Pied Piper Politics; Krugman and Candle Makers Complain about the Sun; Global Trade Wars

The odds of a global trade wars took yet another step forward today.

Brazil’s finance minister went on the warpath complaining about the "international currency war" upset that the Brazilian Real appreciated 25% against the US dollar in less than two years.

Guido Mantega, Brazil’s finance minister, said on Monday the world was in an “international currency war”, in a further sign that Brazil is preparing measures to prevent further appreciation of its currency, the real.

“We’re in the midst of an international currency war, a general weakening of currency. This threatens us because it takes away our competitiveness,” he said, according to Reuters.

The US dollar has fallen by about 25 per cent against the real since the beginning of last year, making the real the strongest performing currency in the world, according to Bloomberg.

Mr Mantega recently said Brazil’s sovereign wealth fund was preparing to make “unlimited” dollar purchases to prevent the real appreciating any more.

Currency Intervention Doesn't Work

Currency intervention does not work but that never stops any country from trying.

Worse yet, with increasingly harsh rhetoric from China, Japan, the US, and now Brazil, I am starting to wonder if anything can stop the trade war that is shaping up.

This is now my third consecutive article touching on the subject of trade wars. See also ...

• Eurozone Recovery Slows; Contraction Evident Except Germany, France
• Prepare for Currency/Trade Wars; How Might China Respond to US Tariffs?

Krugman Favors Protectionism

Would the Yuan rise if China floated it, resulting in more jobs in the US and a better balance of trade? That's what Krugman thinks, but I have stated many times it's not even clear the Yuan would rise. Moreover, Krugman never looks at the unseen effects of what he suggests.

The Acting Man Austrian blog agrees while noting China Bashing in High Gear Again

It began with a NYT editorial by Paul Krugman, who appears to have a number of hobby horses that occupy most of his efforts – demanding more deficit spending, more money printing, raising taxes and bashing China for currency manipulation.

Now, don't get us wrong – we also tend to think that China's exchange rate policies are harmful – alas, they are mostly harmful for China.

Krugman asserts that the yuan's exchange rate would increase if it were allowed to float as though that were an incontestable given (he does not explicitly demand a floating, fully convertible yuan however – he just wants China to keep 'manipulating' it, albeit in an upward direction):

“If discussion of Chinese currency policy seems confusing, it’s only because many people don’t want to face up to the stark, simple reality — namely, that China is deliberately keeping its currency artificially weak.”

How do we know whether the yuan is 'artificially weak'? As a matter of fact, we do not know that, and there are many arguments in favor of the yuan weakening if it were allowed to float. ....

In addition to these considerations, think about the fact that China's citizens had to live with a closed capital account for an eternity. How would they react if it were to be opened? We tend to think that citizens with large savings who have heretofore been forced to invest those savings within China – a major force in driving China's real estate bubble to absurd heights – would begin to divert a lot of capital to investments abroad. While we can not be certain how big a flood of money would leave China in the event, it's a good bet the markets are not prepared for it. The consensus is after all congruent with Krugman's assertion that the yuan is too weak.

Let us however step back for a moment from this discussion and for argument's sake accept the notion that the yuan's exchange rate is too low and would rise if left to float. How can that harm the US? Krugman asserts that a trade deficit is 'negative', but why should that be so? Trade is after all a voluntary economic activity. When people engage in trade, they do so because both parties to the trade deem it to their economic advantage. It follows that there can be nothing 'negative' about this. China's merchants wouldn't sell their goods for dollars if they did not prefer these dollars over their merchandise, and conversely US consumers would not trade their dollars for Chinese merchandise if they thought the trade harmful to their economic well-being. Just because there is a national border between these sets of traders this basic economic fact is not magically suspended. If trade deficits were worth worrying about, why not also worry about the trade deficit between, say, New York and Philadelphia?

The fact that Krugman does not even mention this basic facet of trade anywhere in his articles is tantamount to a red alert. Frederic Bastiat lampooned protectionism back in 1845 when he penned his 'Petition of the Candle Makers'. The candle makers are incensed that the light of the sun can be had for free. The sun's 'unfair trade advantage' surely needs to be curtailed somehow!

We are suffering from the ruinous competition of a rival who apparently works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price; for the moment he appears, our sales cease, all the consumers turn to him, and a branch of French industry whose ramifications are innumerable is all at once reduced to complete stagnation. This rival, which is none other than the sun, is waging war on us so mercilessly we suspect he is being stirred up against us by perfidious Albion (excellent diplomacy nowadays!), particularly because he has for that haughty island a respect that he does not show for us.”

Replace 'perfidious Albion' with China, and you have Krugman. Krugman makes the same mistake he always makes – the one mark of a truly bad economist if you will – he neglects the 'unseen' effects of his policy advice. It may well be true that a small group of domestic producers would benefit from a higher yuan (which ones? We're not quite sure, actually…). Alas, every single consumer would suffer for their betterment by having to pay higher prices. This in turn means that consumers will either have to cut back on their consumption, or lower their rate of saving. It seems obvious that this entails a lower standard of living for everyone but the favored few. Since less money will be available for either consumption or saving, there will also be less money available for investment. Capital formation is thus likely to slow, further impinging on future growth.

Who is Harmed by Low Prices?

From Prepare for Currency/Trade Wars; How Might China Respond to US Tariffs?

Assume for a second that everyone is selling us stuff for far less than it's worth. Who is harmed by this, us or them? The overwhelming percentage of the population (everyone but the handful of jobs we would save by tariffs) comes out ahead. How is this not a good thing?

Pied Piper Politics

Those who believe tariffs will solve our problems effectively argue along with Krugman and the candle makers against the sun. Yet, the parade of protectionists, led by Pied Piper (Paul Krugman), grows with each passing day.

The Pied Piper and his followers all scream for higher prices as if tariffs are the magic elixir that will restore the US to fiscal health. It won't. Trade wars never solve anything.

The US is in a mess of its own making. Screaming about "fair trade" is a scapegoat for preposterous US economic policies on military spending, entitlements, policing the world, public sector pensions, Fannie Mae and Freddie Mac, too big to fail, and numerous other disasters at the state and federal level.

Giving into the Pied Piper, will do nothing but make the problem worse.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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