Page 1 of 4 Krugman blaming victim for the crime
By Henry C K Liu
A year-end (December 31, 2009) opinion piece by New York Times columnist Paul
Krugman with the title "Chinese New Year" contains errors of fact and flaws of
logic. But the most egregious fault of the piece is Nobel economist
prize-winner Krugman's approach of blaming the victim for the crime.
To begin with, the supposedly clever "Chinese New Year", which one would expect
more as a headline for the National Enquirer than a serious newspaper, will
fall flat to Chinese ears because Chinese New Year does not fall on the first
day of the Western calendar year. This year, Chinese New Year falls on February
14, 2010. It would be the 4,408th year since Chinese civilization began keeping
calendar records. Year 4408 is the Year of the
Tiger in the 12-year zodiac cycle in the Chinese lunar calendar. People born
under the sign of the tiger are supposed to be sensitive, given to deep
thinking and capable of great sympathy. Unfortunately, Krugman's piece on
Chinese New Year exhibits few of the above attributes.
Krugman wrote in his article that "China has become a major financial and trade
power. But it doesn't act like other big economies. Instead, it follows a
mercantilist policy, keeping its trade surplus artificially high. And in
today's depressed world, that policy is, to put it bluntly, predatory."
What is mercantilism?
In the current global international finance architecture based on fiat dollar
hegemony, mercantilism cannot be pursued by any trading nation beside the US,
the issuer of the fiat dollar.
Mercantilism is a term tied historically to a national policy on international
trade conducted with specie money backed by gold. A mercantilist trade policy
aims at winning gold with trade surpluses to provide more domestic investment
to keep the surplus country more prosperous and more competitive in
international trade. Fiat dollars, unlike gold, cannot be spent outside of the
dollar economy. China's dollar trade surplus is denominated not in gold but
merely in paper that the US can print at will. Dollars cannot be spent inside
China without first being converted to Chinese currency, a move that would
cause inflation in China since the wealth behind this new money has been
shipped to the US in exchange for real wealth but for paper.
Historically, the processes of globalization have always been the result of
state action, as opposed to the mere surrender of state sovereignty to
unregulated market forces. Adam Smith published Wealth of Nations in
1776, the year of US independence. By the time the constitution was framed 11
years later, the US founding fathers were deeply influenced by Smith's ideas,
which constituted a reasoned abhorrence of trade monopoly and government policy
in restricting trade.
What Smith abhorred most was a policy known as mercantilism, which was
practiced by all the major powers of the time. It is necessary to bear in mind
that Smith's notion of the limitation of government action was exclusively
related to mercantilist issues of trade restraint. Smith never advocated
government noninterference of and tolerance for trade restraint, whether
practiced by big business monopolies domestically or by other governments
internationally.
Historically, a central aim of mercantilism was to ensure that a nation's
exports remained higher in monetary value than its imports, the trade surplus
in that era being paid only in specie money (gold-backed) as opposed to fiat
money. This trade surplus in gold permitted the surplus country, such as
England in the 18th and 19th centuries, to invest in more factories to
manufacture more efficiently for export, thus bringing home more gold. The
importing regions, such as the American colonies, not only found the gold
reserves backing their currency depleted, causing free-fall devaluation (not
unlike that faced today by many emerging-economy currencies), but also wanting
in surplus capital for building factories to produce for export. So despite
plentiful iron ore in America, only pig iron was exported to England in return
for English finished iron goods.
In 1795, when the Americans began finally to wake up to their disadvantaged
trade relationship and began to raise European (mostly French and Dutch)
capital to start a manufacturing industry, England decreed the Iron Act,
forbidding the manufacture of iron goods in America, which caused great
dissatisfaction among the prospering colonials.
The meaning of laissez faire
Smith favored an opposite government policy toward promoting domestic economic
production and free foreign trade, a policy that came to be known as "laissez
faire" (because the English, having nothing to do with such heretical ideas,
refuse to give it an English name). Laissez faire, notwithstanding its literal
meaning of "leave alone", meant nothing of the sort. It meant an activist
government policy to counteract British mercantilism.
The history of the development of the US economy is one of government
protection of US industries against stronger foreign competitor and government
restriction of domestic monopolies. This trend continued until after the US
replaced Britain as the global economic hegemon after World War II. Government
intervention in US foreign trade and antitrust measure in domestic trade built
the US economy into a global power.
Neo-liberal free-market economists are just bad historians, among their other
defective characteristics, when they propagandize "laissez faire" as no
government interference in trade affairs. Currency hegemony of course is the
most fundamental trade restraint by one single government.
