Michael Pettis is the most intelligent commenter on the Chinese role in the global economy that I’ve run across, unfortunately. I say unfortunately because his prognosis is consistently grim and is based on communication with various Chinese and American businessmen and officials. One of the reasons I hate to enjoy his writing is because he focuses on how the current economic crisis is worsened by trade imbalances, and how difficult those are to correct. In that vein, his recent post about the modern version of Smoot-Hawley is disturbing.

Now I know what most people are probably thinking: Smoot-Hawley equals protectionism, protectionism is bad and the US (and Western Europe) is dangerously close to going down this path. However, this isn’t his understanding at all; in fact he thinks that China is the biggest problem in the global trade equation. His concern is that China had a massive trade surplus going into the crisis, and instead of contracting and making it easier for the world to recover, Chinese policy has led to a surplus explosion that is making things worse. They aren’t doing this through the traditional measures of protectionism, but through the more mundane policy of domestic stimulus.

His argument isn’t that Smoot-Hawley was bad because it was protectionism per se, but because it was protectionism by the world’s leading exporter in an vain attempt to maintain surpluses. Similarly, Keynes said that the US should have domestic stimulus in the 1930s not simply to “close the output gap” but to wean itself off an export driven economy and stimulate internal demand. In the present crisis we don’t have protectionism and we do have domestic stimulus, but the major exporters and importers are conspiring to make the trade deficits worse by stimulating the wrong industries, and thus the outcome may be similar.

Indeed, in this environment, protectionism by the deficit countries may be a net positive as long as it doesn’t lead to a trade war. However, the chances that logically valid protectionism will be met with understanding rather than retribution are slim, and he believes a trade war is highly likely.

Pettis has repeatedly called for more international cooperation and stated the need for the creditors to stimulate their domestic economy while the debtors stop consuming as much and develop export driven industries. He views this as the only way to avert calamity and in theory if the transition was accomplished with minimal disruption to total global trade levels then we could avoid a global depression. I agree, but am pessimistic that it is feasible.

It takes many years for the economic makeup of a country to change and I don’t see any way that the US could develop enough exports to support our plunging consumption; we are much more likely to see consumption fall towards sustainable levels and lead to economic contraction. Similarly China, Japan, Germany, and the petrol states/SE Asia are highly export oriented and their industries focus on goods that have little domestic market either for economic or cultural reasons. Japan and Germany in particular explicitly state that their citizens are overall content with their level of consumption and the government has few infrastructure projects to complete. This combination makes them highly vulnerable to an excessive downturn and it will be interesting to see how they react. I made a comment to this effect on one of Michael’s posts and he concurred that it is a major stumbling block, but said his current frustration was officials’ lack of understanding of the core problem at all.

This is a concern I have generally. It seems that people have learned lessons from the Great Depression, but they are based on nationalistic perspectives rather than in the global trade context. Our policy makers are reacting in the way that we should have acted back then, but few have noticed that the roles have changed and we may be exacerbating the problem.