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2011 December 25 Sunday
Outsourced Manufacturing Hobbles Next Gen Development

An article in Technology Review looks at how outsourcing of manufacturing has reduced the ability to innovate to develop next generation products in the United States. In some cases outsourcing has even slowed the rate of technological progress.

It turns out it's not necessarily true that innovative technologies will simply be manufactured elsewhere if it doesn't happen in the United States. According to research by Erica Fuchs, an assistant professor at Carnegie Mellon University, the development of integrated photonics, in which lasers and modulators are squeezed onto a single chip, has been largely abandoned by optoelectronic manufacturers as they have moved production away from the United States. Many telecom firms were forced to seek lower-cost production in East Asia after the industry's collapse in the early 2000s, and differences in manufacturing practices meant that producing integrated photonic chips was not economically viable in those countries. Thus a technology that once appeared to be just a few years away from revolutionizing computers and even biosensors was forsaken. Economists might argue that we don't care where something is produced, says Fuchs, but location can profoundly affect "the products that you choose to make and the technology trajectory itself."

For the computer industry so far the location of factories that make the hardware hasn't have much impact on software development. But the article makes the point that for many industries where materials manipulation techniques are key to how to make better products the engineers who develop the products need access to materials fabrication facilities in order to try out ideas and to tune manufacturing processes. The problems in manufacturing are constraints on what can be designed and there is a tight coupling between product engineering and manufacturing engineering.

Outsourcing cuts labor costs. But higher labor costs are an incentive to develop cheaper ways to manufacture as well as higher value products. Plus, the proximity that manufacturing plants to engineers enable those engineers to do more innovative work.

The United States has been running trade deficits for many years. Contrary to what a confident and cocky economics econ prof taught my macroeconomics class in college, this has not self-corrected. In a very real sense we are going in hock to the world. Worse still, our outsourcing of so much manufacturing undermines our ability to develop high value products we need to sell in order to pay down our debts.

Some call for more government funding of research in universities in order to boost our innovation. But today a substantial portion of basic research done in US universities is more likely to enable Japanese, Chinese, Korean, and German manufacturing companies to develop new products. The connection between academic researchers and local industry was never that strong to begin with. But now that most of that local industry has decamped to distant locales the model of basic research feeding into industrial innovation in the same country is badly broken.

By Randall Parker    2011 December 25 07:54 PM Entry Permalink | Comments (5)
2011 June 25 Saturday
Chinese Bridges, American Stimulus Spending

Half Sigma points to a report about how Chinese engineering companies are building bridge sections in China and shipping them to the United States. Remember when infrastructure spending was a reliable way to boost domestic employment? Yet another thing to be nostalgic about.

Today, American bridges are built by Chinese civil engineering companies. Today, most of the world’s longest bridges are in China.

The reason why stimulus spending doesn’t work is because even when spend on construction projects, the jobs created are Chinese jobs instead of American jobs.

Real wages are stagnating and clearly there's something wrong (among the things I see wrong: more people chasing shrinking resources). Your choice (if you even have a choice) is to move up or down. You can't stay in a thinning middle class.

And you should give up trying to change things with political action. You are better off trying to become one of the elite yourself so you can get rich from this stuff and laugh at the little people who don’t have jobs from your Hamptons beach house.

How are those who do not have high levels of skills supposed to do okay? Answer: they can't. They will lose still more ground.

Hard to compete against guys making 75 cents per hour.

Pan Zhongwang, a 55-year-old steel polisher, is a typical Zhenhua worker. He arrives at 7 a.m. and leaves at 11 p.m., often working seven days a week. He lives in a company dorm and earns about $12 a day.

According to the article by outsourcing a large chunk of the new Bay Bridge to China the state of California saved $400 million on a project that cost $7.2 billion. But since the US runs a large trade deficit with China every time we outsource an infrastructure to China we go more deeply in debt to the world. How can that be a good idea?

Seriously: Does it make sense to make the US trade deficit with China even bigger?

By Randall Parker    2011 June 25 04:06 PM Entry Permalink | Comments (13)
2011 January 16 Sunday
East Asian Trade Protectionism Takes Many Forms

The CEO of Ford is pushing for a lowering of obstacles for Ford car imports in the South Korean market.

Mulally traveled Wednesday to Washington, where he pressed U.S. Trade Representative Ron Kirk and the Obama administration to make sure that a provision to eliminate U.S. tariffs on imported Korean cars was accompanied by countermeasures that would increase access to the Korean auto market for American companies.

Alan Mulally thinks South Korean Ford customers should not be targeted with a tax audit just because they bought a Ford. This should give you a sense of some of the reasons why the US runs a big trade deficit.

Specifically, Mulally insisted that the U.S. tariffs be rolled back over time, rather than immediately, to make sure Korea held up its end of the bargain. He also pushed for non-tariff barriers be lifted and that a tough enforcement mechanism be implemented. Ford had complained, for instance, that Korea limited the hours that foreign brands could advertise, audited the tax returns of import car owners and manipulated its currency to protect Korean carmakers.

That's not cricket.

Why keep your solar photovoltaics company in the United States...

BEIJING — Aided by at least $43 million in assistance from the government of Massachusetts and an innovative solar energy technology, Evergreen Solar emerged in the last three years as the third-largest maker of solar panels in the United States.

...when you can partner with a Chinese company eligible for big government subsidies?

But now the company is closing its main American factory, laying off the 800 workers by the end of March and shifting production to a joint venture with a Chinese company in central China. Evergreen cited the much higher government support available in China.

What worries me: The giant sucking sound of US intellectual property going abroad. US policy is still shaped around a previous era's conditions. US innovation no longer leads to US factories or, in many cases, even a large trail of supporting engineers to productize an innovation. Former Intel CEO Andy Grove understands what mainstream economists, policy makers, and their glee club hasn't cottoned onto yet.

The United States has a big trade deficit problem that is about to get bigger.

Joseph Gagnon is worried. Mr. Gagnon, a former Federal Reserve economist now at the Peterson Institute, contends in a new paper that the world’s financial imbalances — such as China’s trade surplus and the United States’ trade deficit — will probably return to record levels in coming years.

The rising price of oil is going to make the trade deficit worse as well. I foresee a vicious cycle where the trade deficit drives down the value of the dollar and therefore drives up the price of oil more in dollars than in other currencies. As you make decisions on where to live and work and what to drive prepare for higher gasoline prices.

By Randall Parker    2011 January 16 06:48 PM Entry Permalink | Comments (0)
2010 November 15 Monday
QE2 Improves US Export Position?

The Quantitative Easing round 2 by the US Federal Reserve has elicited criticisms in many quarters, including abroad. At the same time, the Obama Administration has been criticized for not achieving diplomatic progress in reduce the US trade deficit. Menzie Chinn takes a more nuanced view: QE2 is doing what diplomatic negotiations failed to do.

The narrative emerging in the wake of the G-20 meetings is that, not only is the rest of the world angry at us over quantitative easing, but we also achieved none of our diplomatic objectives regarding rebalancing (the coverage seemed particularly negative on CNBC).

...

I think one important point is to realize that achieving economic goals and diplomatic successes are not always the same.

If a leader of one country gets praised by leaders of other countries one needs to ask why. Do not take the praise (or criticism) at face value. Could be the praise is an indication of submission and loyalty. Or it could be a way to boost the position of a leader who is acting against his own country's interests to the benefit of other nations. Leaders and countries are competing for influence, power, and profit. Their statements are calculated to further their interests.

Regardless of what foreign critics of QE2 might say publicly, QE2 is being criticized abroad because it is going to help US exporters at the expense of exporters in other countries.

I have also been thinking about the anger with which the policymakers and economists in the rest-of-the-world (as well as certain US politicians [5]) have greeted QE2 with. In some ways, the fact that they are angry speaks volumes about the effectiveness or ineffectiveness of QE2. (In other words, to criticize QE2 as having no effect, and then to be angry that it is being undertaken, are internally inconsistent views.)

My view is that anger at the US position is currently being driven by an understanding that QE2 has been surprisingly effective at depreciating the dollar, and that the rest-of-the-world has limited scope in countering that depreciation. In a game theoretic context, we usually think of competitive devaluation as a form of the prisoner’s dilemma, where the devalue option dominates the no-devalue option, and both parties end up with a devalued currency, but no net improvement because countries cannot all devalue against each other.

Chinese criticisms that QE2 will cause a Chinese bubble are nonsense. The Chinese government has already caused a Chinese bubble. Reduced Chinese competitiveness in the face of a depreciated US dollar will deflate the Chinese bubble, not inflate it further.

By Randall Parker    2010 November 15 09:51 PM Entry Permalink | Comments (13)
2010 September 27 Monday
Obama Corporate Tax Proposal And Redomestication

Barack Obama, in his infinite wisdom, wants to increase US taxes on the foreign earnings of US corporations. Obama's theory appears to be two-fold:

  • Discourage US corps from investing abroad so that (in theory) US corps will invest more in America. Really, I am not making this up.
  • Get more tax revenue to fund his ambitions for a bigger welfare state to help his most cherished factions among the downtrodden.

