Should The U.S. Take A Harder Stance On China's Currency? (Part I) : Planet Money Steve Hanke of Johns Hopkins laments our long history of currency wars in Asia. "Let's hope China ignores U.S. demands for an ever-appreciating yuan," he writes.

Should The U.S. Take A Harder Stance On China's Currency? (Part I)


In his latest New York Times Magazine column, Adam Davidson argues that the U.S. should take a stronger stance against China's currency. To continue the discussion, we asked two economists on different sides of the debate to weigh in on the following question:

Should the U.S. take a harder stance on China's currency policy?

Steve Hanke of the Cato Institute responds below. To read the response from Joseph Gagnon of the Peterson Institute, click here.

The United States has a long history of waging currency wars in Asia. We all know the sad case of Japan. The U.S. claimed that unfair Japanese trading practices were behind the ballooning U.S. bilateral trade deficit.

To correct the so-called problem, the U.S. demanded that Japan adopt an ever-appreciating yen policy. The Japanese complied and the yen appreciated against the greenback, from 360 in 1971 to 80 in 1995 (and 77, today). But this didn't close the U.S. trade deficit with Japan. Indeed, Japan's contribution to the U.S. trade deficit reached almost 60 percent in 1991. And, if that wasn't enough, the yen's appreciation pushed Japan's economy into a deflationary quagmire.

Today, the U.S. is playing the same blame game with China. And why not? After all, China's contribution to the U.S. trade deficit has surged to 45 percent.

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.