A Stronger Yuan May Not Help US Workers or the Economy.

Let me get right to the point: A stronger Yuan won't help the US economy and its workers. In fact, it may actually have a disproportionately negative effect on those who are unemployed, underemployed or on the lower scale of incomes.

The US is sqandering precious political capital by pressuring China to strengthen the value of the yuan in order to reduce US imports and help restore output and jobs to the US.

While a weaker currency does make goods produced in China more competitive on the world market, US leaders are mistaken about the effects of this on the US economy and workers.

The weak yuan is diverting jobs and output from Mexico, Thailand and even Japan, not from the U.S. The top 20 products imported into the US from China are in industries that account for less than 5 percent of US gross domestic product. The emerging countries of the world, such as Mexico and Thailand, are China's true competitors on these largely commodity-type products.

The US has high wages associated with the world's highest productivity rates, and so does not have a competitive advantage in the majority of the products imported from China.

The US does produce other goods -- and, notably, services -- that are both competitive and in demand in China. If the US is serious about stimulating sustainable growth in US production and employment, it should implement policies that encourage investment in these high-value-added products and services, rather than attempting to stimulate production of goods that represent America's past. If the US wants China's assistance in reducing the trade deficit, it should pressure Chinese leaders to allow their workers to become consumers, which would lead to increased exports of these US-produced goods and services.

The table above lists the top 20 categories of products that the US imports from China. These account for 75 percent of US imports from China, but less than 5 percent of US GDP. The top three Chinese import categories combined -- computers and peripherals, communications devices, and apparel -- constitute nearly 31 percent of total US imports from China but less than 1 percent of US GDP. Put in plain English: One third of the US imports from China amount to 1 percent of our total production -- little wonder that the Chinese feel unfairly targeted. And don't take my word for it -- the numbers come from the US Department of Commerce and the US Bureau of Economic Analysis. We are literally fighting over pennies on the dollar. The Chinese and the rest of the world know this. That's why we aren't getting any international support on this issue. It's also why other developed nations are focusing on increasing their exports to China, concentrating particularly on the higher-value-added components of the equation.

The 2004 Economic Report of the President made the point that rising Chinese imports were taking markets from Mexico and other developing nations rather than US producers. The reverse is equally true -- foregone imports from China will be replaced by imports from Mexico, Thailand and even Japan, where they are produced more cheaply than in the US, but at a higher cost to the American consumer. This will have the same effect as a regressive tax.

A stronger yuan will not have a meaningful effect on US production because of the disparity between the products imported from China and the capacity to produce those same products in the US. In fact, the trade deficit might worsen if the yuan's appreciation increases the prices of these imports, and would be exacerbated if they came from even higher cost producers, because in the end, they would still be imported!

Additionally, the low level of US production of these goods is not a result of the rising level of imports from China. The majority of the categories in the table have been in structural decline since before the US trade deficit with China surged. The US industry that has experienced the most significant reduction in size relative to the overall economy over the last decade is motor vehicles, an industry in which the Chinese do not yet compete globally.

Trade benefits all parties involved so long as trade patterns are determined by comparative advantage, meaning each country exports products in which it is competitive due to a greater availability of resources or productivity compared to cost.

The US has an advantage in producing capital equipment, robotics, audio and video content, sophisticated services such as insurance, banking, and real estate, and large-scale agricultural products. Accordingly, these industries command large shares of the US economy, led by professional and business services at 12 percent, real estate services at 13 percent, financial and insurance services at 8 percent and health care at 7 percent.

The US $132 billion annual trade surplus on services and $121 billion surplus on income earned abroad are often overlooked in trade discussions, taking a back seat to the $500 billion deficit on goods.

Instead of pressuring China to help move the US economy back to producing products for which it long ago lost its comparative advantage, the US should be working to expand the buying power of Chinese workers who now save close to 40 percent of their income. This, combined with an opening of their financial and other service markets to US providers, would be the best way to reduce the US-China trade imbalance.

Europe And Austerity Don't Mix

Europe has bought itself time with its E 750 billion bail-out for the euro. But the long-term problem remains.

