James Dorn is one of a long list of Westerners who keeps telling the Asian economies to do what is convenient for Westerners. The record on this is a mixed bag, the East Asian economic zone countries have sometimes done what is convenient for Europe and the US, but often does not. We don't live in an age of rising internationalism, but rising economic nationalism. The very forces which have played out inside the US after the end of the Cold War, are now playing out in the world at large.

And that doesn't bode well for the trade regime that has been constructed over the course of the last 20 years.

Let's start with the name of the game that is being played in this article: International Open Market Macroëconomics. It is somewhat the reverse of that other favorite game of foreign policy specialists, global thermonuclear war - the only way to win, is to play whole heartedly.

The board - for those of you who are old enough to remember rainy days in the sitting room when board games were a good way to pass the time and sharpen intellectual skills - is a triangle and on the triangle there are three points: currency stability, free capital movement, and effective policy - most importantly, effective monetary policy. The rules of the game are complex, but the simplified version runs this way - the closer you move towards two of the poles, the farther you have to move from the third.

All global macroëconomic policy proposals are against this backdrop - read the author or policy in question and ask "which two sides of the triangle does this move towards? And what is the cost of moving away from the third?"

James Dorn would like there to be free capital movement, and he would like low inflation. Low inflation means effective monetary policy, or it means some exogenous monetary standard - such as "the gold standard". However, since the gold standard also means no effective monetary policy - basically if you have a gold standard, the central bank does nothing else with its time, because it creates a fixed exchange rate with other gold standard countries - he has to favor effective monetary policy.

This means he has to sacrifice, or advise against, currency stability.

All well and good, but this is completely unrealistic - the problem is not the one he mentions:

The problem is to get China to adopt liberal economic principles when its political regime is illiberal. For the US to threaten China with protectionist measures for failing to adopt liberal principles is counter- productive. Carrying out that threat would make both China and the US less liberal.

First I'd like to point out the straight up economic theory error here:

For the US to threaten China with protectionist measures for failing to adopt liberal principles is counter- productive. Carrying out that threat would make both China and the US less liberal.

Saying that making a threat is counter-productive because carrying it out would leave both parties worse off is simply wrong. Wrong. Wrong. Wrong. No marks.

A threat which, if carried out would leave both players worse off is effective if it is a dominant strategy. That is, if the relative position of the player carrying out the threat is better regardless of whether the threat is carried out or not. According to Dorn, it is never a good idea to threaten a rook with a knight, if you would lose the knight taking the rook. As countless chess championships show, it is almost always a good idea to threaten a rook with a knight, even if it means the loss of the knight to carry out the threat, because a rook is more valuable than the knight. An American threat of protectionism is effective - and in fact was effective earlier this year - so long as China knows that it will be worse off for it, and the Americans can take the temporary hit that the protectionism causes.

Second, the first part of the assertion is also wrong:

The problem is to get China to adopt liberal economic principles when its political regime is illiberal.

Plenty of illiberal regimes are willing to adopt relatively liberal policies. South Korea under the dictatorships and Taiwan under the one party rule of the KMT were both willing to liberalize economically. In fact, liberalizing economically, while remaining repressive politically is a fairly common combination. The American antebellum south was a one party zone, the Democratic Party, and it was in favor of trade liberalization, hard money and unrestrained property rights. They were, in fact, exhuberantly pro-property, particularly with regardes to their "peculiar institution". In short Dorn's assertion about illiberal regimes is also wrong. Wrong. Wrong. Wrong. Flat out, incorrect, no marks.

Now either Dorn is an imbecilic hack, and the Financial Times is in the business of publishing imbecilic hacks - which there is certainly circumstantial evidence of - or Dorn has another motive and this is the cover for it - or he subscribes to a confused ideology that has very odd meanings for the word liberal. Now the last could be true, there are plenty of venting maniac libertarians on the internet that classify the Confederate South as more "liberal" than America at present. Perhaps Dorn is one of these people with better diction and a better suit.

But I would prefer to believe that Dorn has an ulterior movtive, that his words make sense, but only if one looks at them as being from the point of view of a very narrow class of people. That is, he isn't interested in economic rights generally, but in the economic rights of a narrow class of people - not coincidentally, the narrow class of people that would benefit from his policy perscription versus what is happening now.

Let's frame this fight then on the board game of International Open Market Macroëconomics.

