See our new commentary in RealClearMarkets looking beyond the Google-China dustup: “The Internet is the U.S./China’s new Dollar/Yuan.”

With the China currency question once again in the news, I’m reposting my Wall Street Journal article from early 2009. (For a much longer treatment, see this paper.)

THE WALL STREET JOURNAL / January 26, 2009

Geithner Is Exactly Wrong on China Trade

The dollar-yuan link has been a great boon to world prosperity

by BRET SWANSON

Treasury Secretary-designate Tim Geithner’s charge that China “manipulates” its currency proves only one thing. Three decades after Deng Xiaoping’s capitalist rise, America’s misunderstanding of China remains a key source of our own crisis and socialist tilt.

The new consensus is that America failed to react to the building trade deficit with China and the global “savings glut,” which fueled our housing boom. A “passive” America allowed China to steal jobs from the U.S. while Americans binged with undervalued Chinese funny money.

This diagnosis is backwards. America did not underreact to the supposed Chinese threat. It overreacted. The problem wasn’t “global imbalances” but a purposeful dollar imbalance. Our weak-dollar policy, intended to pump up U.S. manufacturing and close the trade gap, backfired. Currency chaos led to a $30 trillion global crash, an energy shock, bank and auto failures, and possibly a new big government era. For globalization and American innovation to survive, we must first understand the Chinese story and our own monetary mistakes.

We’ve heard the refrain: China’s rapid growth was a mirage. China was stealing wealth by “manipulating” its currency. But in fact China’s rise was based on dramatic decentralization and sound money. (more…)

Here are a few good perspectives on Google’s big announcement that it will no longer censor search results for google.cn in China, a move it says could lead to a pull-out from the Middle Kingdom.

“Google’s Move: Does it Make Sense?” by Larry Dignan

“The Google News” by James Fallows

I agree with Dignan of Znet that this move was probably less about about China and more about policy and branding in the U.S. and Europe.

UPDATE: Much more detail on the mechanics of the attack from Wired’s Threat Level blog.

Intel CTO Justin Rattner

says many people underestimate America’s lead in post-graduate education. Intel has found, for example, that the skills of PhDs from Chinese universities that the company has hired do not yet match those of U.S. graduates, he says.

On the other hand, Rattner says, tougher immigration laws are weakening the U.S. advantage as a magnet for students from around the world. Many Silicon Valley companies were founded by foreign students after they got degrees from Stanford, the University of California at Berkeley, Caltech and other U.S. institutions.

“Now we tell them to go home, and don’t come back anytime soon,” Rattner says. Such a policy could have made it impossible for people like Andy Grove, Intel’s Hungarian-born former CEO, to have risen to the top of the U.S. tech scene. “Nowadays we would have packed him up and sent him home,” Rattner says.

“The Americans have not had to deal with a true economic rival since the British more than half a century ago. America today is as unaccustomed to global economic competition as the British were at their apex. The U.S. often seems lumbering and ill-suited to the demands of economic rivalry.

“The only way to avoid Britain’s fate and meet the challenge of China is to reinvigorate economic life. This is a multiyear endeavor that must be done primarily through innovation, not legislation. America needs to retool its domestic economy to build on the global success of many U.S. companies. It must focus on inventing new products and generating new ideas, rather than defending the rusty industries of yesterday. Fights over health care and climate change are the cultural equivalent of fiddling while Rome burns.

“China thrives because it is hungry, dynamic, scared of failure and convinced that it should be a leading force in the world. That is why America thrived a century ago. Today, such hunger and dynamism seem less evident in American life than petulance that the world is not cooperating.

“The U.S. is in danger of assuming that because it has been a dominant nation on the world stage, it must continue to be so. That is a recipe for becoming Britain.”

— Zachary Karabell, The Wall Street Journal, October 13, 2009

Stanford economist Paul Romer has had lots of good ideas over the years. Particularly his ideas about the importance of ideas in the economy. But his “Charter City” idea explored at the recent TED conference is one of the best yet.

