But, let's step back and take a look at Washington's embrace of mercantilist machismo. The United States has recorded a trade deficit in each year since 1975. This is not surprising because savings in the U.S. have been less than investment. The trade deficit can be reduced by some combination of lower government consumption, lower private consumption or lower private domestic investment. But, you wouldn't know it from listening to the rhetoric coming out of Washington.
This is unfortunate. A reduction of the trade deficit should not even be a primary objective of federal policy. Never mind. Washington seems to thrive on counter-productive trade and currency wars that damage both the U.S. and its trading partners.
From the early 1970s until 1995, Japan was an enemy. The mercantilists in Washington asserted that unfair Japanese trading practices caused the U.S. trade deficit and that the U.S. bilateral trade deficit with Japan could be reduced if the yen appreciated against the dollar — a "weak dollar policy. Washington even tried to convince Tokyo that an ever-appreciating yen would be good for Japan. Unfortunately, the Japanese complied and the yen appreciated, moving from 360 to the greenback in 1971 to 80 in 1995. Today, it's 84.
But, while this policy switch was welcomed, it was too late. Even today, Japan continues to suffer from the mess created by the yen's appreciation.
As Japan's economy stagnated, its contribution to the increasing U.S. trade deficit declined, falling from its 1991 peak of almost 60% to 9.5% in 2010 (see the accompanying chart). While Japan's contribution declined, China's surged from slightly more than 9% in 1990 to 42% in 2010. With these trends, the Chinese yuan replaced the Japanese yen as the mercantilists' whipping boy.
I was introduced to the Chinese currency controversy almost ten years ago, when I appeared as a witness before the U.S. Senate Banking Committee on May 1, 2002. The purpose of those hearings was to determine, among other things, whether China was manipulating its exchange rate.
The U.S. Treasury failed to name China a currency manipulator back in May 2002, and it hasn't done so since then. This isn't too surprising since the term "currency manipulation" is hard to define. Accordingly, it is not an operational concept that can be used for economic analysis.
Even the U.S. Treasury has acknowledged this fact. But, this has not stopped politicians and special interest groups in the United States, and elsewhere, from asserting that China manipulates the yuan.
Protectionists in the U.S. have threatened to impose tariffs on imported Chinese goods if Beijing does not dramatically appreciate the yuan. These protectionists even claim that China would be much better off if it allowed the yuan to become stronger vis-á-vis the U.S. dollar.
This state of affairs could be dangerous, not only for the Chinese, but also for the world economy. Instability and economic troubles in China prompted by protectionist passions could throw a monkey wrench into the world's new growth locomotive: China (see the accompanying chart).
And if you think the political chattering classes in the U.S. are dangerous, take a look at Europe, where the elites are fighting economic reality with all their might — a fight they will lose. Indeed, they have built an economic doomsday machine. And when it comes to Greece, don't fool yourselves into believing that the recent huge debt restructuring exercise will allow Europe's politicos to pull their chestnuts out of the fire. Greece's annual broad money (M3) growth rate has been in negative territory for every month since February 2010, and it is currently contracting at a fantastic 17.5% (see the accompanying chart). In the words of former President George W. Bush (not Yogi Berra): "This sucker is going down." You can forget all the calculations and soothing noises coming from Europe.