Back on December 20, 2008 (Protectionist dominoes are beginning to crumble around the world), British-columnist Ambrose Evans-Pritchard explained the U.S. mercantilism going into the Great Depression and what Great Britain did about it. Pritchard wrote:
There has been much talk lately of America's Smoot-Hawley Tariff Act, which set off the protectionist dominoes in 1930. It is usually invoked by free traders to make the wrong point. The relevant message of Smoot-Hawley is that America was then the big exporter, playing the China role. By resorting to tariffs, it set off retaliation, and was the biggest victim of its own folly.
Britain and the Dominions retreated into Imperial Preference. Other countries joined. This became the "growth bloc" of the 1930s, free from the deflation constraints of the Gold Standard. High tariffs stopped the stimulus leaking out.
It was a successful strategy - given the awful alternatives - and was the key reason why Britain's economy contracted by just 5pc during the Depression, against 15pc for France, and 30pc for the US.
In his November 19 speech, Federal Reserve Chairman Ben Bernanke went back to that same period. Citing a new working paper (Did France Cause the Great Depression?) by Douglas A. Irwin, Bernanke said:
As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new. For example, in the somewhat different context of the gold standard in the period prior to the Great Depression, the United States and France ran large current account surpluses, accompanied by large inflows of gold. However, in defiance of the so-called rules of the game of the international gold standard, neither country allowed the higher gold reserves to feed through to their domestic money supplies and price levels, with the result that the real exchange rate in each country remained persistently undervalued. These policies created deflationary pressures in deficit countries that were losing gold, which helped bring on the Great Depression.
According to Bernanke, the gold standard was supposed to prevent mercantilism, but it didn't because France and the United States violated the unwritten "rules of the game" that countries who accumulate gold have to inflate their currencies. Now, China and the other modern mercantilists are violating an actual written rule of the game: Article IV of the International Monetary Fund Articles of Agreement requires that countries "avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members."
Yet, Bernanke doesn't do anything about it.
There is a simple solution that Bernanke could recommend, should he finally catch up to Evans-Pritchard. It is kin to Great Britain's successful strategy of the 1930s. The United States could impose a scaled tariff on those countries that are practicing mercantilism. A scaled tariff is a WTO-legal tariff whose rate goes up when our trade deficit with a mercantilist country goes up, down when our trade deficit goes down, and disappears when our trade deficit disappears.
It is kin to "Imperial Preference" in that the United States would be buying tariff-free from those countries that don't practice mercantilism. But it is much better because it would also cause the mercantilist countries to take down their barriers to American products.
Disclosure: I own Chinese yuan through CYB.
