I absolutely believe China’s peaceful rise is good for the world, and it’s good for America.

– President Barak Obama

Watching America’s leaders wrestle each other over how to cure the nations budget deficit while the specter of default loomed was all the more frightening when one realized that neither the congressional Republicans nor President Obama and the Senate Democrats have a clue as to how we got into this mess, much less how to get us out of it. They have limited their thinking to the disastrous and false choices of cutting spending or raising taxes. Last week’s frighteningly anemic GDP growth figures show that we are for all intents and purposes still mired in the middle of our longest post war recession. Following either party’s path to debt reduction would be economic suicide and there is an obvious third choice.

The Tea Party spending cuts would have been a great idea eight years ago, back when GW Bush and his old school GOP congress were busy digging our fiscal hole.  We fully agree that no nation finds its way to prosperity by growing its government and that we MUST commit to cut long term spending and limit future entitlements by a much greater amount in the future. However, threatening to cut services the middle of a recession, dumping even questionable federal workers into a crowded job market, and possibly paying these workers extended unemployment benefits for a couple of years was unfortunately flirting with disaster.

On the other side, the President’s best idea seems to be aimed at crushing the spirit of America’s entrepreneurs by burdening the successful few who are still holding our economy up with higher taxes. In 2010, the top 5% of income earners paid more than 60% of America’s income taxes and yet Mr. Obama can simply never pass up an opportunity to suggest that America’s wealthy are “not paying their fair share.” What young American is going to risk everything and work long hours in hopes of being labeled a deadbeat and getting taxed right back into poverty?

What is clear is that none of this would be so bad if we weren’t stuck with 1% GDP growth! Why do our leaders fail to see the much more attractive third option of growing America’s economy and hence revenues while holding both spending and taxes in check? If we want to start making money rather than piling up debt, we must start running this country like it was a business. That is what China is doing and they are cleaning our clock.

Let’s ask ourselves what would a savvy CEO, who actually values all his stakeholders do if he found his firm was unprofitable and his corporate overhead unsustainable? Would he slash investment, fire long-term employees, and punish his best performers? No, he’d refocus expenditures on projects that generate income and he’d grow sales. America must grow its way out of fiscal disaster with the same strategy or face chaos.

The first part of this plan – focusing expenditures for ROI – is easy enough: move spending from entitlements to infrastructure projects, scientific research, and education programs focused on engineering and business. Not surprisingly, this is the simple formula that drove America during her 20^th century heyday and it is exactly the plan that China (and just about every other successful economy) has been following for years.

The second part of the strategy – growing our national sales – seems to elude almost everybody in American politics, because they’ve forgotten how wealth is created. Let’s make it really simple: Dispensing with a lot of impressive economic voodoo, real national income growth – and hence higher standards of living – comes from two sources:

1. Adding value to our domestic resources via innovation and manufacturing.
2. Producing more value in tradable products and services than we consume.

It’s really that simple and before you try to hit me with your dusty old Keynesian or neo-classical econ text please show me the nation that improved its lot by borrowing money to buy foreign goods and fund entitlements.

As to income source A, our returns from innovation are crushed when we do not defend our intellectual property rights from an unscrupulous competitor, namely China; and the main thing preventing us from manufacturing our own innovations at home and selling them to US consumers is that we’ve laid our market bare to the so called “China Price.”

As long as most of our Republican tax rebates go to buy TVs and smart phones made in Shenzhen and our Democratic shovel-ready projects go to buy bridges made in Shanghai, the only economy we are going to stimulate is a Chinese one. Now, there are a lot economists and clever pundits who will obfuscate this very obvious fact with twisted Ricardian puzzles, but ample empirical evidence has rendered the truth painfully clear to anyone with a drop of common sense. In most other sciences, when the model continually fails to describe the reality we observe, we are forced to reject the model and re-evaluate its foundations, not to enshrine it as an unchallengeable gospel.

For income source B the goal is simply to be able to sell abroad what we make at home. Again, the primary thing blocking that is China, with its web of unfair trade practices. We could write an entire book about the many ways China cheats America – actually we did – but just consider this example:

When a firm like General Motors goes to China to make cars for the “enormous” Chinese market the Chinese government forces the US copy into a minority joint partnership with a Chinese – usually state owned – firm. It may say “Buick” on the car and GM on the building but it’s 51% owned and controlled by minions of the Chinese Communist Party. When this factory needs parts, the Chinese government mandates “domestic content” standards that force it to source most of it subcomponents from Chinese firms, cutting the traditional American suppliers out of the running and nurturing a new generation of global competitors.

Further, if the American firm recognizes any profits both, the Chinese government and US tax policy make it difficult to repatriate those profits to the US. Rather, the once proud US firm will find itself pressured into demonstrating that it is a “friend of China” by reinvesting these profits into new R&D centers and factories in China, not Peoria.

In the not to distant future, when GM and its “partner” (read boss) Shanghai Automotive Industry Corporation (上海汽车工业(集团)总公司) export cars to the US they will be subject to about a tiny 2.5% tariff since the US has given China permanent Most Favored Nation (MFN) status. MFN means that we are required to treat products from China’s brutal regime the same as those from civilized nations like Taiwan or Canada. However, since China doesn’t “favor” any foreign barbarian nation, a car made by Americans sold into China gets whacked with a 25% tariff – 10 times as much.

If you haven’t already had enough of that version of “Free Trade” just throw on a 40% price advantage created by China’s blatant currency manipulation, a host of illegal export subsidies and the huge advantage of unenforced environmental, product quality, and labor regulations.

Our trade deficit with China is costing the US nearly $1Billion a day and is close to shaving a full point off our already tepid GDP growth. This deficit is destroying nearly a million new jobs each year, far more (and far better) jobs than even the most optimistic advocates of stimulus spending have claimed to create. Is it any wonder that this former factory for the world is stuck with 10% unemployment and has had to contemplate default? What is amazing is that the word “China” is off the table in almost every discussion of our national economic nightmare. It’s the economic elephant in our national living room, but apparently we’d rather choose between laying-off even more Americans and raising our own taxes before we’d even contemplate threatening the cheating, protectionist thugs in Beijing with a fair tariff.

Peter Navarro is a business professor at the Merage School of Business, UC Irvine. He is a gifted public speaker, a CNBC contributor, and the author of several best selling books on economics and investments,

Greg Autry is the co-author of Death by China. He teaches Macro Economics at the Merage School of Business, UC Irvine. He writes and speaks on China, space, economics, investing, and business strategy.