“The U.S. financial crisis, through lower U.S. demand and a weakened dollar, will eventually force the rest of the world to go through painful adjustments.”

KOBAYASHI Keiichiro from RIETI (Japan)

Decreasing tax revenue and the use of public funds will result in a significant expansion of the U.S. fiscal deficit, thereby causing the dollar to depreciate at a much faster pace than expected. Then, other countries would come under growing pressure to expand domestic demand and upwardly revalue their own currencies. Particularly problematic will be the impact on the Chinese economy. As its economy and the dollar weaken, the U.S. will step up pressure on China to revaluate the RMB, which would force the Chinese economy to go through extremely painful structural adjustments.

Should China continue with revaluing the RMB at its current moderate pace, the resulting effect would be similar to that of pegging to the dollar. That is, as it is dragged down by the easing of U.S. monetary policy, China would be forced to ease its own monetary policy to the extent it would thereby spur inflation in China. The young and the poor are always the hardest hit by inflation. Should inflation escalate further in China, it could give rise to serious political and security problems such as disruption of public safety, ethnic violence, and terrorism. These can be defined as enormous costs resulting from delaying RMB revaluation.

On the other hand, what if China accelerates the pace of RMB revaluation? This would boost its people’s dollar-denominated purchasing power. However, Chinese exports would shrink sharply and the current growth pattern of the Chinese economy, i.e., growth led by exports and capital investments, would become unsustainable. It is highly likely that the Chinese economy, albeit temporarily, would fall into a very acute depression similar, but of greater magnitude, to the “high-yen” recession experienced by Japan in the 1980s. This too, would cause significant disruptions in Chinese society. China may be forced to make a stark choice between either pegging to the dollar or accelerating RMB revaluation. The Chinese economy will face a painful ordeal regardless of which choice is made – high inflation as a result of pegging to the dollar, or acute depression caused by accelerating RMB revaluation.

See full text.