Video: Adam Smith on the Folly of Central Planning (Man of System)

In the following short video, Yeshiva University Professor James R. Otteson explains how Adam Smith assailed the idea of the "Man of System" or the folly of central planning.

Here is a prologue from LearnLiberty.org (again Thanks to Tim Hedberg)

How do you like being told what to do? If someone tells you to do something you find enjoyable or fulfilling, you may not mind. What if you are told to do something contrary to what you would choose for yourself? What if the government was the one telling you to do it? Adam Smith, the philosopher and father of economics, talks about a "man of system," a central planner who believes he can orchestrate the lives of others, like chess pieces that can be moved at will. As Professor James R. Otteson illustrates, society suffers when the man of system attempts to force his desires on the lives of individuals in ways that contradict their own desires. According to Smith, people are not chess pieces to be moved on a board; they are living and thinking and have their own wills. Individuals pursuing their own desires will constantly be in conflict with the desires of any central planner.

Here is Adam Smith excerpted from the Theory of Moral Sentiments

The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might chuse to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder.

Since individuals are fundamentally unique (have different values, preferences, biases, cultural, spiritual or educational orientation, level and specificity of knowledge, and etc...) and have competing interests, this only means that the "principle of motion" will always be "of its own" or different from that envisioned by the man of the system.

The False Khodorkovsky Truth On Globalization

The Street’s Eric Rosenbaum pins the blame of the 2^nd guilty verdict on Russian Tycoon Mikhail Khodorkovsky, which allegedly had been manipulated, to globalization.

He writes, (bold emphasis mine)

In any event, if we have long ago left behind the Cold War and entered the age of globalization, it's pretty clear that globalization means turning a deaf ear to serious human rights and legal rights issues for trade partners like the US, Russia and China, or at least often being hard of hearing.

When a tycoon rots in prison because he was getting too powerful, and too democratic, or when a Nobel Prize winning political dissident is serving a long sentence and his family barred from going to Sweden to accept the Nobel on his behalf -- and yet the major US move in relation to China is to win a dispute at the World Trade Organization over the unfair support of China for its automobile tire manufacturers -- that's the lips speaking truth to the way the powerful act in the age of globalization, as opposed to the lip service that once again overflows with blabber as Khodorkovsky quietly read his book in the metal cage of the Russian court room.

We'll say thank you very much for that cheap plastic mobile for our baby's crib, China, and, thank you very much for the oil that's not coming from those unstable Arabs, Russia, and forget about Khodorkovsky until his next trial, and let Chinese democracy die a silent death. And of course, when it comes down to it, we'll hem and haw and we'll say it's not our place to interfere in the internal affairs of other countries -- except of course, when it's the internal affair of manufacturing car tires.

It’s certainly misleading to impute the seemingly untoward developments in Russia’s domestic political front to globalization since the current body politic of Russia has evolved around the dynamics of the previous polity (Lenin-Stalinism) compounded by the ongoing changes in the economic and international dimensions.

As Stratfor’s George Friedman notes, (bold highlights mine)

Glasnost, or openness, had as its price reducing the threat to the West. But the greater part of the puzzle was perestroika, or the restructuring of the Soviet economy. This was where the greatest risk came, since the entire social and political structure of the Soviet Union was built around a command economy. But that economy was no longer functioning, and without perestroika, all of the investment and technology transfer would be meaningless.

In other words, Russia’s politics have gravitated around the impulses of ‘command mentality’, which she has yet to slough off.

So with or without globalization, the so-called issues of ‘human rights and legal rights’ would still be in place, because of the embedded political structure that operates in Russia.

And perhaps it could even be under worse conditions if a political regime under isolationism had prevailed, since international pressures towards domestic policies would have been muted.

Myanmar and North Korea should be good examples of such isolationist paradigm. Incidentally according to Human Rights Risks Atlas 2011, among the highest “human rights” risk nations, Myanmar and North Korea ranks 5^th and 9^th respectively whereas Russia is ranked 14th.

The top 4 is DR Congo, Somalia, Pakistan and Sudan—obviously countries that have been least exposed to globalization.

As an aside, China is ranked 10th mostly due to recent geopolitical developments. According to African online,

China fell two places from last year’s ranking into tenth place. It is notable that these rankings were released on the day when China would not allow its’ citizens to see the Nobel Peace Prize Ceremony because Chinese political prisoner Liu was being honored. China is ranked worst or joint bottom of the league in several key classes.

