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The United States logged a $26.2 billion trade deficit with China in June. Still refusing to let its currency rise in value against the dollar, China announced a trade surplus of $28.7 billion a month later. This widening of trade imbalances between nations is indeed alarming, and many in the United States believe we should lecture the Chinese about manipulating the international export market but not actually threaten sanctions, lest we start a trade war.

The truth is, lecturing China gets us nowhere. Right now, China’s poli- cies effectively impose high tariffs and provide large export subsidies — that’s how an undervalued cur- rency impacts a nation and its trad- ing partners. This should be a violation of trade rules; it might in fact be a violation, but the law’s language is vague on the subject.

Specifically, an export subsidy is illegal, according to the World Trade Organization. An import tariff is also W.T.O.-illegal. A deliberately undervalued currency, maintained by massive foreign exchange intervention over a period of years, is effectively both an export subsidy and an import tariff.

But leave aside the fine print for a moment. What China is doing by flooding markets worldwide with artificially cheap exports amounts to a seriously predatory trade policy. This sort of move is supposed to be prevented by the threat of sanctions. Yet the Chinese have taken the United States’s measure, and decided that it won’t act. So the United States needs to confront the issue head-on — and if it leads to a trade conflict, bear in mind that in a depressed world economy, countries with trade surpluses have a lot to lose from such a conflict, while countries with deficits might gain. That said, I suppose I should react to an article published in the Financial Times on Aug. 10 maintaining that geography, not the manipulated exchange rate, explains China’s trade surplus.

Yukon Huang, a former country director for the World Bank in China, writes that in 1979, when Deng Xi-aoping, the former Chinese leader, started opening the nation to world trade, “Mr. Krugman began formulating his theories on the ‘new economic geography.’

“These showed how economies of scale and declining transport costs encourage concentration of produc- tion in certain places, and in turn lead to new trade patterns. It is this process that transformed China into the world’s most efficient producer- cum-exporter of manufactured goods,” he writes.

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Yes, the emergence of this pattern has been a major theme of China’s success, and that’s a gratifying vindication of some of my academic work; indeed, I’ve taken to using China as an illustration of “new economic geography” themes. But I don’t understand the logic of the author’s conclusion that this means we shouldn’t pressure China to end its currency manipulation. And, by the way, one thing people don’t sufficiently realize is that China has not been running large surpluses throughout its economic boom. On the contrary, those large surpluses are a relatively recent de- velopment. Just look at the graphic on this page, citing numbers from the International Monetary Fund. To me, this suggests that China’s surpluses — and currency manipu- lation — are not necessary for that growth to continue.

© 2010 The New York Times Company

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Backstory: China Foresees Rapid Assent

In the second quarter of this year, China surpassed Japan to become the second-largest economy in the world after the United States, according to government figures released this month.

However, China's economic growth rate appeared to slow in July following the previous six months of expansion.

This comes as no surprise: the Chinese government has been tightening monetary policy in an attempt to forestall inflation and prevent asset bubbles from forming.

The main indicators of the slowdown are declines in growth within several major sectors of China's economy ‚ including industrial output, retail sales and bank lending ‚ all pointing to an overall drop in domestic consumption.

On the flip side, Chinese exports have remained strong. Along with curtailed domestic spending, this is likely to put even more pressure on China's already strained trade relationships around the world.

As the government invests heavily in foreign currency in an effort to keep the renminbi artificially low, the prices of Chinese exports remain correspondingly low on the international market.

Meanwhile, the profits from this seemingly lucrative arrangement are not necessarily passed on to Chinese workers.

While several labor strikes in the manufacturing sector this summer have led to a rapid increase in workers‚ wages in some coastal cities, various companies are moving their facilities farther inland to lower-wage regions, then raising prices to cover costs in an effort to keep profit margins high.

In July, consumer prices increased 3.3 percent over last year, according to China's National Bureau of Statistics, and could move higher amid further salary spikes and a highly liquid financial system.

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Paul Krugman joined The New York Times in 1999 as a columnist on the Op-Ed page and continues as a professor of economics and international affairs at Princeton University. He was awarded the Nobel in economic science in 2008.

Mr Krugman is the author or editor of 20 books and more than 200 papers in professional journals and edited volumes, including "The Return of Depression Economics" (2008) and "The Conscience of a Liberal" (2007).

© 2010 The New York Times Company

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