Maybe I like it so much because it so closely tracks the concepts offered in my long paper of last August called “Entrepreneurship and Innovation in China – 1978-2008 – Thirty Years of Decentralized Economic Growth”, a follow-on article in The Wall Street Journal, and a previous essay “Breaking Metcalfe’s Law” on the economic importance of the exchange of ideas.

Romer uses China’s “free zones” envisioned by Deng Xiaoping and initially implemented by one Jiang Zemin as the chief example of how his charter cities would work in practice. He explains how they might cut the political-economic Gordian knot of societies too stuck in the past to make obviously needed rule changes that open the floodgates of ideas and entrepreneurship. These were the key themes of my paper.

Also check out this working paper by Romer that surveys the economic growth literature (hat tip: Growthology).

Last December, we celebrated the 30-year anniversary of Deng Xiaoping’s historic “Reform and Opening Up” campaign. 

Today, we remember those who died at Tiananmen Square 20 years ago.

Fortunately, the legacy of Deng’s capitalist opening and decentralized economic program has far, far outweighed the tragedy of June 4, 1989.

Zachary Karabell does a nice job explaining the “superfusion” cooperative arrangement between the U.S. and China, showing why China doesn’t want and won’t trigger a crashed dollar. They want a strong and stable dollar, which, as we have been writing for a long time, is also in our best interest. We are of course constrained by global investors, who rationally want solid real returns. But the competitive and currency positions of the U.S. are a function of our own monetary, fiscal, and regulatory policy actions, not some malign intent on the part of weaker foreign economies who in fact depend on a healthy, thriving America.

David Malpass, as usual, explains it best in this video:

China proposes a new world reserve currency to replace the dollar and, it hopes, launch a new era of global monetary stability. In a paper released Monday in Beijing, central bank governor Zhou Xiaochuan wrote:

Theoretically, an international reserve currency should first be anchored to a stable benchmark and issued according to a clear set of rules, therefore to ensure orderly supply; second, its supply should be flexible enough to allow timely adjustment according to the changing demand; third, such adjustments should be disconnected from economic conditions and sovereign interests of any single country. The acceptance of credit-based national currencies as major international reserve currencies, as is the case in the current system, is a rare special case in history. The crisis again calls for creative reform of the existing international monetary system towards an international reserve currency with a stable value, rule-based issuance and manageable supply, so as to achieve the objective of safeguarding global economic and financial stability.

It’s an interesting concept, and as I contemplate the proposal I’ll air my praise and criticisms. I’m initially skeptical of a single IMF-managed currency and of Zhou’s suggestion that this will allow nations more flexibility in their own monetary policies. Hyperflexible monetary policies, especially in the U.S., were the source of the problem. But it’s too bad we ever arrived at this point. If the U.S. had better managed the stability of the existing world reserve currency — the dollar — there would be no need for a new “super-sovereign” currency. We had a good thing going, and we blew it.

I’ve written lots about the dollar and its nexus with China (here, here, here, and here).

Yet another remarkable dispatch from James Fallows on China’s attempts to navigate the global financial crisis. His conclusions:

(1) the Chinese people are less likely to revolt en masse in bad times than is often suspected. Even now, things are a lot better than ever before.  Fallows quotes one Shanxi province party official:

Do you understand? If it had not been for Deng Xiaoping, I would be behind an ox in a field right now. . . . Do you understand? My mother has bound feet! 

(2) China has at least a very good shot at achieving a truly innovative economy. Listing several new high-tech firms producing the best voice-recognition software he’s ever seen and some of the world’s most advanced batteries for everything from iPhones to new electric cars, Fallows writes: 

In Beijing, in Shanghai, in Shenzhen, and elsewhere, I’ve recently visited companies that are trying to use the disruption of this moment to enter wholly new markets and do what so few Chinese firms have yet done: make high-tech, high-value products that bring high rewards.

These largely mirror my own views. In fact I couldn’t help but notice Fallows’ concluding sentences:

Many Chinese companies will fail or make mistakes under today’s intense pressure. But many are using the moment to prepare for their next advance. The question for Americans to think about is how we are using the same moment.

