Contrarian Investment Strategies
Page 44
Although parts of the country are up in arms about illegal aliens crossing our border from Mexico and taking minimum-wage jobs away from Americans, government at the federal level somehow seems less concerned about our losing much higher-paying skilled jobs to Asian and other lower-paying countries.
Obviously, unrestricted free trade is good for consumers and business buyers because it keeps their costs down and should also dampen inflation in many manufactured products. But is it good for the country? Not necessarily, if in the end we lose millions of jobs because of the enormous disparity in wages. If the loss of jobs is significant enough, our purchasing power will go down as a nation and our standard of living will decline. We will be able to buy fewer goods regardless of the prices they are selling at.
The unemployment rate was 9.1 percent in September 2011. Unofficially, including people who are self-employed not by choice, part-time employees, and those who have dropped out of the labor force because of frustration at not finding a job, it was estimated in September 2011 to be 16.5 percent, not much lower than at times during the Great Depression.
For the United States, this could prove extremely damaging. By knowingly exporting high-paying jobs, we are confronting a situation never faced before on a scale of this magnitude. The cost of high unemployment, the social unrest that goes with it, and the continuing erosion of our industrial base could more than offset the benefit of lower-cost imports. Meanwhile, lower import costs here, while threatening our own standard of living, will certainly increase the standard of living of China, India, the Pacific Rim Tigers (Taiwan, Hong Kong, Singapore, and South Korea), and other low-wage countries.
We have the choice of intentionally lowering our standard of living, which we are now actually considering—witness an independent committee proposal to the president in late 2010 to reduce Social Security and other benefits and raise the retirement age over time, as well as the dismissal of teachers and policemen across the country because of lack of funds to pay them. Or we can take affirmative action to protect our standard of living.
The last but most important part of the picture is that almost no country—not even the United States—is really a free trader in the Ricardian sense of the term. Free trade is in reality an economic myth. Most nations are fair traders to a greater or lesser degree. Fair trade usually consists of trading partnerships or alliances based on negotiation, transparency, and dialogue, with the goal of greater equality in international trade. It attempts to offer better trading terms and conditions to cooperating nations as well as securing the rights—read protection—of marginalized producers and workers. Fair traders open their markets to some extent but make sure their workers are not seriously affected. Many countries, including our major trading partners in Asia, such as China, India, and the Pacific Rim Tigers, are certainly questionable even as fair traders.
China is a classic example of unfair trade practices today, just as Japan was twenty-five years back. Like Japan in the 1980s, China is pursuing an export-led growth strategy, limiting domestic consumption, encouraging saving, and guiding investments into strategic industries. It has a multitude of trade barriers and an undervalued currency. It also carefully protects its major markets, where it is at a large competitive disadvantage relative to U.S. competition, by means of a multitude of skillfully constructed trade barriers. A prime example is the financial industry, where the United States has a significant cost advantage. Restrictions on ownership of financial companies and a myriad of other barriers keep the United States from exploiting this. The same protection is used by many other countries to restrict U.S. access to their financial industries.
There are many industries where restrictions are placed on sectors in which the United States or another highly developed nation has a competitive advantage, particularly in service industries and technology. When this occurs repeatedly, we have a new board game called “Free Trade.” The object is to parrot the words “free trade” continually while obtaining the largest trade advantage possible. It is like Monopoly in the sense that the winner takes all, but in this version, it is the nation that gains the largest continuing trade surplus by taking in the largest amount of foreign currency that wins.
Adam Smith would call the current trade situation neomercantilism, and from his writings and his letters to Alexander Hamilton, we know he would be strongly opposed to it. About a quarter of The Wealth of Nations was devoted to arguments against mercantilism, meaning a policy of protectionism that spurs exports while limiting imports. Free trade cannot exist unless all trading partners subscribe to it, and this is a virtual impossibility in today’s world. Would Adam Smith expect any one nation to adopt free-trade policies in a world that does not? I would doubt it, as his was a multinational, not a single-nation, theory.
The United States is not unaware of the game or its tactics, but our major players change with every new administration, while our most wily competitors keep their ALL-STAR trade negotiators playing for their countries for decades. The way the United States is playing the game must be of serious concern. In recent trade negotiations with South Korea, President Barack Obama offered it the opportunity to build its own jet engines in its own plants in its own country, with U.S. help. If the offer was serious, we would be giving away an industry in which we still have a strong comparative advantage, as well as state-of-the-art technology. This action could allow South Korea to become a low-cost exporter, possibly increasing our trade deficit further and costing us even more skilled jobs.