Well, you might be thinking that corporations from other countries (e.g. Japan, Germany. China, Britain, India, etc) will displace US corps from foreign markets if US corps face higher costs abroad. Sure nuff. Leaders of Japanese, German, and Chinese corps will cackle with glee as corporations from those countries win those other markets and leave US corps to amortize their R&D over a smaller number of US customers.

You might also be thinking those foreign corps will then displace the US corps from US markets using their scale from foreign operations. Hey, that's how the mercantilists in Japan and, coming soon, China do it with considerable success. But Obama, in spite of thinking he's way more worldly and international than you and me, doesn't seem to have a clear understanding of the whole "US corps no longer dominate most markets" idea. He seems to think he's ruling a country that is back in the 1950s with unchallenged supremacy. Or maybe he's not thinking much at all. Time to go golfing might be the main thrust.

Even without Obama's proposal US corps already have much higher tax rates than corps in any other major country.

The real problem is a U.S. corporate tax rate that over the last 15 years has become a huge competitive disadvantage. The only major country with a higher statutory rate is Japan, and even its politicians are debating a reduction. A May 2010 study by University of Calgary economists Duanjie Chen and Jack Mintz for the Cato Institute using World Bank data finds that the effective combined U.S. federal and state tax rate on new capital investment, taking into account all credits and deductions, is 35%. The OECD average is 19.5% and the world average is 18%.

If you have a choice in where to put your world headquarters why make it in America? Seriously. I can think of lots of reasons to put it elsewhere. This is especially true for any business that has more markets outside the US and inside (i.e. most corps). It is still possible to tap into US worker skills even if a corporation is headquartered abroad. One can use a small number of key US workers or US consultants or US service companies that provide specialized services. Cheap telecommunications, computer networks, and air flights allow much more distribution of work across different sites in different countries.

If forced repatriation of foreign earnings becomes mandatory due to Obama's ambitions then US corps will become more likely to be bought by foreign rivals and more likely to move their headquarters abroad. BTW, the latter move is called "redomestication".

Mr. Obama believes that by increasing the U.S. tax on overseas profits, some companies may be less likely to invest abroad in the first place. In some cases that will be true. But the more frequent result will be that U.S. companies lose business to foreign rivals, U.S. firms are bought by tax-advantaged foreign companies, and some U.S. multinational firms move their headquarters overseas. They can move to Ireland (where the corporate tax rate is 12.5%) or Germany or Taiwan, or dozens of countries with less hostile tax climates.

Think about it. Obama's trying to change the US tax code in a way that will drive US corps to redomesticate. As a corp headquartered in Britain, Ireland, or Switzerland or assorted other suitable countries they'll have no obligation to take profits earned in Brazil, Germany, China, Dubai or India and bring them into the US to be taxed. Only their (smaller) US operations will be taxed the US corporate tax rate.

I first got interested in the redomestication phenomenon a couple of years when one of the stocks in my portfolio went thru a transaction that seemed like a sale where I sold one stock and bought another one of equal value with almost the same name without actually putting in an order. I was trying to figure out what happened and whether I faced a tax liability. Turns out this company I owned stock in had shifted its headquarters to another country and its main corporation became a non-US business. Given that it did most of its business in other countries this move made sense.

I found a web page with the Q&A session of the senior management of this corp where analysts asked questions about its quarterly earnings report right after the redomestication went thru. The CFO said the redomestication went well and would result in a substantial reduction in their total tax bill (about 5% more of their profit would be retained rather than paid in taxes). The amount of money paid to Uncle Sam would go down by much more than the amount paid to another country would go up. That's the real world we live in. The whole top layer managers of US corps move to Britain, Switzerland, or other countries in order to cut taxes and boost earnings.

The US needs to compete. Automatic US business dominance of many lines of business, technologies, and markets is a thing of the past. That means the US government has less leeway to make dumb tax policy decisions. The US government can still make dumb decisions. But the cost in lost market share and living standards in the long run outweigh any benefits the politicians think they gain from their decisions. We need to cut out a lot of dumbness in US government policies. We can't afford as much stupidity as we could afford in the past.

By Randall Parker    2010 September 27 07:25 PM Entry Permalink | Comments (3)
2010 September 06 Monday
Migration Does Not Bring Happiness

The grass might be greener on the other side of the border. But that does not make people happier.

The grass might not be greener on the other side of the border, a new study from the University of Leicester has found.

Economic migrants travelling to different shores for greater income could be set for disappointment – because the pursuit of wealth does not equate with happiness.

Sociologist Dr David Bartram carried out the study: "Economic Migration and Happiness: Comparing Immigrants' and Natives' Happiness Gains from Income." It was published by Social Indicators Research online on 27th August and will be printed next year.

He sought to establish whether those people who were motivated by higher incomes in a wealthy country actually gain greater happiness via migration. He also examined whether these economic migrants might have exaggerated expectations about what they will achieve and experience, such that there is some significant disappointment.

Money can't buy you happiness. This is consistent with a wider body of research literature that shows rising living standards do not increase general levels of happiness. Given the important role that relative status plays in determining happiness I do not find these results surprising. Rising living standards still leave lots of people feeling low status. I see the instinctive desire for higher status as one of the major unsolved problems of Western societies.

Aside: Communism did not begin to solve the status problem. Communist societies created new status hierarchies based on other criteria. But even if communism could somehow have made everyone equal in status that would not have made people feel good as people want higher status. They experience less stress and live longer if they have higher status.

Dr Bartram, of the Department of Sociology, said: "The study of happiness tells us that people generally do not gain greater happiness from earning higher incomes – which suggests that migrants might be mistaken in believing that they will be better off if they can move to a wealthy country.

But open borders libertarians want people to be happy as a result of migration. These migrants are letting down the libertarians. Someone tell the migrants they've got to try harder to be happy for the sake of libertarianism.

Rising aspirations cancel out the psychological benefits of having more money.

"The results suggest that economic migrants might well experience disappointment. Migrants do gain happiness from higher incomes, to a greater extent than natives – but the relationship is weak even for migrants. In fact, it also works out that migrants are less happy than natives. The probable reason is that they expect to be happier by virtue of earning the greater incomes available in a wealthy country - but they end up wanting even more after they get there: aspirations probably increase at least as much as incomes.

If the offspring of immigrants are not going to make as much on average as the existing native population then those offspring will be less happy than their parents. At least the parents still have the reference point of the poverty they experienced in the old country. But the kids born in the new country will calibrate their relative well being against the native population of the new country. The most relevant group for the United States are Hispanic immigrants and their income and wealth gap with whites is not closing. So their children and grandchildren will compare themselves to more affluent whites around them and will be unhappy as a result.

By Randall Parker    2010 September 06 10:09 AM Entry Permalink | Comments (7)
Yen Surge Against Dollar Due To Trade Deficit?

Tokyo-based Bloomberg News columnist William Pesek says a most amazing thing.

Trade surplus aside, there's little economic justification for the yen's 28 percent jump against the dollar since Sept. 1, 2008.

Trade surplus aside. Suddenly I'm thinking "Huge rocket engines rapidly burning huge amounts of fuel producing massive thrust aside, there's little reason why the Apollo rocket should have put the Command Module on a course for the Moon".

The most amazing thing here is not the dollar decline. No, what amazes is that trade surpluses could go on for so long without currency rate adjustments big enough to bring trade back into balance. Maybe Pesek is so used to watching exchange rates that seem unaffected by the trade deficit that he sees no reason the past can't continue. But as Herbert Stein famously put it: "If something cannot go on forever, it will stop." The US trade deficit with Japan can not go on forever. Maybe we are nearing the point where it will stop.

By Randall Parker    2010 September 06 10:05 AM Entry Permalink | Comments (3)
2010 August 21 Saturday
Questionable Value Of A Ricardian Advantage

In the comments section of a post by Menzie Chinn about the June 2010 trade deficit (bigger btw) C Thomson summoned the ghost of David Ricardo, presumably to indicate that all is well and the market will make everything to work out to our mutual advantage. W.C. Varones offers a pithy reply.

C Thomson,

I don't deny that we have a Ricardian advantage in producing debt, derivatives, and accounting fraud.
What I question is the value of that advantage.

Blessed be Ricardo. Can I hear an Amen from the free trader chorus? But that the US has been running a substantial trade deficit for many years and continues to run a large trade deficit is a bad thing. If this trade deficit is the result of the workings of the market then the market has some serious flaws.

By Randall Parker    2010 August 21 09:20 AM Entry Permalink | Comments (15)
2010 July 31 Saturday
US Manufacturing Losing To China Industrial Policies

An article in the San Francisco Chronicle features comments from Silicon Valley executives about China's policies that make US manufacturing unable to compete. China's efforts to dominate LED light manufacturing sound like they will be successful.

