Krugman's 'getting tough on China' policy spells disaster

Updated: 2010-03-20 17:26
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CHICAGO: The assumption of The New York Times' Nobel laureate economist Paul Krugman that the United States benefits China more than vice versa would bring catastrophe on an unimaginable scale, a well-known US economist told Xinhua recently.

Peter Schiff, best known for his prescient predictions of the 2008 economic crisis, criticized Krugman's latest arguments in The New York Times: They were so nonsensical that the award committee should ask for its medal back.

"Recent rhetoric from Washington has put the economic relationship between the US and China squarely on the front burner, and Krugman is demanding that we crank up the flame," Schiff, who is also president of Euro Pacific Capital Inc, said.

Earlier this week, 130 members of Congress sent a letter to Treasury Secretary Timothy Geithner, demanding that the Obama administration designate China a "currency manipulator." Then a bipartisan group of senators introduced a bill that may force the Obama administration's hand.

Schiff, author of the bestseller "Crash Proof" (2007), said the US government will never actually press China into revaluing the yuan with any type of real force.

"It is all a PR stunt so our leaders can be 'tough' with the Chinese," he said. "They know full well where their bread is buttered, and they need the Chinese buying our debt and supplying our citizens with inexpensive products that our unproductive economy cannot produce."

As tensions have escalated between Washington and Beijing this week, many economists are urging Washington to tread lightly because of the negative consequences the United States may suffer if China were to begin selling its enormous cache of US Treasury bonds.

However, Krugman asserted that the United States risked little by playing hardball, and that China had more to lose. A decision to end its purchase of US Treasury debt on the Chinese side would only have a marginal impact on long-term interest rates, he said.

Strongly disagreeing with this view, Schiff considered Krugman's argument "has absolutely nothing to do with reality."

Regarding Krugman's suggestion to have the Fed buy the US debt, Schiff begged to differ. "There is a huge difference between selling your debt to another and 'selling' it to yourself," he said.

"When China buys our debt, it uses its own savings. In order to purchase a trillion dollars of US Treasuries, the Fed would have to expand our money supply by a corresponding amount which will cause the dollar to fall sharply," said Schiff, who served as economic advisor to the 2008 Ron Paul presidential campaign.

Schiff warned that a falling dollar would lead to skyrocketing consumer prices, rapidly rising interest rates, and a collapse in US living standards. This would spell the end for Krugman's "get tough on China" policy, he added.

Schiff believed that this apocalyptic scenario can only be avoided if Washington guards the status quo and doesn't provoke China.

"Yet, even that is an outcome that no one can rationally expect," he said. "Given exploding US government deficits and the inability of US citizens and corporations to repair their balance sheets, the United States faces financing needs that even China's gargantuan savings stockpile will be unable to cover."

The economist noted that if China were to reverse its role in the US treasury market, both economies would be destabilized in the short term. But in the medium and long terms, China would clearly emerge as the winner, he added.

"The opposite would occur in America, where an artificial, consumer-based economy, supported by Chinese lending, will come tumbling down," he said. "Without the ability to import cheap goods from overseas, Americans will pay more and get less."

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While gas and food will become cheaper for the Chinese, they will simultaneously become much more expensive for Americans, he further explained.

As an expert on money, economic theory, and international investing, Schiff suggested Washington recognize the current unsustainable relationship and plan for a more viable future.

"We Americans also must be honest with ourselves and recognize that we have been living beyond our means and that our lifestyle has been largely financed by austerity in China," he said. "We must conceive a plan that weans us from this dependence without provoking China to pull the rug out from under us before we have a firm footing."

As a financial professional for over 20 years, Schiff is one of the few non-biased investment advisors to accurately forecast the US stock market, economy, real estate, the mortgage meltdown, as well as the credit crunch. He has been quoted in leading newspapers, including The Wall Street Journal, The Financial Times and The New York Times. He appears regularly on CNBC, CNN, Fox News, Fox, and Bloomberg TV.