In late January 2011, General Electric, one of the aviation industry’s largest suppliers of airplane technology and jet engines, inked a deal for a joint venture in commercial aviation with a state-owned Chinese company that will share its most advanced airplane electronics, including technology used in Boeing’s state-of-the-art 787 Dreamliner. China is seeking technological support in the world’s most advanced industries to eventually challenge the best from Boeing and Airbus. Leading technological industries in highly developed countries are trading off their technological expertise for a share of what they hope will prove to be a gigantic Chinese market.9 The larger the number of advanced companies that play this game, the faster China will probably leap ahead in the development of ultrasophisticated technological products that are likely to increase its exports and reduce the exports of countries with high standards of living. Moreover, the Pacific Rim Tigers, as well as other neomercantilist countries, are also adept at this new variation of “FREE TRADE,” exacerbating the problem further.
China’s commitments to strong protection of intellectual property rights are far more often breached than observed. To make matters worse, the Chinese outright piracy and replication of U.S. intellectual property, from computer software to CDs and DVDs of music and entertainment companies to video games to top-of-the-line fashion, runs into the tens of billion of dollars a year. A Bloomberg article estimated in 2010 that the dollar value of pirated software from 2005 to 2009 doubled to 7.58 billion dollars. According to Microsoft Chief Executive Officer Steve Ballmer, “China is a less interesting market to us than India, than Indonesia.”10 One source estimates that of the millions of copies of Microsoft’s Windows used in China, only about 20 percent are purchased; the rest are illegally replicated there.11
With millions of Chinese entering the ranks of the middle class, knockoffs of such luxury brands as Prada, Louis Vuitton, Burberry, and Rolex are widespread and widely distributed. Movies and other intellectual property of media giants such as Time Warner are also continually pirated, along with those of the music and computer game industry.12 The Chinese go one step further by not allowing distribution of more than several dozen U.S. movies, all censored, in Chinese movie theaters, whereas the United States allows them to distribute theirs here at much lower royalties.
Unfortunately, the problem does not end here. We are not only exporting jobs to China and other countries with very low-cost wages. Many thousands of other U.S. jobs are lost primarily to China through cou
nterfeiting. Our patents are blatantly ignored, and Chinese workers manufacture American and other industrial countries’ products by simply making the goods in China and ignoring patents and copyrights. The magnitude of the counterfeiting is significant. Estimates peg the Chinese counterfeiting at approximately $480 billion worth of goods annually, much of which comes from the United States. The amount is 75 percent larger than the entire U.S. trade deficit to China, which was $273 billion in 2010.13 Although the sums are enormous, they have received little media exposure. Senator Carl Levin stated at the Congressional Executive China Commission hearing, “The Chinese government itself estimates that counterfeits constitute between 15% and 20% of all products made in China and are equivalent to about 8% of China’s annual gross domestic product.”14 The statement was reiterated by Wayne Morrison, Specialist in Asian Trade and Finance, in a Congressional Research Service Report prepared for Congress, January 2011.15
China has thus also taken by illegal means many high-quality jobs out of our country and other industrial countries and given them to its own workers, presumably at a much lower cost, by ignoring patents and licenses. As a result, counterfeit goods are a not insignificant part of the Chinese economy, and have proved costly to both U.S. labor and U.S. industries.
Although the Clinton, Bush, and Obama administrations have attempted to stop these and other unfair trade practices, even going to the International Court of Justice, almost no progress has been made. Other factors, including political considerations such as Iran, North Korea, and global warming, mitigate the United States’ desire to use stronger tactics.
We also continue to have other major disputes with China. For example, China has turned a deaf ear to our urgings to raise the value of the Chinese currency to a more appropriate level, which would increase our exports to them and decrease our imports. Similar negotiations are going on with several dozen other countries having large trade surpluses with the United States.
How should we deal with these problems—or can we? The most serious is our high rate of unemployment and the question of whether it will become chronic. In the past ten years no new net jobs have been created domestically, while U.S.-China trade alone has eliminated or displaced 2.8 million jobs, as well as others to the Asian Tigers and other low-wage countries, all of whom are not free traders. As noted, figures coming from the Obama administration state that 25 percent of the job losses since the 2007–2008 recession are expected to be permanent. Moreover, the accelerating trend of outsourcing U.S. jobs abroad is showing no sign of abating, which could mean that our unemployment rate will continue to stay high over time.
The shortfall of jobs in the United States is the most significant problem the country has faced in decades. In the four years since the recession began, the U.S. working population has grown by about 3 percent. Jobs in a healthy economy would have grown by the same amount. Today the country has 5 percent fewer jobs than before the last recession began.16
There are certainly ways to bring about change. The United States is still a country blessed with almost all the natural resources it needs, other than oil,*93 as well as the strongest manufacturing and technological base that has ever existed. We could play the trade game the way most countries, including those of the European Union, do by expanding and improving our negotiation capabilities and forcing countries with large trade surpluses to open their important but now restricted markets. There is very little that the Chinese or the Pacific Rim Tigers manufacture that we cannot.
Employing a stronger fair-trade policy, the United States could also erect temporary trade barriers against nations that refuse to open up important markets or that indulge in large-scale piracy: theft of our intellectual property or other products. The penalties would have to be rigorously enforced with major fines or other damages. If the penalties weren’t paid, we could perhaps slap on tariffs until they were. This is, of course, only if we could put aside political considerations.
