1. If US fail to stabilize the financial system and revitalize growth, FED have to resort to massive QE or directly monetarizing treasuries, then gradual weakening of USD should bring RMB down together, and China should keep Rmb pegging reflecting the worsening external environment??

2. If China/USA succeeded in reflating domestic demand through fiscal stimulus-monetary easing, there should be a rebound of China domestic dmmand vs. external, rising import prices vs. export, which should reduce China surging Current account surplus. If some months by 2010 China begin to see trade surplus dropping 50% or more from current USD30B/month pace. coupled with capital flow, FOREX RESERVE SHOULD drop, then China have perfect logic-fundametnals to depeg Rmb-USD and devalue?

Lark, there are a number of policies: raise the value of the currency, raise minimum wages, permit workers to organize, raise interest rates, liberalize banking and capital markets, divert greater funding into services and the private sector, extend retail insurance, improve health care pensions, and many others. The problem with all of these, of course, is that many involve short-term pain and all the benefits only occur in the long term. If China were to embark on these it would need to work with the US and Europe to minimize the short term pain – mainly by getting guarantees that they would do nothing to constrain Chinese exports.

Seatrus, I am not sure what you mean by overcapacity in the US. As far as the global balance of payments goes the US is not an overcapacity country. I am pretty sure that US and European policymakers are not worried about the RMB achieving reserve status, and I am very sure they would not be willing to see domestic unemployment rise to prevent that. The RMB is very unlikely to become a reserve currency in the next few decades for a wide variety of factors. For some reason a lot of people in Asia are obsessed with the importance of reserve currency status and the imagined maneuverings to create this status, but I think this is beyond the point, and perhaps largely the fault of the very silly book, Currency Wars. The RMB will not become a reserve currency because US or European policy makers decide to permit it. It can only become a reserve currency when a large number of countries and companies decide it has the right amount of liquidity, security, and independence (and the last of those three is very unlikely) and if, for some reason, US monetary mismanagement forces people to look for an alternative.

Alaister, by net demand I simply mean demand less supply.

Dr. Loo, I think we need to worry a great deal about this. My trip to Washington this week and my many earlier discussions with European and Asian policy types (and I plan to be in Brazil in May) convince me that many people in the world think China is moving in the wrong direction. In my FT OpEd piece on Wednesday I try to argue that even though China seems to be behaving in a predatory fashion, this is not really the case. China’s development model makes it very difficult for it to do the right thing in the short run. As for the impact of the Eastern Europe “tsunami”, it is very worrying indeed, and it is likely to have a significant indirect impact by overwhelming European banks and, in so doing, putting more strains on European consumption.

http://www.nber.org/papers/w14700

“Our results — with the benefit of more recent data and a technique that allows for changes in currency weights as well as changes in the rigidity of the peg — suggest that the regime probably is not best described as a dollar peg with a trend appreciation. Rather, the regime that has recently been in effect is better described as a basket peg with some weight on a non-dollar currency, the euro in particular. By mid-2007, the weight on the dollar had fallen to 0.6 and the weight on the euro had risen correspondingly to 0.4. The euro now apparently plays almost as important a role as the dollar. It follows that the appreciation of the RMB against the dollar in 2007 was attributable to the appreciation of the euro against the dollar, not to a trend effective appreciation of the RMB.”