I have seen many attempts to square the circle on this question, and though I've seen many good ideas on the topic, I've never found any particular approach that I could point to and say "This guy's got it figured out. He's got the right idea." I myself have given the question considerable thought, and I must say that even if I allow myself 'perfect world' scenarios -- i.e. I could trust that a particular plan would actually be implemented and faithfully executed by the authorities in question -- I find it very difficult to come up with anything that the free-trading side can do to counteract the meddlesomeness of the foreign government.
The Free-Traders and the Protectionists
On the one hand, you've got the true blue free-traders who would simply say "to hell with it, we should do the right thing regardless of what the other side does, come what may." There are many in this camp whom I very much respect. There is an argument to be made that 'men with badges and guns' imposing taxes and barriers cannot possibly do anybody any good, so we shouldn't have any on our side of the border even if they swarming on the other side. Adding more badges and guns when it is badges and guns that are causing the trouble in the first place does not appear to be the right approach to making things any better. To which I would have to agree.
On the other hand, you have very real, very serious damage being done to many parties and a destabilization of the entire global economy as a result of wanton market manipulation, mostly by one side though neither side is completely blameless. That is undeniable, and when the free-traders try to deny or trivialize what has happened as a result, or try to dismiss obviously cruel and unfair outcomes as a proper result of the free market when anyone could tell that the market was rigged to begin with, they rightly look like jerks and fools. It is easy to understand that there are protectionists who think that we might be better off shutting down foreign trade altogether, so that even if our own system isn't perfect, at least we aren't importing all the horrors and damage that come with 'dealing with the devil.'
Three Plans From the Middle
In the muddled middle, we have many groups looking for a compromise between the two. Our own idiotic government seems to think that the right answer is to cajole China to change its behavior and allow the yuan to rise. This seems the height of stupidity to me. While it is true that the yuan is undervalued, manipulated exchange rates are not the whole story. Washington is as addicted to Chinese funding of its vote-buying boondogles as China is to the mercantilist model. The two are something of a matched pair, making it difficult to take Washington's position seriously. Besides, nagging somebody else to do what one would like has never seemed to me the most efficacious approach of getting anything done.
Pat Buchanan types think that we should pull out of sovereignty-sapping internationalist organizations like the WTO and pursue bilateral trade relationships. That way we could trade with whom we like on the terms we like and exclude oppressive and meddlesome nations such as China. Well, at least the terms our politicians liked anyway.
Most other such plans are similar attempts to 'fight fire with fire.' They tend to focus on the tax and tarriff side of things, giving tit-for-tat. One of the most interesting and clever ideas I've seen lately is a sliding scale tariff system, where the tariff is proportional to the previous year's (or quarter's) trade deficit. Nations with whom we have a substantial trade deficit will face stiffer barriers until the deficit is reduced, at which point the barriers fall, keeping trade 'balanced.'
The Flaws of the Middle-of-the-Roaders
These sound like reasonable plans, except I think they suffer from important flaws. First, they rely on the creation of too many 'men with badges and guns' acting in a fairly perfect world. I will admit that any such answer relies on 'perfect world' assumptions to a degree, but I don't like seeing badges and guns being turned on private parties any more than absolutely necessary. I think both these plans would create a great number of bureaucrats, and relying on politicians to dispassionately enforce existing law seems naïve to me. I think there would be a lot of selling-out and cheating. Best to give them as little law and power to work with as possible.
Second, and more importantly, even under perfect world conditions, they ignore one of the more important practical facts of trade -- most trade, in terms of the net transfer of non-monetary goods, is not bilateral. That is one of the reasons that money is such an important part of the economy -- rarely do two entities needs and capabilities complement one another so perfectly that direct trade is possible. Usually trade is indirect, with money as the intermediary. It is also the reason that 'trade deficit' is only a sort of economic slang. Actually, there isn't a deficit. The Chinese are buying something -- debt. The correct term is the 'balance of payments.'