These include violation categories such as freedom of speech, the press and religion, minority rights, judicial independence, and arbitrary arrest and detention.

Overall, to link globalization with human rights violations seem not only unfounded, but importantly, a strawman meant to score political talking points.

And here is the morality aspect.

If I decide not to patronize my neighbor’s store, who is reputed to be a wife beater, out of my perception of ethics, what then is my right to impose my sense of morality to the others who don’t share my views? Doing so would be playing into the hands of the same command mentality (human rights abuse) game which the author so abhors. And this would be tantamount to the proverbial ‘pot calling the kettle black.’

Lastly, it would be uncalled for to imply that globalization or growing free trade as politically inhumane. That’s because it would be in almost everyone’s self interest to see the others in good stead in order to promote his own.

Adam Smith wrote in his magnum opus, the Wealth of Nations, the dynamics of unintended social cooperation from the pursuit of one’s own interest.

He calls this the invisible hands, (bold emphasis mine)

As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestick industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the publick interest, nor knows how much he is promoting it. By preferring the support of domestick to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the publick good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

And as we have earlier pointed out, the string of years of world peace have coincided with the growth in free trade. We seem to see the similar parallels in the growth of economic freedom and free trade along with reduction of human rights violation risks (China would be the exception rather than the rule).

Bottom line: In general, where people trade, social cooperation expands, where politics rule, social cooperation deteriorates.

Why Mercantilists Are Wrong (Again)

The Chinese yuan may not be as undervalued as expected by present day mercantilists.

According to the Economist, (bold highlights mine)

The yuan may well still be undervalued but our index suggests American manufacturing should have less to fear from Chinese competition than it did five years ago. Until June 2009 appreciation was largely because of the stronger yuan. Since then it is largely because China’s unit labour costs have grown much faster than America’s. Employers in China’s coastal factories have suffered labour shortages and strikes. America’s factories have reported strong productivity gains as they have wrung more out of the workers that survived the recession (although those gains will be hard to repeat).

Of course, China and America do not trade only with each other. China’s big surpluses and America’s big deficits depend on the real exchange rate between them and all of their trading partners. But calculating that would require timely estimates of unit labour costs for all of China’s trading partners. That is a bit too laborious.

The Economist is correct to point out implicitly how wrong present day mercantilists unduly fixate on China’s currency as the main mechanism for global trade.

These mercantilists allude to trade imbalances as the root of all economic problems and thus recommend policies grounded on ‘restoring balance’ via curtailing trade or applying protectionism (tariff, and controls) or inflationism (currency wars)

Yet the mercantilist perspective deliberately neglects or disregards all other variables or factors which mistakenly presume that the world operates in a “ceteris paribus” or an imaginary two nation world of US and China. Yes, they love to fantasize a world beyond or outside of reality.

Contrary to the mercantilist orthodoxy, trades imbalances are NOT the problem. Instead trade imbalances account for as symptoms of evolving geopolitical and world economic conditions and patterns which had been brought upon by present policies.

One of which is the Triffin Dilemma, which according to the Wikipedia.org, is the paradox by which “the country issuing the global reserve currency must be willing to run large trade deficits in order to supply the world with enough of its currency to fulfill world demand for foreign exchange reserves”.

Another is globalization.

Importantly, trade imbalancess signify as outcomes from voluntary action and not of government mechanistically engaged in trade for no apparent reason at all.

It is individuals who buy or sell services even if it is done with other individuals abroad.

Yet the mercantilist logic goes:

If I frequent my favorite pizza parlor, whose food I savor, which means I repeatedly incur a deficit with the pizza parlor, then the pizza parlor should be forced by edict to obtain my services (as a stock market agent) even if they refuse to get involved in the stock markets in order to balance our trade. By doing so, my favorite Pizza Parlor would only serve to people who they are willing to balance out which alternatively means going out of business. This circular reasoning by the mercantilists is all patent nonsense.

Individuals conduct trade to fulfil specific needs. And the division of labor and comparative advantages channelled via voluntary exchange is what allows our needs to be met. Territorial or geographic boundaries does not change this perspective.

And forcing people to balance trade would result to REDUCED trades, which ultimately leads to impoverishment via higher prices, shortages, diminished of choice of available products, inferior qualities and etc.