The Chinese are pursuing a strategy which has a fixed exchange rate between China and the US, some freedom of capital movement - assymetrically in - and has sacrificed most of the effectiveness of their monetary policy as a result. China has wanted to slow its domestic economy for some time, and has had no success. Simply put, restraining bank credit through the central bank does no good, when there is plenty of foreign investment flowing in. Those who can't get bank loans, go to the international markets. This isn't entirely a bad thing, since the international markets are generally better at picking good projects than chinese banks are.

This strategy has a name: neo-mercantilism. It is mercantilism because it views allowing foreign exchange to flow in as the ultimate objective of economic policy and law. It is neo- because it is not funding colonial expansion with this flow of money, nor military conquest - but instead capital development. It is, Dorn gets half right - an illiberal strategy. But that doesn't mean that the regime itself is illiberal. The Republican Party from its inception until the first decade of the new century was a protectionist party. Lincoln, Grant, Harrison, McKinley all believed in tariffs. It was a Republican appointed supreme court that struck down the income tax - which was an essential part of not funding the government through tariffs. Wilson was the Free Trader. The Republican Party remained the party of protectionism through the 1920's, only to have the Democratic Party join in. It was Republicans who raised tariffs with the 1922 Fordney-McCumber Act, and it was Hoover who ran in 1928 on protectionism for agricultural goods. This was, at the same time, that the Republican Party was also the party of liberalization of the vote, of primary elections, and of progressive reforms such as the ballot initiative. Once again - political liberalism and economic liberalization don't always go hand in hand. In fact quite often they do not, as elites which have a cash crop or resource to export, and the desire to import luxury goods are all in favor of free trade - and also all in favor of rigged elections and local oligarchy.

Neo-mercantilism generally fails as a strategy unless the country in question has something to export that other, generally more liberalized countries, want very, very, very badly. The answer in China's case is simple: disinflationary profit. The US and Europe need this very badly, for reasons that make a hash of Dorn's policy percription.

Why are other nations generally allowing China to flout the liberalizing trade regime? Because of their pension problem. Unlike fiat currencies, the currencies of the major Western nations have a bind that prevents them from using the inflation tax. The inflation tax is when a monetary authority - in modern times a central bank, or an elected government with the complicity of a central bank - prints more money, on the reasoning that since it is a net debtor, reducing the value of debts is good. In otherwords, the monetary authority gets to spend the money, and reduces, rather than increases, the difficulty of paying off its own debts. If a government can do this, it can tax holders of currency by inflation.

However, Western governments don't have this option, because they have large pension and medical obligations. As they found out in the 1970's allowing inflation to run out of control might help their nominal budge balance, but it dramatically increases future liabilities. Even those these liabilities are not formally carried on their budget sheets - though there is a proposal to do just that in the US - they are indexed to inflation. Inflate the dollar, and social security payments go up - juggle inflation, and the old people receiving the debased social security payments vote your government out.

Because Western governments - who if they had fiat currencies would simply print the money and inflate their debts down to some more manageable size - can't do this, they have to go the other direction - lower prices and wages, to make it so that their obligations going forward are lower, and to keep their COLA problem under control.

One option, the unpalatable one, is to constrict money supply down to the level of non-inflationary growth. This would require higher interest rates than we have, and would Japanify the United States rather rapidly.

Enter China and the other East Asian economies. By offering lower priced production, they offer a way to keep the inflation rate down, even as the money supply stays up. However, this comes at a price - they aren't going to open their internal markets, and there is very little that the West can do - the consequences of not offshoring are large, and enforced by strategy - those companies that don't do it lose to the companies that do. Ask anyone who competes with Wal-Mart.

Now let's look at why Dorn's advise is Dead On Arrival. To really open up capital flows in China, Russia and other neo-mercantilist nations, they would have to allow their consumers to buy goods, and they would, more importantly to Dorn and the people who pay his salary - have to allow Western companies to buy up assets at very low prices, before there is enough domestic capitalization to push prices up. This process, thatcherization, is what happens to countries that don't have something really valuable to sell - they have to sell everything, including the water under the ground - to get foreign exchange. Often just to pay the debt service on previous rounds of financing. The end game of thatcherization then, is when a government has to more or less give up any semblence of sovereignty in order to keep access to the outside world.

