It's Not Bad Trade Deals - It's Bad Money (Part 1)
The global trading system's newly activated one-man wrecking crew was at it over the weekend. Mustering up his best Clint Eastwood impression, Trump invited the Brussels trade bureaucrats to make his day. Retaliate against Harley's Hogs, Jim Beam's bourbon and Levi's Skinny Jeans, proclaimed the Donald, and you folks are going to find yourself neck deep in BMW's:
If the E.U. wants to further increase their already massive tariffs and barriers on U.S. companies doing business there, we will simply apply a Tax on their Cars which freely pour into the U.S. They make it impossible for our cars (and more) to sell there. Big trade imbalance!
Let us reiterate what we said last week. This is not just another case of Trump banging on a twitter keyboard that doesn't push back----unlike the courts, most of the Dems, much of the Congressional GOP and a goodly part of his cabinet.
On the matter of trade policy, by contrast, the Donald has considerable unilateral running room owing to the vast presidential powers bestowed by section 232 of the 1962 trade act and section 301 of the 1974 trade act. The former authorizes protectionist measures, including tariffs, to safeguard "national security" and the latter authorizes such measures in order to enforce US trade agreements or to counter "unfair" foreign trade practices.
To be sure, the rubbery definitions of the quoted terms (national security and unfair practices) were meant to be parsed and activated narrowly by mainstream White House occupants, not to be used as a protectionist blunderbuss by a raging wild man intoxicated with 17th century notions of mercantilist economics.
For example, consider the national defense fig leaf under section 232 that Trump tapped for his across-the-board 25% tariff on $29 billion of annual steel imports.
Last year the US produced an estimated 82 million tons of steel and imported another 14 milliontons from Canada, Brazil and Mexico, which are the #1, #2 and #4 steel importers to the United States, respectively. So that's 96 million tons of availability---assuming that our hemispheric neighbors, who have no nukes, are not foolish enough to declare war on Washington and embargo their steel exports to the US.
Somehow 96 million tons seems more than adequate to cover the 3.5 million tons needed for the current US war machine, according to the Pentagon; and in truth the real requirement would be perhaps a few hundred thousand tons per year to protect the actual safety and security of the US homeland.
After all, under the present state of affairs true national security is purely a matter of nuclear deterrence---since no country in the world has an even remote capacity to invade North America. Moreover, the steel used in our current massive nuclear retaliatory force (Trident subs, Minutemen missiles and strategic bombers) was produced long ago. That is, we don't need no more stinkin' nukes nor any more steel to launch them.
In fact, if Washington stopped wasting money on aircraft carriers, tanks, amphibious landing ships, TOW missiles, airlift planes and bunker buster bombs, among other weapons of foreign invasion and occupation, the national defense really wouldn't need much more steel annually than is produced by Denmark (70k tons). In today's world, in fact, military steel is about empire, not homeland security.
At least in his tweet storms, the Donald hasn't hidden behind this lame national security defense--even if it is the source of his authority to scare the bejesus out of the rest of the civilized world.
Nope. Trump came right out and said he loathes the outcome of the current global trading system and plans to take drastic action with protectionist malice aforethought. In fact, not even the Oscars could slow him down, as he tweeted Sunday night:
The United States has an $800 Billion Dollar Yearly Trade Deficit because of our “very stupid” trade deals and policies. Our jobs and wealth are being given to other countries that have taken advantage of us for years. They laugh at what fools our leaders have been. No more!
We are on the losing side of almost all trade deals. Our friends and enemies have taken advantage of the U.S. for many years. Our Steel and Aluminum industries are dead.
The funny thing is that Trump has an overwhelming case. Almost to the year that the foolish Trade Act of 1974 was put on the books, the US experienced its last annual trade (goods) surplus in 1975.
Since then, there has been a continuous and deepening of the US trade deficit. That is, a 43-year plunge into the red that marks the vast off-shoring of US production, jobs, and wages.
In all, it cumulates to about $15 trillion more of stuff America bought versus what it sold to the rest of the world since 1975. And needless to say, that doesn't happen on a level playing field.
In that respect, at least, the Donald's so-called free trade critics have their heads buried deeper in the sand than even the orange comb-over. That's because most of them are Saltwater Keynesians of the Harvard/IMF/Brookings school or Freshwater Keynesian of the Friedman/Chicago/AEI persuasion.
Either way, the establishment free-traders seem to think that America can borrow its way to prosperity forever and ever, world without end, and that the mangled state of the US economy after four decades of this kind of trade mayhem is a natural outcome of relatively free markets at work.
No it isn't!
Even when you throw in the $4 trillion surplus on the services account ( tourism, transportation, insurance, royalties and business services) during the same 43-year period, the deficit on current account with the rest of the world is still $11 trillion, and that's in then-year dollars. Inflated to 2017 purchasing power, the balance with the rest of the world since 1975 is well larger than the current GDP of the US.
