The Peg is Dead

China's controversial currency policy may finally be headed to the gallows, but what remains unclear is how this will affect and prompt movement on numerous politically sensitive issues in the United States, namely its large twin deficits, the current account and government primary deficit.

Make no mistake: China's move is largely motivated by domestic factors - the need to allow inflation to finally creep into its possibly overheating economy and re-balancing its export-based economy with a decidedly smaller dependence on other economies - but, certainly, it was also under pressure to allow the yuan to appreciate by external players.

But for this move to re-balance global economic flows, the United States will have to do its part in the medium to long term. That is, to reduce its deficits and minimize its dependence on foreign creditors to finance those deficits by cutting spending and boosting national saving. Some of this could be accomplished by the hoped-for re-balancing in the current account. But currency values alone do not dictate trade, and therefore current account, balances. The United States needs to go back to being a center of innovation in manufacturing for a real re-balancing to be meaningful. And, with the current crisis in the eurozone, there is even one view that the revaluation could actually backfire.

The Obama Administration and his Treasury have achieved a victory long-sought by the president's predecessor. But now that China has been tamed on the currency issue, the ball is in the American court to do what is necessary to allow the full economic results of a yuan appreciation to benefit those constituencies who yearned for it.