Protect us from this!

Americans never make very convincing free traders. When the going gets tough, they're quick to blame their trading partners. There's been surprisingly little protectionist sabre-rattling during the current recession -- though you'd struggle to convince anyone from Airbus Industrie, who were robbed of a fairly-won contract for refuelling planes after frantic lobbying by Boeing -- but that may be about to change. Paul Krugman, the Nobel-winning economist, wants the US to adopt a hard line to force China to revalue its currency, the Yuan. You can read his arguments here; the article published on March 16 is the most complete exposition.

In brief, Krugman accuses China of running the most drastic mercantilist policy in history, one that's impoverishing the entire world. The underlying economics is the Keynesian "liquidity trap" concept. Saying "this has to stop now", Krugman wants the US to impose a 25% tariff on all imports from China, to force it to revalue. He envisages the EU following suit, in order to avoid becoming a dumping ground for China's surplus goods. And he envisages the Chinese crying "uncle" very quickly.

The undervalued Yuan is a problem all right. If only solving it could be as simple as Krugman suggests. The flipside of China's trade surpluses is an enormous capital outflow, much of which has found its way into the US Treasury market. Until now, China has been a model investor, adding to its holdings through thick and thin. Can it really be imagined that this would remain the case if the US suddenly tried to choke off the flow of imports from China? Beijing wouldn't have to sell many of its Treasuries to cause chaos in the US bond market -- in fact, just threatening to sell them would probably trash the market, with incalculable consequences.

China's "drastic mercantilist policy" finds its exact mirror image in the "drastic overconsumption binge" in the US, a binge which it has directly made possible. (The problem Krugman is trying to solve is actually the result of US monetary policy during the Bush years; it wasn't China that started this, as Krugman implies). It's unlikely that the great American public would take kindly to Krugman hauling all the cheap electronics out of Wal-Mart. Like all protectionists, of course, Krugman argues that domestic producers would take up the slack, and ridicules those who would dare to disagree in one of the most arrogant sentences I've ever read: "If you can’t think offhand of ways U.S. production might replace imports, that’s probably because you just don’t know enough". Well, I guess I don't know enough, and neither do the folks in Detroit who are seriously thinking of putting a quarter of the land area of the Motor City back into agricultural use. I'd refer Krugman to Bruce Springsteen's "Home town": "these jobs are going boys, and they ain't coming back". Time for a Nobel for The Boss?

Krugman has got the cart firmly in front of the horse here. For him, feckless, bankrupt, uncompetitive Americans aren't the problem -- it's the hard-working, solvent Chinese that have to adjust. Luckily, Krugman's outburst has received short shrift so far -- one commentator has compared him to Donald Rumsfeld, which has probably not pleased either man. But he's eloquent and influential, and in the US a protectionist is always preaching to the choir. This could get dangerous.