China has come up with a clever wheeze. It could save the world and save Chinese face in the bargain.

This is the problem. China won’t let its currency the yuan float freely. Instead it has this devilish policy of shadowing the dollar

US politics say it is this that caused the credit crunch.  They threatened to retaliate with protectionism.

The row is dangerous, it is very dangerous. If the world does descend into protectionism, then it will be like rewinding the clock back to the stone age, only with nuclear weapons – not a nice place to go.

Now the argument over whether China really should let the yuan trade freely is complicated. It is almost certainly not the case that this policy alone caused the credit crunch.  But, it didn’t help.

On the other hand, the US adopted an almost identical policy when it was a developing economy.  It didn’t even recognise foreign copyright until 1891.

But, according to Bloomberg, China has come up with another idea.

The big plan in China is this: Rather than let the yuan appreciate, and see China lose competitiveness, with the dangers of social unrest this entails, it plans to do something quite different.

The idea is that instead, the Chinese state gets wages to move upwards. This will mean Chinese workers will he happy, solving the social unrest problem. They will spend more, pushing up Chinese demand, making the economy less reliant on exports.  Sure, China will lose competitiveness which will mean less exports, but the point is that won’t matter because of the benefits this scheme will bring. Presumably, China will keep pushing wages up until such time that the exchange rate between the US and China is about right, after taking into account local wages and productivity per hour.

So everyone is happy. The US is happy, China is happy and the Chinese are happy. And for that matter, it makes happy economic theory.

It is so simple, why didn’t anyone else think of it?

Oh yes, that’s right, it helps if you have a communist government, and a state that controls everything. The question is, will theory coincide with practice? The whole point about capitalism is that reality is complicated. Central control may seem like a good idea, in practice it rarely is. That is why Hayek penned his book the “Road to Serfdom,” over half a century ago.   The idea that the state can decide what is best may seem seductive, but it is an illusion, and at the very best, ends in serfdom for the masses.