CAMBRIDGE For several years, American officials have pressed China to revalue its currency. They complain that the undervalued renminbi represents unfair competition, destroying American jobs, and contributing to the United States trade deficit.

NEW YORK So far, discussions about whether or not China should revalue its currency, the renminbi, have focused almost exclusively on the impact of the currency s exchange rate on China s trade balance. But what would an appreciation of the renminbi do to China s inward and outward foreign direct investment (FDI)?

The argument for legislative action is tantalizingly simple the US merchandise trade deficit has averaged a record 4.4 of GDP since 2005, with China accounting for fully 35 of the shortfall, supposedly owing to its currency manipulation. The Chinese, insists a broad coalition of politicians, business leaders, and academic economists, must revalue or face sanctions.

But no one knows whether China s baby step is the start of something much bigger, as China s authorities hint one day and deny the next. By relenting just a little to intense global pressure to revalue its exchange rate, the Chinese leadership has masterfully stifled the growing chorus of demands to rein in its growing trade surplus.

The transformation in China s banking system, coupled with the recent decision to revalue China s currency, will require major changes in the conduct of monetary policy. Until recently, an exchange rate peg dominated China s monetary policy, with interest rates unchanged for nine years until October 2004, as the government attempted to manage lending through administrative guidance and credit controls.

China will come under pressure to revalue its currency (now being held at artificially low levels) so that Chinese exports are more expensive and imports from others (including the US) cheaper. And China and other developing countries will be expected to do their share to reduce carbon emissions and slow the pace of global climate change.

After all, China has been under constant pressure from foreign governments to revalue, in the mistaken belief that a stronger currency would reduce China s large trade surplus. And, since July 2008, when the exchange rate was 1 8.28 (and had been held constant for ten years), the PBOC has more or less complied, with appreciations approximating 3 per year through 2012.

But labor unrest and the desire to maintain 10 growth suggest that China should be taking the lead in ensuring peace on the Korean peninsula and preventing other political developments from derailing its economy. After all, as the Chinese leadership knows, only continued strong growth will provide the government with the wriggle room it needs to begin to revalue the renminbi.

Were China to revalue its currency, its farmers would be worse off but in a world of free(r) trade, US farm subsidies translate into lower global agricultural prices, and thus lower prices for Chinese farmers. By extending its largesse to rich corporate farms, the US may not have intended to harm the world s poor, but that is the predictable result.