RENMINBI CONTROVERSIES a The foregoing implies that China's current account balance needs deteriorate by a whopping 6.5-7.5 percent of GDP to restore equilibrium to its overall balance of payments. If one does some simulations with a small trade model to calculate what size real ap- preciation of the RMB would generate such a large negative swing in Chinas current account--using a range of plausible price elasticities giving due consideration to how the high import content of Chinas exports affects its export prices, and making alternative assumptions about the second-round feedback effects of income changes on the demand for imports-the answers tend to congregate in the 20-35 percent range. Note again that this estimate of undervaluation of the RMB is not dependent either on the large speculative capital inflows of recent years or on China's large and rising bilateral trade surplus ith the United States A second complementary approach, the global payments approach asks what role RMB adjustment should play in the correction of large existing payments imbalances around the world--not just in China Here, the elephant in the room is the large U.S. current account deficit--running at about 6. 5 percent of GDP in 2005 and threaten ing to go higher over the medium term(see Cline 2005). An analysis of U.S. external debt dynamics suggests that a deficit only about half that size is likely to be sustainable. As argued by Mussa(2005 )and others, one key element in any effective strategy to correct the U.S external imbalance, while simultaneously sustaining healthy global economic growth, is a further depreciation in the real trade-weightee dollar from its current level- on the order of 15-25 percent Emerging Asia plus Japan account for about a 40 percent weight in the trade-weighted dollar index. Whereas the euro. the canadian dollar, and the Australian dollar, among other market-determined exchange rates, have shown strong(real effective) appreciations dur ing the first wave of dollar depreciation (since February 2002), the Asian currencies-with the notable exceptions of the Korean won and Indonesian rupiah--have either appreciated only slightly(e. g, Thai Even for a given set of elasticities, estimates of the degree of undervaluation change over time, reflecting changes in trade balances, exchange rates, the cyclical position of the economy. and other factors es that, in concert with a steady tightening of U.S. monetary conditions, would estic demand growth relative to output growth; and policy measures in Europe nd Japan that would increase the growth of domestic demand relative to the gro utput. According to J. P. Morgan's indexes of real, trade-weighted exchange rate dollar has fallen about 19 percent since the dollar peak in February 2002; Citigroup places the dollar depreciation since the February 2002 peak at a smaller 14 percent 253The foregoing implies that China’s current account balance needs to deteriorate by a whopping 6.5–7.5 percent of GDP to restore equilibrium to its overall balance of payments. If one does some simulations with a small trade model to calculate what size real ap￾preciation of the RMB would generate such a large negative swing in China’s current account—using a range of plausible price elasticities, giving due consideration to how the high import content of China’s exports affects its export prices, and making alternative assumptions about the second-round feedback effects of income changes on the demand for imports—the answers tend to congregate in the 20–35 percent range.5 Note again that this estimate of undervaluation of the RMB is not dependent either on the large speculative capital inflows of recent years or on China’s large and rising bilateral trade surplus with the United States. A second complementary approach, the global payments approach, asks what role RMB adjustment should play in the correction of large existing payments imbalances around the world—not just in China. Here, the elephant in the room is the large U.S. current account deficit—running at about 6.5 percent of GDP in 2005 and threaten￾ing to go higher over the medium term (see Cline 2005). An analysis of U.S. external debt dynamics suggests that a deficit only about half that size is likely to be sustainable. As argued by Mussa (2005) and others, one key element in any effective strategy to correct the U.S. external imbalance, while simultaneously sustaining healthy global economic growth, is a further depreciation in the real trade-weighted dollar from its current level—on the order of 15–25 percent.6 Emerging Asia plus Japan account for about a 40 percent weight in the trade-weighted dollar index. Whereas the euro, the Canadian dollar, and the Australian dollar, among other market-determined exchange rates, have shown strong (real effective) appreciations dur￾ing the first wave of dollar depreciation (since February 2002), the Asian currencies—with the notable exceptions of the Korean won and Indonesian rupiah—have either appreciated only slightly (e.g., Thai 5 Even for a given set of elasticities, estimates of the degree of undervaluation change over time, reflecting changes in trade balances, exchange rates, the cyclical position of the economy, and other factors. 6 Other key elements include: a credible medium-term plan of fiscal consolidation in the United States that, in concert with a steady tightening of U.S. monetary conditions, would slow domestic demand growth relative to output growth; and policy measures in Europe and Japan that would increase the growth of domestic demand relative to the growth of output. According to J. P. Morgan’s indexes of real, trade-weighted exchange rates, the dollar has fallen about 19 percent since the dollar peak in February 2002; Citigroup’s index places the dollar depreciation since the February 2002 peak at a smaller 14 percent. RENMINBI CONTROVERSIES 253