The announcement over the week-end by China to introduce greater exchange rate flexibility is unambiguously good news, provided, of course, that intent is followed up with some actual upward movement of the renminbi, writes Arvind Subramanian.
Of all the major couplings that have gained prominence -- Jairam Ramesh's [ Images ] 'Chindia', Niall Ferguson's 'Chimerica', and Martin Wolf's 'Chermany' -- it is very much the latter that is in the spotlight.
The announcement over the week-end by China to introduce greater exchange rate flexibility is unambiguously good news, provided, of course, that intent is followed up with some actual upward movement of the renminbi.
Domestic economic imperatives, and specifically the role of currency appreciation in dampening overheating, have been widely credited as having influenced China's decision.
But there is a mystery here. China's competitiveness was getting eroded by two sources: domestic wages and prices which are rising faster than in partner countries, and by the decline of the euro which, combined with China's peg to the dollar, was causing the renminbi to rise in trade-weighted terms.
So, why is China, so wedded to the mercantilist export growth model, changing its policies to further aggravate the decline in competitiveness, especially when the global recovery is still looking shaky?
This puzzle, of course, means that China deserves extra credit for its act of responsible international citizenship, for making its contribution to global re-balancing.
From India's perspective, renminbi flexibility will help in two ways: Indian tradable goods industries will get some relief, and the Reserve Bank of India [ Get Quote ] can now deal with inflationary pressures more effectively, without the additional burden of worrying about the competitiveness consequences of further monetary tightening.
Beyond India, what broader lessons might one draw from China's policy change? The first and heartening lesson is that the G20 worked.
It worked by allowing the renminbi to be converted from a bilateral US-China matter (on which little progress had been made for many years) to one in which a broader set of countries had a stake.
The brave public pronouncements by the Brazilian central bank and India's RBI earlier this year reinforced this 'multilateralisation' of China's currency undervaluation and helped play a constructive role.
True, the United States and its Treasury Secretary Tim Geithner played their cards skillfully, privately chiding and cajoling China without allowing the negativity to spill into the public domain.
It is also true that recent sabre-rattling by the US Congress to impose trade measures against Chinese exports may have played a role in persuading China.
But that cannot be a decisive explanation because the US Congress has sabre-rattled in the past, often louder, without much impact on China.
Multilateralising the currency issue had two positive effects. It forced China to confront the weight of a broader swath of international public opinion and hence to take more seriously the international consequences of its currency policy.
And it also made the politics of changing policy less difficult for China, which can portray the currency move not as a caving in to bilateral US pressure but as responding to the wider international community. That the announcement came a week before the next G20 summit is telling.
The euphoria of crisis-induced cooperation was giving way to cynicism about the G20's ability to induce similar cooperation during 'normal' times, when self-interest asserts itself with a vengeance.
But the Chinese action is a welcome jolt to that cynicism. Regardless of what happens at the G20 Summit in Toronto over this weekend, the grouping can already count the change in China's currency policy as its victory.
The second implication relates to the 'Chermany' coupling. With China having made its contribution, or announced its contribution, to global re-balancing, it is time to demand the same of Germany [ Images ], which is the other large surplus country in the world economy.
Germany has just received a steroidal boost of competitiveness with the decline of the euro. Where China was an intentional mercantilist, Germany has become an accidental mercantilist: 'its' currency has declined because the weak economies of Greece, Spain, Portugal and Ireland also share that currency.
The irony is that a strong Germany benefited from being yoked to the weak PIIGS. Its current account surplus will now increase even further, aggravating the global imbalance problem.
How has Germany responded? As it always does: by embracing fiscal consolidation. It has indulged its instinct for rectitude that is etched into its collective DNA at the expense of its international responsibilities.
Some have excused this action on the grounds that the tightening involved would be small and back-loaded. But this misses the key point.
Germany's action has the wrong sign: it should be expanding demand, not just for the sake of global re-balancing but to provide some growth impetus to its dire southern European neighbours. But it is doing the opposite.
So, one interesting question going forward is this: Will Germany be amenable to international persuasion? The short answer probably is no.
Germany could well prove to be an even more difficult partner than China has been for a number of reasons.
For one, any signs of outside pressure will lead Europe to rally behind Germany. But the more difficult obstacle will be ideological.
It was easy to rail against mercantilism which, regardless of its intellectual pedigree, has doubtful moral connotations: mercantilism involves doing well but at someone else's expense. Fiscal consolidation, on the other hand, has the aura of moral correctness and virtue.
Fiscal consolidation serves to protect future generations. That the consequences of book-balancing will inflict pain and suffering on the current generation only lends it additional virtue as Keynes pointed out.
How much more unselfish can a society get? It is a virtuous rejoinder to Groucho Marx's question: "Why should I do anything for posterity? Has posterity ever done anything for me?"
The battle to get Germany to shed its visceral need to always balance the books will, therefore, pit the reckless, today's appetite-slakers against the prudent, deferred gratificationists, the far-sighted custodians of tomorrow, of the future, of our children.
Articulated this way, as it increasingly is, this contest is turning out to be no contest at all. The Keynesians are losing comprehensively.
And because of that, Germany-bashing is unlikely to yield the success, albeit delayed and minimal, that international pressure on China has.
So, as the travelling road-show that is now the G20 moves to Toronto, the intriguing thought that arises is this: Can the G20, which has had a useful role in averting a global catastrophe in managing to influence a policy change in China, also have a role in getting a G7 country to shed its basic but neighbour-unfriendly instincts?
If so, the world will really have changed. For the better.
The author is senior fellow, Peterson Institute for International Economics and Center for Global Development