Power Is One of the Goals of Chinese Mercantilism

by: Howard Richman

In the June 13 American Spectator, Jed Babbin, former deputy undersecretary of defense under George H.W. Bush, correctly pointed out that China is using mercantilism in order to build up its power. He wrote:

China isn't just our lender. It's not a free-market trading partner hoping that a rising economic tide will raise both economies out of the recession. China is an adversary, a 21st century mercantilist nation whose policy is to gain economic strength by manipulating markets. And its role as our reliable lender is aimed at manipulating U.S. economic strength as a means of diminishing our ability to interfere in Beijing's ambitions.

The European mercantilist nations of the 15th-18th centuries sought to increase government holdings of gold and silver as a means of growing economic power. Their main tool was market manipulation -- by tariffs and trade cartels, which were restrictive enough to cause a few wars. But military power was, to them, a secondary means of protecting or obtaining economic power by conquest and colonization.

Indeed power is one of the goals of mercantilism. I also pointed that out in a commentary that I wrote in December:

Modern mercantilism is based upon the twin goals of mercantilism as explained by University of Chicago economist Jacob Viner: (1) maximizing a country's power through accumulation of foreign assets while (2) maximizing long-term consumption by delaying present consumption in favor of future consumption.

In order to accomplish these ends it places tariffs (and other barriers) upon foreign products while at the same time buying foreign assets (mainly interest-bearing bonds today; gold in the past). In other words, mercantilist governments maximize their power and their people's future consumption through the combination of import barriers and foreign loans ....

[T]he effects [of mercantilism] upon its victims can be predicted as exactly in the opposite direction as the effects upon the mercantilist country. In the short-run the victim countries gain consumption, while in the long-run the victim countries lose both power and consumption.

Babbin was on the right track and almost reached the obvious conclusion that we should enact a WTO-legal scaled tariff to balance trade in order to protect our economic and political future. But then he veered off course. According to Babbin, China just abandoned the mercantilist strategy of accumulating foreign assets in order to run trade surpluses. He wrote:

When the dollar was strong, they did everything possible to maintain a trade export to bring U.S. dollars into their reserves. The weakening dollar caused them to reduce their trade surplus in May.

In reality, the People's Bank of China (PBC) has not stopped accumulating hundreds of billions of dollar assets per year as evidenced by the fact that the yuan didn't stop shadowing the dollar in May. Any short-term improving trend in U.S.-China trade in May was probably due to Chinese inflation, which the PBC is fighting in every way possible, except by ending its printing of yuan to use when buying dollars.

Furthermore, China has not started taking down its barriers to U.S. products. Its government still publishes catalogs that routinely exclude almost all U.S. products from eligibility for purchase by its huge public sector. It still keeps out U.S. meat through a wide variety of subterfuges. It still permits its people to pirate U.S. software, CDs and DVDs, even while it places bureaucratic hurdles upon the sales of the legitimate products. It still places tariffs of about 25% on U.S. products ranging from vehicles to raisins to small bulldozers.

If China has changed policy, it does not yet show up in the trade data published by the U.S. Census Bureau. With Chinese aggregate demand growing rapidly and U.S. aggregate demand stagnant, economists would normally expect the Chinese trade surplus with the United States to be shrinking. But for the last 12 months, China's trade surplus has continued to be higher each month than it was the same month of the previous year, as shown by the blue line being consistently above the red line in the graph below:

Babbin is a defense expert who has correctly identified the power threat of Chinese mercantilist policy. But he doesn't understand how mercantilism works. This causes him to make the mistake of claiming, based upon one item of data which runs counter to all the other available data, that China has changed its policy.

China is still practicing mercantilism. It is still buying U.S. assets. It is still keeping out U.S. products. It is still building up its economic and political power and bringing down our economic and political power. And the U.S. political establishment is still practicing what University of Maryland economist Peter Morici correctly calls "appeasement."

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.