Here were the final sentences of my economic history of China’s 30-year rise, released during last summer’s Beijing Olympics:

What seems undeniable is that the next hundred years will be a Chinese century. The biggest question for politicians and business leaders in the U.S. is whether, through a recommitment to entrepreneurial capitalism, it will be another American century as well.

The WSJ’s RealTimeEconomics blog reports on Hank Paulson’s clarification to the Chinese over his recent serial blaming of “global imbalances” as the cause of the financial crash.

“In assessing the financial market crisis, I have repeatedly and consistently targeted the vast majority of my criticism at problems in the United States, particularly our flawed and outdated regulatory structure,” Xinhua quoted Mr. Paulson as saying. “Whenever I have commented on global imbalances, it has been against that backdrop and I have gone out of my way to say that no single country is to blame for the imbalances.”

John Tamny at RealClearMarkets weighs in on the dollar-yuan China trade debate.

See my latest on the nexus of China trade, monetary policy, and our current crisis in Monday’s Wall Street Journal. Contrary to the new conventional wisdom, which is gaining considerable steam, I argue that:

America did not underreact to the supposed Chinese threat. It overreacted. The problem wasn’t “global imbalances” but a purposeful dollar imbalance. Our weak-dollar policy, intended to pump up U.S. manufacturing and close the trade gap, backfired. Currency chaos led to a $30 trillion global crash, an energy shock, bank and auto failures, and possibly a new big government era. For globalization and American innovation to survive, we must first understand the Chinese story and our own monetary mistakes.

A “more competitive currency” and monetary “stimulus” cannot create new wealth. Only technology and entrepreneurship can do that. The “China currency” issue distracts America from all the important things that could actually make us more competitive –e.g., better K-12 education, much lower corporate tax rates, cutting-edge broadband networks, less (not more) centralization and power in Washington, and, of course, a stable dollar.

It looks like incoming Administration official Tim Geithner will continue the long line of clueless protectionist currency policy at the Treasury Department. In written responses to the Senate Finance Committee, Geithner asserted what even the disastrous Snow/Paulson Treasury’s wouldn’t say officially: that China is “manipulating” its currency, the yuan.

Mere journalist James Fallows understands the issue much better than technocrat Geithner:

to boil it down to the bald assertion that “China is manipulating its currency” ignores, vulgarizes, and misconstrues a lot more than it clarifies. 

Gold promptly rocketed $40 today, as the American weak-dollar policy resumes.

Updates: here and here.

Hugo Restall thinks about the implications of Chinese aircraft carriers and its prospective blue water navy:

These are worst case scenarios. There is another possibility, however: that China’s ambitious plan might be a positive development. In the past, the People’s Liberation Army has emphasized asymmetrical warfare, apparently believing it could find inexpensive and innovative ways to counteract American might. If it is now moving toward a more conventional road of military modernization, pitting like against like, that is less likely to cause the miscalculations that lead to war, because China is less likely to be seduced by ideas that it can neutralize U.S. superiority with asymmetry.

James Fallows talks about his forthcoming China book, Postcards from Tomorrow Square:

in watching Japan’s rise and then its financial stagnation, we’d seen the last dramatic stage in East Asian economic development. The similarities in China’s approach — and, mainly, the differences — have been an important touchstone all the way through. And as I think will be evident to readers, I have found China’s economic rise to be a fundamentally more open phenomenon, for the rest of the world, than Japan’s approach was.

As for the latest crisis — hey, blame Alan Greenspan! Not me.

The New York Times, in its series on the origins of the financial crisis it calls “The Reckoning,” pins our housing and credit bubbles on Chinese savings and the U.S.-China trade gap. This is basically the view of Alan Greenspan and Ben Bernanke. We were helpless. Monetary policy had become ineffective. The New York Times also says the U.S. failed to react to the China-U.S. “imbalances” soon enough, that we took a “passive” approach. 

