Chinese Premier Wen Jiabao is fed up with the pressure for currency revaluation. It would be, he warned Europeans, a disaster for many export companies in China that would send workers back to their villages.

"If China saw social and economic turbulence, then it would be a disaster for the world," he added.

But China is not the only nation rigging its currency values. Other nations are also managing currencies, attempting to make them weaker and their products competitive. But as the world's largest exporter with a massive and growing surplus, China is under the spotlight and may have to swallow the bitter pill – one that would perhaps be sweetened if China could persuade its Asian manufacturing partners to adopt a regional currency accord.

Wen is trying to manage demands from the US and Europe to allow the renminbi to strengthen and reduce China's large, growing trade surplus. This surplus was annoying when the world economy was strong, but cheap exports kept prices low. Now, with deflation and unemployment as threats, China's currency management is seen by other nations as predatory and destabilizing.

The US position is that keeping the Chinese currency undervalued – by buying dollar-based assets with Chinese currency – will create dangerous bubbles in China. Indeed, there is massive overcapacity in housing, with one Chinese electric company reporting 60 million housing units connected and not using any electricity, so presumably empty. If another 20 to 30 million units under construction are added, China's excess capacity could house the entire US population. Excess capacity in many commodities such as steel and even infrastructure add to the argument's strength. China will find it very tricky to switch from exports to domestic consumption if there's little need for housing or industrial expansion. It may be that a real slowdown is simply unavoidable in the next few years.

More than a quarter-century ago, Japan played the role that China does now, with its auto and electronics exports. The US trade balance was in a bad position, due in part to high fiscal deficits, when it negotiated the Plaza Accord in late 1985. The current account deficit, largely the trade deficit, was nearly 3 percent of GDP that year, and so a managed strengthening of Japanese and European currencies was negotiated. This currency change shifted manufacturing to other parts of Asia. It's true that the trade balance with Japan did not improve much, but overall the dollar devaluation succeeded in lowering the deficit. This experience gives many in the Congress fuel for believing that if China would "play fair," then the US trade deficit would shrink again.

Critics point out, correctly, that in the event of a Chinese currency adjustment, most of the jobs "lost" to exports from China would not return to the US, but simply move to other Asian or perhaps Latin American nations. However, many of the other exporters would buy more from the US than China does, so there might be a net gain. On the other hand, many of China's exports have imported components and it's only the value added of Chinese parts and assembly that would suffer if China's exports dipped.

If we assume a value added/export ratio of 50 percent for China's exports and $1.6 trillion in exports, a 20 percent currency strengthening might cause an eventual decline of 20 to 30 percent in exports from China, relative to what they would have been. In other words, China's exports would fall by US$400 billion and its domestic value added by half as much. That is 4 percent of China's GDP – an amount that might be offset by fiscal stimulus if there were not already shaky bank loans and excess capacity in many sectors.

China's fear is that their lost exports would simply move to other low-income exporters, leaving China with millions unemployed. If China had a recession, the reduced demand for raw materials would hit many nations that now benefit from China's voracious demand and might also further slow sluggish rich-nation economies. While this is well short of a global crisis, it would be difficult for China and an unwelcome negative shock for the rest of the world.

The basic problem is that large, and certainly growing, trade surpluses chalked up by China cannot continue. The political pressures alone means that there has to be some meaningful move towards adjustment – and the limits of monetary and fiscal expansionism in the OECD countries mean that their economies cannot keep on spending on imports with high levels of unemployment.

China has painted itself into a corner. For years, the nation along with foreign investors built factories to export in an increasingly unbalanced way. This trend had to stop, and that's happening now. China wants more time, but it's not clear they can have it. The global economy needs to be rebalanced. While the rich nations need to reduce deficits and save more, China must also play a role.

One line of argument, which is correct, may be too subtle. While China has basically stopped adjusting its nominal exchange rate against the dollar since 2008, its wages have grown rapidly. With a shrinking labor force and strong export growth, its real exchange rate – the "headline" or nominal rate adjusted for inflation differences – is actually adjusting exactly like US critics demand.

While measured inflation is low in China, the 20 to 30 percent annual increases in wages imply much higher rates of inflation than official data show and also mean factories must raise prices. Some of this impact of higher wages is offset by technical change, and some is absorbed in profit margins. Wen is correct when he says that thousands of factories have thin margins and cannot absorb a 20 percent nominal appreciation. What if they must pay 30 percent higher wages? China may already be adjusting, but the effects will take another year or two to appear.

Another approach might help China, but be less attractive for its neighbors. Many higher-end exports of China compete with those of Taiwan, South Korea and Japan. If those nations could negotiate an Asian Plaza Accord and set their exchange rates relative to one another in some agreeable range, the pain and danger of China adjusting alone would be less. This might allow more nominal exchange-rate flexibility with fewer sales lost to its higher-end competitors.

It would basically be an agreement among major Asian exporters to share the global adjustment and not take advantage of any Chinese currency strengthening. Unfortunately, the political atmospherics are increasingly strident on both sides. China could, of course, retaliate against any US tariff on its exports. But by US count, China's exports to the US last year were four times US exports to China.

It's clear that in a protectionist battle, the larger importer holds better cards. It's even possible that the US and EU would cooperate so that one couldn't be picked off alone in a trade war. The Chinese currency has appreciated slightly against the dollar since June, but actually depreciated against the euro. With the EU not far from a banking crisis, it's also sensitive to growing Chinese exports. In that case, China could maintain its nominal exchange rate and face joint tariffs or agree to some adjustment and try using fiscal policy to offset the reduction in its trade surplus. The latter would be better all around, but does not seem likely.

David Dapice is associate professor of economics at Tufts University and the economist of the Vietnam Program at Harvard University's Kennedy School of Government. Asia Sentinel reprints it with permission from YaleGlobal, the magazine of the Yale Center for the Study of Globalization.