The US and China clash over currency valuation.
A big dirty protectionist cloud has been hanging over the global economic revival during the last couple of years, and it has just edged closer and grown darker.
The last thing the global economy needs is a trade spat between the world's two economic superpowers, but it seems increasingly likely that this is what we are going to get.
The yuan and the Yanks
The trigger is the long-running US gripe that China is keeping the yuan artificially low, effectively subsidising Chinese exporters at the expense of US businesses and workers. The yuan is said to be undervalued by between 25% and 40%, which the US plausibly blames for its huge trade deficit with China.
The issue is building up a head of steam in the States, and the US Treasury is considering naming China a "currency manipulator". Its options include slapping tariffs on imports, or filing a complaint against China through the World Trade Organisation.
Now the Chinese are having none of this. In a recent press conference, Premier Wen Jiabao denied the yuan is undervalued and embarked on anti-American rant that would have fit snugly inside the comment pages of The Guardian. He also threatened sanctions against any US firm that gets mixed up in a controversial $6.4 billion weapons contract with Taiwan.
The phrase tit-for-tat springs to mind.
False growth
Fans of the China growth story, such as Anthony Bolton, ignore the fact that the country has backed itself into a corner by creating an economy that needs to keep spraying the world with cut-price goods to meet its annual growth target of 10% every year. It can only sustain that by recycling its trillion-dollar profits into US government bonds, to keep its currency down. This imbalance was partly to blame for the credit crunch, because it soaked the West awash with cheap goods and infinite credit.
I doubt King Canute is a household name in China, but trying to hold back the rising tide of a rising currency by buying billions and trillions of dollars of foreign bonds creates all sorts of unhealthy distortions. How long can the West commit itself to free trade when an economic superpower continues to fiddle market rules to its own advantage?
Face-off
Not that China is entirely to blame. Many US companies have cashed in by using China as a low-cost manufacturing base, although at the expense of near-17% unemployment. And the insanity of the US sub-prime market wasn't China's fault either. China claims the dollar peg is necessary to help it emerge from a financial crisis that it didn't cause.
It has also previously hinted that it might let its currency slowly rise, although that seems less likely now, as it won't want to lose face in its stand-off with the US.
It should also be noted that China's imports are growing almost as fast as its exports. As I wrote last week, China's astonishing 46% leap in exports in February was matched by a 45% increase in imports, as its manufacturers suck in imported components. This isn't simply one-way traffic from east to west.
And with President Barack Obama's star falling as fast as it once soared, China makes a tempting scapegoat.
Beggars can be choosers
So how dangerous is protectionism? Historians traditionally blamed the 1930s depression on the US Smoot Hawley Act, which raised tariffs on selected imports and sparked a self-defeating global trade war death spiral, although revisionist economists now claim the three waves of panic that afflicted the banking system between 1930 and 1933 were the real culprits.
I suspect protectionism could be more dangerous in today's globalised world. Back in 1930, US imports were worth just 5% of GDP. Now they comprise nearly 14%. China could fare even worse. More than 10% of its annual GDP comes from trade with the US alone.
China isn't the only country beggaring its neighbours with a cut-price currency. The US was perfectly happy to see the dollar slide, and the UK is one of the worst offenders, with Bank of England Governor Mervyn King slapping sterling down on the rare occasions when it gets uppity. I bet Portugal, Ireland, and Italy, Greece and Spain wish they could join in the fun.
They must be MAD
If the recovery continues, the spectre of protectionism will most likely fade. At some point, China might even let its currency strengthen a notch or two, although not because the US has told it to.
But if we enter a double dip recession, then panicky governments faced with social unrest at home may be less concerned about creating enemies abroad, and a spiral of trade sanctions and tariffs could follow. That may look like mutually assured destruction, but it is the export-dependent countries that will struggle most, primarily China.
The big question is whether holding trillions of dollars worth of US government securities makes China strong or weak. You can debate that one in the space below.
Right now, a major trade spat between the US and China is the last thing we need. Experts argue whether it will hurt the US or China most, but one thing is certain: it could cause plenty of collateral damage to UK investors.
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