For five years, he said, China has given its cities billions of dollars to replace public lights, including traffic signals and street lamps, with energy-saving LEDs.

In addition to creating this internal demand, Watkins said China provided up to 80 percent of the capital for companies to set up LED manufacturing plants.

Now that those policies have spawned 55 LED manufacturing firms, Watkins said China is moving into the second phase of industry building, easing off the subsidies while putting a 20 percent tax on incoming LEDs to protect these domestic makers from outside pressure as they compete amongst themselves to become the survivors that light the world.

With large volumes achievable in China the Chinese makers will go up learning curves that will probably allow them to dominate world LED production. Given that LEDs are going to displace incandescent and fluorescent bulbs for lighting this is a substantial win for them. Former Intel CEO Andy Grove says the shift of so many US factories abroad and growth of US competitors mean the US is losing its long term competitive edge.

The policies that other companies pursue to boost their exports, cut our exports, and boost our imports matter to us. The US trade deficit is about 2.7% of GDP right now.

The gap expanded 4.8 percent to $42.3 billion as U.S. companies imported more automobiles and consumer goods, Commerce Department figures showed today in Washington. The deficit was projected to narrow to $39 billion, according to the median forecast in a Bloomberg News survey. Imports and exports rose to the highest level since 2008.

The growth in the trade deficit contributed to a weakening economy. US economic growth slowed to 2.4% and looks to slow further.

The world’s largest economy will probably keep cooling in the third quarter as a lack of jobs prompts American consumers to rein in spending.

The economy in the U.S. grew at a slower-than-forecast 2.4 percent annual rate from April through June after expanding at a 3.7 percent pace in the previous three months, Commerce Department figures showed yesterday.

The Consumer Metrics Institute has metrics that show the US economy headed back into recession. Trade policy matters. That 2.4% growth rate includes a 1.05% inventory restocking. But sales are down. So factories are probably going to stop restocking and that'll lower economic growth further, perhaps back into a recession.

By Randall Parker    2010 July 31 08:19 PM Entry Permalink | Comments (4)
2010 July 04 Sunday
Andy Grove On Declining US Manufacturing Base

Former Intel CEO Andy Grove has written a piece arguing that the US is losing a long term competitive advantage by outsourcing so much manufacturing abroad.

Today, manufacturing employment in the U.S. computer industry is about 166,000, lower than it was before the first PC, the MITS Altair 2800, was assembled in 1975 (figure-B). Meanwhile, a very effective computer manufacturing industry has emerged in Asia, employing about 1.5 million workers—factory employees, engineers, and managers. The largest of these companies is Hon Hai Precision Industry, also known as Foxconn. The company has grown at an astounding rate, first in Taiwan and later in China. Its revenues last year were $62 billion, larger than Apple (AAPL), Microsoft (MSFT), Dell (DELL), or Intel. Foxconn employs over 800,000 people, more than the combined worldwide head count of Apple, Dell, Microsoft, Hewlett-Packard (HPQ), Intel, and Sony (SNE) (figure-C).

Foxconn will inevitably end up doing more steps of the value generation process. Some of the companies now using Foxconn will get wiped out by Foxconn.

In an earlier era a successful American company like Apple would have generated a large number of American jobs. Nowadays a successful American company generates a large number of Chinese jobs for a different company.

Some 250,000 Foxconn employees in southern China produce Apple's products. Apple, meanwhile, has about 25,000 employees in the U.S. That means for every Apple worker in the U.S. there are 10 people in China working on iMacs, iPods, and iPhones. The same roughly 10-to-1 relationship holds for Dell, disk-drive maker Seagate Technology (STX), and other U.S. tech companies.

You could say, as many do, that shipping jobs overseas is no big deal because the high-value work—and much of the profits—remain in the U.S. That may well be so. But what kind of a society are we going to have if it consists of highly paid people doing high-value-added work—and masses of unemployed?

Plus, we make it worse by importing millions of low skilled peasants from Mexico and Central America. How stupid are we? Very stupid. Our political leadership and opinion makers are incredibly foolish.

Grove says the ratio of money spent to jobs created has soared. Silicon Valley has ceased to be a jobs creation machine for Americans. The cost of that job creation has gone from a few thousand dollars initially invested per eventual job created to $100k per job.

Grove says that we are losing the technological ecosystems needed to stay on the technological edge. The innovations for improving manufacturing efficiency end up being made abroad. Engineers in America effectively cease to be in the loop. We can't stay on the cutting edge in design and product development or in the development of manufacturing equipment if we have no manufacturing industry. He criticizes economists who think that the work moving abroad has a low value added. Grove sees the models of economists as overly simplified and not how the real world works.

I strongly urge you to read the whole article.

By Randall Parker    2010 July 04 09:59 PM Entry Permalink | Comments (7)
2009 December 30 Wednesday
Free Trade Failed To Lift The Poor Into First World Conditions

Writing in the New York Times Eduardo Porter points out that trade disputes have faded in importance as free trade hasn't turned out to generate as much prosperity as expected. Who had these expectations? The politically correct of course.

China’s growth stands as a beacon for the power of trade. But others that have hitched their economic strategy to trade, like Mexico, have found prosperity elusive. Despite growing banana exports, both the Latin American banana exporters and Europe’s impoverished former colonies remain poor.

The North American Free Trade Agreement turned out to be the lion that didn't roar. The wage gap between the United States and Mexico has not narrowed. NAFTA is like a non-event.

At least the elephant in the room is now indirectly mentioned via the term "human capital". As each panacea fails to usher in utopia we inch closer to the truth.

One thing we have learned over the past 15 years is that trade is necessary but not sufficient for development. Countries also need investment in infrastructure, technology and human capital. They need credit. They need legitimate institutions — like clean courts to battle monopolies — and help building them. Putting up a few barriers against banana imports, or tearing a few of them down, can’t do it all.

The users of the term "human capital" can ignore the innate parts of capability in humans. But at least the capabilities of humans are now acknowledged as mattering and differing. We can't just cut taxes, drop tariffs, and then sit back assured that the miracle of capitalism will then unfold. Sometimes when the trade barriers drop all we hear is the deafening thud of silence. But given the right set of human traits something like China's economic explosion happens. Economists will eventually approach reality on economic development. But they need to wait for the neurogeneticists to blaze the way first.

By Randall Parker    2009 December 30 06:15 PM Entry Permalink | Comments (72)
2009 October 02 Friday
Economic Recovery Requires Fixing Global Imbalances?

Satyajit Das argues that we can't fix the economy without fixing the global imbalances in savings and consumption. Looks to me that policymakers have decided to inflate a new bubble rather than address the deeper causes.

A cursory look at the respective economies highlights the magnitude of the task. Consumption's contribution to U.S. GDP is 71%, while in China, it is 37%. Given that the GDP of China is around $4 trillion to $5 trillion, vs. $15 trillion for the United States, and average income in China is around 10% to 15% of U.S. earnings, the difficulty of using Chinese consumption to drive the global economy becomes apparent.

Additionally, over the last 25 years, Chinese consumption has declined from around 50% to current levels of 37%. During that same period, Chinese savings have risen and exports have been the engine for growth. Given that a significant portion of exports is driven ultimately by American buyer, lower U.S. growth and declining consumption creates significant challenges for China.

Dealing with these global imbalances has not been a high priority in the various summits, symposiums and talk-fests that global leaders have shuttled to and from. The focus has been ‘NATO' – no action talk only. Half-hearted and unworkable proposals, such as the use of the synthetic Special Drawing Rights as reserve currency, have emerged.

Think about that. In China only 37% of GDP is consumed. The rest is reinvested. The US can not balance its own trade as long as East Asian countries refuse to consume as much as they produce. The US government's budget deficit is in part a reaction to the trade imbalanced caused by Asian savings. The US government is trying to use deficit spending to substitute for the demand loss caused by the large US trade deficit. That trade deficit is caused by external factors - the determination of some other countries to run huge trade surpluses.

The irony is that China's accumulation of dollars doesn't buy them greater security. They can't use those dollars without causing their value to plunge.

Reliance on Chinese foreign currency reserves is probably misplaced. Chinese reserves, a large proportion denominated in dollars, may have limited value. They cannot be effectively liquidated or mobilized without massive losses. Increasingly strident Chinese rhetoric about the safety of their dollar assets reflects increasing panic.

In reality, China is trying desperately to switch its reserves into real assets – commodity or resource producers where foreign countries will allow. In the meantime, China continues to purchase more dollars and U.S. Treasury bond to preserve the value of existing holdings in a surreal logic. On the other side, the U.S. continues to seek to preserve the status of the dollar as the sole reserve currency in order to enable itself to finance itself. The intractable nature of this problem is evident in the frequently contradictory statements from various Chinese spokesmen regarding the official position on the dollar.

