I advocate free bilateral trade among all nations, with no tariffs imposed to hinder trade anywhere. The U.S. has been the leader in establishing free trade, but worldwide there are many barriers here and there. I recognize two caveats: 1. The U.S. may have strategic need to restrict trade for national security reasons, and 2. Should a group in the U.S. be hurt because its product or services can be supplied from elsewhere more cheaply, I believe our government has a responsibility to give help to the injured group.
Warren Buffett has been critical in the past over our negative trade balance and has said that trade deficits are like selling off pieces of the farm to increase present income. Laffer, who I asked in person about this, says,”don’t worry about it.”
My first question to Laffer was about free-trade, to which he responded, “If China buys a piece of the U.S., it just makes it improbable that they would want to bomb us.” Most of what follows then comes from his book.
Free trade has dominated U.S. policy since 1934, when tariffs were 20% as percent of all imports.Since then, this number has declined to 1.5%, and trade in the United States has never been freer. Furthermore, trade as a percent of the U.S. economy over the same time span has increased from about 5% to about 20%. This is spectacular. A faster growing country will have increased imports and reduced exports; i.e., a trade deficit. To the supply-side economist, this is a surefire sign that the economy is healthy. If the U.S. were raising taxes, and the rest of the world was lowering them, it’s obvious that capital would flow from the U.S. to the rest of the world. But the opposite is going on. Trade deficits go hand-in-hand with capital surpluses.
Laffer’sbook goes into the Ricardian Epiphany (David Ricardian, English economist, late 19thcentury). He developed a theory of comparative advantage. (I paraphrase from Laffer’s book). The U.S. will tend to import goods and services that are more cheaply produced elsewhere, and will tend to export goods and services that are more inexpensively produced here. Further, each country pays for its imports with the proceeds it receives from its exports. In static terms, the exchange rate is referred to as the equilibrium exchange rate. But, if the dollar depreciates against the euro, then all U.S. goods become more competitive, and the U.S. will export more of these goods to Euroland, and will import less goods and services than it imports from Euroland. That is, the now-devalued dollar/euro exchange rate and the U.S. trade accounts will go from a perfect zero, where dollar exports exactly equaled dollar imports to a position of U.S. trade surplus. This is where dollar exports exceed dollar imports at the new lowered-value dollar exchange rate. The cheaper the dollar as measured in euros, the greater will be the U.S. trade surplus. The opposite then is the trade deficit. Laffer admits he’s taken considerable liberties in offering this explanation, but it is a useful tool in understanding. What evolves from this is the interesting point that the further the exchange rate moves away from the equilibrium rate, either above or below, the more difficult it becomes to move it further away. It’s almost like the exchange rate is attached to the equilibrium rate by an elastic band. There are natural upper and lower limits on just how far exchange rates can move when each region’s price levels are set by domestic monetary policy. Another modification of the Ricardian analysis is how fast the exchange rate changes. Putting all this together, Laffer has made a chart plotting the inflation-adjusted exchange rate between the U.S. dollar and a composite of all foreign currencies going back to the 1970s. His chart, The Trade Deficit as a % of GDP vs. Value of the Dollar, shows close correlation of the two lines from 1970 up to the year 2000, when things diverge. The conclusion I take the liberty to jump to is that the freer country (lower tax rate, reduced inflation, reduced unnecessary regulations, reduced trade barriers) will have a trade deficit corresponding to its capital surplus.
Steve Forbes, in his magazine editorial of 2-28-18, says that our Treasury secretary Steven Mnuchin recently stated his desire for a weak currency. As I discovered while writing my book, presidents and their treasury secretaries always get the dollar they want (egg heads at the Federal Reserve be damned); fortunately, President Trump immediately contradicted his secretary. Forbes goes on: “No country has ever devalued its way to greatness and enduring prosperity. Ever. Ask Brazil, Argentina, and Zimbabwe.”
In my book,I intuitively suggest that if the whole world operated on a goldstandard, understanding trade balances would be lot easier. But the world is much too messy for a simple explanation. Laffer told me that what Trump is really going after are the 20,000 to 30,000-word trade documents. Laffer privately acknowledged he has a jaded opinion of politicians, calling them easily corruptible. If there were not carve-outs and special deals for various interests all over the place, our trade agreements would be about two pages long. My guess is that Trump looked at two-thirds of manufacturing in the U.S. that shut down prior to his election—which went overseas—and realized whatever, this has to stop, and in his bombastic way, moved like a bull in a china shop in speaking to this subject. The recommended bottom line is this: we should all want free trade with other countries.
Without the discipline of a gold standard, countries that want to be mischievous can find ways to manipulate their currencies, which is to say, they cheat. Consider the wisdom of the following essay on currency manipulation.
“Currency Manipulation Is a Real Problem” by Judy Shelton,
The Wall Street Journal, 2-14-17
Passionate defenders of the “global rules-based trading system should be wary of thinking their views are more informed than President Trump’s. He has been branded a protectionist and thus many conclude he is incapable of exercising world leadership. Meanwhile, those who embrace the virtues of global free trade disregard the fact that the “rules” are not working for many American workers and companies.
