RENMINBI CONTROVERSIES currencies and real trade-weighted depreciations of the euro and the Japanese yen(not a large real appreciation of the RMB with respect to the dollar ). But since the real trade-weighted value of the dollar has to go down in the medium-term while the real effective exchange rate of the yen has to go up, these sources of recent (real effective) ap- preciation of the RMB will likely be reversed Second, the revaluation of the RMB that has occurred since July 21, 2005, is clearly way too small to make a meaningful contribution toward reducing either China's now huge external imbalance or large global payments imbalances more generally. If the undervaluation of the real, trade-weighted RMB is on the order of 20-35 percent, then the roughly 3 percent real effective appreciation of the RMB since July 2005 does not get you very far--no matter what sound bites China(or the G7 or IMF)utters about progress toward greater ex- change rate flexibility Third, with average monthly intervention in the foreign exchange market during the first quarter of 2006 averaging about $19 billion- about the same as a year earlier--there is little indication that the Chinese authorities are giving"market forces"a greater role in the determination of the RMB. Likewise there has so far been little evidence that the rmb is being managed against a"basket"of cur- rencies rather than against the U.S. dollar alone Fourth, the small appreciation of the RMB will also do little to silence strong protectionist pressures in Washington and elsewhere The July 21 announcement provided China with somewhat of a"hon eymoon"from sharp criticism over its exchange rate policies. But that honeymoon is likely to end soon if China's overall current account surplus remains large and if China continues to engage in sizable, protracted, and one-way intervention in the exchange market to keep the RMB from appreciating much vis-a-vis the dollar. In such cir- cumstances, a finding by the U.S. Treasury in May 2006 that China has not been acting as a"currency manipulator, " would carry little credibility and might prompt Congress to pass some kind of protec tionist legislation On the other side, a positive finding of manipula- tion by the treasury could unsettle foreign exchange markets--as speculators bet on how the rising tensions might be resolved What then to do? Since the summer of 2003. Nick Lardy and I Goldstein and Lardy 2003)have been recommending that China adopt a"two-stage"currency reform. In the first stage, China would adopt a basket peg, revalue the rMB by enough to remove the See goldstein and Lardy (2006)currencies and real trade-weighted depreciations of the euro and the Japanese yen (not a large real appreciation of the RMB with respect to the dollar). But since the real trade-weighted value of the dollar has to go down in the medium-term while the real effective exchange rate of the yen has to go up, these sources of recent (real effective) ap￾preciation of the RMB will likely be reversed. Second, the revaluation of the RMB that has occurred since July 21, 2005, is clearly way too small to make a meaningful contribution toward reducing either China’s now huge external imbalance or large global payments imbalances more generally. If the undervaluation of the real, trade-weighted RMB is on the order of 20–35 percent, then the roughly 3 percent real effective appreciation of the RMB since July 2005 does not get you very far—no matter what sound bites China (or the G7 or IMF) utters about progress toward greater ex￾change rate flexibility. Third, with average monthly intervention in the foreign exchange market during the first quarter of 2006 averaging about $19 billion— about the same as a year earlier—there is little indication that the Chinese authorities are giving “market forces” a greater role in the determination of the RMB. Likewise, there has so far been little evidence that the RMB is being managed against a “basket” of cur￾rencies rather than against the U.S. dollar alone.18 Fourth, the small appreciation of the RMB will also do little to silence strong protectionist pressures in Washington and elsewhere. The July 21 announcement provided China with somewhat of a “hon￾eymoon” from sharp criticism over its exchange rate policies. But that honeymoon is likely to end soon if China’s overall current account surplus remains large and if China continues to engage in sizable, protracted, and one-way intervention in the exchange market to keep the RMB from appreciating much vis-à-vis the dollar. In such cir￾cumstances, a finding by the U.S. Treasury in May 2006 that China has not been acting as a “currency manipulator,” would carry little credibility and might prompt Congress to pass some kind of protec￾tionist legislation. On the other side, a positive finding of manipula￾tion by the Treasury could unsettle foreign exchange markets—as speculators bet on how the rising tensions might be resolved. What then to do? Since the summer of 2003, Nick Lardy and I (Goldstein and Lardy 2003) have been recommending that China adopt a “two-stage” currency reform. In the first stage, China would adopt a basket peg, revalue the RMB by enough to remove the 18See Goldstein and Lardy (2006). RENMINBI CONTROVERSIES 263