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Barataria: Mr. Smoot, meet Mr. Hawley

It’s a currency war, it’s a trade war.  It’s every kind of war that can be fought safely behind a desk.   Are you ready for the latest dust-up, the assault on China?

The first shots came from of a rare bipartisan show of unity in the US Senate, which passed a bill requiring new tariffs on Chinese goods if they do not allow the Yuan to appreciate in value.  63 Senators went along with the measure, including 17 Republicans.  It seems like a popular direction to go, but Boehner has said he will prevent a similar measure in the House.  Obama said weakly that diplomacy is a better approach.

Doesn’t sound like the war is on after all.  But support for it is growing.

The root problem is that by most estimates the value of the Chinese Yuan is lower than it should be.  This makes their stuff cheaper than it would otherwise be, which allows them to export more than an open market would allow.  Exactly how much lower the Yuan supposed is than free market rates is an open question — guesses usually are in the 15-25% range, but allegations run as high as 40%.

It is relatively easy for China to keep its currency artificially low and thus keep the factories humming with export goods.  The Yuan is not commonly held by a lot of banks throughout the world because all trade in and out of China is done in US Dollars.  That does make it easier to control, with the Chinese central bank simply selling off more Yuan and buying more dollars whenever things get out of the range they want it to be in.

Their victory in the Currency War depends at least in part on expectations that the Yuan will not increase in value much in the near future, making it a lousy investment.

There isn’t much we can do about this situation because there has been a flight to the US Dollar over the last two years.  The potential collapse of the Euro, the ongoing weakness in Japan, and an increase in international trade between developing nations (priced in US Dollars) have all appreciate the value of our currency.  Our goods stay relatively expensive — and the USofA remains a nation that makes more money shuffling paper around the world than manufacturing stuff in factories throughout the heartland.

The kicker is that the Yuan may not be under-valued at all, at least not by the Big Mac Index.  This popular game is more than a bit of fun because it demonstrates the problem very well.  If you go by real costs in China, technically known as “Purchasing Power Parity” or PPP, a Big Mac costs about the same there as here.  The problem is not currency manipulation as much as it is very low costs of production in China — wages, real estate, and raw materials.  That won’t hold forever no matter how much the central bank manipulates the Yuan — and inflation in China is growing and likely to be a huge issue shortly.

Give it time.  In the long run, the Free Market™ will sort it out. Of course, in the long run we’re all dead.

We may not have many weapons to fight a Currency War, but as the biggest consumer in the world the USofA has a big arsenal for a Trade War.  The problem is that as a WTO member nation we are subject to their judgments, meaning any kind of tariff will likely authorize retaliatory tariffs in other nations, triggering a situation something like the mutually assured destruction of the global economy.  A Trade War is the financial equivalent of a nuclear war.  But killing off global trade would lower the value of the US Dollar rather dramatically in the long run.

But it’s not like we haven’t tried this in response to a Depression before.

Most economic historians agree that the last global depression was made much worse by the passage of the Hawley-Smoot Tariff in 1930.  It was the most repressive tariff ever implemented by the USofA, designed to shore up our manufacturing and put the nation back to work.  It did just the opposite, closing down international trade and putting millions around the world out of work.  By 1932 both Hawley and Smoot (the sponsors) were defeated for re-election and FDR actively campaigned against the measure, repealed shortly afterward.

A Trade War doesn’t do anyone any good, but it sure looks appealing.  That’s the problem with a Congress that can’t agree on anything internally — it starts to look outside the US for the solutions to the problems it cannot deal with.  There could easily be more of this horrible nonsense  in the future.

This post was written by Erik Hare and originally published on Barataria. Follow Erik on Twitter:@wabbitoid.

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