As it becomes increasingly apparent Beijing is intent on ignoring Washington's exhortations to significantly revalue, many investors may move their money back to more secure western locations.

All of this illuminates why it serves China's interests, and those of other Asian countries that would likely follow its lead, to revalue their currencies.

Investing in developing countries is inherently more risky than investing in the United States --issues of legal security, political and social stability, and economic management, not to mention the absence of flexibility inherent in underdeveloped physical and financial-market infrastructures, all dog investors. Investors go to these places seeking higher rates of return that may accompany fast growing export and internal markets.

Over the medium term, undervaluation fuels rapid capitalization and employment growth in export industries, and supporting urban infrastructure (e.g., housing) but at the expense of profits and wages. To maintain its peg, China spends about 12 percent of its GDP and imposes a shadow tax on exports of about 33 percent. This shows up in lower profits for investors and lower wages.

Since 1995, as China's productivity has improved, its currency would have risen gradually had it been left to market forces, and profits and wages would be higher too.

The story is similar in other Asian countries that intervene consistently to keep their currency values from rising.

The portfolio investors who sank funds into Asia in anticipation of revaluation were betting that the dividend of higher profits would finally be paid out -- higher currency values might have curtailed some exports but for stronger exporters, higher prices would have meant higher profits.

Bang -- a big surge in the values of the more robust exporters!

Also, higher real profits and wages would have meant more robust domestic demand for the Buicks GM is building in China, and for others investing to service Asian markets.

Another bang -- a big surge in the value of firms betting on internal market growth!

The trick for portfolio investors has been to identify those extra-marginal businesses -- namely those firms likely to survive long-term in highly competitive and fluid Asian markets.

If meaningful revaluation is not going to happen, then portfolio foreign investment will slow. The portfolio investors will leave first and then the direct investment will slow too.

China may be sitting on massive foreign reserves, and it can buy companies if western governments accommodate; however, it really cannot buy certain know-how only direct foreign investment brings.

In the end, if it wants foreign capital worth having, it will have to play by market rules.

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