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In an emerging economy with rapid productivity growth the real exchange rate should rise over time, through either higher inflation or a rise in the nominal exchange rate.
Over the past decade annual inflation (as measured by the GDP deflator) has averaged 3.8% in China against 2.2% in America.
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Our best guess is that annual real GDP growth over the next decade averages 7.75% in China and 2.5% in America, inflation rates average 4% and 1.5%, and the yuan appreciates by 3% a year.
If so, then China would overtake America in 2019 (see chart).
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