In the New York Times, Paul Krugman, an influential liberal economist, opened the new year with a critique of China's currency policy for "predatory mercantilism". If Beijing would not allow the renminbi to appreciate, he warned, "the very mild protectionism (China is) currently complaining about will be the start of something much bigger".

Only a day or two later, an article in the Guardian, the British daily, criticized China's currency policy and went even further, arguing that "(China's) emergence on to the world stage brought with it a key reason for the global economic meltdown between 2007 and 2009."

If one were to take at face value such arguments, one would have to believe that the entire global crisis has had nothing to do with the failure of laissez-faire capitalism, the absence of adequate regulation in the financial sector, the rise of the "shadow economy", the low interest rates, the housing bubbles, the subprime crisis and the credit squeeze in the United States and Western Europe.

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In reality, China's exchange rate is not the main reason for the global imbalances; nor was the global crisis triggered by the Chinese currency. An abrupt and significant appreciation of the renminbi would not resolve the crisis - but might make it worse by contributing to instability and dampening prospects for global growth.

Certainly, it is important to address the kind of policy distortions that play a key role in the global imbalances. But what are those distortions, really?

In the past few years, the world's largest deficit has been that of the United States, while the world's largest current account surplus has been held by China. As a result, some economists and many politicians argue that China's surplus is the cause of US deficit. In fact, the causal link is tenuous at best.

Trade deficit is not necessarily harmful. It is really a reflection of the imbalance between domestic investment and domestic saving. For years, US savings have been declining, but domestic investment has not. While Americans have saved less and less, foreigners have invested more and more in America. As a result, US current account deficit has ballooned.

However, these shifts are predominantly determined by domestic forces. Americans did not save less because people in China save more. Rather, they saved less because the interest rates were very low, housing bubble generated paper wealth, and Wall Street made speculation a national pastime.

Also, while the US-China relationship may well be the most important one in the 21st century, their bilateral trade accounted for only 3 percent of world trade in 2008. Indeed, global imbalances involve much more than just the US-China trading relationship.

Finally, today foreign investment plays an increasing role in total investment. If, for instance, foreigners invest more in America, the US current account deficit will rise, unless something else changes. At the end of 2008, foreigners held US assets equal to about 160 percent of US GDP, but only a fraction of these - about 5 percent - were held by China.

The United States has run current account deficits since the early 1980s. But the global imbalances have been an issue since 2003, as US current account deficit has soared.

In 2006 - before the onset of the US recession - the current account deficit amounted to 7 percent of US GDP. At the same time, the pressure for the appreciation of the renminbi has steadily increased. Yet, available data does not support the idea that trade surplus in China increased only in the 2000s.

In 2003, Chinese trade surplus was just $25.5 billion, that is, much smaller than the comparable figure in 1997-98 when it exceeded $40 billion. Moreover, as Chinese trade expanded very rapidly, the percentage of trade surplus in total trade was only 2.9 percent in 2003, but exceeded 12 percent in 1997-98. By 2007, Chinese trade surplus increased to 7.7 percent of total trade, but even this was far smaller than in the late 1990s.

Furthermore, if China really was the cause of the US trade deficit, the latter should be driven by China. But that's not the case. Even in 2007, when the US trade deficit peaked, China contributed about one-third of the US current account deficit, whereas Japan, Russia and oil-producing nations accounted for the rest. Yet, global imbalances have not been attributed to Japan, or to Russia, not to speak of Saudi Arabia.

Ultimately, the global crisis resulted from the laissez-faire deregulation that was launched in the United States and the UK in the early 1980s. Initially, it contributed to increasing competition, while intensifying growth in emerging economies as well. Over time, it boosted excessive leverage and risk-taking, which caused the burst of the dot-com bubble at the turn of the 2000s.

Along with the terrorist attacks of 9/11, that led to aggressive monetary policy to reduce the interest rate, while excess liquidity boosted the housing boom. At the same time, household debt soared.

In different circumstances, the dot-com bubble and the post-9/11 wars in Iraq and Afghanistan might have penalized consumption. Now both the households and the government have grown indebted, while the current account deficit has soared.

It is not the renminbi but, ironically, the most advanced financial systems in the most advanced economies that took the world to the brink of a financial meltdown.

As a result of the crisis, there have been significant changes in saving and investment patterns across the world. Global imbalances have narrowed considerably but not adequately. Such imbalances are not in the long-term interest of the United States or China. But nor are drastic and disruptive corrections.

It is almost inevitable that, in the long term, the dollar will depreciate and the renminbi will appreciate. But it is vital that the path to the multipolar future will be gradual and smooth.

The author is the research director of International Business at the India, China and America Institute, an independent think tank in the US.

(China Daily 01/12/2010 page9)