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I have attached the link to this article. I believe the problem
holds the solution to China's currency confrontation with US. Remember
President Hu will be in Washington for a state visit in January.

Michael
http://www.ft.com/cms/s/0/be402a42-f0db-11df-bf4b-00144feab49a.html#axzz15SIPvO7P
Revaluation pressures on emerging markets

By Stefan Wagstyl
Published: November 15 2010 17:29 | Last updated: November 15 2010 17:29
Inflation is so far away from the economic priorities of developed
countries that it has been easy to underestimate the growing price
worries of emerging economies. But a sharp sell-off in emerging market
equities – triggered by last week’s Chinese inflation data – is a
reminder that prices need watching – and in some countries require
urgent policy action.

The 4.4 per cent year-on-year increase in consumer prices announced by
Beijing is the highest for two years and exceeds the authorities’ 3
per cent comfort level.

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In the other Bric countries inflation is even higher – 8.6 per cent in
India, 7.5 per cent in Russia and 5.2 per cent in Brazil. Elsewhere,
it is 10 per cent in Ukraine and 25 per cent in Venezuela.

As often with inflation, it is the poor, spending a big proportion of
their income on food, who feel the most pain. Food inflation is 10.1
per cent in China, 15.7 per cent in India and 16.1 per cent in Turkey.
These are numbers that politicians ignore at their peril.

A big contribution to inflation, particularly for food, comes from the
commodity price boom. While this has been aggravated by speculative
investments, the driver is a global resources hunger that can be
addressed only by expanding production.

Unfortunately, potential investors in agriculture will not be
encouraged by growing protectionist pressures, which make early farm
trade liberalisation unlikely.

But there are other actions emerging market policymakers can take to
counter inflation.

First, they can stick tightly to the prudent fiscal policies that most
are following. And those that have allowed budget discipline to slip
should continue making cuts: Malaysia for example, where the fiscal
deficit this year is 5.6 per cent of GDP.

Next, credit growth needs to be controlled but not so tightly as to
choke growth. This is China’s dilemma. Having boosted the economy in
the 2008-09 crisis through a huge increase in loans, it is now
struggling to pull in the reins.

Fears it might follow its recent interest rate increase with another
rise largely prompted Friday’s market sell-off. The monetary challenge
is exacerbated by the cheap money generated to boost flagging
developed economies, not least Washington’s latest round of
quantitative easing, to the tune of $600bn. Warnings of emerging
market bubbles are multiplying, including one last week from Joseph
Stiglitz, the Nobel laureate economist.

Brazil, Thailand, and Taiwan are among countries that are trying to
staunch the potentially inflationary inflows through capital controls.
Other nations, headed by China and India, have been slower to
liberalise their external accounts and can rely on decades-old
barriers. Even the International Monetary Fund now reluctantly accepts
that capital controls are a necessary weapon in the policy armoury.
But, as Mr Stiglitz pointed out, that leaves attractive open economies
as the “focal point for all this [QE] money”.

Governments are raising interest rates to reduce the inflationary
pressures but do so unwillingly for fear of hampering economic growth
and making things worse by attracting more hot money. Yield, after
all, is what global investors seek.

One answer lies in quicker currency appreciation. In the short term,
countries do not want their currencies to rise for fear of damaging
exports. That is the nub of the US-China currency dispute. But in the
long term, emerging market currencies must rise to reflect these
countries’ rising productivity – just as happened with Germany and
Japan after 1950. Even in the short term, the loss in export
competitiveness is offset by access to cheaper imports – including,
significantly, food- and other dollar-priced commodities.

The currency appreciation record is decidedly mixed. While China has
allowed the renminbi to rise against the dollar since it loosened its
peg on June 21 – by 2.8 per cent – the renminbi’s real trade-weighted
value has actually dropped – by 3.7 per cent. Compared with January
2008, the renminbi was only 3.9 per cent higher late last week on a
trade-weighted basis, far behind Brazil (up 17.3 per cent) and
Indonesia (18.5 per cent). Other key emerging market currencies were
well down – Turkey by 5.5 per cent, India by 6.8 per cent and South
Korea by a startling 15.9 per cent.

In these difficult times, there are no risk- or cost-free choices. But
with inflation rising, the pressures will grow for quicker emerging
market currency revaluation.