Enzio von Pfeil, the author of Trade Myths: Globalization has left trade balances behind, is a Hong Kong-based investment advisor and he also manages his own family of funds using his Economic Clock. He is a regular contributor to Bloomberg TV and CNBC Asia. Enzio earned his Ph.D. in economics at the University of Freiburg in Germany (he studied under renowned “Austrian School” economist Friedrich von Hayek), and subsequently went into banking and garnered invaluable experience in Treasuries, currencies, and macro strategies. He later served as chief regional economist for leading London-based i-banks in Hong Kong.
As someone who has followed Enzio’s work for the past several years, I can confidently say that Trade Myths is as iconoclastic as he intended it to be and with sound reason, not to mention its critical timeliness. While Trade Myths should be required reading for everyone in government (especially in the U.S.), it is also a must-read for those in the capital markets, and it is also readily accessible, and highly suggested to, everyone in the workforce. Trade Myths weighs in at a concise 75 pages, with ten pages of charts that clearly illustrate his trade myth-busting.
Below I provide a synopsis of the book and conclude with some Q&A I just had with Enzio. Before starting, I want to thank Enzio for publishing Trade Myths, which has served as a real eye opener, particularly in terms of what headline trade figures mean (or that is, what they miss), how much foreigners are really financing America, and for the various scenarios provided of what could happen if trade goes wrong.
Trade Myths was originally written in 2008, with its latest revision coming in 2009. Many of the ideas however, stem from Enzio’s years in banking and economic strategizing, and are becoming increasingly acute since the financial crisis. Of the five trade myths he discusses, in each instance, Enzio explains how (American politicians’) misguided and anachronistic beliefs about trade could lead to an impaired U.S. economy with a simultaneous jump in interest rates having widespread repercussions.
The first myth is that “imports kill jobs.” Enzio readily dismisses this as self-serving for politicians wanting to avoid inconvenient truths. In short, politicians (the key subjects of Enzio’s work), rather blame outside forces for their constituencies’ economic troubles, rather than acknowledge failing policies in areas such as education, and matters such as burdensome taxation. Enzio questions how the U.S. can be expected to increase its headline trade surplus as it employs fewer people in manufacturing. And, it turns out that as imports rise, so does employment, primarily in services.
Yet, if all so-called “unfair” imports were banned, America’s multinational corporations (MNCs) would suffer heavy blows since their foreign-made products could not be imported back into the U.S.; and most imports would have to be substituted by local production, resulting in higher costs, in turn pushing up inflation and thus forcing interest rates higher, which would reduce investment and slow job creation (if not resulting in massive job losses), while the higher cost of capital would sink the housing and capital markets.
The second myth is that “exchange rates drive trade,” which is again self-serving for politicians. The argument that if other countries’ exchange rates were stronger, America would not have a deficit, does not hold water, explains Enzio, since a devalued U.S. dollar brings trouble of the kind explained above. In fact, it’s comparative advantage, not exchange rates that really drive trade.
The third myth is that “trade balances are a national matter.” While being a convenient line for politicians, it is a risk infected one. Given the interconnectedness of the global economy, viewing trade balances nationally is purely mercantilist thinking and potentially subjects MNCs to host government protectionist retaliation.
Alarmingly, a tit-for-tat trade war could lead to actual war. Disturbingly however, it turns out that a closer examination of trade data shows MNCs are responsible for very little of the U.S. headline $700 billion-plus trade deficit. More importantly, when factoring in the value of MNC’s foreign affiliates’ purchases and production, the U.S. has an enormous $2.7 trillion surplus! Enzio explains that America’s highly successful MNCs are the root cause of the “bad” trade deficit, not “bad foreigners.” Among his other keen observations is that when backing out the domestic activity of MNCs in China, the latter runs a global trade deficit of $1.7 trillion compared to a headline surplus of $260 billion!
The fourth myth is that “America’s trade deficit is ‘bad.’” This follows myth number three and in short, reiterating what was said about myth number one should politicians ban MNCs from operating abroad, the outcome is likely to be an “economic 9/11.” Two keys to this myth are that non-U.S. MNCs are more than ready to take market share from U.S. MNCs; and it doesn’t necessarily require a ban on U.S. MNCs operating broad, since U.S. politicians angering a host country such as China could result in the same dire consequences. Enzio wonders just how disaffected U.S. MNCs would respond in terms of their political contributions.
The fifth and final myth is that “foreigners finance America.” Once again, he regards this as a political ploy (whether deliberate or naively inadvertent) playing on vulnerability and blaming foreigners for ills. Should foreigners be banned from holding government debt or if they dumped their holdings, the outcome could mirror the fallout from the sub-prime crisis.
However, taking a step back, Enzio enlightens readers on two fronts. The first being one must review just who the foreigners that own U.S. debt are and what percentage of the whole it comprises. Interestingly and also surprisingly, Enzio explains that news reports are misleading, since foreigners as a whole owned 25% of Treasuries outstanding in 2006, but of that an increasing amount is held by private investors (such as hedge funds and also MNCs) as opposed to institutions or governments, thus lessening the impact if there were ever any dumping. Data suggests a very strong correlation since 1970 between the growth of FDI and the “foreign” ownership of Treasuries.
