more on the yuan and misperceptions about international trade...

Another article on currency-- with an emphasis on China-- from Charles Wolf in the WSJ...

It's conventional wisdom that bipartisanship results in improved public policy. That this is not so is strikingly illustrated by a bill, supported by Democratic chairmen and ranking Republican members of the relevant committees in the Senate and House, that would punish China for its "misaligned" currency (the yuan). Its mistaken premise is that this misalignment threatens our prosperity by causing America's large current account deficits with China.

In 2007, China's current account surplus -- the sum of its trade surplus, and net receipts from foreign assets and foreign remittances -- will be nearly 10% of its GDP, or about $300 billion. Two-thirds of this represents a bilateral surplus with the U.S. The U.S. global current account deficit in 2007 will be about $800 billion, nearly 6% of the U.S. GDP. Thus, China's bilateral current account surplus with the U.S. is one-quarter of the global U.S. deficit.

In 2005, the yuan was worth 12 U.S. cents. It is currently worth 13.5 cents. Many believe that if the yuan's exchange value were to increase further, perhaps to 17 cents or 18 cents, the bilateral imbalance between the two countries would be substantially reduced, if not eliminated. China's exports to the U.S. would thereby become more expensive in U.S. dollars and would therefore decrease, while China's imports from the U.S. would become less expensive in Chinese yuan and therefore would increase. If China fails to make this currency adjustment, the pending legislation in Congress would impose a tax on imports from China to offset the putative currency undervaluation.

This reasoning, though plausible, is wrong. A country's global current account deficit depends on the excess of its gross domestic investment over gross domestic savings. Gross savings in the U.S. are about 10%-12% of GDP, largely consisting of corporate depreciation allowances and retained corporate earnings. On the other hand, gross domestic investment is 16%-17% of GDP. The difference between the two comprises the U.S. current account deficit.

China's current account surplus is the mirror image of the U.S. imbalance. Gross investment in China is above 30% of its GDP, but its savings are even higher, above 40%.

Then, Wolf makes some comparisons of this to our financial relationships to Japan and Europe...

While the appreciation of the yuan might initially raise U.S. exports to China and lower China's exports to the U.S., these effects would be small and transitory as long as the imbalances between savings and investment in the two economies persist. Japan and Germany -- two countries with perennial current account surpluses -- illustrate the point.

While Japan's yen has appreciated against the dollar in the past several years, its current account surplus is largely unchanged, because Japan's domestic savings have continued to exceed its domestic investment. The euro has appreciated 30% relative to the dollar, yet Germany maintains a large global current account surplus. That's because the German economy maintains an excess of savings over investment. (The economies of most other eurozone countries show a savings shortfall, and continue to incur current account deficits.)

In both Germany and Japan, the excess of domestic savings over domestic investment persists and hence their current account surpluses persist, notwithstanding their currencies' appreciation....