Howard Richman's  Instablog

According to this morning's press release from the Bureau of Economic Analysis (BEA), in September the overall U.S. trade deficit in goods and services rose to $36.5 billion per month, up from $30.8 billion per month in August. The trade deficit sums the aggregate demand that is escaping our economic tire while our government tries to pump it up through stimulus programs.

The bulk of our rising monthly trade deficit is our goods trade deficit with China which rose to $22.1 billion in September from $20.2 billion in August, after a slight decline the previous month, as shown below:  

The continuing leakage of American aggregate demand to China is contributing to the constant decline in US manufacturing employment, as shown below: 

Meanwhile, even though the US economy is experiencing occasional GDP blips upward when government spending spikes, the underlying pressure is downward from falling non-residential fixed investment, including manufacturing investment, as shown by the quarterly data below: 

China is growing by at least 7% per year through a strategy of subsidizing exports, manipulating exchange rates, maintaining barriers to imports, and stimulating demand for Chinese produced goods only.

Meanwhile, the United States may be failing to recover from the Great Recession because of our failure to patch the trade deficits. If we were to trade our economic advisors for China's economic advisors, we would quickly get out of the recession.

Disclosure: No Positions

President Barack Obama has frequently claimed that his energy policies will create "millions of new American jobs that pay well and cannot be outsourced." But as United Steel Workers President Leo Gerard warned in a commentary Friday, they can and probably will be outsourced. He began with a recently proposed project, being considered in Washington, to buy Chinese windmills with US taxpayer money:

Taking candy from a baby: A consortium of Chinese and American companies goes to Washington and announces plans to build a $1.5 billion windmill farm in West Texas using $450 million in U.S. Stimulus funds, which will create 2,330 jobs – 2,000 of them in China.

Meanwhile, according to a Financial Times story, American parts will continue to be excluded from Chinese-made windmills despite an agreement that was recently negotiated:

At the [US-China meeting in Hangzhou] last week, China agreed ... to relax restrictions on importing wind power components. However, Paulo Soares, head of the Chinese operations of Suzlon, the Indian wind power group, said the new rules would make little difference. “The big companies already have installed manufacturing operations and established supply chains, so it is not going to change anything,” he said.

And American made solar panels and solar panel parts are also being excluded from China as noted by University of Maryland economist Peter Morici in a recent Business Week interview:

China does a lot of things that make it difficult for companies to export into the country. Take, for example, solar panels. The two big markets for solar panels going forward are China and the U.S. But China requires that 75% of the contents of solar panels sold in China be made domestically. We don't.

If companies locate their factories in China, they can sell to both the United States and to China, while if they locate in the United States, they can't sell to China. In a September 16 New York Times column, Thomas L. Friedman, noted that Applied Materials (AMAT), the American company that is the world’s leader in producing the machines that produce solar panels, has built all of their factories abroad. He wrote:

The other day, [Applied Materials’ CEO Mike] Splinter gave me a tour of the company’s Silicon Valley facility, culminating with a visit to its “war room,” where Applied maintains a real-time global interaction with all 14 solar panel factories it’s built around the world in the last two years. I could only laugh because crying would have been too embarrassing.Not a single one is in America.Let’s see: five are in Germany, four are in China, one is in Spain, one is in India, one is in Italy, one is in Taiwan and one is even in Abu Dhabi….

Later in the article, he pointed out that it is even worse than that. Applied's inventing won't be done here for long, perhaps so that their research can be close to their factories:

In October, Applied will be opening the world’s largest solar research center — in Xian, China….

According to the theory of "comparative advantage," each country produces what it produces relatively efficiently while trading with the other countries for what they produce relatively efficiently. But "comparative advantage" requires balanced trade to work. For every $1 we import from China, the Chinese government only allows its people to import about 25¢ from us. 

Our trade with China operates on the "mercantilist" principle. China produces what it produces relatively efficiently as well as what we produce relatively efficiently. They trade goods with us and get our assets, IOUs and industries in return. China grows, we shrink, and eventually Chinese communism dominates the world while American democracy is buried.

We don't have to keep taking this. We could demand that China's government start balancing trade, else we would balance it through auctioned Import Certificates that would limit the value of our imports from China to the value of their imports from us. Such import limitations would be in perfect accordance with a special WTO rule for trade deficit countries which states:

(A)ny contracting party, in order to safeguard its external financial position and its balance of payments, may restrict the quantity or value of merchandise permitted to be imported.