Some of China's commodity buys might make sense. If they focus their buying on commodities that are going to become more scarce in the future (e.g. oil) they might even make a profit.

Das says the problems highlighted by the Global Financial Crisis (GFC) can't be solved as long as the huge imbalances in consumption and savings and investment remain. I agree.

No sustainable global recovery is likely without addressing the fundamental global imbalances that lie at the heart of the GFC.

I do not see Timothy Geithner, Ben Bernanke, and other top US policymakers working this problem in earnest.

By Randall Parker    2009 October 02 11:32 PM Entry Permalink | Comments (12)
2009 July 16 Thursday
Obama Plans Feigned Toughness On Trade Partners

US presidents like to pretend toughness on other countries about trade and Obama is no exception.

WASHINGTON -- In a bid to revive support for free trade within the U.S., the Obama administration plans to press foreign nations to increase imports of U.S. agriculture and manufacturing -- but not to push so hard as to ignite a protectionist backlash.

"In order to save trade, we've got to deal more honestly with those who feel like [trade's] benefits haven't been manifested for them," U.S. Trade Representative Ron Kirk said in an interview Tuesday. "We've got to be serious about enforcement."

Okay, he misspoke. What he meant: "We've got to act serious about enforcement."

Bob Davis and Greg Hitt of the Wall Street Journal demonstrate a grasp of the history of US elite trade rhetoric:

To win over a public skeptical about trade, he is now following a course plotted by earlier Republican and Democratic administrations: appear to get tough with trade partners and show that trade deals can boost exports and jobs, then use that credibility to push for new trade deals.

We've had lots of new trade deals. Our trade deficit has gotten much larger. How about cutting down the size of the deficit before trying to get approval for new trade deals?

The excess indebtedness of US citizens has finally brought us to a point where the trade deficit has plummeted in spite of dumb US government policies.

The monthly trade gap, which peaked at $64.9 billion last July, plummeted nearly 10 percent in May to $26 billion, the Commerce Department reported Friday. After the monthly trade deficit increased relentlessly over 15 years, the recession has managed to cut it by 60 percent in less than a year.

Where there you go. All it took was the biggest downturn since the Great Depression. Now we just have to have a downturn bigger than the Great Depression and we could run a surplus.

If previous Republican and Democratic administrations had gotten substantially serious about getting tough with trade partners we would not now be in hock to the world. But of course we are (need some numbers on annual trade deficit, percentage of GDP, and total indebtedness here).

It would help if press coverage of the US trade deficit and growing indebtedness to the rest of the world grasped the essence of it. But no. This Bloomberg article demonstrates the widespread misinformation about the growing US indebtedness to the world.

July 16 (Bloomberg) -- China’s foreign-exchange reserves are surging again, helping the Obama administration sell unprecedented amounts of debt as it seeks to drag the world’s biggest economy out of a recession.

Stockpiles of currency rose by a record $178 billion in the second quarter to top $2 trillion for the first time, the People’s Bank of China said yesterday.

When the US sells debt abroad this pushes up the dollar against other currencies, decreasing foreign demand for US goods and services while boosting US demand for foreign goods and services. So both Americans and foreigners pay less to buy from America. This decreases demand for what US companies produce within the borders of the US.

Here's the core point: This low demand for products of the US economy leads the Obama Administration to borrow money from the Chinese to bolster demand that was undermined by the Chinese purchase of US debt. We are just digging the hole deeper. If we bought stuff from the Chinese and they used the dollars they received to buy stuff from us then we wouldn't need to borrow from them to bolster domestic demand.

By Randall Parker    2009 July 16 07:57 PM Entry Permalink | Comments (2)
2009 May 16 Saturday
China US Treasury Buys Contributed To Housing Bubble

Economics writer David Leonhardt of the New York Times admits something our elite media should have been focusing on years ago before so much damage was done: China's buying of US treasury bonds contributed to the housing bubble and financial crisis.

Over the past decade, China and the United States have developed a deeply symbiotic, and dangerous, relationship. China discovered that an economy built on cheap exports would allow it to grow faster than it ever had and to create enough jobs to mollify its impoverished population. American consumers snapped up these cheap exports — shoes, toys, electronics and the like — and China soon found itself owning a huge pile of American dollars. Governments don’t like to hold too much cash, because it pays no return, so the Chinese bought many, many Treasury bonds with their dollars. This additional demand for Treasuries was one big reason (though not the only reason) that interest rates fell so low in recent years. Thanks to those low interest rates, Americans were able to go on a shopping spree and buy some things, like houses, they couldn’t really afford. China kept lending and exporting, and we kept borrowing and consuming. It all worked very nicely, until it didn’t.

It all worked very nicely? So then as American factories shut down and got moved to China that worked well? What about the laid off workers left behind? What about the loss of future American productive capacity that happened as we hollowed out? What about the accumulating debt? For some of us the damage being done was apparent years ago. In 2003 Warren Buffett wrote an article Squanderville vs Thriftville calling for policy changes to balance trade.

If one tracks fundamentals and if one measures one's well being by the fundamentals it is easy to see when things are going poorly even if some of damaging effects won't become evident for some years. Is it really too much to ask of economists and economics writers to think about the long term?

Leonhardt admits the Chinese debt purchasing was a cause of the current crisis.

It has already helped create the global economic crisis, by splashing cheap money around the world and enabling American indebtedness and overconsumption. This country is now suffering through its worst recession since the early 1980s, one that could ultimately become the worst since the Great Depression.

Chinese purchases of US debt raised the value of the dollar, decreased US exports, increased US imports, reduced domestic investment in manufacturing industries, contributed to the housing bubble, and increased public and private indebtedness.

Foreign buying of US sovereign debt was one of the two biggest contributors to our on going financial crisis. The other big contributor was the political class's response to immigration: elite support for a huge increase in housing lending to non-Asian (read "poor") minorities. Where did the housing disaster hit hardest? "the immigrant share of the county population is the one that emerges as the most important correlate with the foreclosure rate." The US government's attempts to promote home ownership among the downtrodden has a long disastrous history.

Getting back to China: We need to consume less and make more stuff. The Chinese need to consume more and buy some of our stuff. Can our financial elite manage the transition back to a balance of trade without causing a depression? We are going to find out.

By Randall Parker    2009 May 16 10:31 AM Entry Permalink | Comments (6)
2009 March 14 Saturday
US Trade Volume Plummets

The decline in international trade is far larger than the decline in domestic economies around the world. If domestic economies collapsed as rapidly as trade then we'd be in a depression worse than the 1930s.

The U.S. trade deficit narrowed in January to $36 billion, the lowest level in six years, on tumbling American demand for everything from OPEC oil to Japanese automobiles, Commerce Department figures showed today in Washington. The Labor Department said prices of imported goods dropped for a seventh month in February, another byproduct of the global recession.

Imports fell faster than exports in large part due to lower oil prices. The US trade deficit will therefore shoot up when the economy starts expanding again - and even before then as lower oil production and less oil exploration reduce oil supplies. The decline in the deficit is less remarkable than the decline in overall trade flows. An approximate halving of trade is a massive reduction.

American exports have slumped at a 44 percent annual pace in the most recent six months of data, with imports shrinking 51 percent, probably the most since the Great Depression, according to Morgan Stanley analysts. The figures may add to pressure on the Obama administration to rework international agreements and include protections for U.S. workers and the environment.

The economic deterioration is similar to what happened in the 1970s but worse.

China's exports are down by only a quarter.

HONG KONG — China’s exports plunged by a record 25.7 percent last month, but investment spending surged as the country’s stimulus program took hold, Beijing authorities said Wednesday.

China still expects to run a large trade surplus and achieve a high rate of economic growth in 2009.

Mingchun Sun, China economist for Nomura International, lowered his forecast for China’s trade surplus this year to $155 billion, compared with $295 billion last year. But because so much of China’s exports consists of reprocessed imports — like assembling DVD players from imported computer chips and other foreign components — the Chinese economy may still reach the government’s target of 8 percent growth, he said.

I'm guessing they won't achieve 8% growth though.

The US trade deficit with China grew.

By region in data not seasonally adjusted, the trade gap with Canada, the country's largest trading partner, continued to shrink, to 2.5 billion dollars, its weakest level since May 1999.

The politically sensitive massive gap with number-two trading partner China rose to 20.6 billion dollars in January from 19.9 billion dollars in December.

The US runs few trade surpluses.

The January figures showed surpluses, in billions of dollars, with Hong Kong $1.0 ($1.0 for December), Singapore $0.7 ($0.7), Australia $0.6 ($0.7), and Egypt $0.2 ($0.2). Deficits were recorded, in billions of dollars, with China $20.6 ($19.9), Japan $4.3 ($5.3), OPEC $4.0 ($4.7), the European Union $3.5 ($7.0), Mexico $2.7 ($4.1), Canada $2.5 ($2.8), Korea $1.9 ($1.4), Taiwan $1.3 ($1.3), and Venezuela $1.1 ($1.2).

