Should China Revalue its Currency? Lessons from the Japanese Experience

There is a similarity of pattern between the present international pressures for RMB revaluation and those which were exerted on Japan in the ‘80s for the Yen revaluation. This paper aims at clarifying certain issues of the RMB revaluation debate in the light of Japan’s experience. Two lessons may be drawn from this experience. First the massive revaluation of the Yen against the USD after the 1985 Plaza Agreement did not reduce the US trade deficit, as Japan’s competitiveness was due primarily to the technological quality of its products. The second lesson is that the steep and massive revaluation of the Yen had devastating effects on the Japanese economy, which went through the “lost decade” during the ‘90s.

Mutatis mutandis, these lessons may apply today in the case of China. Its currency is indeed undervalued, possibly by 20-25% on a REER basis. However a revaluation of the RMB of such size would not reduce US and European trade deficits as much as expected, because China’s competitiveness is primarily due to its very low cost of labor. Furthermore, the appreciation should be gradual, although sustained, in order to avoid major economic disruptions. But a steady appreciation of the RMB would be in China’s best interest, all the more as it has presently to adjust its model of development.