MERCANTILISM is back. More than 200 years ago, Adam Smith exposed the cost of running an economy to increase the power of the State, as France’s Louis XIV and his minister Colbert had done. Living standards suffer and progress can be stifled. Yet the nationalistic approach to trade has never entirely lost its appeal, especially in France. Exports and the accumulation of reserves are widely seen as good, imports as bad. Industry should be harnessed and markets managed “for the good of the people” and nations should have their own industries so that they do not rely on others.

In the 20th century, Russia and China lost the power they believed that the world’s biggest country and its most populous were entitled to, because of economic failure. The collective economic model was pragmatically abandoned.

As Deng Xiaoping explained: it doesn’t matter if a cat is black or white so long as it catches mice. The two bureaucratic empires of the 21st century seem to have adopted an updated version of mercantilism as their instrument of economic power.

Vladimir Putin, Russia’s President, is a market reformer. Yet he has determined that his country’s key industries of oil, gas, gold and mineral developments, should be under the direction of the State. Full ownership is not necessary but central control is.

Internally, the new, more open Russia found that economic power could be a rival for state power. So media barons had to flee the country and Yukos, the country’s biggest and most modern private company, had to be destroyed.

Dismantling Yukos and conducting show trials of its bosses has served a dual purpose. The bureaucracy has re-established state supremacy in the oil and gas industry, Russia’s main export earner. Business barons, the oligarchs, have been told that using economic power to gain political influence will cause them to lose both, and their liberty too.

Mr Putin could afford to put on a friendly face when he tried to reassure the remaining oligarchs last week. Yukos had been the most popular stock for foreign portfolio investors and oil and minerals the key to direct investment by foreign companies. Both have tailed off just when Russia needs them.

The Russian State has, however, re-established great power abroad as well as at home. Most of Western Europe already relies on Russian gas to burn and to convert into electricity. Russia has the biggest gas reserves. Western Europe’s are dwindling. On paper, it would be against Russia’s interests to price up its gas too far, let alone threaten to cut supplies. But that did not stop Opec in the 1970s and the oil cartel can still exert great market power.

For China, there is no oligarch problem. It has maintained rigid political control and has paid out the ropes of market economics at its own pace. By mobilising its 1,300 million people, rather than natural resources, it is rapidly overhauling the Group of Seven top economies, one by one. China’s key instrument of mercantilist power is its exchange rate and the roughly $650 billion (£345 billion) of foreign exchange reserves that its fixed and unrealistically low exchange rate have helped it to accumulate.

Historically, when big new market economies have developed, they have run a trade deficit, offset by inflows of capital. In the wake of Japan, East Asian economies relied on exports and domestic savings to develop, and tried to keep their exchange rates down against the currency of America, their biggest market, to keep the momentum going.

The dollar reserves that Japan and others accumulated did not, until recently, matter much because they had little political power or ambition. Today, however, the dollar flutters nervously on any rumour that they might sell dollars for euro, yen or sterling assets.

China is different. Even after importing vast amounts of capital, equipment, fuel and material, allowing its output to grow 9.5 per cent last year, it ran a $32 billion trade surplus. Its bilateral surplus with America reached $350 billion. But China also had a $61 billion net inflow of foreign direct investment, so it is accumulating reserves at an astonishing pace. In a couple of years, it could overtake Japan as the world’s biggest holder of dollars.

Reserves can be mobilised as a powerful army. In a global financial market, their first function is defence. In the Asian crisis of 1998, Taiwan, which had large gold and currency reserves, did not suffer the devastating blows felt by Korea, which did not. Historically, Britain’s last attempt to assert imperial power, at Suez almost 50 years ago, collapsed when a run on the pound exhausted reserves and America declined to help out.

China has about $100 billion of short-term foreign debt, some of it sneaked in to speculate on a revaluation. So it is covered several times over against any sudden withdrawal of foreign hot money.

Foreign exchange reserves could, however, also be used offensively. Suppose, for instance, that China decided to invade Taiwan. Any attempt by America to resist the invasion could be scuppered by dumping, or threatening to dump, dollar assets on such a scale that falls in bond prices and the dollar could precipitate a collapse in the US financial system. That would not be in the rest of the world’s economic interest any more than China’s, but mercantilism never was.

graham.searjeant@thetimes.co.uk

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