As if the world did not already suspect it, China's currency is undervalued and responsible for its large trade surplus.

William Cline of the Peterson Institute for International Economics (PIIE) published a study suggesting that if China allowed its currency to rise by 1 percent against its trade partners, its trade surplus would shrink by 0.30 to 0.45 percent of GDP.

Using China's 2009 GDP of $4.9 trillion, a 1 percent rise would cause China's trade surplus to narrow by $14.7 to $22.1 billion.

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Indeed, a simple graph shows that China's trade surplus as a percentage of GDP declined from the peak of 11 percent of GDP in 2007 to less than 6 percent by 2009. During this period, the yuan appreciated against its trade partners because it became pegged to a rising U.S. dollar.

Some “satellite” currencies – from countries like Malaysia, Singapore, and Thailand, who also trade with the West – at times move in tandem with the yuan. Therefore, the impact of the yuan on the trade balances of the United States and Europe are magnified.

The study also suggests that even if China were to keep the yuan constant against its trade partners, their surplus as a percentage of GDP would still increase. The yuan needs to increase between 1.7 to 2 percent a year to keep the percentage constant.

This is due to productivity growth in China's exportable products and services, which would flood Western markets with their products and widen China's trade surplus if the yuan does not rise appreciate.

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