THE BLOG
09/28/2010 06:35 pm ET Updated May 25, 2011

Currency Just Tip of China Iceberg

In the past few weeks the media has been abuzz with stories about China's currency manipulation. Given the stratospheric unemployment rate and bulging trade deficit, focusing on China's questionable trade practices is long overdue.

Mercantilism. That's the term for the policy path that China has been following. Mercantilism is the practice by which a nation "protects" its economy by doing everything it can to encourage exports and discourage imports. Essentially, it's the inverse of American economic policy. Our policy is all about borrowing from the rest of the world to pay for imports from the rest of the world. While most of us are familiar with our policy of importing nearly everything thanks to any time spent at a Wal*Mart, we're still unfamiliar with how China does business, so let's take a closer look.

First, China encourages exports. They essentially subsidize the costs of production in a variety of forms. Their behavior ranges from a lump-sum cash payment to spur growth in an industry, giving big discounts on utilities or other raw material costs, discounted (or free) land/factories, large low-interest loans, etc.

Second, China actively discourages imports. They do everything they can to make it difficult or expensive for foreign companies to sell in China. Tariffs are the simplest way to do this: add a fee on top of any good being imported making it more expensive . Regulatory barriers are more common-- complicated rules and laws are created to make it nearly impossible for foreign firms to comply with, with the intention of keeping them from market. Another common practice is forcing foreign companies to partner with a local firm or requiring technology transfers to develop a strong eventual Chinese competitor.

Currency manipulation lives above all of these policies. When a country's currency is undervalued it makes their exported goods cheaper in the rest of the world while simultaneously making it more expensive for their citizens to buy foreign goods. It has the dual effect of boosting exports while shrinking imports.

The net effect of these policies has been a massive Chinese revolution. In just a few short decades, China has essentially become the factory to the world. Consequently scores of jobs have fled the US, consumers mounted a back-breaking debt load to cope with the broken employment market, and China's ownership of our debt has allowed them to, at times, effectively dictate American policy.

China's policies went from a brewing problem to that of a global crisis with their admittance to the WTO in 2001. Despite China's fierce mercantilist policies, our leaders gave little concern for what the impact would be for American production and workers. As we focused on the "war on terror," China found that they would get little, if any, pushback to their anti-US policies. Slowly the relationship found it's equilibrium, starkly in the favor of China acting with impunity. While China built their production capabilities and raised the standard of living for millions, they simultaneously began financing the ever-growing massive amounts of money that Americans wanted to borrow. In a nutshell, as they laid the groundwork for the industries that would provide employment and wealth for the future, they also began to finance the American lifestyle.

Today China is both our largest supplier and creditor. We buy goods that we used to make from them, with money borrowed from them. But we shouldn't pretend that the undervalued Chinese currency alone caused our current sad state of affairs -- nor that it alone will fix it.

China chooses to invest their excess savings in American debt because each passing day only increases their leverage over us. Our position only grows weaker with each passing dollar and so our best chance is to work with the European Union, Japan and the rest of the world to confront these unfair practices.

Currency is just the tip of the China iceberg. We must recognize the current global war for capital and jobs that is being waged. A war that doesn't deal in rockets or tanks but in factories and financial leverage. Recognizing this new reality will lead us to designing a system of tax, regulatory, educational, and trade policies that set us up for a real recovery and a long-term sound economy. If we don't, our economy will remain on a course of full speed ahead for the Chinese iceberg.

This is the third in the series "A Business Plan for America" that will outline critical public policy proposals that are free of partisan politics, ideology and dead ideas. http://votechili.com/businessplan