It is, of course, a fuzzy question the extent to which a discounted peg is neo-mercantalism, and the extent to which it is just what a country has to do if it is trying to maintain a peg.

That is, if there is a cut-throat, non-cooperative international exchange rate system, then a country whose industrial development requires the stability of pegged exchange rates is forced to a discounted peg. A peg that is neutral "on average" will require as much defense from short-term downward pressure as from short-term upward pressure. And while a country defends a peg against upward pressure using its own currency, which it can create as required, defense against downward pressure requires the use of foreign exchange reserves, which cannot be created as required.

So a nation that needs to peg in the current, non-cooperative exchange rate system, needs to establish a discounted peg.

However, when the peg is arguably in the range of a 30% to 50% discount, such as the Chinese Yuan/Renminbi, there is no doubt that this is beyond the technical demands of a peg that can be defended, and into the range of pursuing a deliberately undervalued currency in an effort to export unemployment to overseas trade partners.

(1) Here in the US, our current combination of policies is pursuing short term profits for large corporations, by going along with the Chinese efforts to export unemployment and using the threat and reality of Chinese competition to squeeze down costs from competitive supplier networks across the board.

(2) The value of US investments in China is not a big issue, since the US has not had a substantial surplus on the capital account in the period since it has been possible to engage in foreign direct investment in China. And even for Japan, which has been in a position to accumulate FDI assets in China, the primary purpose has been to cement relationships with Chinese suppliers, and the benefits of the FDI are gained from the profitability of the operations at the final stages of the supply chain, rather than from repatriating profits from the Chinese operations.

(3) China knows perfectly well what they are doing ... they are doing it, after all, as deliberate policy established after much internal deliberation, study and debate, while in the US the complementary policy has been established on the basis of interest groups introducing enough noise and confusion in the political process that they can get the individual deals or individual loopholes that they require to play their part in the Chinese policy.

So its not a matter of the Chinese "realizing they are getting screwed", but rather the Chinese deciding that the situation has changed, and that their interest no longer lies in an exchange rate that is steeply discounted against the US$. I previously diaried on one scenario for that ... where the Chinese decide that imported inflation for Energy and other commodities is a more serious issue than their competitiveness in the US market, and decide to go for a partial revaluation of the yuan/renminbi.

If that happened, the US$ would drop, the US would gain new non-traditional export markets in various parts of the world ... though probably very little in the neo-mercantalist zone ... there would be some partial recovery at the margins of domestic production that has been under heavy pressure from import competition - though more in terms of things like machine tools and agricultural machinery than in terms of things like textiles ... the US mean standard of living would take a hit, and employment and economic would benefit, so that the median standard of living would either remain fairly stable or quite possibly rise.

The combination of some mild benefit to the majority of Americans and a big hit to the economic power of the US$ earnings of the top 1% would be portrayed in the US media as a massive crisis in US standard of living, and given the tendency of media to focus on mean averages rather than median averages, there would be all sorts of numbers floating around to persuade people that their personal experience of things being not so bad after all were only unusual special circumstances.

(4) It isn't like the median US citizen has decided to go along with the Chinese policy of exporting unemployment to the US ... when given an opportunity to vote against that policy, they do so. However, the example of this year tells the tale of the tape on that fight ... the nominees of the two parties for President this year only differing in terms of how enthusiastically to participate in the export of unemployment from China to the US. So the only votes that can be cast "against" are meaningless protest votes.

(5) All the big transnationals that benefit from a wage squeeze and weak organized labor in the US benefit from this policy. Its a big part of how they were able to accomplish a decade in which all the gains from productivity increases went to profits, instead of being split roughly fifty fifty as in the previous half century.

(6) There is nothing at all strenuous in this for a General Theory based Keynesian economics. Its only the cluster of traditional marginalist economic approaches that struggle to make sense of this, since they start at the outset with models in which the natural thing to happen is for foreign exchange rates to take the future trajectory of various economic paths into account, and therefore have baseline foreign exchange rates and domestic discount rates established at "fair prices" for both lender and borrower.

The fact that there is intrinsic uncertainty might be acknowledged by a traditional marginalist, but with modeling focusing on reactions to forces, there is no formal vocabulary for modeling the impact of true uncertainty in terms of the "universal" unaccounted for downside is always greater than the "universal" unaccounted for upside. The party accumulating net obligations ... the net "long" side ... is intrinsically more exposed to systematic risk from unforseen shocks.

All that is, of course, perfectly straightforward in a General Theory system, so its not like "no economic theory can cope with it", but rather that the economic theory that can cope with it has low social standing within the profession and therefore has relatively few people exploring its implications, bringing it up to date to the evolution of domestic economies and the international order, etc.

I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.