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Peterson Institute for International Economics

We Can Fight Fire with Fire on the Renminbi

Op-ed in the Financial Times October 4, 2010

© Financial Times

China continues to manipulate the renminbi to the extent that it is now undervalued by at least 20 percent. Japan has resumed intervention on a massive scale to lower the yen. Switzerland recently spent more than $100 billion to keep its franc from rising. All these countries, and a number of others, already run large trade surpluses and hold huge reserves but nevertheless want to weaken their exchange rates to boost growth through exports.

Now some deficit countries, notably Brazil, feel compelled to emulate these interventions to defend their competitive positions, even though they too already hold large reserves. Virtually all economies, including the European Union and the United States are seeking to avoid stronger exchange rates. In short, the competitive undervaluation of China is infecting the entire global economy.

This exposes a glaring gap in today’s international monetary system: the absence of effective discipline on surplus countries. All adjustment pressures fall on those with deficits—resulting in an inherent deflationary bias that is especially acute during global slowdowns. The International Monetary Fund (IMF) was set up to stop the competitive devaluations that deepened the Great Depression, but it has never been given the tools to do so.

The United States suffers especially from this shortcoming. Other countries can set the dollar exchange rate, by intervening to hold its price up and their own currencies down, as China has done by buying a daily average of $1 billion for the past five years. IMF guidelines call on member countries to take into account the “interests of other members, including those of the countries in whose currencies they intervene,” but there is no indication that those intervening ever do. Europe will increasingly face a similar problem with greater international use of the euro, while Japan already complains about China’s operations in yen.

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Originally published at the Peterson Institute for International Economics.© 2009 Peterson Institute for International Economics.

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