The real exchange rate -- including domestic inflation -- is still the appropriate measure:
The [Chinese] central bank has been pumping out currency at an ever-accelerating pace over the past decade to limit the renminbi’s appreciation against the dollar. That strategy has helped preserve a competitive advantage of Chinese exporters by keeping their prices relatively low on global markets — while also protecting the jobs of tens of millions of Chinese workers in export factories.
Now, though, that cheap currency policy seems to be reaching its limits. The extra renminbi are feeding inflation. That is starting to undermine exporters’ price competitiveness — just as a stronger renminbi would do if Beijing was not intervening to begin with. ...
Inflation in China is not just the result of China’s currency market intervention, although Mr. Hu and other economists describe it as the biggest single cause. Another cause is aggressive lending by Chinese banks, despite repeated demands by regulators to slow things down.
Meanwhile, David Leonhardt tries to play down currency concerns in advance of Hu Jintao's visit to the U.S.:
For the United States, the No. 1 problem with China’s economy is probably intellectual property theft. Technology companies, for example, continue to notice Chinese government agencies downloading software updates for programs they have never bought, at least not legally.
No wonder China has become the world’s second-largest market for computer hardware sales — but is only the eighth-largest for software sales.
Next on the list, say people who work in China or do business there, is the myriad protectionist barriers China has put up. These barriers make this country’s recent efforts at “buy American” protectionism look minor league. In some cases, Beijing has insisted that products sold in China must not only be made there but be conceived and designed there. The policy goes by the name “indigenous innovation. ...
The most relevant comparison of two currencies is one that is adjusted for inflation in the two countries. When inflation is higher in one country, as in China today, it means that country’s products are becoming more expensive — and imports into the country become relatively cheaper. In effect, the real price of Chinese-made goods is rising faster than the exchange rate suggests.
Without taking inflation into account, the renminbi has risen 3 percent against the dollar since last summer, when China began letting it rise. Once inflation is accounted for, the real increase has been about 5 percent. At that pace, the renminbi could erase its artificial undervaluation — as some economists estimate it — in less than two years.