June 29, 2005

#185: Yellow Peril

P. Krugman

KRUGMAN TRUTH SQUAD

The one thing you could say for Paul Krugman over his years as partisan columnist for the NY Times was that he stayed true to his free trade principles – even when the Democrats in Congress were engaging in protectionist demagoguery. Well. No more! With The Chinese Challenge (06/27/25) he's thrown in with the protectionists and we can now expect a steady stream of combined Bush/China bashing right up to the next election. In this column he is twitterpated over the Chinese bid for Unocal, a small but well-connected international energy company.

Here is his quote:

"Unocal sounds…like exactly the kind of company the Chinese government might want to control if it envisions a sort of "great game" in which major economic powers scramble for access to far-flung oil and natural gas reserves.

If it were up to me, I'd block the Chinese bid for Unocal. But it would be a lot easier to take that position if the United States weren't so dependent on China right now, not just to buy our I.O.U.'s, but to help us deal with North Korea now that our military is bogged down in Iraq."

This view is so flawed that it deserves careful parsing. The first point to be made is that oil, like most natural resources, is perfectly fungible, i.e., one barrel of oil is substitutable (with appropriate premiums and discounts for quality) with any other. Thus when President Bush says that drilling in ANWAR will make us less dependent on foreign oil he is just as wrong as his critics who say all Alaskan drilling is of no benefit to the U.S. because most of that oil goes to Japan. The point is that because of fungibility it does not matter who produces the oil or where it is shipped. If the Japanese buy our Alaskan oil, it just means they buy less somewhere else. It's an issue of logistics, not supply.

Think of world crude oil as a large pond. Producers add to the pond and consumers subtract from it. The price rises and falls with the level of the pond. If China does buy Unocal and they find some "far-flung oil" as Krugman fears, that's a good thing. It adds to the pond. If for some peculiar nationalistic reasons the Chinese decide to consume the newly discovered oil directly (not add it to the pond), that's good too. Because of fungibility the pond would still rise since the Chinese would draw less from it.

The bottom line is that Krugman has made a grievous error here. His professional colleagues must be cringing.

He then compounds his illogic by claiming it would difficult to block the Unocal deal because we are in a weak position vis-a-vis the Chinese (they hold our I.O.U.s and, with our military bogged down in Iraq, we need their help with N. Korea). This amounts to a colossal howler. The real direction of dependency is from the Chinese economy to the U.S. consumer. If the latter were to shift away from buying Chinese exports it would have regime threatening implications for the boys in Beijing. Chinese adventurism in foreign policy would have the same result. We suspect the leadership is well aware of their fragility. As to N. Korea, that's primarily a Chinese problem too. This will become apparent for all to see the first time N. Korea tests a nuclear missile and Japan announces the next day they too are going nuclear unless China knocks some heads together in Pyongyang. As to our military being bogged down in Iraq, that's a real laugh. What is Krugman suggesting? That if it weren't we maybe should invade N. Korea? Yellow Peril here we come!

[The Truth Squad is a group of economists who have long marveled at the writings of Paul Krugman. The Squad Reports are synopses of their discussions. ]

Posted by John Weidner at June 29, 2005 6:06 PM
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