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By Philippe Legrain 1 COMMENT

In his blog post, Dealing with Chermany, Paul Krugman advocates threatening China (and, indirectly, Germany) with an anti-dumping duty to get them to boost domestic demand.

China has done nothing to change its policy of massive currency manipulation...  Europe is going wild for fiscal austerity… everyone is counting on the US to become the consumer of last resort, sucking in imports thanks to a weak euro and a manipulated renminbi. Oh, and while they rely on US demand to make up for their own contractionary policies, they’ll lecture us on how irresponsible we’re being, running those budget and current account deficits.

This is not going to work — and the United States has to take steps to protect itself….

Nicely, nicely isn’t working. Time to get tough.

Yet his proposal would make matters far worse. This is my reply:

You are forever warning politicians to avoid the mistakes of the 1930s in macroeconomic policy and yet in the same breath you advocate that America should threaten Europe and China with protectionism. This risks far more than a “diplomatic tiff”: it could easily cause a tit-for-tat cycle of protectionism akin to that which caused global trade to collapse during the Depression years. Have you taken leave of your senses?

In the case of Europe, the notion that it is going “wild for fiscal austerity” because it is counting on American demand to save the day is blinkered and self-centred. Most European governments are being forced into austerity by the threat that markets will stop funding their deficits. The euro’s fall is hardly under their control either. America might be in a similar position were it not for the privileged – and deflationary – role of the US dollar in the international monetary system. Count your blessings that there isn’t a run on US Treasuries when America’s deficit and debt are higher than most EU countries’.

The main reason why the pattern of supply and demand in the global economy is so distorted is because of America’s unprecedented housing and financial bubble. You are right that now that the bubble has burst, surplus countries ought to do more to boost demand. But threatening protectionism is hardly the answer. And America should put its own house in order before lashing out at foreigners. The Fed’s monetary policy would be more effective if the banking system’s balance sheet had been cleaned up. Fiscal policy would be more effective if it was directed at investment in future growth – improving America’s crumbling infrastructure, for instance – and supporting the incomes of the poor, who by necessity are spenders rather than savers. It seems instead as if Ben Bernanke is intent on doing a Greenspan: inflating another bubble to rescue America from the previous bust. Don’t blame the rest of the world for that.

Posted 11 Jun 2010 in Aftershock, Blog, Global Economy

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