The Complexity of Trade Balance
To illustrate what I mean, I'll give a simple idealized example. Consider the US, China, and Australia in a triangular relationship. All three trade freely in both directions with one another, but the reality is that forcing any pair to have exactly balanced trade is going to be hugely uneconomical. Most likely, the specialized demands and capabilities of each economy are going to cause some degree of net 'cyclicality' to the trade, with every nation running a surplus with one and a deficit with the other. For example, China might overwhelmingly export cheap manufactured goods to the US, which overwhelmingly exports cheap agricultural products to Australia, which overwhelmingly exports cheap minerals to China. Every nation is technically running a 'trade deficit' with somebody, but they all have a neutral balance of payments. No debt need change hands. Nobody 'owes' anybody.
In reality, an economically efficient free trade system would have a very complex flow of goods, with each nation having overall exports roughly equal to imports, but not necessarily with any particular nation. Some individual surpluses and deficits might be very high, yet with everything overall balancing out. Both the Buchanan and the Richman plan fail to deal with this situation, at least not efficiently.
But I think that especially the Richman plan has its heart in the right place -- we need to preserve free trade, but somehow neutralize the foul play, if possible, without 'men with badges and guns.'
Fighting Fire With Water
I am someone who tends to think that correct answers usually lie at the extremes, not in the middle. If an idea is wrong, a little bit less of that idea probably isn't right, and mixing it with another idea probably isn't going to make that one any more correct. So, I've been hunting and pecking at this mess, and I think maybe I've come up with something, if at least not the correct answer, better than anything I've read so far.
It seems to me that these plans and others too often focus on the 'fight fire with fire' approach. But in reality, it is not the actions of Chinese exporters that Americans really have the problem with, so why should they be targeted with policies like tariffs and quotas? It is the actions of the Chinese government and central bank that are causing the problems. They are the ones responsible for creating the mercantilist dilemma, and it seems to me that these are the transactions that should be the ones targeted by any remediating actions on the part of the American government.
Analyzing the Problem
Most people understand the actions of the Chinese government as acting through currency markets to boost the value of the dollar by purchasing US Treasury debt. All of which is true, to an approximation. In reality, it's a little more complex than that. But in any case, it would seem that if somehow the exchange rate could be fixed by the market, or by some definitional certainty, that would put an end to this behavior.
Now, I'm all for the abolition of fiat money and moving towards a gold coin standard, preferably an international one. That would be great, and it would put and end to the exchange rate tampering. But of course, America could not force China to adopt a gold coin standard, and besides, it wouldn't put a stop to the mercantilism.
China could still boost its exports by taxing or borrowing and using the money to buy US Treasury debt. Or it could go whole hog and cheat the gold standard by inflating, and use the money to buy Treasury debt. Eventually it would get caught in a gold-redemption nightmare, but to politicians and bankers, words like 'eventually' mean 'go ahead and do it anyway.' That is probably what it would do.
Targeting the Debt
Some observers have gotten so far as declaring the purchase of Treasury debt to be the problem. To their credit, that is a second part of the Richman suggestion -- ban the purchase of Treasury debt by foreign governments. Or better yet, get the national debt under control, so that there is no debt to buy.
But, while closer to an acceptable answer, this would still not work. The fact is, there are actually many other ways of effecting the same thing. Treasury debt is really just one of many, many kinds of economic goods. That's why there is technically no 'trade deficit.' There can't be. What raises hackles is that China buys these goods selectively for a specific reason -- there is almost no labor component in the 'production' of such assets. A nation that imports these goods rather than manufactured goods therefore gets a 'jobs boost' because it produces all the manufactured goods for itself plus a fraction of its trading partner. China also gets the bonus that Treasuries are 'guaranteed' to be repaid, but as far as the mercantilist angle is concerned, that isn't strictly necessary.
Other Ways to Unbalance the Books
Any such good will do, and the fact is that China has already made use of other avenues for mercantilism-mongering. For example, the Chinese version of Social Security is managed by an entity called a sovereign wealth fund which is responsible for investing the tax proceeds of the program that form the basis of future payouts. And guess what the fund has invested heavily in? American financial assets, boosting the dollar and American financial asset prices in the process and tamping down the yuan.
Similarly, the Chinese government could achieve comparable effects by doing things like --
-- purchasing other American financial assets and real estate directly
-- contributing heavily to the campaigns of American politicians
-- buying lots and lots of oil (oil is typically priced in dollars)
all of which allow them to dump dollars without providing competition for domestic workers. Those last two aren't quite as efficient at stimulating domestic exports, however, at least from an accounting perspective.
So, what's a mercantilist-buster to do?
