Mercantilism is indeed the rational response to fractional reserve and/or paper money. You need to quarantine their economy, isolating it from yours until the infection burns itself out. (Listening to dumb peasant policy prescriptions "foreigners bad! myside good!" is dumb.) Mercantilism and its arguments should not be confused with a logical or rational policy strategy. It was merely a kneejerk reaction that happened to be less buggy than average, which is why it appeared not to fail as badly as average.
Inflating currency inflates everything it comes into contact with. Fractional reserve is typically used to back bad loans, meaning every currency which comes into contact with the paper money becomes "financialized" - inflated by counterfeit bills and shackled to interest rates set by the counterfeiting bank.
Optimistically, house prices in American, China, etc. are 40% housing demand and 60% monetary demand. The counterfeit bills try to flee the inflation regime but only manage to "financialize" i.e. infect the housing market. Ulterior bids raise prices and suppress genuine demand via competition. Once they run out of houses in their own country, they will "financialize" the houses in your country too. Unless you make it illegal. And make all intermediary instruments equally illegal. Make drug laws look like ponies and flowers and skipping and flouncing.
Trade has to be handled delicately. If you let them buy your goods for their money so you can buy their goods, they will "financialize" your currency. Even if you have a hard gold standard you have a Cantillon gradient to concern yourself with. You can try tariffs but the tariffs will never move as quickly as the printing press.
Necessarily, interacting with their money at all has to be forbidden. If they want your goods, they need to sell you goods first to acquire your currency, then buy with your currency. I recommend a physical quarantine. Expand the embassy to a whole port, and physically forbid them from leaving the port area. (Functionally, encourage barter.) As your currency skyrockets in value compared to theirs, they will only become more and more desperate to use it as an inflation hedge. You have to continue to want it more than they do.
You don't have to worry about them buying your money for goods. It will cause deflation, which means it will become ever more expensive for them to buy your currency with goods. Self-limiting. Indeed it should help collapse the counterfeit-bank regime due to Goodhart's law. They will offload their ""money"" and try to hoard yours until they have to use your money to trade amongst themselves - driving up the value of your currency even further.
Possibly it's okay to buy their stuff on debt, since they love debt so much.
...yes, the accounting works out. In fact, where possible, all trade with the infected country should be carried out using loans in their money. Instead of paying them directly in your own money, hold your money (like collateral) and take out an equivalent loan, then spend their money. Their interest rates are always lower than inflation. When you pay off the debt, it will always cost less of your money than you originally set aside. Indeed, do it dynamically. As relative deflation hits your coinage, siphon the top off the buffer, since you don't need it anymore.
As always, lies are a vulnerability. They produce exploitable weaknesses. When someone creates a central bank, you ought to ruthlessly exploit it until they learn better. Note that e.g. Amish towns could issue tokens among themselves and execute these trades. You don't need to be a whole country. You can David vs. Goliath this.
"Mercantilism became the dominant school of economic thought in Europe throughout the late Renaissance and the early-modern period (from the 15th to the 18th centuries)." What a coincidence. However, they didn't quarantine hard enough. Instead they started endogenous infections. Everyone gets a "financial" crisis. Ultimately, because Mercantilism came from low cunning instead of conscious strategy, it couldn't protect them from the very hazard that worried them. It merely camouflaged itself and hacked into their zombie brains.
Yet another reason you don't [black government] even once.
In the modern world, everyone is banking centrally, with counterfeit bills. This means you want to North Korea and isolate yourself almost entirely. NK, likely due to the black government thing, doesn't realize they could trade just fine with a few measures that are less draconian than the ones they're already used to. Caino hypocriens is not a rational animal, but it's fine to aspire in that direction.
No, really. Don't let me stop you.
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