http://www.indianexpress.com/news/exchanging-rates/699884/0 MK VENU Wed Oct 20 2010, Economist Jagdish Bhagwati, a professor at Columbia University who is known for his passionate advocacy of free trade, has advised India not to join Americaâ€™s â€œChina bashingâ€ over the â€œhavoc wreaked by an undervalued yuanâ€. US President Barack Obama, of late, has stepped up the attack on China for â€œhurtingâ€ large parts of the global economy with a much cheaper currency which makes China by far the most competitive seller of goods in the world. With the US unemployment problem far from abating, Obama has vowed he is going to â€œprotect the US economic interests and we look for the Chinese to take actions. If the Chinese donâ€™t take action we have other means of protecting the US interestâ€. The â€œother meansâ€ threatened to tame the Chinese include special complaints at the WTO and some legally mandated trade sanctions to prevent China from exporting to America. The Economist describes this as a â€œphoney warâ€ which may or may not degenerate into a real â€œdog fightâ€. Americaâ€™s threats are possibly aimed at externalising a problem which is fundamentally internal. Besides, the deep US-China trade and economic engagement is part of a strategic embrace between the two which dates back a few decades. It has had its own unique and complex trajectory. So Bhagwati is right when he says India should not blindly join Americaâ€™s campaign against Chinaâ€™s undervalued currency. This has largely been a bilateral issue between the two countries as China traditionally built the bulk of its forex surpluses by exporting to the US. This has essentially been a happy marriage of Americaâ€™s over-consumption and Chinaâ€™s over-investment. The marriage is evidently turning a bit nasty now, at a time when the world economy is struggling to fully recover from the ravages caused by the 2008 financial meltdown. However, Bhagwati argues, America is now trying to multilateralise what was essentially a bilateral issue. Recently, Chinese Premier Wen Jiabao urged EU nations not to join Americaâ€™s chorus against the yuan. Like Bhagwati, Wen has also claimed that the reasons for Chinaâ€™s growing trade surplus with the US cannot be entirely blamed on a cheap yuan. To buttress his argument, he said the yuan had appreciated 22 per cent against the dollar since 2005 and yet during this period Chinaâ€™s surplus grew by a big margin. Besides, during this period China accumulated a surplus in trade with the US and EU but ran deficits with Japan, South Korea and Asean nations. So the question Wen is implicitly asking is, how are countries like Japan and South Korea earning surpluses by exporting to China? Why canâ€™t the US do the same? He then concludes that the real issue is not the exchange rate asymmetry as much as structural changes in trade patterns caused by the rapid economic globalisation in the past decade-and-a-half, especially after trade barriers were dropped drastically following the Uruguay round of negotiations in the mid-â€™90s. China reaped a huge comparative advantage, especially since 1994, in the export of goods. No wonder it runs big surpluses with the West in goods but has deficits in services. Clearly, the opening up of global merchandise trade helped China a lot more than it did other economies like India. An undervalued yuan might have acted as a top-up bonus to what was essentially a structural advantage China got. India, in sharp contrast, runs a huge surplus in services trade even though no firm agreement has been signed at the WTO on services yet. Now just imagine the bonanza India might have had if there were a comprehensive multilateral agreement on services. The structure of global trade and the surpluses/ deficits between economies would have been of a different nature if services were as open as merchandise trade. So India need not have the same problem as the US when it comes to dealing with an undervalued yuan. The RBI governor is right when he says India will get pressured to manage its own currency if China does not let the market forces decide the movement in the yuan. As a general proposition, the G-20 or some other forum must create a common currency governance system which China is also mandated to follow. But it would be a mistake to suggest that much of the distortion in the global economy is attributable to an undervalued yuan. Top scholars such as Nobel Laureate Robert Mundell of Columbia and Ronald McKinnon of Stanford have also said the Chinese current account surplus and US current account deficit cannot be explained primarily by an undervalued yuan. At best it is one of the factors that explain the burgeoning US current account deficit. Besides, other countries such as Germany and Japan too have consistently run current account surpluses with the US. An economist at the Berlin University told me some time ago that Germany had consistently kept its wages deflated to gain a big trade advantage with other nations. Real wages in organised manufacturing have hardly moved in recent years in Germany. This is a sort of substitute for undervaluing a currency and gaining a cost advantage in relation to other trading partners. Japan too has historically, especially after the Plaza Accord in 1985, kept appreciating its currency and yet continued to post big trade surpluses against the US. Even now, the Japanese currency is at a 15-year high against the dollar and yet Japan doesnâ€™t seem like losing its competitive edge against other big trade partners. So the US may be barking up the wrong tree in drumming up global opposition to Chinaâ€™s undervalued currency. And worse, the American officialdom may be privately aware that it is making out an excessive case against China. India has to particularly guard against this. For at a subsequent stage the Americans may well do some other complex deal with the Chinese which would neatly fit into their love-hate relationship matrix. Other emerging economies who echo Americaâ€™s rhetoric may then be left carrying the can. India cannot afford this because, in the decade ahead, China will become the primary absorber of world imports, like America was in the second half of the 20th century. India will do well to remember that opportunity. The writer is Managing Editor, â€˜The Financial Expressâ€™ [email protected] [email protected] second america as economic problem are because of its internal conditions and Chinese devalued currency only plays little part in it ? is it?