In fact, most of this is backward. We did not under-react to China. We overreacted. The U.S. weak-dollar policy — a combination of historically low Fed interest rates and a Treasury calling for a cheaper currency — was a direct and violent reaction to the trade gap. A series of Treasury secretaries and top U.S. economists, from John Snow and Hank Paulson to John Taylor and Martin Feldstein, explicitly backed this policy as a way to “correct” these “imbalances.” This weak-dollar policy was designed to reduce the trade gap but in fact boosted it by pushing oil and other commodity prices through the roof. It also created and pushed excess dollars into other hard assets like real estate, resulting in the housing boom and then bust.

America’s overreaction to China’s rise in particular and our misunderstanding of global trade and finance in general was thus, I believe, the chief source of our current predicament. The Fed and Treasury failed to grasp the truly global nature of the economy and the centrality of the dollar around the world. I tell the story of Chinese-U.S. interaction in this long paper, “Entrepreneurship and Innovation in China: 1978-2008.”

Three decades ago today, Deng Xiaoping shook the world.

Treasury Secretary Hank Paulson is back at it. Having presided over the debasement of the U.S. dollar, he is once again cajoling the Chinese over the value of its currency, the renminbi (or yuan). Paulson earns a few points for his semiannual Special Economic Dialogue that has facilitated U.S.-Chinese cooperation on some fronts and helped defuse some of the worst protectionist policy on both sides. But the Greenspan-Snow-Bernanke-Paulson weak dollar policy — which was in itself deeply protectionist, and ultimately highly self-destructive — utterly swamped any of Paulson’s good intentions vis-à-vis China.

Digging through some old files, I found a May 13, 2006, e-mail I wrote to a senior White House economic official, warning of the certain harmful effects of its weak-dollar policy. (I had, six months prior, met with the official in the West Wing to discuss the matter.) The morning of my e-mail, The Wall Street Journal, citing top Administration officials making clear their weak-dollar preference, had published a major story: “U.S. Goes Along With Dollar’s Fall to Ease Trade Gap,” with the subhed, “Quiet Acquiescence Holds Possible Risks for Economy; Surge in Exports in March.”

The previous week economist John Taylor, just off his post as Treasury Undersecretary, had, in another Wall Street Journal article, dismissed the views of Nobel laureate Robert Mundell and Stanford economist Ronald McKinnon. Mundell and McKinnon had been arguing against dollar weakness and urging dollar-yuan stability. Taylor’s offensive, moreover, had been previewed by yet another two articles, one from Martin Feldstein and another from Lawrence Lindsey, arguing for a “more competitive” dollar. That’s a euphemism for weak, as in competitive devaluation. (See, not supposed to happen in America).

Written in the heat of battle, I think my e-mail memo holds up pretty well:

From: Bret Swanson <bret.swanson@********.com>
Date: Sat, May 13, 2006 at 1:38 PM
Subject: stunning protectionist mercantilism
To: [senior White House official]

*** Warning: Blunt Statements to Follow ***

[senior White House official],

Even considering Treasury’s misguided currency stance these past few years, today’s news in the Journal that the White House approves of the further weakening of an already too-weak dollar is stunning and alarming. 

Using monetary policy to target the trade deficit instead of using monetary policy for its only legitimate purpose of price stability and currency stability, is massively irresponsible. The trade deficit is a mostly meaningless accounting number that if anything demonstrates the strength of the American economy, not its weakness. “Competitive devaluation” is what Third World nations did for decades. It’s what helped keep them poor. It’s what we did in the 1970s, a lost decade of malaise. In an era of globalization, currency devaluation is more damaging than ever when there is more cross-border trade and investment and a larger proportion of inputs into our final products and services come from abroad.

An already inflationary dollar will become more inflationary. Oil prices will rise further. Recession in 2007 now becomes a real possibility because the Fed will likely now overshoot on interest rates to combat inflation that they and Treasury created but which they never see until it’s too late. Why are we risking ruin of a robust economy?

The best economists I know are alarmed at the Fed’s lack of vigilance and the deepening of Treasury’s weak-dollar policy. Having now lost faith in the Fed and Treasury, these economists have changed their outlooks for the  U.S. economy from positive to negative.

