05/17/2010 05:12 am ET Updated May 25, 2011

The Showdown with Chermany

Where will the jobs come from? Double exports in five years, says President Obama. That offers a ray of hope in a bleak landscape -- the recovery act spending is winding down, states and localities are laying off employees, banks still are not making loans, and consumers are reeling from unemployment, stagnant wages, and losses in home values and retirement plans, Moreover, the US can't go back to the old economy where trade deficits reached 6% of GDP, and we were borrowing over $2 billion a day from abroad to pay for goods made elsewhere.

But if the US is to sell more abroad and borrow less, countries with trade surpluses -- notably Germany and China -- will have to spend more, buy more, save less and export less. That is the only way to reduce the dangerous and unsustainable imbalances in the global system that the G-20, governments, representing the leading economies in the world, agreed was essential to a secure recovery.

Only China and Germany clearly haven't got the message. The Chinese continue to manipulate their currency, now starkly undervalued against the dollar. This is a centerpiece of a comprehensive mercantilist policy to grow by dominating export markets. Germany, the world's second greatest surplus country, continues to restrain demand at home, while subsidizing its high end export engines.

Both countries reject any change of course. China's Premier Wen Jiabao scorned US pressure on the Chinese to revalue its currency, summoning up the wondrous gall to accuse the US and other countries of "protectionism" for seeking to depreciate their currencies. Germany's government similarly has spurned calls led by the French to increase demand domestically to help fuel European recovery.

Martin Wolf of the Financial Times, coins the neologism Chermany to describe these trading giants and highlights the absurdity of their position. The Germans are insisting that its trading partners in Europe - dramatized by the Greeks but truly represented by the French with deficits at about 9% GDP -embrace austerity to reduce their deficits rapidly. But if Europe is to avoid a deep recession and is to play its part in a global recovery, then Germany will have to buy more from its partners. It will have to kick up domestic demand and save less. By rejecting this course, the Germans could well push Europe back into recession.

Similarly, the Chinese demand that the US bolster the dollar by rolling back deficits and raising interest rates. And they want to sustain their export markets in the US. But the only result of this impossible combination would be crippling high unemployment here, and the export of a global recession. This isn't an acceptable outcome.

The resulting showdown will escalate rapidly given the continuing crisis. In Europe, Wolf suggests that Germany's intransigence could either to a sustained European recession or a rift that may break up the Eurozone itself.

In the US, the rumble with China is heating up. On April 15, the Treasury Department has to decide whether it will formally acknowledge reality, and designate China as a currency manipulator. On Monday, 130 legislators of both parties wrote Treasury Secretary Tim Geithner a letter demanding that he do just that. On Tuesday, a bipartisan group of Senators, led by Chuck Schumer and Lindsey Graham, introduced legislation to force Treasury's hand, and to map the way towards imposing retaliatory trade barriers on Chinese goods.

The Chinese, meanwhile, are openly recruiting US companies with subsidiaries in China to lobby against any US action. The China lobby - think tanks, multinational companies and banks - will rant about US protectionism, warn of trade wars, discount the importance of Chinese mercantilism, and remind us of the benefits of a cheap yuan. Chinese threats to dump dollars from their $2.4 trillion cache will rattle financial markets (even though a declining dollar will cost the Chinese bigtime).

But in the US, the corporate "free trade" consensus is cracking apart. Mike Elk describes the growing calls for action on China from across the political spectrum.

Free trade zealots like Washington Post columnist Robert J. Samuelson now argues we can't "sit passively while Chinee trade and currency policies jeopardize jobs here." And the New York Times now editorializes in support of action.

This could easily get out of hand, but the showdown with Chermany can't be avoided. We can't go back to a world in which the US is the consumer of last resort, borrowing $2 billion a day to buy goods from abroad. Europe can't grow if Germany enforces austerity on the rest of the continent, while sustaining an economy based on massive trade surpluses. If global demand is to be sustained, and the destabilizing imbalances that helped bring down the old economy countered, Chermany will have to change course, as will deficit countries. Rebalancing is best done cooperatively but it must be done. And it can no longer be delayed.