In some screeds I've written about free trade, I've deliberately ignored the complicating factor of exchange rate policy, in an effort to give mainstream Economics some benefit of the doubt. I'm willing to assume, for the sake of focusing the argument, that Ricardian concepts hold at some level.
But a scenario occurred to me this morning that made the exchange rate policy all the more significant. It is this. What if, after just about 100% of manufacturing (including pharmaceutical) is offshored, which might make bottom-line economic sense with the current exchange rate, the exchange rate starts to shift? What if, as is pretty well documented and understood, the Chinese have held their exchange rate artificially low, encouraging foreign capital investment, for a long enough time to dry up all remnants of capital investment in the United States? This is complicated by the fact that the US Dollar doesn't necessarily naturally float (although supposedly it does so much more freely than the Chinese Yuan).
But then, the Chinese stop artificially keeping the Yuan low. Prices skyrocket, and US Companies are paying much higher rates for the goods that are manufactured in China. In Ricardian Economics, US Companies should now start investing in capital back at home. But will they? How long will that take? Will instead the US, in order to protect all those companies that are getting screwed by the flux in exchange rate, modify its own exchange rate policy because it is politically popular to the wealthy interests (owners of Chinese capital)?
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