Besides, contrary to conventional mercantilists expectations, exports ALONE do NOT make a country prosperous. This mercantilist perspective, which aims to increase ‘surpluses’ by fiat or protectionism, actually confuses wealth with money and have long been demolished by Adam Smith (bold highlights mine)

I thought it necessary, though at the hazard of being tedious, to examine at full length this popular notion that wealth consists in money, or in gold and silver. Money in common language, as I have already observed, frequently signifies wealth, and this ambiguity of expression has rendered this popular notion so familiar to us that even they who are convinced of its absurdity are very apt to forget their own principles, and in the course of their reasonings to take it for granted as a certain and undeniable truth. Some of the best English writers upon commerce set out with observing that the wealth of a country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds. In the course of their reasonings, however, the lands, houses, and consumable goods seem to slip out of their memory, and the strain of their argument frequently supposes that all wealth consists in gold and silver, and that to multiply those metals is the great object of national industry and commerce.

The two principles being established, however, that wealth consisted in gold and silver, and that those metals could be brought into a country which had no mines only by the balance of trade, or by exporting to a greater value than it imported, it necessarily became the great object of political economy to diminish as much as possible the importation of foreign goods for home consumption, and to increase as much as possible the exportation of the produce of domestic industry. Its two great engines for enriching the country, therefore, were restraints upon importation, and encouragements to exportation.

In short, wealth is acquired through capital accumulation via savings and investment and expressed through voluntary exchange.

In truth, the undeserved obsession towards trade imbalances represent as selective perception and data mining applied by modern day mercantilists in order to justify all sorts of interventionism. They apply fallacious ‘cart before the horse’ reasoning.

Seen from the bigger picture trade deficits are part of the international transactions that can be seen from Balance of Payment (BOP) data where trade deficits are fundamentally offset by capital flows.

Professor Mark J. Perry points out that under double-entry accounting, debits have to equal credits, which applies to BOP accounting:

BOP = CURRENT ACCOUNT + CAPITAL ACCOUNT = CREDITS - DEBITS = 0

Professor Perry additionally writes,

The current account and capital account are the two main components of the U.S. Balance of Payments (BOP), which is a record of all international transactions for both: a) trade flows and b) capital flows in a given period. Every international transaction (e.g. export, import, U.S. investment abroad, foreign investment in the U.S.) is recorded on a double-entry accounting basis, so that each transaction involves both a debit and credit.

Professor Perry further notes that alarmism over deficits are unwarranted for the following reasons: (bold highlights mine)

1. There are no BOP deficits once we account for all international transactions, both for: a) goods and services, and b) financial transactions. For all of the one-sided coverage in the press about the "trade deficit," you would almost never even know that there is an offsetting "capital surplus" or "capital inflow." It's important for the general public to understand that trade deficits are offset by capital inflows on almost a 1:1 basis, resulting in a "balance of payments" for international transactions. When the public constantly hears about "trade deficits" without any understanding of the offsetting surplus, that economic ignorance allows politicians and special interest groups to exploit the general public, by advancing and promoting protectionist trade policies aimed to reduce the "trade deficit," or by refusing to approve trade agreements between Chile, Panama and Korea, etc.

2. The "trade deficit" generates so much negative coverage, that the significant advantages of capital inflows from abroad get frequently overlooked. Since 1980, the U.S. has attracted almost $8 trillion of foreign investment, which has provided much-needed equity capital that has allowed U.S. companies to start or expand, has provided much-needed debt capital that has also funded the expansion of American companies, along with providing debt capital for U.S. consumers in the form of mortgages, student loans, and car loans. Some of the $8 trillion of investment includes billions of dollars of Foreign Direct Investment, which has funded thousands of new projects in the U.S. (Toyota factories for example) and created hundreds of thousands of jobs.

This goes to show that “imbalances” serve more as political talking points meant to promote dogmatism than of observing factual operating circumstances.

Moreover what matters most is what mercantilists refuse to bring up in the imbalance debate: what seems to ail the US, isn’t China, but the entitlement mentality effected by the political leadership through inflationary policies (such as the recent housing bubble).

The negative effects of inflationism can be broken down into the following

-diverts resources to one that is not desired by the markets.

-crowds out the private sector

-generates systemic malinvestments.

-causes overvaluation in assets or the currency.

-misallocates the distribution of economic weighting towards areas preferred by government at the expense of the consumers.

-raises the costs of living.