Advanced technology products (ATP) exports were $18.7 billion in January and imports were $20.7 billion, resulting in a deficit of $2.0 billion. January exports were $3.3 billion less than the $22.1 billion in December, while imports were $3.6 billion less than the $24.3 billion in December.

See this set of tables for some by-country breakdowns of US imports and exports. What leaps out at me: The US exported $4.178 billion of goods to China in January but imported $24.748 billion from China. That is a ratio of over 5.9 dollars of goods purchased per dollar of goods sold. Remember in the 1990s when business leaders and free market economists trumpeted a free trade agreement with China as opening up a vast market for our goods and services? What a joke that turned out to be.

By Randall Parker    2009 March 14 12:00 PM Entry Permalink | Comments (4)
2008 December 27 Saturday
Ben Bernanke Sees China As Cause Of Lack Of US Savings

Enforced savings by the Chinese government causes a lack of savings in the US. It also causes financial distortions that lead to bubbles.

WASHINGTON — In March 2005, a low-key Princeton economist who had become a Federal Reserve governor coined a novel theory to explain the growing tendency of Americans to borrow from foreigners, particularly the Chinese, to finance their heavy spending.

The problem, he said, was not that Americans spend too much, but that foreigners save too much. The Chinese have piled up so much excess savings that they lend money to the United States at low rates, underwriting American consumption.

I've been complaining about this for years. Can the head of the US Federal Reserve get people to take this problem seriously?

Here's how it works: Americans buy something from Chinese exporters. The exporters get dollars and are required by the Chinese government to deposit them in a Chinese bank at a fixed exchange rate. Then the Chinese bank (which is really part of the Chinese government) takes those dollars and buys US Treasury bonds. One effect of doing this is to keep the US dollar strong against the Chinese currency. This cuts US sales to China by making US goods more expensive in China while simultaneously making Chinese goods cheaper in the US.

How does this cause a financial bubble in the US? Easy enough. The Fed sees that US companies aren't generating enough economic activity in the US (what with lots of factories shifted over to China and engineering as well). It expands the money supply to try to generate more economic activity here. Normally an over-expansionary money supply should cause inflation in the US. But the Chinese are keeping goods prices low with cheap imports.

The Chinese purchases of US Treasuries inject money into the US financial system and lower interest rates while also making imported goods cheap at the same time. Since consumer goods inflation is prevented by the cheap Chinese goods the monetary expansion causes inflation in the prices of real estate and financial assets instead. The inflation has to pop up somewhere.

The lower interest rates cause potential investments to look more attractive than a non-distorted money supply would cause them to look. The result was an excessive investment in the financial industry and in real estate. This caused excessive spending in industries that supply construction materials and in luxury goods as well. Eventually the bubble burst. We all see the results.

Other factors contributed to the real estate binge. Foolish deregulation of government-insured banks and really dumb policies aimed at boosting home ownership of non-Asian minorities (NAMs) both played roles in causing the unfolding financial disaster. But this one big monetary distortion caused by mostly East Asian countries played an important role in creating the mess we are in.

By Randall Parker    2008 December 27 08:56 AM Entry Permalink | Comments (10)
2008 November 18 Tuesday
China Becomes Biggest US Treasury Buyer

China has passed Japan as the biggest holder of US government sovereign debt.

China led all foreign official investors in September by posting a net increase in U.S. Treasuries for the sixth month in the past seven, bringing its total ownership close to $600 billion. Japan was a net seller of Treasuries for the fourth month in the past six.

Some people amazingly see this as a positive development.

“The details of the report paint a much more positive picture of cross-border investments than expected,” said Michael Woolfolk, a senior currency strategist at Bank of New York Mellon Corp. “China, along with others, is showing more demand than anticipated for U.S. assets.”

This guy is a senior currency strategist. What explains his statement? Is he long on US dollars? The Chinese buying of US Treasuries boosts the value of US dollar versus the Chinese currency and therefore makes Chinese goods cheaper in the US and US goods more expensive in China. This increases the flow of goods from China to the US and decreases the flow in the opposite direction.

I tend to think of investments as purchasing of productive assets. By that measure the Chinese government is not investing in the United States.

If China's government did not buy US Treasuries then the interest rate in the US would rise. The higher interest rate would serve as an incentive for more private savings by US citizens. It would also serve as a signal to the US Congress and President that they are spending and borrowing too much. The East Asian purchases of US debt effectively encourages the American people and their leaders to live beyond their means.

By Randall Parker    2008 November 18 10:41 PM Entry Permalink | Comments (2)
2008 July 31 Thursday
East Asian Bond Purchases Seen As Cause Of US Trade Deficit

A lecture by Financial Times writer Martin Wolf in 2005 entitled "Will Asian Mercantilism Meet its Waterloo?" correctly called attention to Asian purchases of US debt as the cause of the massive US trade deficit and the housing bubble.

Thus, the job of sustaining demand in the context of the huge drain on demand of the current account deficit shifted from the private sector to the government sector. If the US government had not gone so massively into deficit, what would have happened? Either a big recession, which would have reduced the current account deficit somewhat, or a still more aggressive monetary policy. Fed Funds might well have hit zero, as the Federal Reserve tried to sustain a huge private sector financial deficit in the post-bubble era.

The widely held view that the fiscal deficit is causing the current account deficit is, therefore, the wrong way round. It is much closer to the truth to say that the current account deficit is causing the fiscal deficit.

It is equally wrong to argue that the current account deficit is merely the consequence of relatively fast US growth. It is rather the consequence of relatively fast demand growth, in relation to supply, itself a function of the overall real exchange rate — or, to put the point in less technical terms — of US (un)competitiveness.

This story can be told in the following way: US demand has had to grow faster than potential GDP to accommodate foreign lending. Technically, at the real exchange rate of the dollar created by the policies of the rest of the world, US demand has had to grow faster than potential output, if actual output is to grow in line with potential output. And that is again precisely what has happened. From 1997 to 2003, inclusive, real demand grew faster than GDP in every year, except 2001, the year of the slowdown. Cumulatively, the difference was more than 4 per cent of GDP. The price that had to be paid was policies that promoted what may well prove to be a housing bubble, after the earlier stock market bubble.

We had a massive misallocation of capital, huge US government deficits, and a housing bubble so that the Chinese could build up large foreign reserves and grow their factories.

We live in a world of manipulated currencies and mercantilistic countries competing with countries which have lower barriers to trade. When the Doha trade talks finally collapsed recently a major reason was that the Chinese leaders decided that protecting their farmers was more important than a new world trade agreement.

After nine consecutive days of high-level talks, discussions reached an impasse when the United States, India and China refused to compromise over measures to protect farmers in developing countries from greater liberalization of trade.

Supporters of the so-called Doha round of talks, which began in 2001, say a deal would have been a bulwark against protectionist sentiments that are likely to spread as economic growth falters in much of the world.

Peak Oil is going to cause major economic contraction. Will this strengthen trade barriers?

By Randall Parker    2008 July 31 11:53 PM Entry Permalink | Comments (6)
2008 June 14 Saturday
High Commodity Prices Might Cause Stagflation

Countries that maintain dollar pegs with their currencies must relax monetary policy when the US Federal Reserve relaxes monetary policy. Otherwise their currencies would rise against the dollar. Well, the Fed relaxed monetary policy in 2007 and into 2008 in order to prevent the popping of the housing bubble from causing a recession. But East Asian countries relaxed their currencies too. This sped up the growth rate of their demand for commodities and in doing so contributed to the rise in commodity prices. The rise in commodity prices pushes up prices over a large range of goods and services and could force the Fed to raise interest rates even as unemployment rises.

"The important thing to recognize is that we are more interconnected financially with the rest of the world," says Tim Duy, an economist at the University of Oregon in Eugene. "The expectation ... was that oil prices were going to go down" as the US economy slowed, but that didn't happen, he says.

One reason is simply that the US, while still by far the world's largest single economy, is now counterbalanced somewhat by fast-rising emerging nations. Their continued strength has buoyed both the global economy and commodity prices.

But Mr. Duy says that another factor may be at work – an unintended consequence of the Fed's recent interest-rate cuts.

When the Fed eases monetary policy to stimulate growth at home, other nations with currencies pegged to the dollar also have to ease their monetary conditions in order to maintain their exchange rates. The result is more money in the global system, which translates into more upward pressure on oil, food, and other prices.

"That linkage of domestic policy having global impact [and then rippling back into US consumer prices] is new for the Federal Reserve," Duy says. "If it is true, I think it does represent a significant change."

The inflation rate is already higher than the Fed acknowledges.

Some argue that inflation is not out of control.

Nor has inflation spread across the rest of the economy. The core rate, which excludes food and energy, has been eerily consistent for a long time. In April, the annual core inflation rate was 2.3 percent higher than a year before. In April 2007, it was up 2.4 percent. In April 2006, 2.3 percent. A year before that, 2.2 percent.

