First the President tells China that it is holding a bunch of worthless IOUs …

And now he tells China it really should revalue, in far stronger language than the US (or the G-7) has used before.

It seems like Tim Adams, the incoming Treasury Under Secretary for International Affairs, plans to get tough on China. Adams reportedly thinks that China has not rewarded Bush for keeping the rhetorical heat on China down during the campaign ...

I’ll be watching to see if China fires a few rhetorical salvos back.

If I were part of the Bush Administration’s economic high command, though, I would worry that China might take the hint. If China revalued (really revalued) and its reserve accumulation slowed, the US might find it a bit harder to find buyers for all the IOUs the Treasury is churning out, even as US "soft patch" could widen the US deficit. And there might not be quite so much demand for Agency debt/ mortgage backed securities either.The case for a revaluation of the renminbi, incidentally, is quite strong.

The argument that China runs bilateral surpluses with many countries other than the US (and the EU) is a red herring. China’s overall trade and current account surplus is now large in relation to China’s GDP, and it is rising.

China’s current account surplus has risen steadily from 1.5% of its GDP in 2001 to 4.5% of its GDP in 2004. Right now, Jon Anderson of UBS estimates China’s seasonally adjusted monthly trade surplus is around $9 billion: he is forecasting a 2005 Chinese current account surplus of $145 billion, or 8.5% of China’s GDP. If nothing changes, China’s 2005 current account surplus will be comparable in size (relative to its GDP) to the US current account deficit.

Bert Keidel’s argument that the real problem is Europe is wrong (link via Dan Drezner): the Eurozone’s 2005 current account surplus, $50 billion according to the IMF, is expected to be smaller than China’s surplus. That is not to say that Europe could not do more to help bring about global rebalancing. It clearly could, but it is also important to recognize that by letting its exchange rate appreciate, it has been doing something.

Add in Europe’s other current account surplus countries (The Nordics, Switzerland) and its deficit countries/ regions (the UK and Eastern Europe), and "Europe" writ large runs a current account surplus of only about $55 billion. Take out the $46 billion surplus of oil exporter Norway and "Europe" writ large is roughly in balance.

The big surplus regions right now are Japan, the oil exporters (The IMF expects the Middle east, Russia and Central Asia to have a surplus of $252 billion), China (which will have a surplus of at least $100 billion, and probably more) and the Asian NICs (the IMF estimates they will have a 2005 current account surplus of $92 billion). Add up the surpluses of China, the Asian NICs and dollar-pegger Malaysia (roughly $10 billion) and you get a sum almost equal to the projected current account surplus of the main oil exporting regions.

Moreover, there seems to be pretty good evidence that the value of the renminbi does have an impact on China’s export growth.

Consider this:

From 1996 to 2001, China’s real exchange rate rose from 86 to 101, and its exports almost doubled, going from $174 billion to $301 billion.

From 2001 to 2004, China’s real exchange rate fell from 101 to around 90. China’s export growth accelerated: China’s export grew by 35% in 2003, 35% in 2004, and, according to the latest (March) data, are increasing by 33% y/y in 2005.

China’s exports are on track to more than triple between 2001 and 2006: rising from $310 billion to $1030 billion (China’s end 2004 exports were around $740 billion). That’s a much bigger increase than the increase in the five years that preceded 2001, when the renminbi generally was appreciating along with the dollar.

That forecast, by the way, assumes that China’s pace of export growth SLOWS significantly during 2005 and 2006. If China’s exports continue to increase by $200 billion a year, they would reach $1150 billion in 2006. Compare that number with 2004 US exports ($1146 billion). It is an enormous sum.

The fall in the dollar has not done wonders for US export growth, but it sure has had an impact on China.

A very large hedge fund (oops -- a well-respected investment bank) used more formal econometric techniques to arrive at the same conclusion. A recent Goldman study indicates that even a 10% rise in the renminbi’s real value would cut the growth in China’s exports by 15%.

That has to happen at some stage: China is too big for its exports to keep growing at a 30% plus annual rate. And if a Chinese move made it a bit harder for the US to finance its deficits at current rates, that just might provide some of the impetus the US needs to start putting its own house in order ...