Most of the European Union is living beyond its means. Government deficits are out of control and public-sector debt is rising. If European governments do not use their new breathing space to control spending, financial markets will get dangerously restless again. Unfortunately, European voters and politicians are simply unprepared for the age of austerity that lies ahead.

I used to think Europe had got it right. Let the US be a military superpower; let China be an economic superpower -- Europe would be the lifestyle superpower. The days when European empires dominated the globe had gone. But that was just fine. Europe could still be the place with the most beautiful cities, the best food and wine, the richest cultural history, the longest holidays, the best football and cricket teams. Life for most ordinary Europeans has never been more comfortable.

It was a great strategy. But there was one big flaw in it. Europe cannot afford its comfortable retirement.

Greece's financial crisis is, unfortunately, an extreme example of a broader European problem. Investors have been looking nervously at debt-levels and budget deficits in Spain, Portugal and Ireland for months. But even Europe's big four -- Britain, France, Italy and Germany -- are hardly immune from concern. Italy's public debt is about 115 per cent of gross domestic product. some 20 per cent of this needs to be rolled over during the course of 2010. Britain is currently running a budget-deficit of nearly 12 per cent of GDP, one of the largest in Europe. George Osborne, who is likely to end up as chancellor of the exchequer in the new government, has described Britain's official economic forecasts as a "work of fiction". The French government has not produced a balanced budget for more than 30 years. And one of the reasons for the deep bitterness in Germany at bailing out Greece, is the knowledge that Germany is already struggling to balance its own books.

It is true that the citizens of Latvia and Ireland have already swallowed actual cuts in wages and pensions. But these are both countries that have experienced real poverty in living memory, followed by massive and unsustainable booms. They know that the last few years have been a bit unreal.

As the riots on the streets of Athens illustrate, however, not all Europeans will react so stoically to deep cuts in spending. Many have come to regard early retirement, free public healthcare and generous unemployment benefits, as fundamental rights. They stopped asking, a long time ago, how these things were paid for. it is this sense of entitlement that makes reform so very difficult. As the British election has just amply illustrated, politicians are extremely reluctant to confront voters with the harsh choices that need to be made.

Yet if Europeans do not accept austerity now, they will eventually be faced with something far more shocking -- soverign debt-defaults and collapsing banks. For many Europeans that is the kind of thing that only happens in Latin America. The discovery that Latin Europe -- and maybe northern Europe, too -- can also hit the financial wall will come as a horrible shock.

The growth in the size and power of the EU has fed a dangerous sense of complacency. for the countries of southern and central Europe -- who joinced later than the inner core -- "Brussels" was sold as the ultimate insurance policy. Once they were inside the EU, it was felt that war, dictatorship and poverty were safely consigned to the past. Everybody could aspire to the relatively comfortable, stable lives of the French and the Germans. For many years, it worked beautifully -- as living standards shot up in countries such as Spain, Greece and Poland.

In recent years, European unity has also been marketed as an insurance policy for the founder members of the Union. Both President Sarkozy of France and Angela Merkel, the German chancellor, speak of a Europe that "protects". The idea was that a Union that spanned 27 nations was large enough to protect a unique European social model from the uncertainties of globalisation.

At the most fundamental level, the EU does indeed protect. But while Europeans no longer fear foreign armies, they are starting to fear foreign bondholders. Europe's existence as a "lifestyle superpower" has depended on an ample supply of credit.

This weekend's bail-out essentially extends one last, massive credit-line to those European governments that might need it. But, for all the talk of pan-European solidarity, once cost of this credit-line will be a sharp increase in political tensions with the EU. There is already much bitter talk in Greece about the loss of national sovereignty; matched only by bitter talk in Germany about the costs of bailing out feckless southern Europeans. This crisis has set two peoples against each other as close as it comes to war in modern Europe.

Let us hope so.

But Europeans are discovering that the "European project" provides no protection against the harshness of the outside world. Things can still go badly wrong -- even within the walled garden of the European Union.