I see two flaws in this argument. First off, the focus on "core inflation" is suspect since people spend real money on food and fuel. Second, rising commodity prices have squeezed producer profits and their input costs have gotten high enough that they are starting to pass along more costs.

Prices are 4.2% higher than a year ago. That is a substantial rate of inflation. The Fed has put other priorities ahead of price stability.

On an annual basis, inflation worsened for the first time in four months, running at 4.2 percent in May compared with a year ago.

The index, which rose more than economists had forecast, comes on the heels of repeated warnings about inflation from the world’s central banks. The chairman of the Fed, Ben S. Bernanke, joined other bank officials this week in focusing on higher prices, citing the economic damage wrought by the record run-up in food and oil prices.

Since the causes of inflation are worldwide only a worldwide recession will put a damper on inflation.

By Randall Parker    2008 June 14 12:36 AM Entry Permalink | Comments (2)
2008 April 27 Sunday
Martin Feldstein Foresees Further Dollar Drop

The US dollar has not dropped far enough yet to close the US trade deficit.

The dollar has declined during the past two years against not only the euro but also against most other currencies, including the Japanese yen and the renminbi. On a real trade-weighted basis, the dollar is down about 13% relative to its value in March 2006.

This improved competitiveness of American goods and services is needed to shrink the massive US trade deficit. Even with the dollar’s decline and the resulting 25% rise in US exports over the past two years, the US still had an annualized trade deficit at the end of fourth quarter of 2007 of about $700 billion (5% of GDP). Because US imports are nearly twice as large as US exports, it takes a 20% increase in exports to balance a 10% increase in imports. That means that the dollar must fall substantially further to shrink the trade deficit to a sustainable level.

The dollar has to fall much further because of the rising price of a barrel of oil. Peak Oil will send the cost of oil far higher and the United States and other countries will have to export far more in goods and services in exchange for the oil. In other words, we do not just need to export another 5% of our GDP to close our current trade deficit of 5% of GDP. We also will need to export several percentage points more of our GDP to pay for future oil price increases.

Another doubling in the price of oil will not double our oil import bill because a lot of demand destruction will occur as oil prices go up. But we are going to have to give up a lot more stuff to the rest of the world in order to balance our trade. More for them means less for us.

Given this trend a job in an industry which sells most of its goods and services abroad might be the ticket for job security.

By Randall Parker    2008 April 27 02:04 PM Entry Permalink | Comments (8)
2008 February 01 Friday
China Inflation Spilling Into United States

For a few years now I've held the view that foreign buying of US bonds was causing a weak US currency, cheap imported consumer goods prices, the large US trade deficit, and inflation of housing and capital prices. But the conditions that caused this state of affairs are coming to an end. Prices are rising in China and causing higher prices in the US.

Soaring energy and raw material costs, a falling dollar and new business rules here are forcing Chinese factories to increase the prices of their exports, according to analysts and Western companies doing business here.

The rise was a modest 2.4 percent over the last year. But even that small amount, combined with higher energy and food costs that also reflect China’s growing demands on global resources, contributed to a rise in inflation in the United States. Inflation in the United States was 4.1 percent in 2007, up from 2.5 percent in 2006.

Because of new cost pressures here, American consumers could see prices increase by as much as 10 percent this year on specific products — including toys, clothing, footwear and other consumer goods — just as the United States faces a possible recession.

Welcome to the 1970s flashback era of stagflation.

Place this in context. For a few years Alan Greenspan has been saying he sees an eventual resurgence of US inflation on the horizon. I've never heard him say why. But put this in context. We've had a huge run-up in oil prices for a few years without a recession (at least until now). We underwent too much monetary expansion. But the monetary expansion didn't cause consumer price inflation because we were getting flooded with cheap Chinese goods and the Chinese were using their trade surplus to buy US bonds to keep their currency weak and the prices of their goods low in the US. The monetary expansion did cause an inflation in housing prices and other more durable asset prices.

Well, all that was not sustainable. Hence the recession. Economist Martin Feldstein at Harvard says the housing asset price inflation enabled American consumers to borrow against their equity to keep their buying power up even as energy prices rose.

MF: In the post-World War II period, recessions have been preceded by a combination of increased oil prices and high interest rates. And we certainly got a dose of both of those this time. The Fed raised the federal funds rate from 1 percent to 6 percent, and oil prices tripled. So yes, I would have been worried that that combination alone, driven by the high oil prices, could have turned us down. In fact, I wrote a piece in the Wall Street Journal a couple of years ago, asking: Why did the jump in oil prices (that we had then observed—from roughly $20 to $60 a barrel) not push the economy into recession? And I answered that by saying: because there was this surge in home-equity borrowing that allowed individuals to increase their consumption faster than their incomes. I concluded by saying that if energy prices continue to increase, we cannot count on that kind of offset from higher consumer spending financed by mortgage borrowing.

Feldstein says that the US recession probably isn't going to cut into China's or India's economies. This means that total world oil demand probably won't go down as much as US demand if world demand even goes down at all.

MF: I don’t think that India and China are going to be adversely affected by a slowdown in the United States, if it occurs. Now, that’s different from having them pick up the slack, to use your phrase, and provide aggregate demand for the rest of the world. I think those two ideas get confused sometimes when people talk about decoupling. India does not depend on exports to the United States. Similarly, I think the direct impact on [U.S.] imports from China would not be that large. China exports a lot, but its net exports (when you net through how much it imports in order to reexport) are not so much a driving force in their economy, and they have other ways of picking up the slack domestically. In fact, they’ve been worried about the fact that their economy has been growing too fast, and they’ve been looking for ways to dampen it. If their exports slow down, they will shift toward more domestic spending. That’s a very good thing for the Chinese economy and may make for a structural change that will reduce the future trade imbalance between China and the United States. So, I don’t think the Chinese should be that worried about a U.S. recession.

Since oil prices probably won't slacken and prices of goods from China are on the rise a recession in the US will not eliminate 1 source of inflation in the United States while inflation of goods prices from China will add another source. Plus, the US dollar will decline against the Chinese currency adding to that price inflation.

The US has been living beyond its means. This inflation of consumer prices is part of the process of lowering living standards that is needed to bring us back within our means.

By Randall Parker    2008 February 01 11:06 PM Entry Permalink | Comments (0)
2007 September 20 Thursday
US Dollar Hits Parity With Canadian Dollar And 2 Dollars Per British Pound

The dollar hit a record low against the Euro.

FRANKFURT, Sept. 20 — Investors around the world dumped the dollar today, pushing it to an all-time low of $1.40 against the euro and to parity with the Canadian dollar for the first time in three decades as currency traders digested the full implications of the Federal Reserve’s new course for interest rates.

In a nutshell: The US trade deficit has forced the dollar down against unmanipulated currents to compensate for the inability of the dollar to drop against East Asian currencies. Oil hit a new high too. That makes sense. As the dollar declines the price of oil drops in other currencies and that pushes up demand for oil from other countries. Hence the price of oil rises in dollar terms.

At some point the US dollar has to go down against the Chinese and Japanese currencies. The tie of the East Asian currencies to the dollar has driven their value down against the Euro even as they run up huge trade surpluses.

European Central Bank President Jean-Claude Trichet and French Finance Minister Christine Lagarde urged Asian governments to let their currencies appreciate more to close disparities in global trade.

``The yen and the yuan in particular are currencies whose level and spread pose a problem to global trade,'' Lagarde told reporters today after a meeting of euro-area finance chiefs in Oporto, Portugal. Trichet singled out China in saying it is ``desirable'' that Asian nations without floating exchange rates allow more movement in their currencies.

The Europeans are looking at a deluge of cheap goods from America and East Asia. They do not want the US trade deficit to become a European trade deficit. They aren't going to be as complaisant as American policy makers have been about the US trade deficit.

The Canadians are on a roll in large part due to Alberta oil sands production.

Consider what has happened since: the unemployment rate has slid to a 30-year low of 6.0%, wage gains are rolling along at a 4.0% clip, the Toronto stock market is near record highs, house prices have soared, government coffers are overflowing, the strong dollar has helped turn us into champion consumers and we are on the cusp of becoming a creditor nation -- joining the elite ranks of countries like Germany that own more abroad than they owe.

And oh yeah, the world has finally figured out that Canada holds the world's second-largest oil reserves after Saudi Arabia.

Oil hit another new high.

Crude oil prices jumped above $84 a barrel late on Thursday after production platforms in the Gulf of Mexico were shut down ahead of a threatened tropical storm.

Nymex October West Texas Intermediate hit a record $84.10 a barrel, up $2.17, but settled at $83.32, up $1.39 on the day. The October contract expired at the end of trading. The most active November WTI contract was up $1.05 at $80.75.

This is a good time to bring innovative energy technologies to market.

