How to Combat an Arrogant China?
Maximize economic growth at home.


Larry Kudlow

Everyone wants cooperation rather than confrontation. Creating trade barriers for Chinese exports would damage American consumers and businesses, each of whom enjoy access to decent quality, low-cost Chinese goods. But if China continues to violate World Trade Organization rules, something has to be done.

On the financial side, the great yuan debate goes on. I have never believed the yuan value should be linked to the U.S.-China trade deficit. Two-way trade is exploding. That’s good for growth. However, Treasury Sectary Tim Geithner’s new angle on the China inflation bubble has merit.

In order to hold down the yuan, China’s foreign-exchange reserves jumped another $200 billion in the fourth quarter of 2010. Those reserves now total $2.85 trillion. With these massive foreign-reserve purchases, China’s money supply is growing by 20 percent. Its inflation rate is rising above 5 percent.

Surely, if the Fed were not printing so many excess dollars — which circulate to China — the Chinese money-supply problem wouldn’t be so great. Nevertheless, holding back the yuan is creating what looks suspiciously like a big asset bubble. When that bubble is finally punctured, it could do great damage to the economies of China, the U.S., and the rest of the world.

Both the Chinese yuan and the U.S. dollar have depreciated substantially relative to gold. That tells me each currency is way undervalued because money is too loose in both countries. As Prof. Robert Mundell has counseled, U.S.-China currency stability is greatly to be desired. However, that desire can only be accommodated with a high degree of currency- and monetary-policy cooperation — of a sort that is nowhere on the radar screen. Why not look to a gold reference point for both currencies?

At the end of the day, the best thing the U.S. can do to protect its own interests with respect to China is to adopt Ronald Reagan’s strategy toward the Soviet Union. The Gipper knew that maximum security abroad requires maximum economic growth at home. That’s why the new Republican Congress, hopefully doing business with a more centrist Obama, must follow through on its pledge to reduce spending, lower the corporate tax rate, and roll back unnecessary regulations.

China has gotten cocky because it is growing at 10 percent while our unemployment rate is close to 10 percent. But greater economic strength at home will give the U.S. more leverage to deal with China on all fronts.

This was Reagan’s great lesson.

– Larry Kudlow, NRO’s Economics Editor, is host of CNBC’s The Kudlow Report and author of the daily web blog, Kudlow’s Money Politic$.