The Donald and China, or The Fallacy of Protectionism

For reasons that will forever remain a mystery to us, mercantilism and protectionism actually hold enormous popular appeal. The best explanation we can come up with for this phenomenon is that the support for such policies is based on a mixture of economic ignorance and relentless propaganda by vested interests over the past, say, four centuries. Still, it is almost comical that people are so vociferously clamoring for policies that can actually cost them a fortune and will definitely lower their standard of living.


Trump-GOP-EstablishmentEntangled in the Donald’s magnificent hair.

Cartoon by Sack


Donald Trump currently enjoys great success as the frontrunner in the Republican nomination race. Usually the business candidate never wins, and maybe his participation will end up increasing the chances of the candidate the Republican establishment really wants – i.e., Jeb Bush, a member of the immensely costly American aristocracy, and a dependable neo-con warmonger. For now though, Trump seems to have said establishment in disarray.

Anyway, the Donald has evidently noticed that his political incorrectness and populism are a huge draw for the grumpy and by now quite cynical electorate, and so he couldn’t let an opportunity for a little China bashing pass him by. As we have pointed out, we do like him for his great entertainment value and his remarkably candid and correct assessment of Fed policy, but there are a number of areas in which he seems quite deficient. As CNBC reports, Trump reacted with characteristic hyperbole to the recent devaluation of the yuan:


Republican presidential candidate Donald Trump on Tuesday said China’s devaluation of the yuan would be “devastating” for the United States. “They’re just destroying us,” the billionaire businessman, a long-time critic of China’s currency policy, said in a CNN interview.

“They keep devaluing their currency until they get it right. They’re doing a big cut in the yuan, and that’s going to be devastating for us.”

Earlier on Tuesday, China devalued its currency following a series of poor economic data in the yuan’s biggest fall since 1994. Some said this could signal a long-term slide in the exchange rate.

China has been a frequent theme for Trump since he entered the 2016 presidential campaign, promising to be a tougher negotiator with Beijing in order to bolster the U.S. Economy.”


(emphasis added)

If a devaluation of the yuan by a few percentage points really has the potential to “devastate the US economy”, the US economy must be a lot more fragile than we thought.


donald-trump-cartoon-luckovichI solemnly hair that I will faithfully execute the office…

Cartoon by Mike Luckovich


Is a Weaker Yuan a Threat?

It is of course absolutely true that China has manipulated its currency for decades. However, the economic rationale of China’s rulers is simply misguided – and Trump seems to be saying “we should pursue the very same misguided currency policy”. In other words, he seems to believe that China will gain wealth to the detriment of the US by lowering the value of its currency and would prefer it if things were the other way around.

First of all, we should point out here that the yuan was actually egregiously overvalued at its recent highs. In trade-weighted terms, it had risen by 14% against the US dollar just over the past year – the only currency in the world exhibiting such strength against the surging USD. At the same time, China’s economy has actually begun to wobble, as its credit and housing bubbles are teetering on the edge. If China’s leaders were to finally listen to their critics and make the yuan fully convertible, we would confidently predict that it would crash by at least 30% against the dollar. In short, if China were to cease to act as a currency manipulator, its critics would be faced with the exact opposite outcome they are apparently hoping for.


USDCNY(Daily)The yuan vs. the USD, daily – if the yuan were to become fully convertible, it would likely weaken a lot more.


It is true that China’s policymakers for a long time did everything they could to keep the yuan from appreciating. As a result, they kicked off an almost unprecedented credit bubble in China, creating an orgy of malinvestment that has been stunning to behold. However, the low yuan was a great boon to consumers in the countries trading with China. Thus, while China’s economy was structurally undermined, others reaped great benefits. Every dollar a consumer can save because China offers him goods at extremely low prices can be put to other uses – it can be saved and invested, or used for additional consumption. This is great for individual consumers and the economic areas in which they reside.

However, in recent years, China’s currency policy has changed. The country’s policymakers gained a lot of “face” when China was the only emerging economy not to devalue after the 2008 crisis. Subsequently a decision seems to have been made to let the yuan appreciate, for three main reasons: 1. protectionists in the US and Europe had to be pacified. 2. China’s economy needed to be moved away from its investment-heavy model to a more balanced one (especially in light of the fact that much of this investment was akin to Keynesian pyramid building or ditch digging, i.e., a complete waste of scarce resources) and 3. China wanted and still wants to see the yuan included in the SDR currency basket, which is a matter of prestige and would moreover imbue the yuan with potential reserve currency status. Apparently the fact that the IMF rejected the application for the time being caused China’s policymakers to bring the yuan closer to its market value, essentially saying “let’s see how you like it”.


up-yours_00031305A subtle gesture from Beijing…


Capital outflows, a weak economy and a number of easing measures by the PBoC over the past year were all contradicting the strong yuan policy. The markets were well aware of this fact, which is why setting the yuan’s trading band closer to the appropriate value indicated by the markets resulted in a weaker yuan. Trump seems to be saying that China should continue to manipulate the value of its currency, only in a direction more to his liking.


China money supply growthNot least due to the “strong yuan” policy of the past few years, money supply growth rates in China have collapsed – this is beginning to unmask a lot of malinvested capital, leading to a weakening of economic activity in China – click to enlarge.


