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China's Export Engine

According to McKinnon, a substantial rise in the yuan would lead to a fall in China's exports but would damage the Chinese economy so severely that the nation's demand for foreign goods would plunge as well, the result being no net shrinkage in the trade imbalance. That, McKinnon points out, is what happened with Japan in the last decade when it bowed to U.S. insistence on a rise in the value of the Japanese yen.

In recent months, a new issue has dominated the debate -- the risk that China's economy has overheated. Policymakers in Beijing are concerned that a boom in such fast-growing sectors as autos and real estate is leading to construction of more factories and office parks than China can use. The upshot could be a bust that would wreck the banking system.

Some economists assert that a higher yuan is precisely the right medicine. According to this theory, that would slow exports, limiting the buildup of China's foreign reserves and slowing the flow of funds into banks whose lending is fueling investment.

The Beijing government remains divided over how quickly to move, with the central bank urging a faster appreciation to prevent overheating and other ministries lobbying for little change.

Chinese exporters are vocal in opposing a rise in the currency. At the Shanghai Datong plant, Jin, the manufacturing supervisor, was asked recently what would happen if the yuan were to rise by 10 percent or so. He looked pained. "We couldn't afford that," he said.

Analysts say China's powerful State Council is striving to maintain a middle position, the most likely outcome being a rise in the yuan of perhaps 3 to 5 percent a year over the next two years.

"The consequences are so great that ultimately nobody can make a decision," said Mao Yushi, chairman of the Unirule Institute of Economics in Beijing. "Everyone knows the [yuan] must appreciate now, but no one has the courage to make it happen."

Blustein reported from Washington.


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