February 16, 2013

China is Cheating! Another Overused Protectionist Fallacy

By In Economics, History, Politics

This is a re-post from September 20, 2012.  China is on the news again.  The war horns are blaring and the Mainstream media has the awestruck audience convinced that the US economy would be roses and dandelions if China wasn’t, you know, rigging the market.  The following is a response to a Mitt Romney (remember that guy?) email I received.  However, it is applicable to the propaganda put forth by the Obama administration.  I tell you this in case you are still under the laughable assumption that Barack Obama and the Republican Party had radically differing goals in their policy (sic for tyranny) pursuits.

 

Adam Smith is considered the father of modern economics.  He is also considered one of the greatest free-market economists in the history of economic thought.  I have no problem with the first consideration.  It is the second one that bothers me.  Economic thought existed before the English Smithian Classical school and was especially dominated by the Spanish Scholastics and the French Physiocrats.  Not only did these two major groups of economic theorists precede Smith, they were also considerably better, that is, more free market.  So while it is untrue to say that Smith was the first economist, if a historian wants to call him the founder of moderneconomic thought, that is fine.  It just so happens therefore that modern economic thought started with a thinker who was not as good as his predecessors.

That said, one school of thought that Smith did well in overcoming were the so-called mercantilists, a group of trade protectionists. One aspect of mercantilism that was popular in its day was something called protectionist tariffs.  The theory of protectionist tariffs as argued by the mercantilists in those days was that heavy taxes needed to be placed on imports being received from other countries so that the domestic businesses in the receiving country could stay competitive and would not be driven out of business by foreigners.  This protectionist argument has a major fallacy, which we will get to below.

I received an email today from the Mitt Romney campaign.  I don’t know how I got on their mailing list.  The title of the email was “China is cheating.”  The email included the following message:

Year after year, President Obama has had the chance to label China a currency manipulator. But he hasn’t.

When China cheats by holding down the value of their currency compared with ours, it makes their products artificially cheap. It’s a rigged set-up that drives American manufacturers and American producers out of business, and kills jobs.

Mitt Romney and Paul Ryan will hold China accountable, and ensure they play by the rules. American goods, and the hardworking people who produce them, deserve a fair share in the global marketplace.

I have several comments.  One is regarding our own monetary policy.  The second is regarding an indication of the future Republican goals.  The third is regarding economic theory, based on the history given above about Mercantilism and protectionist trade policy.

First, you’ll always hear our political leaders complaining about other countries manipulating their currencies.  But never anything about the Federal Reserve and the fact that they manipulate the United States dollar.  In fact, by definition, central banking is manipulating currency.  They print more and lower interest rates sometimes.  Other times they retract the money and raise interest rates.  This is currency manipulation pure and simple.  But it always seems to be okay if the United States does it.  Just not other countries.  This is a hypocrisy issue.  For further reading, I will soon write a post on the inherent hypocrisy of the State, based solely on its own nature.

Secondly, this email just furthers my previously held belief that the Republican Party, just like the Democrat Party, wants to get into everyone else’s affairs and involve the United States in every part of the world.  The ever-expanding role of the Federal Government in the Middle East is easy to point to.  But now the Republican Party is starting to open its horizons a bit and move into Asia in our newest trend to conquer the world and create a bigger, stronger, scarier government.  Mitt Romney and Paul Ryan, says the email, are going to make sure that China plays by the rules.  Whose rules?  The rules of the United States.  But isn’t the United States Federal Government only allowed to act in the way prescribed by the Constitution?  That’s what I thought too.

Third point: the assumption that China is somehow cheating ignores good economic theory.  Because while the neo-Mercantilists in the United States academic setting call China out for cheating, all they are really cheating are themselves.  In fact, from an Austrian point of view they are subsidizing the American consumer!  This should be a good thing.  Let me explain.

The argument in this email is that since China is making their currency work less, their goods sell for less on the international market.  This is true.  Let’s say that the Yuan (Chinese currency) trades 1 to 1 with the Dollar (US currency).  This means that for every Yuan traded, they can get one Dollar in return.  Simple enough.  But let’s say China devalues their currency by half.  And so now it takes double the amount of Yuan to trade for the same amount of dollars.  Now the situation is 2 Yuan for every 1 dollar.  The Mercantilist says that this is good for China and bad for America.  But is this true?

