The Times of London
Irwin Stelzer, American Account
July 18, 2009

Trade skirmishes are one thing, full-blown trade wars quite another. Politicians, even the most fervent believers in free trade, sometimes have to bend to constituents’ demands for protection. But these skirmishes have not laid waste to what remains basically a globalised free trading system.

A worldwide recession changes things. In America, banks taking bail-out funds were told not to hire foreign workers, states receiving stimulus money were enjoined to “Buy American”, and when wearing his hat as chief executive of General Motors, President Barack Obama forced the carmaker to shift production of small vehicles from China to American states that were important contributors to his election victory.

America, of course, is not the only country finding protectionism an attractive way of soothing the trade unions and taxpayers who do not want to see their bailout and stimulus money leaking abroad. The World Trade Organization (WTO) reports 100 trade-restricting measures undertaken by 30 countries and the EU in the past six months. And the World Economic Forum reports that America ranks a high 16th on its “enabling trade index” among the 121 nations studied, a notch above France (17th), and well above Russia (109th) and China (49th).

It is the disparity between America’s more-or-less free-trade policies and China’s increasingly restrictive policies that contains the seeds of real problems for a global economy struggling to emerge from recession. If any recovery is to prove durable, America and China must rebalance their trading relationship. So long as China runs a huge surplus with America, America will send dollars to China, China will use those dollars to buy US Treasury bills, thereby keeping interest rates low in America, discouraging savings and encouraging unsustainable levels of debt and consumption.

Neither party to this deal is happy. The Chinese complain that the Obama administration’s madcap spending and borrowing spree will eventually generate inflation that will shrivel the value of the trillion or so of dollar assets stored in their vaults. Our politicians are unhappy because the Chinese manipulate their currency to keep it “substantially undervalued”, in the words of a new International Monetary Fund (IMF) report, to stimulate exports. Late last week sighs of relief could be heard in Chinese ministries as the country’s growth rate climbed to 7.9%, almost hitting the 8% target set to keep unemployment below socially destabilising levels. The Chinese regime considers currency manipulation a minor offence compared with the greater evil of unemployment that might lead to social unrest and riots.

This means that the prospect of a G2 meeting at which these problems are resolved is becoming less likely. The Chinese are furious that the US International Trade Commission has imposed duties as high as 55% on imported Chinese tyres that it says are disrupting the American market. Obama has to approve the decision, and risks antagonising the 15,000 tyre workers whose union initiated the proceedings if he does not.

The Chinese are even angrier that the Obama administration’s fiscal policy, and the Federal Reserve Board’s policy of increasing the money supply — a policy that the Fed might, but only might, be reversing — have the potential to reduce the value of their dollar hoard. So angry, in fact, that they continue to call for a reduction of the role of the dollar in world markets, their latest argument being that wild fluctuations in the value of the dollar make trade difficult and expensive.

But it is important to look at what the Chinese do, not only at what they say. In the second quarter China continued to increase its holdings of US Treasury bonds, and quietly admitted it recognises that the dollar will remain the world’s reserve currency for a long time.

Meanwhile, this nation that benefits so much from virtually free access to American and other markets continues to distort world markets by setting export quotas on raw materials such as magnesium, zinc and coking coal, keeping prices to its own manufacturers low, and raising prices for US and EU companies. After two years of futile negotiations, the US and EU have filed a joint complaint with the WTO.

There’s more. China recently increased tax rebates to exporters, stepped up its generous loans from state-owned banks to finance exports and incorporated a “Buy Chinese” provision in its stimulus package. So much for hopes that faster growth in China will be the engine that pulls the world out of recession.

Most important of all, the Chinese have come up with a policy they hope will allow them to dominate the emerging markets in green technologies. These, reason the Chinese, are infant industries, worthy of protection that will enable them to realise economies of scale and hone the technological skills needed to dominate world markets. If they have to rely on export subsidies, technology pilfered from America (say critics here), and control of rare metals such as neodymium, needed in the manufacture of wind turbines and electric cars, so be it. This is about dominating a technology, not preparing for free and open trade in wind machines and solar panels.

The important results of all of this are two: a rebalancing of world trade becomes an even more distant goal, and China’s protectionism is grist for the mill of our own protectionists. When consumer spending in America recovers, but job creation lags because much of the new spending is on T-shirts, appliances, cars and computers made in China, don’t expect American politicians to try to explain to angry voters why such an international division of labour is really in their interests. Indeed, our better educated politicians might recall that Adam Smith wrote “There may be good policy in retaliations . . . when there is a probability that they will procure a repeal of the high duties or prohibitions complained of”.

Irwin Stelzer is a business adviser and director of economic policy studies at the Hudson Institute