Lindsey and Feldstein are 180-degrees wrong on monetary/currency/trade policy. Clearly their recent Journal articles were a set-up for this potentially disastrous currency move. John Taylor’s statements last week pooh-poohing Mundell and McKinnon — who are absolutely right on China — were equally discouraging. Not since Richard Nixon have Republicans stood for debasing the currency. It’s painful to agree with those who say this may be the most protectionist Administration since Herbert Hoover.

The U.S. Auto Companies and manufacturers want a weaker dollar — manufacturers always do — but the dominance of the Japanese auto makers is not a currency issue. Japan has just come out of a decade of deflation – the yen was way too strong, not artificially weak – exactly the opposite of what the auto makers say. Manufacturers in general face a huge challenge from China, but not because of the yuan, which is exactly in line with the dollar. The China challenge is real, not monetary. The U.S. must become more competitive via lower tax rates and less regulation. Currency is nothing but a scapegoat, and focusing on it reduces the chances we can solve our real competitive disadvantages on taxes and regulations. Because changing the unit of account cannot change the terms of trade, debasing the dollar does not make us more competitive; it makes us less competitive because it fosters inflation and possibly recession.

Furthermore, autos and manufacturing are a shrinking portion of our economy, and this misguided protectionist policy at their behest is highly damaging to the real, growing, leading edge sources of American wealth and power: our prowess in technology, finance, and entrepreneurship.

Please forgive my blunt statements. I make them with respect and concern for the success of this White House. I know you can’t comment on currency matters, but if I am overreacting or wrong on my interpretation of what appears to be happening, please let me know.

Very best,

Bret 

I then sent the following warning to a number of friends at the U.S. Chamber of Commerce, who had been seeking my views:

From: Bret Swanson <bret.swanson@*******.com>
Date: Sat, May 13, 2006 at 2:26 PM
Subject: ALERT: stunning protectionist mercantilism
To: [U.S. Chamber officials]

ALERT                       

I believe the outlook for the U.S. economy could be shifting. An article in this morning’s Wall Street Journal makes clear that instead of reversing the dollar’s decline and inflationary pressures, the White House and the Fed are actually encouraging a further fall of the dollar. Amazing. This means more inflation, a potential Fed overshoot on interest rates, and a slow-down and possible recession in 2007. None of this was necessary. We’ve had a very robust economy since mid-2003, and it could have easily continued. Debasing the dollar in a misguided protectionist attempt to reduce the trade deficit is hugely counterproductive. I warned of this possibility in my February memo but held out hope that the Fed and Treasury would reverse its inflationary/weak-dollar course in time to blunt these effects. No such luck.

What this means: The Chamber should prepare for a slow-down/recession in 2007-08. We should prepare for an inflationary environment. This policy means gas prices will probably stay high or go HIGHER. Some auto and manufacturing companies could benefit in the very short term, but overall this is bad for the larger economy, especially for technology and financial firms and for entrepreneurs. When the Fed figures out what’s going on, it will have to raise interest rates more than if it had gotten ahead of the curve in 2004-05. Commodity based businesses will continue to do well for a while, with intellectual property based businesses being hit the hardest. Eventually a recession would hurt everyone.

Currency volatility will also discourage international trade and investment, which could lead to slower global growth.

I’ll continue to think about what this means and how the Chamber should prepare.

Best,

Bret

Most of this scenario came to pass. Oil and commodity prices rocketed. Subprime loans, fueled by easy weak-dollar credit, kept flowing through 2006 and 2007. And the U.S., we now know, hit recession in “2007-08.”

Only the mechanism was a bit off. With elevated inflation, real interest rates never got very high — certainly not to the point that normally causes recessions. But the bursting of the adjustable-rate housing bubble, enabled by weak-dollar easy money, and the ensuing credit crisis had the same effect as a high real Fed Funds rate.

Many of the easy money mistakes had already been made by the Fed in 2003-2005. But this crucial period in 2006, when the U.S. government doubled down on a misguided weak-dollar strategy, told foreign capital to stay away, directly devalued all dollar assets, accelerated the financial collapse, and destabilized the globe. 

Please, Mr. Paulson, enough with the currency lectures.