If we were to implement this policy, the Chinese government would be forced to take down its many barriers to American products. Not only would U.S. manufacturing employment immediately turn around, but the new business investment that we would get in our manufacturing sector would pull the U.S. economy right out of the Great Recession.

Unless President Obama requires balanced trade, his energy policies could produce lots of green jobs in China and very few in the United States.

Disclosure: No Positions

President Obama's Plan A tested the proposition that you can fix an economic crisis caused by too much borrowing from abroad for consumption, by borrowing more money from abroad for consumption. So far it hasn't worked.

The latest unemployment numbers are out, showing that the jobs created by his Recovery Act are largely imaginary. The blue line shows the projected unemployment rate at the inception of the plan. The red squares show the actual unemployment rate which just rose from 9.8% in September to 10.2% in October.

The employment numbers in the manufacturing sector continued their steady decline, as manufacturing shed 61,000 more jobs in October as shown in the graph below:

1,000
These falling manufacturing employment numbers come despite the fall of the dollar vs. the European and Japanese currencies, perhaps because China continues to peg its currency to the dollar, and many Asian countries have resumed their currency manipulations so as not to lose market share to China.

Plan B is Balanced Trade

Meanwhile, there is hope on the horizon. Balanced trade is precisely the remedy required for a trade deficit economy whose consumers are too deeply in debt to keep spending beyond their incomes.

The G-20 leaders are finally addressing the trade imbalances that are preventing recovery from the Great Recession. This weekend, the G-20 finance ministers will meet in St. Andrews, Scotland. According to Reuters they are "expected to focus on a framework to foster future balanced trade."

This is an excellent development. The only problem is the word "future" in the above statement. It may take lots of time for the world to negotiate the framework that could lead to balanced trade. And the question remains whether or not the Asian countries will cooperate and whether the West will have the fortitude to take coordinated actions if they refuse.

Treasury Secretary Geithner could show that he means business. He could begin to balance trade now, without waiting for a framework for balanced trade to be negotiated. All he would have to do is tell the Asian countries that they had better start balancing trade with us by taking down their barriers to our exports and ending their currency manipulations, or we will start limiting our imports from them to the level of their imports from us. Such a policy would be in perfect accordance with WTO rules which state:

(A)ny contracting party, in order to safeguard its external financial position and its balance of payments, may restrict the quantity or value of merchandise permitted to be imported.

If we were to implement this policy, not only would U.S. manufacturing employment immediately turn around, but the new business investment that we would get in our manufacturing sector would pull the U.S. economy right out of the Great Recession.

Not only that, the Asian countries would be forced to stop suppressing their people's consumption, including their consumption of imports. The result would be a much higher standard of living for the people of Asia.

Disclosure: No Positions

A depression is a long period of high unemployment characterized by GDP that stays at or below pre-depression levels. The following graph shows Real GDP during the Great Depression which began at the end of 1929 and ended in 1939:

 

The Great Recession began in the first quarter of 2008. So far there have been two upturns. The first upturn only lasted one quarter, the second quarter of 2008, in response to President Bush's stimulus plan. The second blip just started last quarter, in response to Obama's recovery plan:

 

Don't expect this blip to last much longer than the first. The reason is simple: China. When President Bush wanted to borrow money from China to pay for the first stimulus plan, China started pegging their currency to the dollar. As a result, the United States trade deficit with China stopped improving. During Obama's most recent quarter, our trade deficits got worse:

 

There is a positive statistic in these data, the stabilization of residential investment, which had been falling ever since the house price bubble popped in 2006, as shown in the graph below:

 

 The depressing statistic in these data is non-residential fixed investment, which includes building new energy production, building new factories, and retooling old factories. That sort of investment has not yet stopped declining since the current recession began, as shown in the graph below:

 

There is nothing that wouldn't get better if business fixed investment would increase. New and improved factories would mean more demand for products now, and higher productivity and exports later.

The United States got out of the Great Depression as a result of increased net exports to the warring countries in Europe. Those exports, in turn, resulted in increased fixed investment. If we were to require that China buy our goods in return for us buying Chinese goods, net exports and fixed investment would get the United States out of this current depression.

Disclosure: No Positions

Many economists hope that the falling dollar will boost American exports, stimulating our recovery. But the boost may be small if we continue to let the mercantilist countries exclude American products from their markets. For example, the Chinese government is currently minimizing all of the following American exports:

1. Autoparts. The Chinese government has high tariffs (about 25%) on foreign-made autoparts. Otherwise the Ford and GM plants in China would be importing them.