If a Chinese devaluation happens, suddenly the producers in China see their costs go up.  There are more Yuan now in circulation than before, but the amount of goods in the economy has stayed the same.  This means there are more Yuan chasing fewer goods. Supply and Demand.  Prices go up.  The Chinese consumers and savers suddenly have to shell out more money to get the same amount of goods.  This is painful for them because now they have to work harder and live at a lower standard of living.

If the same Chinese devaluation happens, what does it look like for the Americans?  Well, assuming that the Federal Reserve has kept the supply of dollars the same (economists refer to this as Ceteris paribus, which is Latin for “all else being equal.”) it makes the Chinese goods cheaper.  This is because our dollars are now twice as strong as the Yuan, due to the Chinese devaluation.  So therefore it takes fewer dollars to buy the same Chinese good.  This is great news for the American consumer!

But the Romney email stated that this scenario drives American manufactures out of business.  That is their complaint.  Less manufactures means less jobs, they say.  But they have missed the one lesson of economics as written by Henry Hazlitt.

“The art of economics consists in looking not merely at the immediate but at the linger effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

There you have it.  Economics in one lesson.  Now let’s apply this lesson to the Mercantilist -and now Republican Party- defense for trade protections against currency manipulation.  Firstly, the jobs that are allegedly lost in the American economy aren’t really lost at all.  They are merely shifted away from the manufacturing sector and into lines of business that have opened up due to the new and cheaper products.  Importation-based businesses and retail super stores will be able to expand and add jobs.  Furthermore, because the goods that are being purchased from the devalued Chinese economy are cheaper, this keeps more money in the consumer’s pockets allowing them to save more (build American capital/wealth) or spend more here and support businesses (and creating jobs) that do not rely on exporting.  Looking at the bigger picture therefore shows the silliness of leaping to conclusions about losing jobs.

Moreover, we must realize that the Chinese are seeing their goods rush to America ever more quickly because of the cheaper price.  Every time they devalue their currency America has the ability to buy more per transaction (Ceteris paribus).  So the foreign exporters are experiencing more demand and their supply will more quickly lessen, thereby making the costs of the goods for Chinese consumers even more expensive!  Like I said above, the Chinese are subsidizing the American consumer, not the Chinese businesses.  Soon the Chinese exporter will find he is selling goods to America at a cheaper price than its costs to manufacture the goods because inflation has destroyed his economy.  The Romney email is claiming that the exporting businesses are doing well in China because there is higher demand.  What the email fails to realize though is while there is more demand, the exporter is getting paid half of what he was making before.  He is making half the money but prices in his economy have skyrocketed.  This obviously is bad for his long term survival.  America on the other hand is expanding the amount of goods it can buy and at the same time paying less for them than before.

Let’s look at it from one more perspective.  What happens to wages paid out to workers?  Obviously in China, the workers will not be able to utilize their wages to the same amount of goods as before.  Their standard of living will go down as it will take longer to save the money to improve their living situations.  The American worker on the other hand will find that his wages can buy more things and it will take less time for him to save his money to improve his standard of living.

As you can see, the protectionist argument is very much distanced from economic reality.  Contrary to their claims, we don’t need more government rules in order to survive.  We need less.  Free markets alone can produce positive results.  We need strong money.  When China weakens their money, it strengthens ours relative to theirs.  This is a good thing.  We shouldn’t get angry at the Chinese for devaluing their currency.  We should feel bad for them.  They are essentially working harder so that we can work less.  And their central bank is creating that circumstance.

It is shocking that our economists today are resorting back to 18th century arguments of government intervention into the market.  Especially when they work hard in the classroom to raise Adam Smith up as the greatest economist in history (besides John Keynes of course).  Don’t they realize that Smith demolished the Mercantilist position?

Here is to liberty and free markets.  The only way we can become economically healthy again.

Written by C.Jay Engel

Editor and creator of The Reformed Libertarian. Living in Northern California with his wife, he writes on everything from politics to theology and from culture to economic theory. You can send an email to reformedlibertarian@gmail.com