Hopefully, this discussion has revealed what I think is probably the 'best' answer. All of these transactions are basically un-economic (i.e. not primarily profit driven) actions of state actors made in an attempt to boost the employment and profits of private exporters. In other words, none of these transactions would have been undertaken by a private entity.
One simple rule, it seems to me, would solve the problem --
All foreign states and agencies of foreign states, including state owned companies, are hereby forbidden to purchase financial assets or to contribute to any campaign, charity, or non-profit organization in the United States of America. Foreign private actors may do as they please.
Maybe that's not the best wording, but I think it gets the idea across. Maybe it should be a ban from purchases of American assets altogether. It might also be a good idea to ban the US government from doing the same thing to foreign nations. I don't know. Maybe somebody else can think of a better way of putting it.
Putting Badges and Guns to Good Use
This still requires 'men with badges and guns,' but hopefully in a way far more satisfactory to conservative/libertarian sensibilities. The badges and guns would not be used against private parties. They would be directed towards an appropriate target, if ever such a thing were to exist -- a foreign state power attempting to meddle in the markets and domestic affairs of Americans. It also can't be claimed that these men with badges and guns would be reducing economic efficiency and wealth creation to any significant degree because they would not be interfering with voluntary exchange, mutually beneficial or otherwise. They would be interfering with the decidedly wasteful, un-economic, and coercive actions of meddlesome foreign states.
States don't have any business involving themselves in these activities anyway. If it isn't proper for our government to lend money and buy stakes in private American enterprises, how much less appropriate is it for foreign governments to do the same thing? If we don't like our government propping up various entities with taxpayer money, why should we let the Chinese or anybody else do it for our own government? These are all inappropriate behaviors that shouldn't be legal anyway. Anyone who opposed the Wall-Street bailouts by Washington should oppose the Washington prop-up by Beijing.
Freedom lovers are supposed to support individual discretion and freedom of action by private individuals, not governments.
What Happens When You Douse Mercantilism
With such a ban in place, mercantilists like China would be stripped of their tools for counteracting the rise in their currencies caused by the trade barriers they have erected, which created the 'need' for currency manipulation in the first place. The yuan and other suppressed currencies would have to rise until such point as America's exports equalled imports. Well, at least the imports and exports that most people are worried about.
Of course, this idea isn't perfect. First of all, there's no guarantee that if these new powers were granted that they would be used appropriately. That's always a problem. Mercantilist governments could also counteract such a measure by either trying to operate under the guise of private companies, perhaps through subsidies for foreign acquisitions, or through straightforward currency debasement through inflation. But the latter would result in a great deal of domestic economic pain and chaos, and the former would at least be considerably more difficult than it is now, and could not operate at anywhere near today's volumes.
At the very least it would absorb the brunt of the problem. China would be forced to either open up her markets if she wanted to maintain export volumes, or to accept vastly reduced exports and develop an economy based almost purely on serving domestic consumer demand. China's government doesn't want to do either of these, and in all likelihood such a move would reveal the massive distortions it has created and the sham of the mercantilistic model for what it is. But that is neither America's doing nor her problem.
Of course, in the event such action is taken, America's own economic restructuring would be.
Alas, such a plan would be a total non-starter in the present environment, as Washington is far too dependent on foreign financing. And who knows what China might do? With little to gain by maintaining a portfolio of American holdings as the dollar slides against her own currency, China might just decide to dump all those Treasuries and be rid of the thing altogether.
Too bad. Oh, what tangled webs we weave!
One other, somewhat related note. There is a lot of talk right now about the FED's 'quantitative easing' program 'exporting inflation' to foreign markets, as US dollars 'flow overseas' to buy oil and other imports or foreign financial assets. This is a complete and total falsehood that results from an oversimplified, inaccurate understanding of foreign exchange. There are plenty of bad things you can say about quantitative easing, but this isn't one of them.
The FED can cause domestic inflation by increasing the supply of dollars and devaluing our currency, but the only way that translates to inflation outside the US is if foreign central banks respond by devaluing their own currencies in an attempt to maintain the exchange rate. But that, of course, would not be the FED's doing. If they want to counteract the falling dollar with their own monetary mischief, that's their business.
The FED is to be blamed for many things, but inflation in foreign countries isn't one of them.