Trade Wars: The Empire Strikes Back

Returning from NY and SF a few weeks ago, the word "fragile" kept ringing in my ears. I met with some very bright people on those shores of America. When I asked them about the economy, their chief concerns were that this recovery may not last, that the stock market rally was too broad, that employment (despite the trillions) was still stuck, and that the overall economic situation was, well, fragile. But where, I asked myself, were the fault lines? Where could all of the progress of the last 6 months unravel?

Enter Paul Krugman (Darth Vader theme music, please). The accomplished and respected economist (Nobel prize and all) is now giving America the justification it requires to embark on a protectionist crusade. Krugman in his recent New York Time op-ed column says this: "...there’s the claim that protectionism is always a bad thing, in any circumstances. If that’s what you believe, however, you learned Econ 101 from the wrong people — because when unemployment is high and the government can’t restore full employment, the usual rules don’t apply."

Krugman is righly upset with the Chinese for their unwillingness to allow an appreciation of the Yuan against the Dollar (this policy makes Chinese goods artificially cheap, and thus hampering US production and the recovery of the US economy). He thinks that protectionism is the appropriate weapon for America to fight back . With Chinese domestic demand weak relative to their production capacity, a real serious trade war, hints Krugman, would be a huge blow to the Chinese economy. In a vieled threat Krugman says "I’d urge China’s government to reconsider its stubbornness". Whether it is protectionism he is advocating, or only the threat of protectionism, it hardly matters. The genie is out of the bottle.

Terrific. So now we have the world's most widely read economist giving the Obama Administration a green light to raise protectionist barriers. Not that the US was waiting for Krugman's blessing, barriers have been slowly appearing, but it always helps to have the guru on your side.

In its attempt to fix the unintended consequences of the Internet bubble, the Federal Reserve helped create the credit bubble. Now to fix the unintended consequences of the credit bubble the US Government is flirting with trade protectionism. And the question is, what will be the unintended consequences this time round?

Open markets have been good for standards of living in the West and in the East. We eat better, sleep warmer, live longer. For much of this we have to thank the free movement of goods and services between markets. Protectionism takes us back in the opposite direction and should be viewed with extreme skepticism and worry.

Exit Krugman, enter Eric Schmidt. Google's announcement last week of a potential exit from China must be seen in this context. I don't fault Google's reasoning. But I do worry about its symbolic value.

Google is not just any company. It is an American icon. It is symbolic of American progress, brilliance and freedom. Like America, Google dominates the world. Plenty of companies do business in China, but Google's business is the very lifeblood of the economy - information.

The withdrawal of Google from China is akin to the withdrawal of an ambassador. It signals a severing of ties between the US and China, and the next step in the trade wars. May the Force be with us.