(You can find a much more detailed history of the whole era within this longish economic history of China (1978-2008) or this shorter article.)

About 10 days ago I gave a presentation to a D.C. business group on “Innovation: The End? Or a New Beginning?” We got into a discussion of high-end immigration and were in general agreement that we should grant easy green cards to all STEM PhDs educated in the U.S., among other enticements to smart immigrants. One commenter then suggested this was a kind of a zero-sum race between the U.S., China, and India for the world’s human capital.

I replied, however, that the technological, economic, and political advance of China and India is a good thing. Innovation anywhere in the world benefits us, too, if we are open to the global economy. For hundreds of years, North America attracted much or most of the world’s financial and human capital because (1) though imperfect, we were an attractive realm of freedom and (2) much of the rest of the world was so inhospitable to innovation, entrepreneurship, education, and was generally politically intolerant. This massive tilt in our direction is now over. Other parts of the world present more opportunities for entrepreneurship and education, and we’re not going to get all the smart people, no matter how open our immigration laws. Doesn’t mean we shouldn’t try to get the smartest people. Just that there’s going to be lots of innovation and new enterprise in new non-U.S. places, and that overall that’s a good thing.

So I was intrigued when an Economist article on this very topic hit my radar yesterday. Turns out Amar Bhidé of Columbia Business School has written a whole book on the subject: The Venturesome Economy.

So does the relative decline of America as a technology powerhouse really amount to a threat to its prosperity? Nonsense, insists Amar Bhidé of Columbia Business School. In “The Venturesome Economy”, a provocative new book, he explains why he thinks this gloomy thesis misunderstands innovation in several fundamental ways.

First, he argues that the obsession with the number of doctorates and technical graduates is misplaced because the “high-level” inventions and ideas such boffins come up with travel easily across national borders. Even if China spends a fortune to train more scientists, it cannot prevent America from capitalising on their inventions with better business models.

That points to his next insight, that the commercialisation, diffusion and use of inventions is of more value to companies and societies than the initial bright spark. America’s sophisticated marketing, distribution, sales and customer-service systems have long given it a decisive advantage over rivals, such as Japan in the 1980s, that began to catch up with its technological prowess. For America to retain this sort of edge, then, what the country needs is better MBAs, not more PhDs.

A lot to agree with. The addition of China and India to the world economy, with new minds and new centers of research and innovation, make it more likely that new general purpose technologies like the integrated circuit or laser will be invented — maybe the next one will be in the field of biotech or energy, who knows. It will be good for humanity, at least for those open to these inventions and, yes, the commercializers. But how does clustering — like Silicon Valley, where a whole ecosystem of talent, firms, and infrastructure spiral virtuously upward — come into play? Does clustering mean as much as it used to in the age of instant global broadband communication? If technology and the corresponding innovations rapidly diffuse everywhere — and they do — it’s largely a matter of who earns the profits. Who sets the standards. And which governmental jurisdictions get to tax the innovations and entrepreneurs. In nationalist terms, where military and political power derive from economic power, it is largely a competition for tax revenues.

But I think Bhidé, at least in this article (I’ve yet to read the book), still underplays the importance of PhDs or their equivalents who not only make the once-in-a-generation breakthroughs but also do help manufacture and commercialize these inventions. And Bhidé probably overplays the the importance of MBAs, who he says are key to our “consumer” culture. Consumers don’t drive the economy. Entrepreneurs do. Yes, MBAs are good at cleaving consumers from their wallets. But consumption is a function of growth and growth expectations, which depend on entrepreneurial confidence. Supply creates its own demand.

If we had a perfectly globalized, flat, frictionless world — a world of “maximum entropy” — it’s true, the “where” of innovation wouldn’t matter much. And we should basically be shooting for that type of world. After all, I named my blog after it. But until we get there, the “where” of innovation probably matters more than Bhidé would like.

In this game, it’s the farsighted innovators and consumers, who want free trade and tax competition, against the all-too-often shortsighted politicians, who seek the short-term advantage of protectionism, tax gouges (which can only be achieved through tax harmonization cartels), and “energy independence” campaigns. It takes real wisdom to understand that China’s or India’s gain is also our own.