-distorts corporate profitability and income streams

-raises the cost of doing business which translates to reduced competitiveness

-destabilizes the economy from the boom bust cycle which eventually leads to a consumption of capital.

The mercantalism-inflationist agenda does the opposite of what it intends to accomplish.

Applying real life examples, if the mercantilists-inflationists school is correct then Zimbabwe, North Korea, Cuba and Burma should have been the most prosperous countries (having been closed economies).

Ironically, the opposite is true, nations that have been economically free, are those whom have been prosperous.

Unfortunately reality isn’t what mercantilists are concerned with. Political religion is.

Does Importation Drain The Wealth Of A Nation?

This has long been a fallacy used by mercantilists to advance protectionism which had been demolished by classical economics led by Adam Smith.

In short, the answer is NO.

First, accounting equations does NOT replace the essence of human actions.

Where GDP=private consumption + gross investment + government spending + (exports-imports), the impression derived from exports minus imports is that imports signify a drag to the economy.

This is plain nonsense. Exports and imports are activities of individuals who engage in voluntary exchange. And no one would willingly undertake trade if there are no perceived benefits from it.

And this also applies to people trading with one another from different countries. To quote Professor Don Boudreaux, “Consumers’ nationalities are economically irrelevant.”

Second, trade is NOT a zero sum game.

It is not what Michel de Montaigne (1533–1592) calls as “no profit can possibly be made but at the expense of another” from which Professor Ludwig von Mises calls as the Montaigne fallacy.

Trade is voluntary exchange via division of labour. We trade for the purpose of attaining things or services which we cannot provide to oneself, and in exchange, provide things or services that we have which the others want.

Trade isn’t mechanistic. It arises from individual choices and preferences.

Third, money should NEVER be confused with wealth.

As Adam Smith in the Wealth of Nations wrote, (bold emphasis mine)

Some of the best English writers upon commerce set out with observing that the wealth of a country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds. In the course of their reasonings, however, the lands, houses, and consumable goods seem to slip out of their memory, and the strain of their argument frequently supposes that all wealth consists in gold and silver, and that to multiply those metals is the great object of national industry and commerce.

Exactly. This especially for people who argue from the basis of their political religion.

And the principal aim of trade isn’t to accumulate money, but to benefit from the exchange of goods and services.

Again Adam Smith,

The importation of gold and silver is not the principal, much less the sole benefit which a nation derives from its foreign trade. Between whatever places foreign trade is carried on, they all of them derive two distinct benefits from it. It carries out that surplus part of the produce of their land and labour for which there is no demand among them, and brings back in return for it something else for which there is a demand. It gives a value to their superfluities, by exchanging them for something else, which may satisfy a part of their wants, and increase their enjoyments.

Fourth, money in a free market is self-regulating and that interventionism will NOT prevent outflows...

Again Adam Smith,

The quantity of every commodity which human industry can either purchase or produce naturally regulates itself in every country according to the effectual demand, or according to the demand of those who are willing to pay the whole rent, labour, and profits which must be paid in order to prepare and bring it to market. But no commodities regulate themselves more easily or more exactly according to this effectual demand than gold and silver; because, on account of the small bulk and great value of those metals, no commodities can be more easily transported from one place to another, from the places where they are cheap to those where they are dear, from the places where they exceed to those where they fall short of this effectual demand...

When the quantity of gold and silver imported into any country exceeds the effectual demand, no vigilance of government can prevent their exportation.

Finally those who preach mercantilism DO NOT argue for the benefit of the entire society but argue for the interest of a select few.

According to Jacob Viner in the Studies in the Theory of International Trade [1937]

The mercantilist literature, on the other hand, consisted in the main of writings by or on behalf of “merchants” or businessmen, who had the usual capacity for identifying their own with the national welfare. Disinterested exposition of trade doctrine was by no means totally absent from the mercantilist literature, and in the eighteenth century many of the tracts were written to serve party rather than self. But the great bulk of the mercantilist literature consisted of tracts which were partly or wholly, frankly or disguisedly, special pleas for special economic interests. Freedom for themselves, restrictions for others, such was the essence of the usual program of legislation of the mercantilist tracts of merchant authorship.

Restricting trade is a way to impoverishment.

Spurious Mercantilist Claims And Repercussions Of A Strong Chinese Yuan

``As no one can purchase the produce of another except with his own produce, as the amount for which we can buy is equal to that which we can produce, the more we can produce the more we can purchase.” John Say to Thomas Malthus

The second cyclical variable that should drive the markets over the short to medium term could be the Yuan factor.

