In a recent speech, Chinese Premier Wen Jiabao declared that the Chinese currency is valued fairly and more importantly that any calls to revalue its currency is hypocritical.

Jiabao is reported to have said: "We oppose countries pointing fingers at each other and even forcing a country to appreciate its currency." Implicit in his statement is the idea — fundamental to the resurgent Chinese political ethos — that the rest of the (Western) world is pursuing a collective strategy to fence China in. Whatever the truth of the conspiratorial air may be, it is clear that Chinese exchange rate policy will in the coming days become a rallying call to unite various political strands of a divided American electorate.

In the United States, where the far Right and far Left have continually hammered the idea over the past two decades that China continues to pursue a beggar-thy-neighbour exchange rate policy, the present economic climes are a godsend. In a significant turn of events, insofar as the economic policy wonks and political cognoscenti are concerned, this year's Nobel laureate and a pro-free trade guru, Paul Krugman, has upped the ante. He has called for applying a surcharge of around 25 per cent on Chinese imports.

Given Krugman's stature amongst the Left, and particularly amongst the Democrats in the US Government who seek to be seen as "doing something" in wake of staggeringly high unemployment in an election year, one should anticipate the sound and fury of protectionism to be followed up by legislative action. The rationale behind such calls for protectionism (for lack of a better word) is that China has continued to sell local currencies and buying US dollars. This results in an artificially weakened currency, which leads to cheaper Chinese exports worldwide.

To boot, the Chinese have been accumulating over $30 billion (Dh110.18 billion) per month, and as per the IMF, this will result in a more than $450 billion trade surplus this year. With serious doubts about Chinese small-bank solvency on the rise and an unemployment problem, the Chinese economic juggernaut needs to export its way out of this global slump. Even if it means that the rest of the globe may indeed slump.

Should the US decide to aggressively pursue a strategy to levy some combination of trade-distorting barriers and explicit surcharges, the oft-repeated mantra is that the Chinese would start dumping the Treasuries they hold into the open market. This would arguably crash the value of the dollar.

As apocalyptic as that scenario may be, it is useful to remember that continued depreciation of the dollar would do incalculable harm to the Chinese exchequer and its plans for stable growth over the next 30 years. Fears of inflation would increase, which would result in a rise in rates, at least at the long end of the US interest rate curve.

But the immediate impact would naturally be an onshoring of jobs back into the US. Whether that makes good economic sense or not is beside the point, but politically, nothing like a good rallying call to ‘bring the jobs back home'.


So, brinksmanship not withstanding, both governments continue to realise that pragmatism must eventually triumph. And the long run pragmatist viewpoint makes it clear that the present Chinese currency strategy is unsustainable.

The present dollar accumulation strategy continues to result in over investment in physical infrastructure, irregular and unreliable credit strategies that have led to nearly a decade of institutionalising bad behaviour.

The accumulated dollar offers little recourse against domestic disequilibrium. The last time countries accumulated foreign exchange to these levels (5-7 per cent of world GDP) were the Japanese in 1980s and the Americans in 1920s. Neither of that ended happily.

There is also a creeping idea that the US may not be as badly fenced in as the start of the crises may have implied.

The economic and political institutions that buffet US against social unrest are precisely what might allow it to disregard all prognostications of collapse. In case of China, it is less clear. And a war, over trade or Taiwan, remains infeasible. That is something Washington intends to exploit.


The columnist works for a major European investment bank in New York City. You can follow his tweets at : http//