Is Protectionism Coming?

Twice during the Geithner confirmation hearings, Mr. Geithner replied exactly the same way with regards to questions from Senators regarding China and its currency. This was his written, prepared answer:

"President Obama -- backed by the conclusions of a broad range of economists -- believes that China is manipulating its currency. President Obama has pledged as President to use aggressively all the diplomatic avenues open to him to seek change in China's currency practices."

This was his written, prepared answer. He was clearly answering on behalf of President Obama.

China's Commerce Ministry issued the following statement in response:

"/China/ has never used so-called currency manipulation to gain benefits in its international trade. Directing unsubstantiated criticism at China on the exchange-rate issue will only help US protectionism and will not help towards a real solution to the issue."

Why is this significant?

• China owns more U.S. treasuries than any other country in the world. If China should begin to dump them suddenly, in a spirit of retaliation, it would almost certainly force interest rates in the United States to rise significantly and rapidly. It may also cause the Dollar to plunge, sending prices of nearly everything sky-high, as commodities respond to a Dollar collapse. As the world's largest debtor nation, the United States can not afford to see a sell-off of its debt.
• If the United States declares China as a currency manipulator, and retaliates with sanctions of any kind, China would almost certainly respond in kind by limiting or restricting U.S. goods and services. This would make the United States economy worse. Quite frankly, the United States has more to lose.
• One of the lessons that nearly all economists and students of economic history agree is that one of the factors that powerfully amplified the gravity of the Great Depression were policies that ignited a trade war. If a trade war begins between the world's two largest economic powers, the consequences could be catastrophic.

This will be something that we will want to monitor very carefully! While most economic advisers see a trade war as extremely harmful to U.S. interests, as political instability mounts, Congress may respond to such instability with retaliation regardless of the harmful long-term consequences!