A strong dollar and US national interest
Since the end of the Civil War, a strong-dollar policy has been viewed by all
administrations to be in the US national interest because it keeps US inflation
low through low-cost imports and it makes US assets expensive for foreign
acquisition.
This arrangement, which former Federal Reserve Board chairman Alan Greenspan in
congressional testimony proudly called US financial hegemony, has kept the US
economy booming in the face of recurrent financial crises in the rest of the
world, at least until the current crisis. It has distorted globalization into a
"race to the bottom" process of exploiting the lowest labor cost and the
highest environmental abuse worldwide to produce goods for export to US markets
in a quest for the almighty dollar, which has not been backed by gold since
1971; nor has it been backed by economic fundamentals for more than a decade.
Before the emergence of dollar hegemony through which it became possible to
finance the US trade deficit with a US capital account surplus, Federal Reserve
chairman Paul Volcker had to raise the Fed funds rate to an all-time high of
19.75% on December 17, 1980, to curb US stagflation caused by a rising trade
deficit.
Five years later, in 1985, Volcker and Treasury secretary James Baker III
engineered the Plaza Accord to force the Japanese yen up against the dollar to
curb the US trade deficit with Japan, promptly pushing the Japanese economy
into a sharp deflationary depression from which Japan has not yet fully
recovered.
During the Plaza Accord negotiations, Baker famously told his Japanese
counterpart that "the dollar is our currency but your problem". In 2010, this
statement is no longer operative. The weakening dollar has reverted to being
fundamentally a US problem. It is a puzzle why Krugman is now trying to jawbone
the dollar further down against the Chinese yuan.
Financialization of the global economy
Financialization of the deregulated global economy through excessive debt and
structured finance speculation supported by fiat dollar hegemony has detached
asset values from underlying economic fundamentals to form financial bubbles.
The adverse effects of this type of globalization on the developing economies
are obvious. It robs the people of the meager fruits of their exports and keeps
their domestic economies starved for capital, as all surplus dollars from
export must be re-invested in US sovereign debt instruments to prevent the
collapse of their own domestic currencies.
The adverse effects of this type of globalization on the US economy are also
becoming clear. In order to act as consumer of last resort for the whole world,
the US economy has been pushed into serial debt bubbles fueled by unsustainable
over-consumption and fraudulent accounting. The unsustainable and irrational
rise of US equity prices, unsupported by revenue or profit, had merely been a
devaluation of the dollar. Ironically, periodic adjustments in US equity
prices, known to the public as market crashes, merely reflect a trend to return
to a stronger dollar, as it can buy more deflated shares.
Overcapacity caused by wage stagnation
The world economy, through technological progress and deregulated markets, has
entered a stage of overcapacity in which the management of aggregate demand is
the obvious solution. Yet we have a situation in which the people producing the
goods cannot afford to buy them and the people unfairly receiving the profit
from goods production cannot consume more of these goods. The size of the US
market, large as it is, is insufficient to absorb the continuous growth of the
world's new productive power in the emerging economies.
For the world economy to grow, the whole population of the world needs to be
allowed to participate with its fair share of consumption. Yet neo-liberal
economists and monetarist policymakers continue to view full employment and
rising fair wages as the direct cause of undesirable inflation, which is deemed
a threat to sound money.
Demonizing China not a policy option
Professor Krugman should know that demonizing China for its monetary policy,
which under dollar hegemony is fundamentally a reactive derivative response to
US monetary policy, serve no useful purpose. Instead of pushing China to
revalue the exchange value of its currency upward, he should be pushing both
China and the US to raise domestic wages aggressively. Until US workers doing
the same work are not paid more than their Chinese counterparts, US-China trade
cannot be balanced. The preferred solution is for Chinese wages to increase at
a faster rate than US wages and not for US wages to decrease. Co-operation on
this front is urgently needed in US-China bilateral trade talks.
Mercantilism is a trade theory that assumes international trade to be a
zero-sum game. In such as game, a trading nation's prosperity is dependent on
increasing its procession of capital in the form of gold through trade surplus
denominated in specie money. The theory has since been invalidated first by
Adam Smith's trade theory of absolute advantage and later by David Ricardo's
trade theory of comparative advantage.
Adam Smith (1723-1780) argues that a country should produce and export
commodities for which it has an absolute advantage and import commodities from
countries that have absolute advantage in producing other commodities. Such
terms of trade will benefit both trading partners by expending both economies.
Protectionism works against such mutual benefits.
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