2. Automobiles. The Chinese government has high tariffs (about 25%) on foreign-made vehicles. The Doha Round of the WTO agreement collapsed because China and India refused to reduce them.

3. Video Games and DVDs. The Chinese government allows piracy of these products while delaying approval of import licenses for the legitimate products.

4. Chicken. The Chinese government stopped issuing import licenses for import of American chicken at the same time they filed a complaint over U.S. rules against the importation of Chinese cooked-chicken products.

5. Commercial Aircraft. The Chinese government is currently building its own commercial aircraft industry through huge government loans.

6. Mining Equipment. The Chinese government currently has high tariffs (about 25%) on foreign mining machinery, a major U.S. export.

7. Computer Products. When the U.S. government hands out consumer subsidies (such as "cash for clunkers") foreign products are eligible, but when the Chinese government hands out subsidies, including subsidies to computer products, only domestic manufacturers are eligible.

8. Motorcycles. The Chinese government has numerous barriers to foreign motorcycles, starting with 25% tariffs and continuing with restrictions against using motorcycles with large motors on many Chinese roads.

If the United States were to tie the value of American imports from China to the value of Chinese imports from the United States, the Chinese would have to give up their mercantilist strategy of maximizing their exports to the United States while minimizing their imports. The result would be a U.S. export boom. Such action would be sanctioned by WTO rules which state:

(A)ny contracting party, in order to safeguard its external financial position and its balance of payments, may restrict the quantity or value of merchandise permitted to be imported.

Instead, we let China grow by about 7% per year, while we shrink, proving to the world that American democracy is incapable of electing competent leadership.

Disclosure: No Positions

On October 15, rather than combat Chinese currency manipulations, Treasury Secretary Timothy Geithner issued a ludicrous report to congress which claimed that China is not manipulating its currency. It concluded:

[This] report must consider whether any foreign economy manipulates its rate of exchange against the U.S. dollar to prevent effective balance of payments adjustments or to gain unfair competitive advantage in international trade. For the period covered in this Report, January 1, 2009 to June 30, 2009, Treasury has concluded that no major trading partner of the United States met the standards identified in Section 3004 of the Act. (p. 3)

America is currently experiencing the persistent economic depression that comes to countries who let their trading partners practice mercantilism, the strategy of maximizing exports and minimizing imports in order to run trade surpluses.

China is now using mercantilism to grow at about a 7% pace, while shrinking the economies of her political rivals in Japan, Europe, and America. China uses export subsidies, currency manipulations, and various tariff and non-tariff barriers to steal aggregate demand and production from the economies of her trading partners.

And American economists, following the lead of Adam Smith's 1776 book (The Wealth of Nations), allow this. Smith argued that mercantilism is a mistake because it reduces a country's current consumption. He correctly wrote:

Consumption is the sole end and purpose of all production; and the interest of the producer ought to be attended to only so far as it may be necessary for promoting that of the consumer. The maxim is so perfectly self-evident that it would be absurd to attempt to prove it. But in the mercantile system the interest of the consumer is almost constantly sacrificed to that of the producer; and it seems to consider production, and not consumption, as the ultimate end and object of all industry and commerce. (iv.8.49)

But Smith missed an important fact. The mercantilist country only misses out on consumption for a while and the victim country only gets increased consumption for a while. Eventually the growth of industry and income in the mercantilist country and the loss of industry and income in the victim country reverses the tide. As we noted in our book Trading Away Our Future:

In 1997, Peking University economics professor Heng-Fu Zou, a Senior Research Economist for the World Bank’s Development Research Group, showed, in an intriguing paper [“Dynamic Analysis of the Viner Model of Mercantilism”], that mercantilism can succeed on its own terms for a small economy. Accumulating foreign assets (running a trade surplus) leads to long term positive outcomes. “A nation with strong mercantilist sentiment ends up with large foreign asset accumulation and high consumption in the long run.” (p. 26)

In 1936 while writing his magnum opus (The General Theory of Employment Interest and Money), John Maynard Keynes rejected Smith’s mercantilism theory, pointing out:

(A) favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)

We don’t have to permit Chinese mercantilism. Should we require that our trade ratio with China move to balance, the Chinese government would be forced to take down their many tariff and non-tariff barriers to American products.

Currently we buy about $1 from China for every 25¢ that China buys from us. The U.S. Treasury Department could achieve equality by auctioning import certificates that allow the same value of Chinese imports as China imports from us. The revival of American manufacturing and the American economy would be dramatic.

Disclosure: No Positions