Certainly, the rules regarding international exchange-rate arrangements are not working. Monetary integrity was the key to making Bretton Woods institutions work when they were created after World War II to prevent future breakdowns in world order due to trade. The international monetary system, devised in 1944, was based on fixed exchange rates linked to a gold-convertible dollar.
No such system exists today. And no real leader can aspire to champion both the logic and the morality of free trade without confronting the practice that undermines both: currency manipulation.
When governments manipulate exchange rates to affect currency markets, they undermine the honest efforts of countries that wish to compete fairly in the global marketplace. Supply and demand are distorted by artificial prices conveyed through contrived exchange rates. Businesses fail as legitimately earned profits become currency losses.
It is no wonder that appeals to free trade prompt criticism among those who realize the game is rigged against them. Opposing the Trans-Pacific Partnership in June, 2015, Rep. Debbie Dingell (D., Mich.) explained: “We can compete with anybody in the world. We build the best product. But we can’t compete with the Bank of Japan or the Japanese government.”
In other words, central banks provide useful cover for currency manipulation. Japan’s answer to the charge that it manipulates its currency for trade purposes is that movements in the exchange rate are driven by monetary policy aimed at domestic inflation and employment objectives. But there’s no denying that once the primary “arrows” of Japan’s economic strategy under Prime Minister Shinzo Abe, starting in late 2012, was to use quantitative easing to boost the “competitiveness” of Japan’s exports. Over the next three years, the yen fell against the U.S. dollar by some 40%.
Last April, U.S. Treasury Secretary Jacob Lew cautioned Japan against using currency depreciation to gain a trade advantage and he placed the country on a “monitoring list” of potential currency manipulators. But in response, Japanese Finance Minister Taro Aso threatened to raise the bar saying he was “prepared to undertake intervention” in the foreign-exchange market.
China has long been intervening directly in the foreign-exchange market to manipulate
the value of its currency. The People’s Bank of China announces a daily midpoint for the acceptable exchange rate between the yuan and the dollar, and then does not allow its currency to move more than 2% from the target price. When the value of the yuan starts to edge higher than the desired exchange rate, China’s government buys dollars to push it back down. When the yuan starts to drift lower than the desired rate, it sells off dollar reserves to buy back its own currency.
China’s government has reserves that amount to nearly $3 trillion. According to Mr. Lew, the U.S. should mute its criticism because China has spent nearly $1 trillion to cushion the yuan’s fall over the last 2 ½ years or so. In a veiled reproach to Mr. Trump’s intention to label China a currency manipulator, Mr. Lew said it was “analytically dangerous” to equate China’s currency manipulation intervention policies with its earlier efforts to devalue its currency for purposes of gaining a trade advantage. China, he noted, would only be open to criticism that is “intellectually sound.”
Whether China is propping up exchange rates or holding them down, manipulation is manipulation and should not be overlooked. To be intellectually consistent, one must acknowledge that the distortion induced by government intervention in the foreign-exchange market affect both trade and capital flows. A country that props up the value of its currency against the dollar may have strategic goals for investing in U.S. assets.
The notion that free trade should be based on stable exchange rates so that goods and capital flow in accordance with free-market principles has been abandoned by technocrat elitists who simultaneously extol the benefit of globalization. But it makes no sense to devote hundreds of pages to carefully constructed trade terms that ratchet down tariffs a few percentage points when currency movements can wipe them out in a matter of days.
Mr. Trump is taking the right first step to address this issue by questioning why there aren’t adequate rules in place to keep countries from manipulating their exchange rates.
The next step is to establish a universal set of rules based on monetary sovereignty and discipline that would allow nations to voluntarily participate in a trade agreement that did not permit them to undermine true competition by manipulating exchange rates.
Mr. Trump’s penchant for identifying core problems and taking bold actions to resolve them is encouraging. He would do well to take the next step for the sake of free trade and to establish a system that ensures stable exchange rates.
The United States has been running a negative trade balance with the rest of the world for years. Not only does the public have trouble understanding the ins and outs of this subject, but our national leaders over the years must also have had trouble understanding the same, as what they, their advisers, and so many economic pundits say and write constitutes what I would call muddled thinking. The daily news for the most part completely ignores the subject, since the trade deficits growth stays basically always with us and is thus not news. Economic columns in magazines and newspapers will occasionally focus on this, and politicians will likewise occasionally mention it, but there certainly is no groundswell of anxiety building up about the nation’s rising debt via trade with the rest of the world. It certainly doesn’t get the same attention as the national debt does. The electorate, ever-mindful of the dangers awaiting them if they live foolishly by spending more than they make, completely understands the concept of bankruptcy. But our trade imbalances get shuffled aside by what seems to be more present dangers and fears of the day.
Let me first try to impress you with the variety of thoughts on the subject. Confusing and disparate thoughts serve to completely confuse most people to the point where they just turn off the volume on a problem that seems to be only a worry in the distant future.