Likewise, with China and other low-wage countries, if we demanded that they adhere to some minimal environmental, worker protection, and employee medical and benefit standards, these standards would raise their labor costs, helping to decrease their exports to us, perhaps significantly. This is dangerous ground and measures other than environmental standards are probably best not approached by the federal government. But we have flirted with such ideas before, with respect to restrictions on child labor and to the strong, effective embargo that was placed by companies, unions, and individuals on South Africa before blacks were given the right to vote in the 1980s.
Similarly, we could follow up with tax credits for companies that increase employment domestically. We could also decrease tax benefits to U.S. companies that continue to increase employment of workers abroad or raise the tax when such firms want to repatriate their earnings unless these funds go into creating jobs in the United States. To date, neither of the two previous administrations, nor any economic theorists, have really taken on or acknowledged the depth of the problem.
Government policy over a number of administrations has helped destroy our auto industry. For almost thirty years our cost per vehicle was $1,500 to $2,000 more than that of foreign competitors. Foreign companies that were not unionized used cheaper labor, while our domestic companies could not. They were also given tax incentives by various states that wanted them to locate in one of their areas. It was only after the bankruptcy of GM and Chrysler that the playing field was finally level, at least for the moment. Ironically, no other major manufacturing country that I can recall has given foreign companies a major competitive advantage in an important home market. Our policy for decades of maintaining unionization for domestic producers, while allowing foreign manufacturers in the United States not to be unionized, puts our domestic auto companies on the chopping block.
The United States cannot be the sole exponent of the very liberal fair-trade policies we practice without the serious consequences discussed. If we continue on our current fair-trade course, we will see an enormous transfer of wealth from the pockets of our citizens into those of China and other Third World countries and quite possibly suffer from chronic unemployment in the process. It’s certainly not a problem we want to face, but not facing it is likely to make it progressively worse with time.
At this time, such actions seem nearly impossible, but times change. If high unemployment remains a serious problem, and little on the horizon indicates that it will not, the fallout from this will affect and alarm increasing numbers of voters. We are seeing a glimpse of this in the demonstrations and crowds camping out near Wall Street and in a number of American cities, as well as in mounting numbers of cities in Europe. The internal political pressures for full employment will mount, and with them the demands for changes in trade policy. Neither political party will be likely to want to oppose this challenge. Whether in two years or five, it is likely that a U.S. administration will eventually start promoting more aggressive policies toward fairer trade.
Adam Smith and David Ricardo both wrote about the merits of free trade. Would they have considered the current problems this nation faces here simply a matter of disagreement among trading nations? I doubt it—particularly when the wealth of the nation, its labor force, is being systematically put out of work or forced to take lower wages. That’s how we’re managing to freely trade in our high standard of living for something less, especially for our children.
The Case for Future Inflation
Investors have come out of the Great Recession frightened, battered, and with their confidence shaken, if not shattered. How could it be otherwise? What we went through was not a recession but the second worst depression in the nation’s history. Economists do not currently use the term “depression” and have not used it since 1945, no matter how bad the downturn has been. The D-word has not been used since the 1930s—not a bad application of Affect theory by economists, but hey, knowing the beating they would take if the D-word had to be used again, it’s been any port in a stor
m.
But whatever the official name of what investors have been through, we are hopefully better armed, with our new psychological tools, than the average investor to deal with what lies ahead. We know the risks of forecasting, something almost nobody can do with precision. We also should remember from chapter 14 that stocks and real estate, along with other similar investments, do very well over time.
What most of us also know (and would not like to remember) is that our government is running some of the biggest budget deficits on record. This is true not only on an absolute but on a percentage basis: $1.4 trillion in 2009 (fiscal year ending September 30), $1.3 trillion in fiscal 2010, and $1.3 trillion in fiscal 2011, plus more than $2 trillion in other Federal Reserve and Treasury bailout costs and monetary stimuli. The Treasury printed and continues to print enormous amounts of dollars. For a benchmark to measure it against, the entire TARP bailout of the banking system, which has been repaid, totaled $700 billion, or about 12 percent of the money the Treasury has already printed to meet the budget deficits, potential bailouts, and monetary stimuli.
Deficits will continue to push upward if the divided Congress does not cut spending or raise taxes to the tune of $700 billion plus a year. Now that the first waves of terror of the Great Recession are fading into the past, investors are beginning to look beyond sheer survival to what comes next.
What seems likely, even if employment continues to increase at a very modest pace, is that we will see inflation, perhaps modest for the first few years but then accelerating at a more rapid rate. It is not only the United States that has bailed out its economy but most of the world. Stimulus funds to China accounted for $2.1 trillion, the European Union for $500 billion, South Korea for $117 billion, Russia for $111 billion, Brazil for $80 billion, and Canada for $58 billion.17 Money is being printed on a worldwide basis.