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Winds of Trade Wars

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President Obama argues that the Chinese Yuan is undervalued, contributing to the large trade deficit with China and depriving Americans of jobs. Further, he argues this creates a dangerous imbalance and that the government should intervene to fix the situation, possibly by engaging in trade war.

This asseverates the suspicion that the Obama administration is misguided on basic economic issues.

There are several wrong notions here. One is that our excess imports create an "imbalance" that is somehow harmful to us. Another, that we need to "retaliate" against trade restrictions imposed by other countries. And a third, that our government should "stimulate" our exports (presumably by devaluing the dollar), in order to "save jobs".

Suppose that citizens of Los Angeles decide to buy only goods and services made in Los Angeles. This would make them poorer, because confining economic activity reduces opportunities for investment and specialization.

But more importantly, it still would make no sense for residents of San Diego to stop buying from Los Angeles. San Diego would make itself poorer if, in response to L.A.'s deranged economic notions, they stop trading with it. The best thing for San Diego is still unilateral free trade, even if they have demented neighbors. There is no imbalance if San Diego buys more goods from Los Angeles, and it doesn't have an adverse impact.

And changing "San Diego" to "America" and "Los Angeles" to "China" does not alter the crux of the matter. If Peter wants to sell something and Paul wants to buy it, it makes no difference if they live on different streets, different states or different countries.

As for the casuistry of saving jobs, if it's true that preventing free trade with people in other political jurisdictions creates jobs, then each state should immediately stop trading with other states, not just other countries. California should not only impose tariffs on imports from South Korea, but also on imports from South Dakota. And ofcourse that would be very unwise, because the purpose of trade is to serve consumers, not create jobs.

And finally, the President believes China is manipulating its currency. The "manipulation" is actually in our benefit because a weak Yuan makes Chinese goods cheaper for American consumers, making us wealthier and China poorer. It makes American companies MORE competitive. Conversely, a weak Dollar enables others to buy our valuable goods and services at low prices, subsidized by American taxpayers.

As Professor Donald Boudreaux from George Mason University notes, artificially stimulating the country's exports is not a good way to achieve prosperity. Devaluation creates more trade, but not better trade. It doesn't matter how many dollars exchange hands, but what they buy, because voluntary exchange is not sum-zero. It is positive for both sides, and this concept, although not always intuitive, is crucial to understanding economics.

So what if the Chinese are producing more machines than we do? Our goal should be to productively use machines, not to produce them. As Adam Smith understood more than 200 years ago, we should focus on producing those goods and services that we have a competitive advantage in, specialize in what we can do more efficiently and buy the products we most need, regardless of where they came from.



Alan Schram is the Managing Partner of Wellcap Partners, a Los Angeles based investment firm. Email at aschram@wellcappartners.com.