Let’s hope China ignores U.S. demands for an ever‐appreciating yuan. China’s compliance would do little more than attract massive hot money flows into the country and destabilize its economy. This would be bad news for the world economy’s main engine of growth.
To appreciate just how dangerous currency wars can be, let’s lift a page from the U.S. government’s old currency war playbook. During his first term, President Franklin D. Roosevelt delivered on his Chinese currency stabilization “plan.” China’s yuan was pegged to the price of silver, and it was asserted that higher silver prices would benefit the Chinese by increasing their purchasing power. Congress granted the Roosevelt Administration the authority to buy silver in massive quantities. The administration pushed the price of silver up by 128 percent in the period between 1932 and 1935. As the dollar value of silver went up, so did the value of the yuan.
America’s “plan” worked like a charm, but it had consequences that Washington had not quite advertised. The rapid appreciation of the yuan threw China into the jaws of the Great Depression. Between 1932 and 1934, its gross domestic product fell by 26 percent and wholesale prices in the capital city, Nanjing, fell by 20 percent. China officially abandoned the silver standard on November 3, 1935. This spelled the beginning of the end for Chiang Kai-shek’s Nationalist government.
China’s (as well as the rest of the world’s) future lies with stability. Stability requires China to adopt a free‐market, fixed exchange‐rate system — just like the one in Hong Kong. It’s time for China to end Washington’s currency war. China can do this by a preemptive strike: adopt a fixed yuan‐dollar exchange rate and dump capital controls.