As noted in Thursday’s blog Free Trade? What Free Trade? talk of trade wars are looming. The silliness continued today and the US Senate is set to get tough over the renminbi.

The US Senate will vote no later than July on legislation that would slap across-the-board tariffs on imports of Chinese goods unless China agrees to revalue its currency. In the House of Representatives, Duncan Hunter, the powerful Republican chairman of the armed services committee, on Thursday also introduced legislation that would define currency manipulation by a foreign government as an export subsidy. This could then allow the US to offset the subsidy by imposing duties on imports.

In a sharp exchange yesterday with John Snow, Treasury secretary, Mr. Schumer charged that “this administration, on this issue, has had the strength of a wet noodle”.

Regi on Silicon Investor writes:

This is pure and simple economic blackmail! In fact, it puts self determination of any nation that presents an economic challenge into question.

Under the pretext of free markets, threats of this nature tell the world that if you become too competitive with us, we will find a way, any way, to take your competitive edge away. This is not competition but plan economics where the bigger economic benefit has to be on the U.S. side otherwise the U.S. will change the rules.

Institutions like the U.N., the World Court, and WTO serve their purpose as long as the decided advantage goes to the U.S. As soon as that is not the case and they become a hindrance and the agreements are abolished or the institutional rules are simply ignored. We are moving inevitably into a time of protectionism that might have increasingly militaristic overtones. It is moves of this sort that WILL upset that tender balance between the Asian lender and the American consumer.”

Thanks to Regi for the preceding commentary.

As for me, I really never thought it would get this far. Are we bound and determined to replay the great depression, complete with a more modern version of Smoot-Hawley? It will be interesting to see what the tone is by the time the vote comes. I will say this:

The US Congress has no idea who it is dealing with. The average US bureaucrat and CEO thinks about one to six months ahead but China tries to think decades ahead. China is not likely to abandon its long terms goals to appease short term US policy. In addition, the US has no clues on the Asian concept of “face saving”. China is very unlikely to lose face by backing down to publicly made US threats. Finally (but most importantly) China can dump US treasuries in retaliation. Exactly how would we counter that? Point blank, China has almost all the cards, but unlike our “huffing and puffing” legislature, the Chinese will probably make their threat in private.

Besides, the fact of the matter is that the US is just plain wrong. Floating the RMB will not solve either the US trade deficit or the outsourcing of US jobs as long as there is a 20-1 or 30-1 wage differential between the US and China. The REAL problem is that the US public and private sectors are both spending way beyond their means.

China’s peg of the RMB to the US dollar is not the cause of our job losses or the trade deficit so it stand to reason that floating the RMB is not likely to fix those twin problems either. The endgame is not really in doubt. The US consumer will eventually toss in the towel. Historically, consumer-led recessions have been the only means to fix such imbalances, and this time will not be different. Meanwhile, the clock is ticking and the US day of reckoning is closer at hand with every quarter point hike by the FED and with every $1 rise in the price of crude.

It would be a mess no doubt for China to get into a trade war with the US. However, given the US over-leverage on low interest rates, and China thinking decades ahead, China has the US over a barrel whether we know it or not, and the problems China can create for the US are far far greater than the other way around.

IF the US passes this legislation, I expect a world-wide economic depression as opposed to the guaranteed brutal world-wide recession that is otherwise written into the cards.

In the meantime let’s see if cooler heads prevail. I think they will.

I penned the above late yesterday but thanks to “blogger” being down for 6-10 hours I never quite put the finishing touches on it. This AM it was interesting to see Roach worrying about exactly the same issues this morning in his Drumbeat of Protectionism missive.

It was inevitable. With America beset by record trade- and current-account deficits, the drumbeat of protectionism is getting louder and louder in Washington. Not surprisingly, the assault is taking dead aim on China — by far the biggest bilateral piece of a US trade gap that hit $617 billion in 2004. Is this just political saber-rattling or a threat to be taken seriously?

I have said from the start that the odds of passage for such legislation are low. Those odds are now increasing. In large part, that’s because of the shifting context of America’s trade dilemma — an exploding overall deficit and an increasingly visible role played by China, which accounted for 26% of the total US trade gap in 2004. Washington has had a number of long-simmering concerns with respect to Chinese trade — especially over furniture, semiconductors, and intellectual property rights. But the recent surge of Chinese textile imports into the US could well be the proverbial straw that breaks this camel’s back; following the expiration of the global Multi-Fiber Agreement at the end of 2004, Chinese textile exports into the US have surged some 63% from year-earlier levels in the first three months of 2005. Little wonder that anti-China sentiment in the Senate has risen to a boil.

As I pointed out on Thursday and Roach mentioned today, fully 62% of our deficit with China is via “foreign-invested enterprises”, i.e. US and other multinational companies as opposed to Chinese owned companies. The US Congress couldn’t care less about such logic. When an angry swarm of hornets is looking for revenge, the hornets do not care that it was the neighbor’s cat as opposed to your dog “Muffy” that disturbed their nest. Right now, the US Congress is acting with all the logic of that angry swarm of hornets.

Roach is calling on China to appease the US, but on that issue I am not so sure. For starters, the US is the problem not China and as discussed earlier the principle of “Face Saving” is also at stake. Bowing to outside public pressure is just not the “Chinese Way”. IF this resolves itself I doubt it is because of pressure from the US. By my way of thinking there would have to be some sort of quid pro quo offering from the US. (Taiwan?)

Let’s now turn the discussion to what might happen IF mammoth tariffs are passed by the US. We will kick that thought off with a question: Have any of the senatorial geniuses sponsoring this legislation ever heard of Frederic Bastiat or the Smoot-Hawley Tariff Act of June 1930? That is what Trotsky on Kitco was wondering earlier today. Here is a recap:

The Smoot-Hawley Tariff was allegedly enacted to “protect” US industry from “unfair competition” from abroad. It is probably no exaggeration to say that this law not only worsened the Great Depression considerably by denying the newly impoverished populace and suffering businesses access to cheap goods, but it also hastened the arrival of WW2 since it helped to slow down international trade and co-operation which had just begun to recover from the WW1 debacle.

Bastiat laid the theoretical framework that shows that tariffs are among the biggest enemies of prosperity ever devised. It is simply wrong to believe that prosperity is evidenced by scarcity. Prosperity is, au contraire, evidenced by abundance. Tariffs are a means to artificially create scarcity on account of the wrong-headed beliefs that these economically illiterate politicians have just revived. Of course it is true that some will profit from this scheme, but like many such schemes devised by the state, few profit to the detriment of the many.

Tariffs invite inflation, diminish the international division of labor, and ultimately reduce consumer choices thereby lowering standards of living. They have however ALWAYS been good for at least one thing: buying votes. This is because the bulk of the populace is just as ignorant as the politicians when it comes to the economies of trade.

Admittedly it does require an open mind as well as at least some rudimentary skills in the thinking department to get to the bottom of the matter and recognize how the seen and unseen effects balance out. That is why Bastiat wrote his treatise – he wanted to make things clear. It is of course no wonder that people are getting worried about the persistent and continually expanding trade deficit. It IS worrisome but the root of the problem is not a lack of tariffs or even the pegging of the Chinese currency. The root of the problem is the fiat money system itself. Of course THAT will NEVER be attacked by the good senators since it allows them to spend a lot of money they don’t have, and is thus an even better means of buying votes.

Here is Bastiat’s treatise.

Let’s conclude today’s “Free Trade” discussion with the obvious question:
Is Congress attempting to buy votes or are they just plain stupid? How about or both?