Start with Adam Smith’s writings on national trade imbalances. He wrote, “Nothing, however, can be more absurd than this whole doctrine of the balance of trade. And thus, perhaps nothing can be more absurd than to have trade policies guided by politicians guided by pointless concerns about the balance of trade.” His thinking was that a trade deficit means that foreigners are increasing their investment in the country, making it more prosperous. Adam Smith wrote in the time period of the forming of the United States. His Wealth of Nationswas published in 1776. He was Scottish, writing in England, when England was the dominant world military and economic power. England had been operating under a gold standard since 1717. Today, the United States is the dominant military and economic power. We operated under a gold standard from the beginning of the country until 1971. From WWII to the 1970s, the U.S. had no trade imbalance. The trade deficit each year after 1971 started building, and has risen steadily in size ever since.
Now, nobody of sound mind can dispute the fact that we all basically benefit from international commerce; that is, those with the natural resources, and with the skills and knowledge to make things the best, and the most cheaply, should sell to everyone else needing such things. Through trade, everyone gets goods and services of the best quality for the lowest price. The larger the trade area, the greater the effect of producing goods and services to be the best, at the lowest price. Adam Smith called this effect comparative advantage.
As of late, the U.S. has suffered higher unemployment, and higher underemployed rates, with many working in less remunerative and less satisfying work. Often these represented workers displaced from factories that were closed with the work shifted out of the country to areas of cheaper labor. While the returning goods became available to Americans at lower prices, those left by the factory closings obviously were disadvantaged. So, many benefited at the expense of a few. But, it is important to note that, “Most job losses are not due to international trade. Every month roughly five million new jobs are created in the U.S., and almost that many are destroyed, leaving a small net increment. International trade accounts for only a minor share of that staggering job churn. Vastly more derives from the hurly-burly of competition and from technological change, which literally creates and destroys entire industries. Competition and technology are widely and correctly applauded—international trade is not so fortunate.” This comes from an opinion piece by Alan S. Blinder, a professor of economics and public affairs at Princeton University and former vice chairman of the Federal Reserve. He goes on to say, “Trade is more about efficiency—and hence wages—than about the number of jobs. You probably don’t sew your own clothes or grow your own food. Instead, you buy these things from others, using wages you earn by doing what you do, better. Imagine how much lower your standard of living would be if you had to sew your own clothes, grow your own food…and a thousand other things. The case for international trade is no different. It’s not mainly about creating or destroying jobs. It’s about using labor more efficiently, which is one key to higher wages. But there is a catch: Whenever trade patterns change, some people will gain (either jobs or wages), but others will lose.”
Blinder, who also served on the Clinton Board of Economic advisors, continues in the same piece saying things such as, “bilateral trade imbalances are inevitable and mostly uninteresting,” and “running an overall trade-deficit does not make us ‘losers’”; I most definitely disagree. But the main point is that overall, everybody benefits from international trade. Still, here is a person of enormous economic prestige with great influence belittling trade deficits. He is not alone. Some say a rising U.S. trade deficit means foreigners are increasing their investments in the American economy, making us more prosperous.
There are also those of prominence who take the opposite view; that is, they take the view that trade deficits are bad, which is the opposite of Adam Smith’s idea of making us prosperous. Commerce Secretary-designate (as of January 2016) Wilbur Ross claims, “Econ 101 teaches that a trade deficit shrinks GDP and weakens our economy.” One of the most brilliant of all economic thinkers is, in my opinion, Warren Buffett. Mr. Buffett penned an article published in Fortune magazine in 2003, poignantly writing on the dangers of a persistent trade deficit. I am tak
ing the liberty of attempting to display Mr. Buffett’s fanciful story converted from his verbiage to a more diagrammatic form, in the hope that more people can see the light of his logic, and that this will help others to better understand what I believe is a difficult subject. So, here goes:
Imagine two islands where the only capital asset is land, and the people work 8 hours per day to produce their food.
Then,Thriftville decides to work 16 hours per day, will consume food produced in 8 hours, and export that from the second 8 hours of production to Squanderville.
Squanderville is ecstatic as they now don’t have to work. They pay for the food by exchanging Squanderbonds, denominated in Squanderbucks, to pay for the food.
Thriftville accumulates bonds, which are a claim on future output of Squanderville. Then, the people of Thriftville get nervous about the large quantity of IOUs from Squanderville, so Thriftvilledevelops a strategy; they continue to hold some bonds, but sell most of them to Squanderville for Squanderbucks. Then, they use Squanderbucks to buy Squanderland, so that eventually, they own all of Squanderville. Squanderville now must deal with an ugly equation, they now must return to working 8 hours a day in order to eat, plus, they have to work another 8 hours per day to service the debt and pay rent on the land they sold.
SQUANDERVILLE IN EFFECT HAS BEEN COLONIZED BY PURCHASE RATHER THAN BY CONQUEST.
The first generation gets a free ride, while future generations pay for it in perpetuity.
Now, Squanderville faces ever-increasing debts and embraces inflationary policies, which dilutes the value of Squanderbucks. This causes Squanderbucks to decrease in value.
Why would Thriftville opt for direct ownership of Squanderville land, rather than hold government bonds?
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