Zachary Karabell writes about China’s ever growing importance, especially now, with our stumbles and its $2 trillion in reserves.

China’s actions could also have direct — and positive — effects on the U.S. economy. An investment arm of the Chinese government is now deep in talks to buy up parts of AIG. China is already the primary source of growth for many U.S. companies, including ones like Caterpillar that make things in the U.S. and export them to China. As the developed world sags, China is becoming even more important to the global system.

China also needs a vibrant U.S. (and Europe). Beijing will likely take action to prevent a collapse by continuing to purchase U.S. Treasuries. We may not like the fact that China is our creditor, but having no creditor would be a good deal worse.

Even more important than its reserves, though, are the deeper sources of its economic strength — its decentralized entrepreneurial economy.

Update: In his final international address, President Bush pushed continued free trade with China. Good for him. But if only his administration had realized that its weak-dollar policy was effective protectionism, which boomeranged — as it always does. The policy inflated the home, oil, and credit bubbles, which of course led to our present crash.

Bruce Gilley writes that the Sichuan earthquake will prove a bigger jolt to Chinese society and government than the Olympics:

A survey of 784 people in the quake zone conducted in August by Beijing-based Horizon Research Consultancy Group found that 98.8% were satisfied with the central government’s performance. Premier Wen Jiabao told a meeting on post-quake reconstruction in Sichuan in September the government had achieved a “major victory.”

Yet the price of that victory was to unleash forces of liberalization that will prove irreversible in coming years. For starters, the earthquake undermined support for local government in the affected areas, and intensified the campaign against corruption. 

Steve Pearlstein of the Washington Post is on Charlie Rose right now saying the U.S. trade deficit was a chief cause of the present financial crisis. He’s got it just backwards. It was our overreaction to the innocuous trade deficit — namely, inflationary weak-dollar easy credit, designed in part to close the trade gap — that brought us here. The weak-dollar Fed juiced oil and home prices. High oil prices boosted the trade deficit — just the opposite of the weak-dollar advocates‘ intent. Skyrocketing home prices required, and were fueled by, hyper-aggressive and unsustainable mortgage lending.

Pearlstein then said we needed an international regulator to stop this from happening. This entity should have stopped the U.S. from buying so much from China. Wrong again. We needed the Fed and Treasury to maintain a stable dollar. A stable currency is the ultimate financial regulator and disciplinarian. If we had ignored the trade deficit and focused on stable money, there would be no financial crisis.

Gordon Chang wonders whether a President Obama will “restrict trade with China.”

Absent from recent trade debates in the U.S. is the fact that last year all but $5.9 billion of China’s overall trade surplus of $262.2 billion related to sales to America. The temptation is that Obama will try to use this leverage over Beijing to restructure trade relations in the coming years. In President Bush’s second term, a fundamental realignment of ties with China was unthinkable. In view of the powerful forces at work in these volatile times, however, many of the assumptions we now make about trading with the Chinese may no longer be valid.

Lots of people mistakenly get charged up over trade deficits. But Chang, who has been predicting — or more accurately, hoping for – The Coming Collapse of China for a decade, should really know better than to take a bilateral trade imbalance seriously. Think about it: Japanese and Korean firms send goods into China for final assembly and shipment to the U.S. The U.S. trade deficit with China jumps but falls vis-a-vis Japan and Korea. Problem? No. 

Anyway, Chang may not need an explicit Obama trade blockage to get his China crash wish. Washington’s more indirect but just as ill-conceived effort to cut the U.S. trade deficit via an inflationary weak-dollar has already worked its wicked protectionist magic — see, global panic and recession — and the question now is whether China’s juggernaut will merely slow, or succumb.

China and Taiwan continue to reconcile.

Yesterday China and Taiwan agreed to open new air, sea and postal links. This establishes the hitherto elusive “three links” — direct trade, transport and mail — that the two governments have been talking about for years. They also agreed to cooperate on food safety regulation as well as to hold further talks every six months, alternating between Beijing and Taipei.