The other point here is that even if foreign holders were to dump Treasuries, there is no other market that offers the depth, liquidity, and sophistication of the U.S. Enzio notes that the size of the U.S. bond market is greater than the EU, UK, Japan, and Switzerland’s combined.
The remainder of Trade Myths includes an explanation of the drivers of trade flows, the history of the economics behind trade, and Enzio’s suggestions for how to remediate the discussion of trade. His first suggestion concerns myth number three or specifically, antiquated (mercantilist/nationalist) trade balance accounting, and how it needs to be modernized. His second suggestion involves tax solutions for helping the working class. And adding to that, his third suggestion relates to the necessity of improving the quality of the U.S. workforce by way of better vocational and pre-college education.
In closing, while Enzio duly noted that political self-interest can prevail during economic downturns, this reader was compelled to reflect on an earlier quoted passage from the late Professor Daniel Boorstin, which Enzio recaps in stating:
[America's] politicians/leadership recognizing the U.S. itself is the largest stakeholder in the globalized economy will be the necessary first step in the process of transforming mindsets about America’s trade balances and trade policies.
ST: What are your thoughts on the latest “currency manipulation” talk out of Washington, especially since the situation seems to be worsening with growing bipartisan support in both Congress and Senate?
Enzio: This cheap talk has to be seen against the backdrop of mid-term elections in America. It also has to be seen against the backdrop of Congressional “stimulus” packages which have resulted in 10% unemployment rates – and in 20% unemployment rates for males who are 30 – 55 years old. Another backdrop is that charade of the Treasury report on currency manipulation. Everyone bandies around the “glories” of purchasing power parity; I, for one, have severe methodological problems with this bit of nationalistic chauvinism. It is interesting that the one country whose currency has fallen the most uses this, the U.S. You never hear serious intellectual debate coming from Germany, Japan or Switzerland about how “overvalued” their currencies are – yet, they keep generating huge and growing trade surpluses.
ST: Although it’s mostly “cheap talk” at this point, there’s a palpable escalation of angst in the U.S., meantime while there seems to be firm resolution in China (re. a desired gradual appreciation of the yuan). Do you think another Smoot-Hawley type tariff and a subsequent devastating impact is a possibility?
Enzio: Absolutely not. I don’t think that Congress would be that short-sighted. But I can see its members chasing the WTO with all sorts of law suits, depending upon which constituencies these Reps and Senators are representing.
ST: Changing directions then, tell me, is trade balance accounting consistent among the U.S. trading partners, and what, if anything, is being done to modernize the accounting?
Enzio: Yes, everyone uses the same, 16th century framework. Thus, all trade balances are measured in terms of national borders. This was logical in the 16th century, when there were very few MNCs and when mercantilism was common practice.
ST: Okay, so let’s assume that politicians accept your suggestions and everyone now recognizes that the U.S. has a massive trade “surplus” when factoring in activity of U.S. MNCs’ overseas affiliates. In your opinion, what then is a healthy amount or range of debt-to-GDP? Does or should this vary much across borders, given idiosyncrasies within countries (Japan comes to mind)?
Enzio: It is not as much the ratio per se as it is who is financing that deficit. If the foreigner really is financing that deficit, then the country that is borrowing the money is vulnerable to the foreigner pulling their funds out. But a second point also is relevant: what is the currency of the fiscal deficit? If it is a small currency, then the foreigner, in fact, can pull out. But in the case of the USA, the dollar is the world’s dominant currency, so that reduces the leverage of the foreigner. Furthermore, if American politicians accepted that their own MNCs are very much “at fault” for America’s geographical trade deficit, their whole mindset would change from: “how can we punish ‘bad’ China, to: how can we re-invigorate our own competitiveness?”
ST: For my last question, I want to get your thoughts on if we recognize the massive trade surplus in the U.S. and correspondingly the huge deficit in China when backing out MNC activity, does this change the ongoing U.S.-China trade and currency arguments?
Enzio: Absolutely. Were MNCs’ balances to be included in such “global” trade balances between China and America, then Americans would be asking their very own politicians just why American MNCs are producing more and more abroad instead of back home in the United States. Answer: the politicians have, in their quest to get re-elected, made many expensive promises. That means that taxes and regulations have increased, courtesy of politicians’ desire to get re-elected. The upshot is that the U.S. (like Europe and Japan) have “priced themselves out of the market” in terms of costs and regulations. As a second fusillade primarily against U.S. politicians: instead of focusing on what could make America more competitive – namely, pre-college vocational training – those very politicians who rail against “bad and dangerous” China have a mendacious record when it comes to vocational education policy in America.
Thus, were my points regarding America’s global trade surplus and China’s global trade deficit to be heeded, then this rubbish about exchange rates “really” affecting trade flows would wilt in the face of much more important competitive considerations, e.g. domestic tax as well as regulatory regimes, along with (vocational) education policy. Laconically, you cannot import a car repair; you need a qualified local to repair that Mercedes that you have imported from Germany. Were exchange rates really as important as some politicians claim, then why do Germany, Japan and Switzerland – whose currencies have appreciated fourfold against the dollar since 1970/71 – all have trade surpluses (as I mentioned in your first question)?
ST: Thank you for your time, Enzio.