T he currency regime China adopted three years ago this week is faltering. Official reserves grew by a massive $280bn (£140bn, €177bn) in the first half of 2008. The central bank has strengthened controls on capital inflows. Consumer price inflation has risen to 8 per cent. The currency has become more flexible and appreciated about 20 per cent against the dollar. But on a real trade-weighted basis the appreciation has been only 15 per cent. China’s current account surplus has soared, from 3.6 per cent of gross domestic product in 2004 to 11.3 per cent last year.

The under-valuation of the renminbi has in fact increased in the past three years because the equilibrium value of the currency, the value consistent with economic fundamentals, has risen even faster, as its external surplus has mushroomed and as rapid productivity growth in export industries has enhanced China’s competitiveness. The appreciation in China’s real trade-weighted exchange rate is only about a third to a half of what is needed. Dominique Strauss-Kahn, managing director of the International Monetary Fund, recently characterised the renminbi as “substantially under-valued”.