Here’s how I see things playing out:
- Congress looks at this report and concurs that the key to ending slower global growth is to correct global imbalances via a Chinese currency revaluation. Fair enough.
- However, individual Congressmen, looking to reassure jobless constituents ahead of the midterm elections, will escalate by presenting bills to ‘punish’ China if no actions are taken.
- China will be aghast at this and, in a further escalation, start making noises about ditching the dollar.
At this point, the question is how does this get resolved. To date, bilateral U.S.-Chinese economic tensions have escalated and led to protectionism. Further escalation will yield unpredictable results and will be destabilizing. Chinese officials cannot be seen by their domestic constituency caving to American pressure. This would undermine their authority and create problems domestically. Therefore, a public frontal assault on the renminbi peg is likely to backfire.
I wrote this in October of last year. Isn’t this exactly what is happening? Just wait until April 15th. That’s when the fireworks will begin.