“When some foreign nation restrains … the importation of some of our manufactures … revenge … naturally dictates retaliation.” Some trade union protectionist? A politician backing restrictions on imports so as to “save jobs for American workers?” Actually, this was written by Adam Smith in Wealth of Nations, the bible of free traders. And once restrictions are installed, “freedom of trade should be restored only by slow gradations” to avoid throwing lots of people out of work.

Smith, of course, saw retaliation as a means of forcing a trading partner to end its own restrictions in a process of bilateral mutual disarmament. Now, battles over trade policies gets played out in the World Trade Organization, and against a background of mounting Sino-U.S. geopolitical rivalry.

After a 17.7 percent jump in its exports in December, China surpassed Germany as the world’s largest exporter. A 15 percent increase in imports from China helped to drive the U.S. trade balance to the unexpectedly high level of $40.2 billion, up from $36.4 billion a month earlier. Both the E.U. (imports from China up 10 percent in December) and the U.S. reacted with import restrictions, the U.S. on tires, the E.U. on shoes. To which China responded by barring imports of U.S. poultry and auto parts, and hiring some of the world’s top trade lawyers to complain to the WTO about the special 16.5 percent anti-dumping tariff the EU has imposed, at Italy’s insistence, on shoe imports from China.

On one level this is all about jobs. Despite an emerging recovery, almost one in every four American workers remains unemployed, working only part time, or too discouraged to continue looking for work. President Obama and Congress are cranking up another stimulus package and a series of tax incentives to encourage small businesses to hire. But the president says more must be done: He wants to double U.S. exports in the next five years to create two million good, new jobs.

Some, but only some, experts think this goal is attainable, among them C. Fred Bergsten, director of the Peterson Institute for International Economics. But only if, among other things, the president can persuade a reluctant Congress to approve the trade deals languishing in its inbox, which to this observer seems highly unlikely, either because the Obama heart just isn’t in it, or because he won’t be able to persuade incumbents that they can afford to antagonize their trade union masters right before the November elections.

Another thing: The president will achieve his goal, says Bergsten, only if the Chinese allow market forces to correct the “undervaluation of at least 25%” in their currency. Fat chance. The Chinese halted even a modest rise in their renminbi when the recession hit. Recession-offsetting exports took precedence over peace on the trade front. And now China’s authorities say that if their imports continue to boom they would contemplate a 3 percent rise in their currency sometime later this year, no more. So much for Treasury Secretary Tim Geithner’s statement to a Senate committee, “I think it’s quite likely they will move” on the currency issue -- unless Geithner, an old China hand, considers 3 percent a significant move.

One thing is certain. China’s continued rapid economic growth, combined with slower growth in the West, will increase pressure on Obama to have China declared a “currency manipulator,” and take the issue to the WTO. But whether Obama responds to that pressure will depend on more than the trade deficit. It will depend on his judgment about our overall relationship with the Chinese regime.

The president feels he needs China, which is why he abased himself before his hosts on his visit to Beijing and allegedly allowed a low-level Chinese bureaucrat to stab his finger at the president of the world’s only superpower in Copenhagen. He still hopes the Chinese will go along with meaningful UN sanctions on Iran, although most observers see this as many see second marriages, the triumph of hope over experience. He needs the Chinese to continue to buy the IOUs he is grinding out to support the spending programs he insists on increasing even as he himself predicts the debt: GDP ratio will approach the 90 percent level that experts say will stifle growth. He still hopes that China ($789 billion), which has surpassed Japan ($769 billion) as our biggest lender (Britain is third at $277 billion), will allow its currency to appreciate by a meaningful amount, even though it should be clear to him that a regime with no democratic legitimacy can avoid threats to its existence only by offering its masses improved material well-being. That means keeping the export machine running at high speed to create jobs.

There is an even greater constraint on the president’s perceived freedom to get tough with the Chinese. Respected historian Arthur Herman (author of histories of the Royal Navy and the Scottish Enlightenment) reports that China might dump dollars even if such a move wipes out billions in the value of their holdings. “On an issue like Taiwan or Japan, rational judegment can take a backseat to national pride, and the desire to reverse old humiliations,” he writes in the New York Post. In a Pentagon simulation of an economic war with China held last March, “China won,” reports Herman. Which may explain why senior Chinese military officers last week took to a state-run weekly magazine to call on China to respond to the U.S. decision to sell arms to Taiwan by “using economic means," such as dumping some U.S. government bonds as part of “a strategic package of counterpunches.” The Washington Times quotes John Tkacik, a former State Department China expert as observing, “The Chinese military now believes that China has tremendous economic and financial leverage, especially over the United States, and they are giving fair warning to the world that they will use it when they can.”

China clearly considers itself to be on a roll. It has so far emerged relatively (only, relatively) unscathed from the recent world recession. One (unnamed) Chinese official told the Financial Times, “We used to see the US as our teacher but now we realize that our teacher keeps making mistakes and we’ve decided to quit the class.” Or as The Economist put it, a “Beijing consensus’ has been gaining ground, extolling the virtues of decisive authoritarianism over shilly-shallying democratic debate.” Market capitalism is so yesterday, state capitalism is so now, new role-model for the developing world in search of material advance. That gives impetus to the Franco-Chinese demand that the dollar be replaced as the world’s reserve currency by a new global currency.

Before consigning the American economy and the market-based capitalist system to the dustbin of history consider this. First, America is once again reforming its system, as it did during Franklin Roosevelt’s New Deal, and is likely to emerge from its current difficulties with a financial system less prone to systemic collapse. Second, a populist wave is rising against borrow-spend-tax, and if it crests during the November elections, a very different congress will convene in 2011. Third, America’s trade deficit and dependence on Chinese credit are now recognized as a national security problem, rather than merely an economic problem. Winston Churchill’s repeated calls for “action this day” on a variety of issues might be too much to ask of this president, not known for rapid decision-making, but action soon on an issue of national security, or at least some day, might be a reasonable goal.

Perhaps most important, poorer countries are also finding it difficult to compete with China’s undervalued currency: Chinese exports to India, Brazil, Mexico, and Indonesia have been growing by between 30 percent and 50 percent in recent months. This gives the U.S. and the E.U. new allies in their trade battles with China.

Best of all, President Obama is stiffening his spine. He told members of his party that he plans “to get much tougher” on currency rates “to make sure our goods are not artificially inflated in price and their [China’s] are artificially deflated in price.” He is going ahead with $6.4 billion in arms sales to Taiwan, plans to welcome a visit from the Dalai Lama next week, and has the State Department siding with Google in its dispute over censorship and cyberattacks. Next might, only might, come a decision to declare that the Chinese are indeed currency manipulators. If this risks a trade war, so be it. Pentagon simulations have been wrong in the past. We do hold an important trump card: We are China’s most important customer.

Irwin M. Stelzer, a contributing editor to The Weekly Standard, is director of -economic policy studies at the Hudson Institute and a columnist for the Sunday Times (London).

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