Quotes of the Day

China's long-awaited currency adjustment is unambiguously positive for the global economy. I applaud Beijing's action for three reasons: first and foremost, it derails Washington's protectionists and the serious threat they pose to geopolitical stability. Admittedly, a 2.1% revaluation of the renminbi stops well short of the 27.5% adjustment proposed by several U.S. Senators. Their bill, which would impose damaging tariffs on Chinese imports, had garnered surprising bipartisan traction in Congress and could well have been passed by the upper chamber later this year. The China bashers certainly did not get anything close to what they were seeking, but the wind is now out of their sails. U.S. Treasury Secretary John Snow's statement that he welcomes the currency shift makes it likely that protectionist legislation will now lose support in Washington. Likewise in Europe, the anti-Chinese sentiment on trade policy should recede.

Second, the revaluation is a big plus for the Chinese economy. China has already taken actions to cool off its overheated property sector, and it does not want to risk overkill by crushing exports. Collectively, fixed investments and exports account for 80% of China's GDP, and they are both still growing at close to a 30% annual rate. China's boom would quickly turn into a bust if both slowed sharply. A small upward adjustment of the currency should reinforce the modest slowing of Chinese exports that was already in the cards. China's leadership will most likely adopt a wait-and-see stance as far as further currency moves are concerned. If GDP keeps surging at its current 9.5% rate, policymakers will probably push harder on the currency-revaluation lever—using slowing exports as the cushion to engineer a soft landing.

Third, China's new currency policy is a much more stable arrangement for the global financial system. From the Chinese perspective, it will help relieve the tensions that have been building from its failed "sterilization" tactics—the inability of China to issue enough domestic debt to offset the massive purchases of U.S. Treasuries required by the now abandoned dollar peg. This was leading to excess money and credit creation—underscoring the mounting risks of inflation and asset bubbles. China's coastal property bubble was a manifestation of this risk, which Beijing could no longer afford to ignore. A "managed float" provides China with greater discretion on the sterilization front, thereby tempering the excesses of its domestic financial system.

This is also an encouraging development for the rest of the world—but with a potentially painful twist. By moving to a currency basket, China will need to diversify its enormous portfolio of foreign-exchange reserves, which totaled some $660 billion at the end of the first quarter. Other Asian countries—also massively overweighted in dollars—should follow China's lead. The near-simultaneous announcement by Malaysia that it would abandon the ringgit's dollar peg in favor of a managed basket float confirms such a possibility. The Bank of Korea has also been itching to diversify out of dollars.

Consequently, a more flexible renminbi mechanism raises the odds of an Asian shift out of dollars, in effect removing the artificial bid for dollar-denominated assets that has prevented U.S. interest rates from rising more sharply. This will undoubtedly put pressure on the interest-rate prop supporting U.S. asset markets—especially property. Asset-dependent American consumers may slow their spending as a result. While this may be painful, it may also be the only way for the U.S. and the rest of the world to come to grips with the U.S.'s glaring foreign-trade and current-account imbalances. China's dollar peg was a major impediment to the rebalancing of a global economy, which has become dangerously dependent for growth upon the unsustainable excesses of U.S. consumption.

Many may argue that China's 2.1% revaluation does little to fix the U.S. trade deficit with China or to placate manufacturers that can't compete with cheaper Chinese makers. But there is nothing wrong with a China that goes slowly in feeling its way down the road to currency flexibility. A large move could have tipped the scales toward the more disruptive option—always a risk for a global economy with such massive imbalances. That could have led to a precipitous decline in the dollar, a spike in U.S. interest rates, a collapse in the U.S. property market, a severe adjustment by the American consumer, and a worldwide recession. By moving gingerly, China minimizes the risk of going too far and triggering a hard landing in a U.S.-centric global economy.

Let's give credit where it's due—always a hard thing for the world to do when it comes to China: its currency adjustment is excellent news for an all-too-precarious global economy.

• Stephen Roach
• Beijing's shift in currency policy is great news for the global economy