The declining dollar is good news for US manufacturers. But more expensive imports and higher oil prices could combine with the housing bust to push the United States into a recession.

By Randall Parker    2007 September 20 06:50 PM Entry Permalink | Comments (3)
2007 February 13 Tuesday
US Trade Deficit Hits New Record

The US trade deficit continues to grow rapidly.

The gap between what the U.S. sells abroad and what it imports rose to a record $763.6 billion last year, up 6.5 percent from the previous record of $716.7 billion in 2005, the Commerce Department reported Tuesday.

For December, the deficit jumped a bigger-than-expected 5.3 percent to $61.2 billion.

How long will this continue? Can the Chinese and Japanese continue to prop up the value of the dollar against their currencies? I do not see how they can continue this indefinitely. But how long till the correction?

The previous article reports Democratic Party claims that of 3 million manufacturing jobs lost in the US since Bush took office a third of them went due to the trade deficit.

Curiously, House Democrats find rising inequality as a reason to oppose a massive trade deficit. But by that logic if rising inequality is bad these very same people should oppose low IQ immigration.

In a letter to President Bush, top Democrats, including House Speaker Nancy Pelosi (D-Calif.) and Rep. Charles B. Rangel (D-N.Y.), chairman of the Ways and Means Committee, called the trade deficit "unsustainable," listing among its consequences "failed businesses, displaced workers, lower real wages and rising inequality."

The House leaders called on the president to submit an action plan within 90 days aimed at shrinking the deficit by removing barriers to U.S. exports and eradicating trading practices they regard as unfair.

Exports surged but imports grew even faster.

"It was a banner year for U.S. exports," said Joseph Quinlan, chief investment strategist at Bank of America Corp., noting that manufactured exports surged by 14.7 percent, aerospace exports skyrocketed by 30 percent, exports to oil-producing countries jumped by 26.7 percent and exports of advanced technology products to India soared by 60 percent. The United States posted double-digit export gains to 30 out of 41 trading partners in 2006.

But the gains were overwhelmed by America's unrelenting thirst for oil, with the cost of imported energy jumping 20 percent to $291.3 billion during the year. That barely eclipsed the $232.5 billion trade deficit with China, the largest ever recorded with any nation, and a resurgence in imports of fuel-efficient cars that raised the deficit with Japan to a new record of $88.4 billion.

The United States also crossed an ominous threshold for the first time last year, with U.S. income payments to the rest of the world exceeding foreign payments to the United States by $11 billion -- a shift that could escalate pressure on the deficit in the future, Mr. Quinlan said.

We live in what Warren Buffett calls Squanderville. I think we'd be better off in his Thriftville.

By Randall Parker    2007 February 13 11:17 PM Entry Permalink | Comments (2)
2006 December 16 Saturday
China Demonstrates Flaw In David Ricardo Trade Theory

Political economist David Ricardo famously argued for the benefits of trade due to comparative advantages where each participant in trade comes out ahead. Steve Randy Waldman argues that Ricardo is dead.

First, the current incarnation of free trade is coming under pressure not because people are stupid, but because people are smart. The publics in countries like the United States and Britain have been remarkably tolerant of free trade over the last two decades, because the policy-relevant public "gets it", has been persuaded by economists from Ricardo on down that free trade is a positive-sum good thing.

Free trade is a positive sum thing if it is truly free trade and not the result of political distortions of markets. But that's not the world we live in.

Ricardo argued that free trade is mutually beneficial because it leads to specialization. But what happens when trade does not lead to greater specialization?

Free trade is positive sum because of specialization. The idea is that if someone else makes cars better or more cheaply than the UK can, Brits will do some other thing in which they have a comparative advantage, maximizing both overall productivity and the wealth of both nations. But there's a catch to this ancient Ricardian reasoning, a hidden assumption: The other thing that Brits do has to be tradable. If the UK stops building cars, and instead concentrates on home-building and retail sales, then there are no certain gains to trade.

In a nutshell: America is exporting debt rather than exporting products. So we aren't exchanging Chinese towels and shoes for US goods in industries where we specialize. Instead we are just exporting debt in growing piles while a succession of industries cuts back on production. In an amazingly long list of industries the US runs a trade deficit with China. This is madness.

Free trade is failing for a couple or reasons. First off, currency manipulation. The East Asians are buying large amounts of US debt in order to keep their currencies cheap. As a result the US trade deficit keeps growing and growing. Second, intellectual property theft is a problem. A US company that has to buy legal software and pay for the creation and use of intellectual property is at a competitive disadvantage to a Chinese manufacturer who can operate with all illegal software and use intellectual property of others without compensation.

The intellectual property theft problem reduces the amount of new intellectual property generated. If companies can not earn back the costs of developing intellectual property then they'll make less of it.

During recent talks with US Treasury Secretary Henry Paulson Chinese Vice Premier Wu Yi argued that China has to run a huge trade surplus with the United States and manipulate currencies in order to compensate for China's past abuse by colonial powers.

Wu's opening statement Thursday included a lengthy account of China's widespread poverty and history of colonial domination.

"It is our hope that by making an introduction on China's development road and economic strategy for our American friends (we can show) why we have chosen this development road and where it will lead us in the future," she said.

She thinks those Americans who oppose running a huge trade deficit with China do this because we misunderstand China.

"We have had the genuine feeling that some American friends are not only having limited knowledge of, but harboring much misunderstanding about, the reality in China," she said, according to a text of her speech released by the government.

Why should our understanding of China - or lack thereof - have anything to do with the desire to avoid America becoming what Warren Buffett calls Squanderville?

Treasury Secretary Paulson made it clear to the Chinese that he wanted a reduction in our trade deficit because the American public is mad - not because the trade deficit is harmful to the national interest.

"The way I've articulated the situation to the Chinese is to look beyond Congress," Paulson said. "Congress is a reflection of the American public, and the American public has a perception that the benefits of trade between our two countries aren't being shared equally or fairly."

Following the talks, officials on both sides avoided any suggestion of concrete progress on the principal American demand that China should stop undervaluing its currency as a way to promote exports.

So sorry Chinese leaders. We'd be happy to go along with the Squanderville status quo. But our public forces us to go through the motions of complaining to you in hopes you'll stop pegging your currency. Not to worry though. We are just going to complain and then go home and do nothing. We are on your side on this and trying to ignore our own masses to the extent possible.

I do not think we should be bargaining with the Chinese over their currency manipulations and over our mounting debts to the world. We should just enact tariffs and gradually raise them till the trade deficit declines to a balance. But that course of action is anathema to the "free trade" zealots.

By Randall Parker    2006 December 16 09:36 AM Entry Permalink | Comments (24)
2006 October 18 Wednesday
US Trade Deficit Hits New Record

The American people should not be so blase about the size of the trade deficit. We are living far beyond our means.

The U.S. trade deficit rose to a record $69.9 billion in August, driven by high oil prices, a growing trade gap with China and rising consumer demand for imported goods from antiques to appliances, the government said yesterday.

The trade deficit was 2.8 percent bigger than in July, despite strong growth in exports, led by sales of agricultural products and aircraft, the Commerce Department reported. American companies sold $122.4 billion worth of goods and services overseas in August, an increase of $2.7 billion over the previous month.

Even if we could somehow magically replace oil with another energy source that would eliminate only $20.8 billion of the $69.9 billion August 2006 deficit.

Our yearly deficit with China will be over twice as much as the cost of the Iraq war - and the Iraq war won't last as long.

The total value of imports rose by 2.4% to $192.3bn in August, while exports rose by 2.3% to $122.4bn.

During August, the politically charged trade deficit with China rose by 12.2% to a monthly high of $22bn. The is on course to top last year's record figure of $202bn.

The $22 billion deficit with China represents over 31% of the total trade deficit. Take it away and the US would still have a trade deficit that is far too large. But part of that is due to other East Asian countries trying to keep their currencies just as weak as the Chinese Renminbi currency so that they are not overwhelmed by Chinese imports. But they also keep their currencies weaker so that they can export to the US.

Exports to China actually dropped.

The politically sensitive deficit with China widened to $22 billion, exceeding the previous record of $20.5 billion reached in October 2005. Thursday's report showed that imports from China increased to an all-time high of $26.7 billion in August. U.S. exports to the Asian nation fell to $4.8 billion.

Remember when all of America's business leaders converged on Congress en masse in May 2000 to argue for granting China status as a Permanent Normal Trade Relations (PNTR) trade partner? This was supposed to open up a massive market for US goods. All it did was allow capitalists (e.g. Wal-Mart's bosses) to automate and speed up the indebting of America to the world.

Why are people living so far beyond their means? Does the influx of foreign money drive down the cost of borrowed money so much that people run up more debt? Or has the development of mechanisms to aggressively market credit cards and other debt instruments worked on human weaknesses to buy now and worry later to lure an increasing percentage of the populace to live beyond their means? Has capitalism become the enemy of prudent living and sound personal economics?