For those reading the international scene the Chinese currency the yuan has hugged the limelight of late. That’s because prominent personalities associated with leftist politics have stridently assailed the Chinese government for allegedly perpetuating what they claim as “global imbalances”. It’s a spurious populist claim though, specifically meant to divert the public’s attention from their failed policies.

Nevertheless some variables are proving to be very compelling to suggest for a Yuan appreciation (see figure 5)

Figure 5: Danske Research: Implications of the Rising Yuan

The money printed by China’s central bank, the People’s Bank of China, utilized to accumulate foreign exchange has been generating unwieldy inflation and bubble-like pricing activities in the housing markets. This hoard has reached $2.4 trillion in foreign exchange reserves as of 2009.

China has attempted several times since last late year to arm twist several industries to stem credit expansion which has led to inflation. Lately she has threatened to nullify loans granted to local governments and has similarly instructed 78 state owned enterprises (SOE) to quit the real estate market leaving 16 SOE property developers.

And economic overheating presents as a real risk. There has been an acute shortage of labor where factory wages have risen by as much 20% as the inland now competes with the coastal areas and reduced migration in search of jobs.

We are now witnessing a classic adjustment in trade balances as taught in classical economics. As Adam Smith once wrote, ``When the quantity of gold and silver imported into any country exceeds the effectual demand, no vigilance of government can prevent their exportation.”[1] (emphasis added)

In short, this leaves the Chinese government little or no option but to allow its currency to rise as a safety valve against a runaway inflation.

As shown in Figure 5, left window, USD-China’s yuan currency forward has been trending downwards which shows how the markets today have been factoring in the rise of the yuan. The right corner shows how adjustments were made in 2005 to reflect the advances in inflation. So yes, the Chinese policymakers in 2005 have responded to such scenario, and is likely to apply the same soon.

This means political pressure or no political pressure, China’s yuan will need to appreciate soon, simply because the economic pressures have been endogenously seething which will require for policy adjustments.

This leads us to the next issue which deals with why the cry for protectionism is spurious and the potential impact of the rise of the China’s yuan.

Mercantilism is a form of economic nationalism, which has long been rebuked by Adam Smith in his magnum opus, the Wealth of Nations. Mercantilism today has served as a basis for calls of protectionism.

Here we will unmask the partisanship of protectionist overtures against China.

First, the fallacy of the notion that trade is a zero sum game.

For the myopic protectionists who sees the world as confined to the equation GDP= C (Consumption) + I (Investments) + G (Government spending) + X - M (Exports-Imports), the mathematical operation involved in the equation which subtracts exports from imports engender a negative connotation for imports on economic growth. Hence, the bias or slant against imports for exports.

For instance, as I walked out of the pizza house following a hearty meal, I realized that the Pizza house, which earned the money I spent on, incurred a trade surplus. This left me with lesser money in my wallet, which accounts as my trade deficit. Although after the delectable meal, I also realized that my need for nourishment has been satisfied, unfortunately this has not been represented for in the GDP equation.

If I continue going to the same pizza house because I enjoyed the food, the ambiance, the services, the pretty youthful waitress or for many other reasons, the Pizza house will continue to incur surpluses while my wallet gets drained by deficits.

In the view of mercantilists whom tunnels on the flow of money only, but not the impact of or the satisfaction attained from the voluntary exchange, I would demand from the government that the Pizza house ‘balance its trade’ with me, by forcing them to take my services as a stock market agent, even if the owner isn’t inclined to deal with stock markets. If this sounds nonsensical, that’s exactly how the protectionists think.

If all the entities that I spent money on will be required to take on my services, from which rule applies to everyone, do you think the economy will prosper? Apparently not, that’s because people will probably stop trading with each other legally and do it behind the scenes.

In the above case, the pizza house will refuse me as a customer, that’s because they don’t need my services, even if I need them. In essence, forcing the people to buy or sell beyond their self-interests will cause a restriction of activities.

And be reminded that it is the individual that conducts trade. Whether it is done through personal, or through various forms of enterprises (proprietorships, partnerships or corporations), trade balances are incurred as individuals but only represented as enterprises or as states or nations.

In short, trade is exchange, where people conduct exchanges in order to fulfill a desire. The difference between local trade and trade with foreign enterprise is matter of classification. But the rudiments are the same, it is meant to satisfy some desires.

