"If China were coerced into really large appreciations of the renminbi, it could face the same deflationary fate as Japan in the1980s and 1990s -- and all this without reducing its trade surplus," said Ronald McKinnon in an article published Wednesday by The Wall Street Journal.  

The U.S. current account deficit simply reflects the excess of expenditures in the United States relative to income, or, equivalently, the amount by which America's moderate level of investment exceeds its very low saving rate -- both by households and the federal government, McKinnon said in the article titled "The Worth of the Dollar."  

So the first order of business in correcting the trade deficit is to reduce the structural fiscal deficit of the United States and possibly run with surpluses.  

The second order of business is to provide incentives -- possibly tax incentives -- for American households to increase their saving.  

Both require major changes in U.S. public finances and should be phased in gradually but very deliberately, said the professor.  

However, this is not the end of the story. To work smoothly, adjustment has to be two-sided, McKinnon said.  

"The East Asian countries with large saving and trade surpluses, notably China and Japan (also Germany and various oil producing emirates), must move to increase consumption in parallel with American efforts to reduce consumption."  

McKinnon said that some people worry that if Washington was to move unilaterally to raise tax and reduce private consumption, aggregate demand would be insufficient. U.S. households would no longer be "consumers of last resort" for the world at large. Thus unilateral moves by Washington to contract consumption, unless done very gradually, could foment a world-wide slump.  

However, if contraction in the United States was offset by expansion elsewhere, such problems would be minimal -- and trade imbalances could be reduced more quickly.  

"In neither case, however, would any substantial change in the dollar's exchange rate be necessary or desirable," said McKinnon.  

In considering China's (and other Asian countries') trade surpluses, McKinnon said, U.S. Treasury Secretary Henry Paulson "should not reach for the wrong instrument -- particularly one that is based on faulty theorizing."  

McKinnon said that a major reduction in the RMB value of the U.S. dollar will not correct the saving imbalance between the two countries.  

"However, it could cause a major bout of monetary instability with deflationary consequences in China itself," the professor said.  

"And if China is the linchpin, such that other countries in Asia and even Europe follow with their own appreciations against the dollar, the inflationary pigeons may well some home to roost in the United States -- as in the 1970s," McKinnon said.