Democrats claim they could do a better job of closing the US trade deficit.

Democrats, hoping to take control of the House and Senate from Republicans, contended the August deficit figure underscored the need for a change in trade policies being pursued by President Bush and the Republican Party.

They said the administration has failed to crack down on unfair trade practices of other nations including China's currency manipulation and its widespread piracy of U.S. goods.

Just a reminder to the Democrats: Democrat Bill Clinton was instrumental in opening the US market to Chinese goods.

The big corporations and their stockholders do not see the trade deficit as a threat to their interests.

The Dow Jones index of major US shares swept above the 12,000 level for the first time on Wednesday but eased back to close short of the landmark level.

The index rose as high as 12,049.51, boosted by falling US inflation, oil and petrol prices and ongoing optimism about corporate earnings.

A slowing of job growth is also not seen as a threat to the profitability of large cap stocks.

The US economy added 51,000 jobs last month, far below analyst expectations, in another signal of slowing growth.

...

Last month's figures contrast with job additions of 188,000 in August and 123,000 in July.

One reason the capitalists can be optimistic about how things are going even as many workers are doing worse is that an increasing portion of all economic output is going to corporate profits.

One way to comprehend what is happening is to look at the split between how much of the economy is won by profits and how much by wages.

The share allotted to corporate profits increased sharply, from 17.7% in 2000 to 20.9% in 2005, while the share going to wages has reached a record low.

If the shift of revenue from wages to profits is due to higher productivity of smart holders of capital then this trend is not so bad. But I wonder if it is due in part to flooding the US labor market with imported labor and I wonder if the higher profits are coming via shifting of external costs onto the rest of us. How much of those profits are paid for by the middle class with taxes that fund for the health care, crime handling, and other costs of the cheap imported labor?

By Randall Parker    2006 October 18 05:43 PM Entry Permalink | Comments (7)
2006 July 23 Sunday
Japan Gains Against US In Exports To China

Why did Japan do better than the United States in exporting to China?

Japan’s auto sector now accounts for one-third of U.S. auto market sales. But Japan still depends on exports and, since 2001, has been much more exposed to the Chinese market. Japanese exports to China, which were very small before 2000, make up almost 15% of total Japanese exports, while the U.S. share has declined by nearly the same amount.

Japan’s export base increased at a 20% annual rate between 2002 and 2004, with almost a quarter of this growth coming from China. During this period, Chinese imports were growing at about a 50% annual rate, while Japan’s exports to China were rising at almost a 60% annual rate.

“China’s explosion onto the world economic stage was a huge boon for Japan, which not only benefited in terms of export stimulus, but from a direct source of domestic stimulus to an economy that had struggled to find the momentum to lift itself out of its long-term recession,” says Fosler.

But Fosler says much of the optimism about Japanese economic growth may be a delayed reaction to the better than expected performance of 2004-2005 rather than a hard-nosed appraisal of the future. Recently, Japan’s machinery export orders and industrial activity have been flat, and its profit growth is slowing rapidly and its productivity growth is stagnating. And China’s exports, which have been important to all of Asia, are now rising at only about a 15% annual rate.

My guess: Japanese businesses are less eager than American businesses to move factories from the home country to China. So what would have been US export growth to China instead became US companies making their goods in China for the China market. Mind you, that's just a guess.

Anyone have a source for what percentage of manufacturing of US and Japanese companies takes place in the home countries versus various other countries?

By Randall Parker    2006 July 23 01:02 PM Entry Permalink | Comments (5)
2006 March 13 Monday
Stephen Roach: China Saving Half Of GDP

One reason why the US trade deficit is 5.8% of GDP:

The numbers leave little doubt as to the extraordinary contrast between the two economies. Last year China saved about half of its gross domestic product, or some $1.1 trillion. At the same time, the US saved only 13% of its national income, or $1.6 trillion. That's right, the US, whose economy is six times the size of China's, can't manage to save twice as much money.

And that's just looking at national averages that include saving by consumers, businesses, and governments. The contrast is even starker at the household level — a personal saving rate in China of about 30% of household income, compared with a US rate that dipped into negative territory last year (-0.4% of after-tax household income).

These are extreme readings by any standard. The US hasn't pushed its personal saving rate this far into negative territory since 1933, in the depths of the Depression. And the Chinese rate is higher than it has been at any point in the past 28 years, since its modern reforms began. Similar extremes show up in the consumption shares of the two economies — the mirror image of trends in personal saving rates. US consumption has held at a record 71% of GDP since early 2002, while Chinese consumption appears to have slipped to a record low of about 50% of GDP in 2005.

China's lopsided economy and their manipulation of their currency (the awkwardly named renminbi) are setting the US up for a severe fall should the Chinese go into a depression. Chinese money is keeping US interest rates unnaturally low and is feeding the US housing boom. All that could change very rapidly should the Chinese economy go unstable.

The focus of many economics and free marketeers on tariff trade barriers and their complaints when Bush restricted steel imports strike me as a case of fighting the last war. That the US has incredibly low barriers to foreign goods is demonstrated by America's ridiculously high trade deficit. This is a dangerous situation.

Some say the Chinese have a huge trade surplus because they are rapidly developing. Then by that argument the US should have run a huge trade surplus in the 19th century. Did it? I don't think so. My impression is we were net receivers of foreign investment and that while we had high trade barriers we didn't run a large trade surplus.

By Randall Parker    2006 March 13 08:54 PM Entry Permalink | Comments (6)
2006 February 11 Saturday
US Trade Deficit For 2005 Was Over 725 Billion Dollars

The mind boggles.

The $725.8 billion deficit, announced Friday by the Commerce Department, was a 17.5 percent leap from 2004's then-record deficit of $617.6 billion. The 2005 trade deficit equaled 5.8 percent of this country's gross domestic product, up from 5.3 percent of GDP in 2004 and 4.5 percent in 2003.

When I hear some argue for lower trade barriers my reaction is they are arguing for the freedom to send the whole nation deeply into debt.

The US runs large trade deficits with most (all?) of its major trading partners.

The $201.6 billion trade deficit with China in 2005 was a sharp 24.5 percent jump from 2004's $161.9 billion gap, prompting critics of free trade to concentrate their ire on that country. (Japan was second at $82.7 billion, up 9.4 percent. Canada was third at $76.5 billion, up 15.1 percent.)

If foreign banks were not buying US debt to push up the US dollar I'd be more sympathetic to arguments for letting the market work it all out. But foreign trade isn't free trade when currency valuations are manipulated by governments.

China sells the US 6 times as much as the US sells China.

America set a record for the value of goods exported to China - $42 billion - but that was dwarfed by the almost $250 billion travelling in the opposite direction.

...

Also contributing to the record figure was the $176 billion of crude oil imports, with America paying an average price of $47 a barrel.

By the way, if the US dollar declines in value that will lower the real cost of oil to the rest of the world since holders of their currencies will be able to buy US dollars more cheaply. That will increase demand for oil in the rest of the world and hence eventually lead to higher oil prices in US dollars. A sharp decline in the US dollar could cause a bout of inflation in the United States.

Organized labor says the trade deficit is doing real economic damage.

"Such a huge trade gap undercuts domestic manufacturing and destroys good U.S. jobs," said Richard Trumka, secretary-treasurer of labor's AFL-CIO. "America's gargantuan trade deficit is a weight around American workers' necks that is pulling them into a cycle of debt, bankruptcy and low-wage service jobs."

Sen. Byron Dorgan (D-N.D)., said the new deficit figure showed that "our trade policy is an unbelievable failure that is selling out American jobs and weakening our economy."

Amazingly, the dollar's value rose even as the US trade deficit broke new records.

The dollar recovered from an initial decline against the euro yesterday. It appreciated 14.4 percent against the 12-nation currency in 2005 and climbed 14.7 percent versus the yen.

I can remember a college economics professor explaining to us how we didn't have to worry about trade deficits since currency values would adjust to cause exports and imports to approximately balance.

Back in 1991 the trade deficit was only 30 billion dollars.

The trade deficit, which has risen more or less steadily since 1991 when it was $30.7 billion, widened 17.5 percent in 2005 to set a record for the fourth year in a row.

The increase in the US trade deficit in 2005 was over 4 times bigger the total US trade deficit in 1991.

Such a huge deficit seems crazy to me and I'm not persuaded by arguments that this is not a problem. I agree with Warren Buffett. Americans are living in Squanderville. The question in my mind: Why is this happening? Wider availability of consumer debt? Some demographic trend in the US population? Foreign governments manipulations of the US dollar? US capitalists shifting their capital abroad to get cheaper labor? Other?

Robert Musil argues that we should see the trade deficits as a massive purchase of political risk insurance by people in other countries. But does that explain our trade deficit with Canada for example? Still, an interesting idea.

What if anything should be done at the level of US government policy about the US trade deficit?

By Randall Parker    2006 February 11 11:01 PM Entry Permalink | Comments (80)
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