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The Latest on the Renminbi

Paul Krugman has an excellent economic analysis of the inflationary pressure that the cheap renminbi is creating in China, followed by what I think is a flawed political analysis:

So where’s China? It’s clearly in the lower zone: a trade surplus at levels that is raising international tension, plus inflation. It’s actually not clear which way domestic demand should do — but renminbi appreciation is clearly indicated, for China’s own sake, not just to head off the outraged reactions of the rest of the world.

There are obviously political considerations keeping the Chinese from doing the right thing. But with a little encouragement — say, a Treasury report saying that yes, they do manipulate their currency — things might happen.

I think that’s backwards. You don’t need a Nobel Prize to figure out that a degree of renminbi appreciation would keep a lid on inflation and is probably what the doctor ordered. But a Treasury report demanding that China revalue its currency is going make the “political considerations” worse, not better. The leaders of self-respecting great powers don’t like to be seen as getting bossed around by other great powers’ Treasury departments. If Tim Geithner has some reason to believe that the Chinese genuinely don’t understand the currency/inflation nexus (which I doubt) he can always have Lael Brainard explain it to them quietly (Congress could even speed this process by approving her long-delayed nomination to be Undersecretary of Treasury for International Affairs).

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Meanwhile, if you ask me this inflation tends to vindicate China’s earlier much-complained-about currency policy. Keeping the renminbi cheap was a form of monetary stimulus that kept the economy growing throughout a global downturn. Now that Western demand is increasing again and China’s exports are rising rapidly you’re starting to see some inflation, which is precisely what happens as you come to the end of a successful stimulus cycle. Now it’s time for policymakers to start backing off from these measures.