods unless Beijing revalues the yuan. Yet China's premier Wen Jiabao insists the currency isn’t cheap. Goldman Sachs also thinks the yuan may be fairly valued. The argument that the renminbi may be less undervalued than it appears is persuasive. The yuan has a fair value of 6.86 to the dollar, according to Goldman’s chief economist, Jim O'Neill. That would make it 0.4 per cent overvalued. That view pits Goldman against the International Monetary Fund, the World Bank, and the oft-cited Peterson Institute, which claims the yuan is undervalued by as much as 40 per cent.

Economists endlessly debate the “correct” way to value currencies. Goldman's method looks at relative prices and per-capita income, and accounts for factors such as rising productivity.

The other camp starts from an ideal world where countries have balanced current accounts and optimal levels of employment, and then works backwards to see what the value of the currency should be. The evidence on the ground suggests people are getting less bang for their yuan. A Starbucks grande latte costs $3.75 in the United States but $4.10 in China in dollar terms. A movie ticket goes for $10 in Shanghai, versus $12.50 in New York for a comparable seat at the same film. One flaw in the argument that the yuan is undervalued is that it may assume that countries should all have balanced trade and capital accounts. Moreover, it assumes that if that isn't the case, the exchange rate must be to blame. Yet free-floating currencies are no panacea. Japan still ran a current account surplus even after revaluing in the 1980s.

The best test of whether the yuan is fairly valued would be to leave it to float. But that won't happen soon.

Chinese policy makers are fearful that unpegging the currency would lead to damaging fluctuations. They see a stable currency as protection for China’s underdeveloped financial system. In the meantime, a revaluation may do less than US politicians think to help rebalance trade and boost jobs. China’s trade surplus widened even as the yuan appreciated 20 per cent in 2005-8. The revaluation lobby is loud, but its case is far from conclusive.