The great error of both China’s mercantilists and US protectionists is to believe that a positive trade balance is somehow improving a country’s welfare. They all need to urgently read what Frederic Bastiat wrote on the topic 167 years ago already . Apparently Mr. Trump and many other politicians are the modern-day incarnations of a certain M. Maguin:


“The balance of trade is an article of faith. We know what it consists in: if a country imports more than it exports, it loses the difference. Conversely, if its exports exceed its imports, the excess is to its profit. This is held to be an axiom, and laws are passed in accordance with it.

On this hypothesis, M. Mauguin warned us the day before yesterday, citing statistics, that France carries on a foreign trade in which it has managed to lose, out of good will, without being required to do so, two hundred million francs a year.

“You have lost by your trade, in eleven years, two billion francs. Do you understand what that means?”

Then, applying his infallible rule to the facts, he told us: “In 1847 you sold 605 million francs’ worth of manufactured products, and you bought only 152 millions’ worth. Hence, you gained 450 million.

“You bought 804 millions’ worth of raw materials, and you sold only 114 million; hence, you lost 690 million.”

This is an example of the dauntless naïveté of following an absurd premise to its logical conclusion. M. Mauguin has discovered the secret of making even Messrs. Darblay and Lebeuf laugh at the expense of the balance of trade. It is a great achievement, of which I cannot help being jealous.

Allow me to assess the validity of the rule according to which M. Mauguin and all the protectionists calculate profits and losses. I shall do so by recounting two business transactions which I have had the occasion to engage in.

I was at Bordeaux. I had a cask of wine which was worth 50 francs; I sent it to Liverpool, and the customhouse noted on its records an export of 50 francs. At Liverpool the wine was sold for 70 francs. My representative converted the 70 francs into coal, which was found to be worth 90 francs on the market at Bordeaux. The customhouse hastened to record an import of 90 francs.

Balance of trade, or the excess of imports over exports: 40 francs. These 40 francs, I have always believed, putting my trust in my books, I had gained. But M. Mauguin tells me that I have lost them, and that France has lost them in my person.

And why does M. Mauguin see a loss here? Because he supposes that any excess of imports over exports necessarily implies a balance that must be paid in cash. But where is there in the transaction that I speak of, which follows the pattern of all profitable commercial transactions, any balance to pay? Is it, then, so difficult to understand that a merchant compares the prices current in different markets and decides to trade only when he has the certainty, or at least the probability, of seeing the exported value return to him increased? Hence, what M. Mauguin calls loss should be called profit.

A few days after my transaction I had the simplicity to experience regret; I was sorry I had not waited. In fact, the price of wine fell at Bordeaux and rose at Liverpool; so that if I had not been so hasty, I could have bought at 40 francs and sold at 100 francs. I truly believed that on such a basis my profit would have been greater. But I learn from M. Mauguin that it is the loss that would have been more ruinous.


(italics in original)


bastiat_0Frédéric Bastiat: bane of protectionists and social engineers

Image via Wikimedia Commons


What more can one say? A good businessman of course doesn’t necessarily have to be a good economist. In fact, in most cases that would probably be a drawback rather than an advantage (Bastiat evidently was a rare exception). However, if someone wants to become president, he should perhaps acquaint himself with a few basic principles of economics.

With regard to the policy of devaluation, we always cite the two paragraphs shown below, which were penned by Ludwig von Mises. They represents the most concise and easy to grasp indictment of the debasement policy we have ever seen in print:


“The much talked about advantages which devaluation secures in foreign trade and tourism, are entirely due to the fact that the adjustment of domestic prices and wage rates to the state of affairs created by devaluation requires some time. As long as this adjustment process is not yet completed, exporting is encouraged and importing is discouraged. However, this merely means that in this interval the citizens of the devaluating country are getting less for what they are selling abroad and paying more for what they are buying abroad; concomitantly they must restrict their consumption. This effect may appear as a boon in the opinion of those for whom the balance of trade is the yardstick of a nation’s welfare.

In plain language it is to be described in this way: The British citizen must export more British goods in order to buy that quantity of tea which he received before the devaluation for a smaller quantity of exported British goods.


(emphasis added)


ludwig-von-misesLudwig von Mises: Hi there, sorry to inform you that you can’t get richer by devaluing your currency.

Photo via


So if you like restricting your consumption (i.e., if you like your standard of living to decline), you should root for the devaluation of your own country’s currency and root for currencies elsewhere to strengthen. This is why we will never truly understand the populist appeal of protectionism. It helps only a tiny group of producers to the detriment of everybody else in the economy, and even that tiny group’s advantages are strictly temporary.

In fact, in the long run, advantages gained due to either devaluation or the imposition of tariffs always turn into a competitive disadvantage, because they make businessmen lazy and foster the misdirection of resources that could be much better employed in other sectors than the protected ones.

Someone should perhaps get Mr. Trump a book or two.



If China’s authorities are so eager to support consumers in the US and elsewhere in the world by making Chinese goods cheaper for them, then by all means let them forge ahead! Should he be involved in negotiations with Beijing in the future, Mr. Trump should perhaps choose different topics to discuss.



One more hair joke – because we can.

Cartoon by Steve Kelley


Charts by:, St Louis Federal Reserve Research