After Mitt Romney put the issue of Chinese currency manipulation into the Presidential race, economists and analysts rushed to explain that such manipulation isn’t happening, and anyway Romney is dishonest, and his policies, if carried out, would start a trade war. I responded that, even if you accept that China has stopped manipulating their currency, plenty of research shows that other countries have more than picked up the slack, and that this can be easily combated by the kind of penalties available in the currency manipulation bill that passed the Senate which everyone assumed targeted only China.

However, Josh Bivens of the Economic Policy Institute took a look at the data and found that even the assumption that China stopped its manipulation needs to be re-thought:

So, have the artificial capital exports from China continued? …the latest Treasury report on foreign exchange rates indicates that China’s total reserve accumulation (i.e., their capital export) has proceeded strongly through the first quarter of 2012 [...]

Krugman also notes that this real appreciation of the yuan has been mostly spurred by higher Chinese inflation and points to the falling Chinese current account surplus as evidence that this real appreciation is doing its job.

The key question, however, is how durable this will all be. My guess is not very. The higher Chinese inflation has already greatly moderated, and was largely driven by commodity (and housing) price inflation as well as the big increase in domestic investment as China passed its own stimulus package in response to the Great Recession.

Bivens adds that China’s current account surplus came from the refraction of economic troubles in other countries, not a dedicated policy of its own. “The fundamental forces that were driving large imbalances between China (in particular) and the U.S. economy (an undervalued yuan especially) are quite possibly still there,” Bivens writes, arguing that a US recovery would bring them back into play, and show the need for what he calls currency management.

It seems to me you can accomplish this in a few different ways. You can engage in the kind of monetary policies that would lower the value of the dollar to boost US exports. You can engage in fiscal policies to promote full employment, at which point China’s policies that boost their domestic industries and strip the US of manufacturing jobs become less of a bother. Or you can recognize the importance of lowering our trade deficit, without which we will simply have to either increase public or private debt to finance a recovery. And ending the over-valuation of the dollar, the critical piece of this puzzle, can be aided through tariff policy, making manipulation by China and other countries less attractive. We’re already in a trade war, and the rest of the world is winning. It would be nice if we brought some artillery.