Howard Richman's  Instablog

On October 15, rather than combat Chinese currency manipulations, Treasury Secretary Timothy Geithner issued a ludicrous report to congress which claimed that China is not manipulating its currency. It concluded:

[This] report must consider whether any foreign economy manipulates its rate of exchange against the U.S. dollar to prevent effective balance of payments adjustments or to gain unfair competitive advantage in international trade. For the period covered in this Report, January 1, 2009 to June 30, 2009, Treasury has concluded that no major trading partner of the United States met the standards identified in Section 3004 of the Act. (p. 3)

America is currently experiencing the persistent economic depression that comes to countries who let their trading partners practice mercantilism, the strategy of maximizing exports and minimizing imports in order to run trade surpluses.

China is now using mercantilism to grow at about a 7% pace, while shrinking the economies of her political rivals in Japan, Europe, and America. China uses export subsidies, currency manipulations, and various tariff and non-tariff barriers to steal aggregate demand and production from the economies of her trading partners.

And American economists, following the lead of Adam Smith's 1776 book (The Wealth of Nations), allow this. Smith argued that mercantilism is a mistake because it reduces a country's current consumption. He correctly wrote:

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce. (iv.8.49)

But Smith missed an important fact. The mercantilist country only misses out on consumption for a while and the victim country only gets increased consumption for a while. Eventually the growth of industry and income in the mercantilist country and the loss of industry and income in the victim country reverses the tide. As we noted in our book Trading Away Our Future:

In 1997, Peking University economics professor Heng-Fu Zou, a Senior Research Economist for the World Bank’s Development Research Group, showed, in an intriguing paper [“Dynamic Analysis of the Viner Model of Mercantilism”], that mercantilism can succeed on its own terms for a small economy. Accumulating foreign assets (running a trade surplus) leads to long term positive outcomes. “A nation with strong mercantilist sentiment ends up with large foreign asset accumulation and high consumption in the long run.” (p. 26)

In 1936 while writing his magnum opus (The General Theory of Employment Interest and Money), John Maynard Keynes rejected Smith’s mercantilism theory, pointing out:

(A) favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)

We don’t have to permit Chinese mercantilism. Should we require that our trade ratio with China move to balance, the Chinese government would be forced to take down their many tariff and non-tariff barriers to American products.

Currently we buy about $1 from China for every 25¢ that China buys from us. The U.S. Treasury Department could achieve equality by auctioning import certificates that allow the same value of Chinese imports as China imports from us. The revival of American manufacturing and the American economy would be dramatic.

Disclosure: No Positions