Hence, trade is not merely an accounting entry. It deals with human satisfaction.

In addition, trade balances do not include the sale of financial assets, as Robert Murphy writes, ``When economists compute the trade balance (or more accurately the current account), they don't include the sale of financial assets. So if foreign investors want to spend more (once we convert to a common denominator) on American assets than US investors want to spend on foreign assets, the trade balance is negative. The capital-account surplus is counterbalanced by a current-account deficit.”[2]

Once again Adam Smith[3], ``To import the gold and silver which may be wanted, into the countries which have no mines, is, no doubt, a part of the business of foreign commerce. It is, however, a most insignificant part of it.” (emphasis added)

Second, money isn’t wealth; inflation isn’t a Philosopher’s stone.

For instance current ploy of protectionists today is to arrive at a comparison of benefits. In such an instance, they distort the data to produce the account of which country is more dependent on trade. From here they argue, that by imposing trade restrictions, whatever vacuum left by closing the trading doors might be covered by money from central banks.

In other words, government can be relied to print money to produce jobs and investments. Had this logic been true then people don’t need to work at all, since the government can just print money.

Since voluntary exchange is aimed at satisfying human desires, then the role of money is essentially just as a medium of exchange.

And as medium of exchange, the valuation of a monetary unit, according to Ludwig von Mises, depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money.[4]

In other words inflating away out of protectionism will not achieve the desired prosperity.

What inflation will do is to vastly reduce the purchasing power of a nation which would redound to an erosion of wealth.

It is another absurdity to suggest that inflation won’t transpire because of output gaps. England has shown resilient inflation in spite of the similarities of condition with the US. To assume that the US is beyond the scope of the laws of scarcity is no more than living in a fantasy land.

Instead, it must be reminded that wealth is attained by accumulating capital, again Adam Smith ``The wealth of the country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds.”[5] (emphasis added)

Third, Protectionism Is Mutually Assured Destruction (MAD).

It is naive to believe that protectionism applied to China will not spillover to other countries. Such intellectual weenies fail to learn from the lessons of the Smoot Hawley act during the Great Depression.

To consider, should the US government engage in reckless inflation to finance the said gaps from protectionism with China, as the other holders of US treasuries realize of the scale of indirect default applied to their assets, many, if not all of them, will be panic sellers of US sovereign papers. And Americans will probably impose capital controls to curtail the exodus, and the ensuing capital controls would result to political counteractions.

And as reminder, the US is so dependent on oil that it imports 65% of what it consumes.[6] Guess who suffers more from a MAD policy?

According to Ludwg von Mises, ``The philosophy of protectionism is a philosophy of war. The wars of our age are not at variance with popular economic doctrines; they are, on the contrary, the inescapable result of consistent application of these doctrines.”[7]

Fourth, it is a myth that the appreciating Yuan and depreciating US dollar would expand US competitiveness while derail Chinese growth.

Pieter Bottelier and Uri Dadush writes in the International Herald Tribune, ``The immediate effect of renminbi appreciation will be to raise prices for U.S. consumers. A 25 percent revaluation of the renminbi, which some economists have said is needed, would — if not offset by a reduction in China’s prices — add $75 billion to the U.S. import bill. And since the United States imports three times as much from China as it exports there, higher U.S. exports to China would not nearly offset the welfare loss to U.S. consumers from higher Chinese prices.

``In the end, though some U.S. firms would gain and some export jobs would be created, the U.S. consumer would be the loser.”[8]

Fifth, fix currencies do not automatically equate to arbitrary currency manipulation, that’s because there is no free markets in currency, today. All governments control or somehow manipulate respective currencies to a certain degree.

The US dollar is pegged to 23 nations according to wikipedia.org. By definition of the protectionists, all 23 nations are also currency manipulators.

The Wall Street Journal hits the nail on the head,

``At the core of this argument is a basic misunderstanding of monetary policy. There is no free market in currencies, as there is in wheat or bananas. Currencies trade in global markets, but their supply is controlled by a cartel of central banks, which have a monopoly on money creation. The Federal Reserve controls the global supply of dollars and thus has far more influence over the greenback's value than any other single actor.