So notwithstanding his rhetorical bombast and primitive mercantilism, the Donald is on to something. In fact, it's why his candidacy rallied large swaths of voters in Flyover America, and it is ultimately why he won the electoral college, effectively, in the swing industrial precincts of Pennsylvania, Ohio, Michigan, Wisconsin and Iowa.
Alas, the $11 trillion economic enema depicted above (between the blue and orange lines) is not the work of fools, knaves or traitors in the trade negotiations departments of the US government. That is to say, the USTR (US trade representative), the Commerce Department and the State Department trade apparatchiks had comparatively little to do with it; nor can it be pinned on NAFTA, the WTO (world trade organization) or even the globalist minions at the IMF and World Bank, either.
Instead, the malefactors names are Alan (Greenspan), Ben (Bernanke) and the Two Janets (Yellen and Powell). America is losing its shirt in trade owing to bad money, not bad deals.
That's because Keynesian monetary central planning has it upside down. It seeks to inflate domestic prices, wages and costs at 2% per year (or more if correctly measured) in a world teeming with cheap labor---when a regime of honest money would have generated deflationary adjustments designed to keep American industry competitive.
Likewise, Bubble Finance has resulted in drastic financial repression, ultra-low, sub-economic interest rates and debt fueled consumption and financialization---when sound money would have caused the opposite. To wit, high interest rates, low consumption and enhanced levels of savings and investments in order to maintain sustainable equilibrium with the rest of the world.
Above all, America's greatest export was not merely the continuous trade surpluses racked-up every single year between 1893 and 1971, but actually the idea and institutions of free enterprise and capitalist invention. Yet it all went wrong after Tricky Dick's disastrous lurch to 100% state controlled money at Camp David in August 1971.
By unleashing the world's leading central bank to print money at will, he paved the way for the Eccles Building to become a massive exporter of monetary inflation. At length, these floods of unwanted dollars mightily encouraged the mercantilism-prone nations of the East Asia, the Petro-states, much of the EM and sometimes Europe, too, to buy dollars and inflate their own currencies in order to forestall exchange rate appreciation and the consequent short-run dislocations in their own heavily subsidized export sectors.
In subsequent installments we will track exactly how the Fed's great export contraption of monetary inflation brought about the hollowing out of industrial America as per the Donald's case of mistaken blame. But suffice it to say that in the pre-Keynesian world in which a monetary settlement asset governed the flow of trade and international finance, and which was anchored in gold rather than the fiat credit of national central banks, there would have been no such thing as $15 trillion of continuous US trade deficits over 43 years running.
Instead, the large trade deficits caused by the mobilization of cheap labor from the Asian rice paddies and cheap energy from the sands of Arabia would have generated their own correction. To wit, large US current account deficits would have caused a painful outflow of the settlement asset (gold),which, in turn, would have caused domestic interest rates to rise, domestic credit to shrink and prices, wages and costs to deflate.
At length, imports would have been declined, exports would have increased and the US current account would have returned to sustainable equilibrium, thereby bringing about a reflow of the settlement asset.
As it happened, however, the Fed's destructive monetary inflation spread like an infectious disease, and nowhere is that more evident than in the case of the Donald's favorite whipping boy, NAFTA. To wit, Mexico went whole hog trashing its own currency in response to dollar inflation after the inception of NAFTA and the peso crisis in the early 1990s. Since then, the peso's exchange rate has plunged from about 4:1 to 19:1.
Not surprisingly, Mexico's already cheap labor become that much cheaper in dollar terms. Or as the Donald pronounced Monday AM:
We have large trade deficits with Mexico and Canada. NAFTA, which is under renegotiation right now, has been a bad deal for U.S.A. Massive relocation of companies & jobs. Tariffs on Steel and Aluminum will only come off if new & fair NAFTA agreement is signed.....
The evidence for that lays in the other half of the Donald's NAFTA tweet concerning Canada, which he got all wrong. Whatever games the Canadians have played in mercantilist promotion of individual commodities such as forest products, the Canadian exchange rate has not changed much since the early 1990s, nor has its internal prices, wages and costs relative to the domestic US economy.
Not surprisingly, there has also been no trend change in the US trade balance with Canada. Both imports and exports have grown by about 4X compared to their pre-NAFTA levels. In fact, during 2017 US exports to Canada totaled $282 billion and imports from Canada were $300 billion. With exports at 95% of imports, we'd say that's close enough to zero for government work.
Stated differntly, an allegedly "bad" trade deal led to wholly different outcomes as between the NAFTA partner to the north versus the partner to the south.
As we said, the massive trade problem and the resulting drastic decline of the US industrial economy during recent decades is a function of bad money, not bad trade deals. The divergent exchange rate history of these two NAFTA partners since 1993 provides a pretty good illustration of this phenomenon.
When mercantilist nations used the flood of Fed dollars as an excuse to engage in persistent exchange rate suppression and dirty floats, they did in fact steal production and jobs from American workers.
But as we will see in subsequent installments, the solution to that is a hard dollar at the Fed, not loud hollering through a Twitter account from the Oval Office.
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