China knows this, and Russia got a good solid taste of in in the 1990's. The regimes there aren't intrinsically opposed to liberalization of trade, but they are opposed to having foreign elites buy things at fire sale prices - "big bang" and "shock therapy" being the approved terms in international economic circles. Thus they are going to open capital markets only as they can float sectors of their economy. Now that China thinks it can defend the Yuan, it is willing to slowly float the Yuan. As China thinks its banking sector is expensive enough to keep control over and still get foreign buyers, it will open that. Steps are being taken to put more companies on international markets, and as they become expensive enough, they too will be offered.

Hence having Dorn say that the problem is that "China is an illiberal regime" is completely incorrect. Instead the reality, one that Dorn would admit if pressed I am guessing, is that the US has no strategy which will force China to open its markets to consumer goods and to foreign ownership of key assets fast enough. This isn't a problem of ideology, it is a problem of nationalism.

In short if we want the Chinese to open their markets, then the west needs to kick its disflationary habit - it needs to find ways of reducing the cost of production, increasing productivity and reducing inflationary pressures - without drawing down savings and without simply engaging in labor arbitrage. Changing China's illiberal strategy will come, not from changing the regime in Beijing, but in Washington DC, London, Paris, Berlin and so on.

- - -

And that gets me to the bigger picture that I alluded to at the top of the article.

In the post-war environment, there were several strong spurs to internationalism, however imperfect that internationalism would become. Churchill - almost ever the visionary - once he had realized that England would not be a colonial or imperial power any more - spoke of it in his famed "Iron Curtain" speech. It was the motivation behind making the UN effective, and behind a series of international institutions such as the IMF, WorldBank, the Bretton Woods Agreement, the Global Agreement on Tariffs and Trade, NATO and so on.

The first of these was the creation of a bi-polar world. Free nations had to coöperate in a variety of ways in order to survive the pressure from totalitarianism of the left, as they had to coöperate in a military alliance against totalitarianism of the right. Second the break up of the colonial and imperial system produced a host of new nations. This required new mechanisms to deal with new regimes.

As noted, this internationalism was often honoured in the breech - one would take a fairly thick book to catalog the interventions, invasions, violations of "international law" and so on of the major powers. However, it was a large step towards internationalism against the protectionism, outright colonialism and imperialism of the previous age. And once established, internationalism has a logic of its own - for one thing, unilateralism leads to failures in war. Ask any history of Vietnam, or in a few years, the historians of Iraq that will have emerged.

These dual pressures - the rise of a totalitarian bloc and the break up of old empires - kept internationalism moving forward. Forward far more slowly than many of us would have liked, forward far more slowly that was compatible with basic human decency in many cases, but moving forward none the less.

With the collapse of the Soviet Union, there was a paradoxical resurgence of internationalism. This is because while the totalitarian factor of internationalism was much reduced, the break up of empire problem was increased. Suddenly there were numerous baby states and collapsing buffer zones to deal with. However, as this problem retreats, and the spectre of totalitarianism ends, the very force that pushed internationalism dies away.

We've already seen this in the United States, the great era of bi-partisanship was created by a string of crisis moments and external pressures. It was New Gingrich's realization that without these outside pressures, bi-partisanship could be dispensed with, and the road was open to virtually unlimited viciousness in politics. This same realization is working its way into international affairs - headed by one George W. Bush, whose adoption of the neo-conservative position that the US was, essentially, the world's most powerful self-interested state - could invade Iraq even without international approval.

China, having come in from the cold, realizes most particularly that it does not need to sacrifice its interests for any international order, beyond one that keeps oil flowing and factories going up. They benefit greatly from the US consumer spending down savings, but they have no reason to open their consumer markets in return. There is no ultimate threat.

One group of people this works against are those who want to end "international imbalances" - so what if the currency order has a disequilibrium? The world has survived the collapse of major and minor currencies, and while it might create some degree of economic uncertainty and require bail outs, it does not create a weakness that an aggressive power will exploit. In short, so what? Even if the dollar were to collapse, it might burn those people who have banked wealth in dollars, but it does not endanger the liberty of nations.

The other group of people that it burns, however, are the people like Dorn who want the benefits of internationalism, without having the reasons for internationalism in place. The Chinese in particular have no reason to sell their country's assets in return for temporary convenience of elites from outside the country. They are happy to buy assets of other countries, and they are very happy to thatcherize other countries, but opening their own country to the same flood of capital that less advantage countries have seen, is not required.