``A fixed exchange rate is also not some nefarious economic practice rare in human affairs. From the end of World War II through the early 1970s, most global currency rates were fixed under the Bretton-Woods monetary system created by Lord Keynes and Harry Dexter White. That system fell apart with the U.S.-inspired inflation of the 1970s, and much of the world moved to "floating rates."

``But numerous countries continue to peg their currencies to the dollar, and with the establishment of the euro most of Europe decided to move to a fixed-rate system. The reason isn't to get some trade advantage against their neighbors but to gain the economic benefits of stable exchange rates—and in some cases a more stable monetary policy. A stable exchange rate eliminates a major source of uncertainty for investment decisions and trade and capital flows.”[9]

In short, the labelling of manipulation is a matter of political convenience than truth.

The real problem has been China’s non convertibility and capital controls.

Again the Wall street Journal, ``China's real problem isn't its peg to the dollar but the yuan's lack of convertibility to other currencies and capital controls. These controls have blunted the yuan's development as a tradable currency, which means private markets can't recycle the flow of dollars into China from its large trade surplus.” [10]

Finally, as we have long argued US trade deficits are a function of the US dollar standard.

The more the world engages in global trade, the bigger the need for US dollar to finance this trade, since it is the de facto, reserve currency of the world, where transactions are quoted, paid and settled through US dollars.

Hence, until the US dollar is replaced with another alternative it is a fairy tale to believe that a strong yuan would rebalance the global economy. What would occur instead would be more distribution of surpluses around the world, but US deficits will continue to swell as the global economy expands.

Although there are more to discuss including the transition to the information age or China’s internal economic structure we will leave this discussion here.

But for those wishing that April 15^th to be the fateful day where the US tags China as currency manipulator, good luck to you. Prediction markets, google trends or market indicators haven’t been pointing to such direction.

The appreciation of the Yuan will allow for cheaper imports and essentially reduce dependence to lend money to the US. This means that China would have more bandwith to employ resources for its own development, depending again on the degree of economic freedom embraced by China. And the impact is likely to be seismic.

Peter Schiff rightly argues, ``Absent Treasury-bond purchases, the value of the Chinese currency would rise sharply, causing goods prices to tumble in China. This long-delayed increase in purchasing power for everyday Chinese will unleash pent-up demand in what is already the largest middle class in the world. Chinese factories would retool in order to produce goods for their own citizens to consume. In RMB terms, commodity prices would plunge, making it easier for China to produce all kinds of stuff, such as automobiles, while also making it cheaper for the Chinese to buy gas. Millions will trade in bikes for cars, and Chinese oil imports will swell.”[11]

This means that there could indeed be temporary uncertainties from expectations of the Yuan appreciation, which will depend on the degree of the allowable strengthening of the Chinese currency.

As a caveat, while the Japanese Yen firmed over the past decades, the Japanese haven’t been transformed into a US consumer type of compulsive shopper or oniomania. Hence, habits or forms of addiction in a society should apply. In short, no society is homogeneous.

Figure 6: Danske Research: Strong Stock Markets And Commodities Post Yuan’s Revaluation

Nevertheless, if history would serve as precedent of the future, then the uncertainty from a revaluation is likely to be short-lived (see figure 6). And the impact from a revitalized yuan has could be tremendously salutary in terms of stocks, Asian currencies and commodities.

Finally another word of caution, every expert I know expects the Yuan to appreciate, while this is the most likely the political outcome, we can’t rule out policy errors. This means that inflation can go berserk, if China refuses to budge, perhaps out of the recalcitrance to bow to political pressure.

A bubble bust or a hyperinflation in China would cause massive outflows and reverse all these expectations [even without protectionism].

For protectionists, I suggest for you to just mind your own business as nature will force the hand of economic imbalances.

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[1] Smith, Adam Wealth of Nations, Book IV, Chapter 1 wikisource.org

[2] Murphy, Robert; Trade Deficits and Fiat Currencies, Mises.org

[3] Ibid

[4] Mises, Ludwig von; Stabilization of the Monetary Unit

[5] Smith, Adam Wealth of Nations, Book IV, Chapter 1 wikisource.org

[6] See The Delusion Of The Mercantilist Miracle

[7] Mises, Ludwig von Human Action, The Conflicts of Our Age, Human Action, oil.lbertyfund.org

[8] Pieter Bottelier Uri Dadush The Myths About China's Currency

[9] Wall Street Journal, The Yuan Scapegoat

[10] Ibid

[11] Schiff, Peter Paul Krugman Versus Reality