THE renminbi, or yuan, is now the lightning rod for criticism.

Since US Treasury Secretary Timothy Geithner started to use the word "manipulation" to describe China's foreign exchange rate at the beginning of last year, the controversy surrounding the yuan has reached a staggering height this month, with noted economists Paul Krugman and founder of the Peterson Institute of International Studies, Fred Bergsten, joining the choir.

On March 16, New York Senator Charles Schumer and four senators proposed a bill that would effectively compel the US Treasury Department to name China as a "currency manipulator" in its annual report to the Congress that is scheduled to be released on April 15.

Additionally, 130 US House members sent a letter to Geithner, calling on the Treasury to issue a finding of manipulation and calling on the Commerce Department to impose countervailing duties, a practice which I call post-verdict evidence seeking.

Let me begin by first pointing out the gross misunderstanding and exaggeration of the Sino-US trade imbalance, which is the pillar of the argument for a higher valued yuan.

In October last year, China's Ministry of Commerce, the US Department of Commerce and the Office of the US Trade Representative conducted a joint study to determine the statistical discrepancies that have been existing for a long time between the merchandise trade statistics issued by the two sides.

Take 2006 for example. Statistics from the US side say the merchandise trade deficit is US$232.6 billion, while the China side says it is only US$144.3. It turns out that the discrepancy is explained by two factors. First, a sizable part of the Chinese exports are via intermediary countries on route to the US for further processing and repacking. The US Customs counts the total value of goods when arriving at the US as originating from China.

In addition, the valuing of the goods is based on the arriving prices at US ports (CIF price in trade terminology), ignoring the cost of freight, insurance and other services involved in the trade.

According to China's Ministry of Commerce, these two factors account for a 25 percent exaggeration of China's merchandise exports to the US.

Note that I have been very careful in using the word "merchandise trade" versus "trade" in general.

The US is the dominant world exporter of service, as its economy is increasingly becoming service and high-tech oriented.

The China side does not have official statistics on trade in service (which by the way, I suggest the Chinese government should do) while the US side has numbers at the aggregate level.

Overall service accounts for about 40 percent of total US exports. I would surmise this percentage number is even higher, if you see every major American company in banking, insurance, accounting, and consulting service industries is doing great businesses in China.

The big four accounting firms account for 40 percent of the total accounting service revenues in China, according to statistics from the Ministry of Commerce.

Again take 2006 as an example. The US$144.3 merchandise trade deficit may be reduced to between US$50 billion to US$100, if taking into account the value of service flows across the Pacific.

The trade imbalance isn't really as bad as the doomsayers in Washington have been preaching, and the gap is shrinking rapidly.

In the past three months, China's imports have been growing much faster than exports. In fact, the government said the second quarter is likely to see a trade deficit.

At the center of the revaluation of the yuan issue is the free convertibility of the yuan - let the market demand and supply decide its true value.

And the market demand and supply is not only driven by current account items such as trade in goods and services. It is also driven by capital account items, a fact that the revaluation camp chooses to ignore.

China's foreign currency regime is still under government control. Outflow of dollar-denominated assets by ordinary citizens is very difficult, while influx of hot money in exchange for yuan or yuan-denominated assets via irregular and sometimes illegal channels accelerated over the last few years in anticipation of the yuan appreciation.

For example, unofficial statistics suggest that one third of Shanghai's new housing apartments in prime locations in recent years, those condo units within the inner ring area in Shanghai, have been bought by foreigners. This increase of supply of dollars in the capital market due to foreign investors and the suppression of demand for dollars from domestic investors creates artificial pressures on yuan appreciation.

Fred Bergsten talks about the Chinese government buying US$1 billion with yuan on the open market each day, leaving the impression of a currency manipulator.

But the fact is this so-called open market is an inter-bank electronic trading system owned by the central bank that only allows a narrow band of price fluctuation.

At the end of the day, any imbalance in demand and supply of dollars has to be ultimately taken up by the central bank.

In the last few years, of course, it is all the dollars flowing into the central bank's coffer, including those dollars that foreign hot money investors have poured down the throat of China in order to buy yuan-denominated assets.

In that sense, China's central bank is more like a currency manipulatee - being manipulated by the foreign hot money - than a currency manipulator.

Eventually the evolution towards a fully convertible yuan is the solution, a direction that no one, including the Chinese government, opposes.

But this process takes time and has to be managed in an orderly manner. A shock therapy to the exchange rate is a recipe for failure, causing harm to both economies.

Many empirical studies have pointed out that "elasticity" is not just "pessimism" as Krugman postulates. It is a fact.

It happened to Japan in the 1990s. It happened to China between 2005 and 2008. And it happened to many other countries as well.

Let's face the fact. This cross-Pacific brawl is all about jobs. The win-win solution is for America and China to both increase jobs.

Realistically at the moment this means increasing US exports to China and maintaining Chinese exports to the US. Appreciation of the yuan does the exact opposite, as we are likely to enter a Smoot-Hawley era.

There are many policy instruments that both governments can use to increase American exports to China and balance the current and capital accounts.

On the China side for example, China can lower tariffs on automobile and luxury consumer products. China can be more accommodating to American agricultural products.

China can gradually relax controls over private outflow of dollar assets. Many policy instruments on the US side are available as well.

A confrontational approach on the exchange rate alone is clearly a beggar-thy-neighbor approach for a beggar-thy-neighbor solution.

(The author is associate professor of economics at the University of International Business and Economics. His e-mail: johngong@gmail.com)