In essential terms, the only tax the Chinese worry about is a currency meltdown, since this would hinder their access to resources they need and capital they need. Which means they have no reason in the world not to continue their neo-mercantilist policies, even though they know, from time to time, they will have to allow particular deals when those deals are backed with threats of tariffs. This they can manage, because the number of deals with enough pull to rent a few Senators is not large compared to the total demand to get into China,

- - -

And that brings me to my closing point. You might think I am hostile to trade liberalization. On the contrary, I am very much in favor of it. However, Dorn is an unreliable ally. He can be counted on to push liberalization for his friends, but he, and the rest of the Cato Institute, when push comes to shove, can be counted on to side with the theocratic right almost every time, and spew a variety of stupidity on say, the minimum wage and decreasing the returns on rent and protected industries. Dorn is a plutocrat, and while it is in some cases in his favor to want liberalization, like a southern slave holder, beyond that narrow interest, he is actively hostile to liberalization for other people. Dorn hates protectionism, except when it is protectionism that profits the interests that pay his salary.

As a result, libertarians can be trusted to betray the moment they get a whiff of a tax cut for the ultra-rich, or a chance to change contracts in mid-stream in their favor. Allies like this are not worth having. In the end the society that Dorn wants, and the society that say Dobson of Focus on the Family wants, differ only in that there are exemptions from the noxious social rules for elites. The Mark Foleys of this world don't have to obey the rules, and as long as that is the case, Dorn will go along. The Institute of global warming denial will look to the party of Darwin denial for its friends - anti-science zealots are birds of a feather.

The crowning irony is how the Cato Institute has come to be against the war in Iraq, after having spent the 2000 campaign shilling for George Bush. They are shocked and appalled that the idea of an irresponsible fiscal policy comes attacked to the idea of an irresponsible foreign policy. Shocked I tell you. Shocked.

The reality is that Dorn is part of a rhetorical and political coalition that has been willing to shaft most of the American public for a generation on wages, bargaining power at work and a variety of other issues. They've managed to get and hold power by bringing on board a large slice of the American public that is willing to live less well, so long as they have a small chance of getting rich, and in the mean time can bash gays, hate black people and Mexicans, and strut around after invading Iraq. Lie down the the dogs, get up with the fleas Mr. Dorn. They made a host of assertions back in the 1970's and 1980's about wages, budget deficits and growth - they've all turned out to be wrong, and yet they shamelessly chug along telling people to keep doing what has not worked so well for the last generation. This is not the kind of thinking that bodes well for any kind of reality based political coalition with them as part of it.

Even among liberalizers of the left there is a growing realization that the liberalizers of the right are unreliable, and willing to spread their cheeks the moment some theocrat comes bouncing through with a tax cut. As haters of government, and as believers in a top down system where the people on the bottom are debt slaves to the people at the top, their natural allies are other haters of government and believers in top down societies. And thus, sooner rather than later, they can be counted on to go back to that natural alliance.

I realize that Dorn doesn't care. He's well paid to be an idiot and make obvious screaming errors in his columns. However, perhaps some of the people growing up now will care, perhaps they will realize that a world that is poorer, nastier and more divided is one that, ultimately, doesn't favor their interests. And that being young, they are going to see a great deal more of ultimately than old people who are already rich are going to see. Perhaps they will also care that history is turning against them - that the very creation of national super-rich elites which Dorn rode to personal prosperity is going to create more and more national elites that are hostile to them, and that as the period where the west's technological advantage wanes goes on, those elites are more and more often going to take actions which are detrimental to the elites in Europe and the US.

Of course, I am probably being excessively hopeful. Last time around it took a great depression and the rise of Hilter to convince moneyed elites in Europe and the US that their fate is bound up in the fate of the culture that produced them. The time before that it took the American and French Revolutions. But be that as it may, let me get back to the more immediate point. We are going to have to live with a neo-mercantilist China for a long time, as they work to keep their favored national elites in control of the country, and not have it thatcherized. That means prattling about having them open their markets is just that - idle chatter promoted for the benefit of those people who hope that Chinese consumers can be convinced to spend their savings as profligately as westerners have. It won't happen and they won't be allowed to even if they wanted it to happen. Even if it did, the next result would be a revolution in China, as the hundreds of millions of have nots realize that they hate the haves even more.

Like it or not, this is a generational problem, and will not be solved by simply forcing the door, or wheedling it to be opened.