Instead, as the dollar has fallen over the past 18 months, the Chinese currency in effect, has fallen with it. Clearly, they say the yuan is undervalued In evidence, they point out that according to economic theory exchange rates in countries with rapid productivity growth should be appreciating. China's economy has been growing much faster than the rest of the world and its current account has been in surplus since 1994. For a fast-growing emerging economy with high levels of investment, a current-account deficit would be more normal. Moreover, capital is pouring into China. Last year it was the world's largest recipient of foreign direct investment with inflows totalling $53 billion. Like trade surpluses large capital inflows should push up the currency. Lastly, the huge and accelerating build-up of reserves suggests that, left to its own devices, the yuan would appreciate Estimates of the degree of undervaluation differ wildly. According to The Economist's informal Preeg, an economist at America's Manufacturers Alliance argues that if normal market force at applied, the yuan would rise by 40%. a recent study by UBS, a bank, put the figure aroung oo measure of currencies, the Big Mac index the yuan is undervalued by a whopping 56%. Erne 20%. Others reckon it might be only 10-15% he problem is that traditional gauges of undervaluation do not work well in an economy with tight capital controls and in the midst of colossal structural changes. Nobody can be sure that China's currency really is grossly undervalued. And if it is, it may not remain so for long For a start, the scale of China s current-account surplus is frequently exaggerated. Many Americans think it has a Up from behind huge overall surplus when in fact it has a large and rising bilateral trade surplus with America, which is now Trade surplus with America, sbn bigger than Japan's bilateral surplus(see chart 12) China s overall current-account surplus, on the othe hand, is much smaller than Japan 's, and is shrinking fast. In the first few months of 2003, China's trade Japan balance was actually in deficit This may reflect temporary factors: higher oil prices in advance of the iraq war, and a one-off surge in imports delayed to take advantage of tariff cuts introduced on January 1st. But it may also reflect a longer-term trend towards higher imports of capital and consumer goods 1986889092949698200002 China's imports have been growing at an annual rate of Source: US Bureau of Economic Analysis over 40%a year recently, even faster than its exports (30% plus). Many of those imports are inputs for exports, but not all. According to Nicholas Lardy, a China expert at the institute for International Economics, there are signs that imports are being fuelled by rising domestic demand. Car imports, for instance are up more than 60% on last year. The big tariff cuts associated with China's entry into the Wto may push up import growth even further. If Mr Lardy is right, and China's imports are set to grow rapidly even at the current exchange rate the case for a large appreciation looks weaker. Evidence from the capital account must also be treated with caution. Yes, China has recently been the worlds biggest recipient of direct investment, but according to Mr Lardy, many capital inflows have been speculative and might easily reverse themselves. Chinese companies expecting a revaluation of the yuan, are bringing home money that they had illegally stashed abroad. Mr Lardy reckons that these"unrecorded inflows"make up a big share of the recentInstead, as the dollar has fallen over the past 18 months, the Chinese currency, in effect, has fallen with it. Clearly, they say, the yuan is undervalued. In evidence, they point out that, according to economic theory, exchange rates in countries with rapid productivity growth should be appreciating. China's economy has been growing much faster than the rest of the world, and its current account has been in surplus since 1994. For a fast-growing emerging economy with high levels of investment, a current-account deficit would be more normal. Moreover, capital is pouring into China. Last year it was the world's largest recipient of foreign direct investment, with inflows totalling $53 billion. Like trade surpluses, large capital inflows should push up the currency. Lastly, the huge and accelerating build-up of reserves suggests that, left to its own devices, the yuan would appreciate. Estimates of the degree of undervaluation differ wildly. According to The Economist's informal measure of currencies, the Big Mac index, the yuan is undervalued by a whopping 56%. Ernest Preeg, an economist at America's Manufacturers Alliance, argues that if normal market forces applied, the yuan would rise by 40%. A recent study by UBS, a bank, put the figure around 20%. Others reckon it might be only 10-15%. The problem is that traditional gauges of undervaluation do not work well in an economy with tight capital controls and in the midst of colossal structural changes. Nobody can be sure that China's currency really is grossly undervalued. And if it is, it may not remain so for long. For a start, the scale of China's current-account surplus is frequently exaggerated. Many Americans think it has a huge overall surplus when in fact it has a large, and rising, bilateral trade surplus with America, which is now bigger than Japan's bilateral surplus (see chart 12). China's overall current-account surplus, on the other hand, is much smaller than Japan's, and is shrinking fast. In the first few months of 2003, China's trade balance was actually in deficit. This may reflect temporary factors: higher oil prices in advance of the Iraq war, and a one-off surge in imports delayed to take advantage of tariff cuts introduced on January 1st. But it may also reflect a longer-term trend towards higher imports of capital and consumer goods. China's imports have been growing at an annual rate of over 40% a year recently, even faster than its exports (30% plus). Many of those imports are inputs for exports, but not all. According to Nicholas Lardy, a China expert at the Institute for International Economics, there are signs that imports are being fuelled by rising domestic demand. Car imports, for instance, are up more than 60% on last year. The big tariff cuts associated with China's entry into the WTO may push up import growth even further. If Mr Lardy is right, and China's imports are set to grow rapidly even at the current exchange rate, the case for a large appreciation looks weaker. Evidence from the capital account must also be treated with caution. Yes, China has recently been the world's biggest recipient of direct investment, but according to Mr Lardy, many capital inflows have been speculative, and might easily reverse themselves. Chinese companies, expecting a revaluation of the yuan, are bringing home money that they had illegally stashed abroad. Mr Lardy reckons that these “unrecorded inflows” make up a big share of the recent