Foreign policy expert and Harvard PhD Thomas Barnett pointed to the "slew of articles declaiming the 'damage' of China's pegged yuan" in his blog yesterday. Is protectionism just around the corner? And what would that mean for investors with money tied up in the Chinese economy?

Barnett is right of course about what the media is saying. National Public Radio wrapped up its summary of the recent Chinese-US trade talks by saying that "Wednesday Republicans and Democrats said they plan to push legislation which would retaliate by imposing tariffs on all Chinese imports." The Agence France Press put it this way: "The Bush administration is under pressure from US lawmakers threatening to push ahead with legislation imposing punitive tariffs on Beijing if the Chinese refuse to allow an appreciation of the yuan." Reuters, Bloomberg, the LA Times, and news sources as diverse as Azerbaijan's Baku Sun and Malaysia's Bernama news service are discussing the possibility of a US-China trade war over the value of the Yean Renminbi.

The common political rationale in America has to do with jobs China has "stolen" from us. But with unemployment at a low 4.5% in April (about the lowest it's been in 35 years or so), Barnett and many others rightfully point out that it's hard to blame what little unemployment America has on China. (The unemployment rate is at 5.5% in the UK at the moment, 6.1% in Canada, 8.7% in France, and 9.5% in Germany.)

If the issue of all our jobs we've lost to China doesn't make you see the problem, politicians begin talking about the huge trade deficit we have with them. We buy more from China than we sell to it, in monetary terms.

John Stossel published an insightful and entertaining article earlier this year about the trade deficit in which he quoted one of my favorite comedians, Pat Buchanan, as saying that the trade deficit is a "malignant tumor in the intestines of the U.S. economy." Stossel disagrees in a convincing manner and says that Adam Smith was right when he wrote, "Nothing, however, can be more absurd than this whole doctrine of the balance of trade."

Traditional economic thought seems to be that there will come a time when foreigners don't want dollars (or assets measured in dollars) because of the trade deficit. The US dollar will then become weak. The US Government will have to raise interest rates to attract foreign investment. The increased interest rates will then push the US economy into recession. (Stossel raises questions about whether that traditional view is accurate.)

What happens when the Yuan is revalued? Chinese products will then cost more in dollar terms. Since the cheapest items in American stores today are made in China, prices would go up. Isn't that called inflation? The usual solution to that is to increase interest rates. And then we get the same recession we would have gotten with the trade deficit problem.

So what's the difference? One difference is that protectionism of that type would hurt investors who have interests in China. Globalization has meant that there are many American companies with interests in China. Protectionism could hurt Microsoft and GM and result in layoffs Seattle and Detroit as well as Shanghai and Chengdu.

Would the end result be a better trade balance for America? Not useless American consumers change their buying habits or American companies start making what their own consumers want here at a price those consumers will pay for it. If the end result is that Americans buy $25 widgets from Vietnam instead of $20 widgets from China (and buy just as many of them), the trade deficit just gets bigger...