Wednesday, December 31, 2008
GETTING THE RIGHT TOOLS
Among other things, the secretary is quoted as saying:
• “… we’ve done all this [in response to the financial meltdown] without all of the authorities that a major nation like the US needs.”
• “We’re dealing with something that is really historic and we haven’t had a playbook. The reason it has been difficult is first of all, these excesses have been building up for many, many years. Secondly, we had a hopelessly outdated global architecture and regulatory authorities …in the US.”
• Future efforts should aim at “better and more effective regulation.”
• “I am sure I am going to look back … and think of all kinds of things I wish I had done differently.”
On a personal level, I feel deep sympathy for the secretary and many of his colleagues who have had to preside over the dismantling of a system that earned them great wealth and sterling reputations. That must be painful and more than a little confusing.
However, I would like to ask Mr. Paulson whether every one of the statements made above might not apply equally to his failed policy to contain mercantilist currency policies. Haven’t the resulting imbalances – trillions of excess currency reserves and other assets in the hands of mercantilist governments – been building for years? Haven’t we lacked the “authorities,” i.e. an effective IMF and WTO as well as national policy tools, to deal with the problem? Don’t we need “better and more effective regulation” to manage the problem?
Paulson’s insistence that he had the tools needed to end monetary misalignment stands in stark contrast to his lamentations regarding financial fraud and failure. He’s wrong on the former for the same reasons as he’s right on the latter. The new administration should scrap this part of Paulson’s playbook and take a fresh approach.
Monday, December 29, 2008
THE THREE R’S
In dealing with the eocnomic crisis, the new administration is not likely to have the same freedom. It’s got to get its own set of three R’s – relief, recovery, and restructuring – right and right from the start. Larry Summers’ op ed piece in yesterday’s Washington Post (“Obama’s Down Payment”) suggested a promising direction. The incoming economic point man touted Obama’s program in the works, the “American Recovery and Reinvestment Plan,” as a way of supporting the “jobs and incomes essential for recovery while also making a down-payment on our nation’s long-term financial health.”
For me, relief is a matter of putting cash and credit in the hands of the many millions of individuals and businesses who desperately need it to avoid calamity. Other sources indicate that the new administration might be considering some form of broad-based immediate tax relief as a way of reinflating disposable income. While they’re at it, the Obamistas might consider relieving employers of FICA payments for the first six months of 2009 to ease labor cost pressures and business cash flow crunches.
Recovery is more a matter of recovery sustained over time with a generous dollop of confidence building. Smart regulation will help in that regard, as we try to convince American creditors with money and those without enough to trust one another again. In his op ed, Summers revised the Obama jobs target again: now it’s 2.4 million private sector jobs and 600,000 government positions. However, as I previously commented, even three million private sector jobs over the next two years wouldn’t come close to qualifying as a real recovery.
Restructuring is what interests me most. That’s partly a matter of investment, of course. Summers makes a good pitch for considering spending on infrastructure, health care, and education as “investments that will work for the American public.” The he adds an argument for “laying the groundwork for recovery and future prosperity … [by] shedding Washington habits.” That implies no Congressional earmarks and other changes in the stupid way we’ve been allocating government resources for a long time now.
I have no problem with Summers’ arguments – as far as they go. However, as I never tire of repeating, long-term success requires fundamentally changing the way we save and invest, produce and consume, export and import. Such a transformation goes way beyond income relief and public investment, no matter how huge the number of dollars injected into the economy. We also need a big increase in private investment in plant and equipment rather than paper assets and estate. That will require, more than anything else, a wholesale revamping of the American tax system. Failing such a fundamental change in the incentive structure, why would a rational investor put money in production facilities in this country when competing nations offer far more attractive terms and conditions?
So, while pursuing relief and recovery, we need to give equal attention to a national strategy to restructure the American economy so that it can be fully competitive in global markets. To get that right, we need a clear, coherent vision of what that economy would look like -- and we need it soon. Otherwise, we’ll end up making a thousand uncoordinated decisions that so muddy the waters as to make subsequent transformative change virtually if not literally impossible. I’m hoping that’s what Summers meant when he concluded: “Far from being an excuse for inaction or delay, the magnitude of the work ahead is all the more reason to begin that work.”
Saturday, December 27, 2008
As the new administration tries to formulate its economic goals, it seems to be consciously aiming low. At first, President-elect Obama hoped to generate 2.5 million jobs in his first two years. Later, he upped the target to 3 million jobs. That would be better, but it’s still a rather paltry number and would hardly constitute a full recovery for
Consider the basic numbers:
--In November, according to government statistics, 10 million Americans were unemployed. That’s more than triple the current target for the next two years.
--The American economy has lost 2.6 million jobs since the peak in June 2007 for total private employment. In November 2008 alone, employment levels fell by 533,000. When December numbers are released, we may be close to or even beyond three million jobs lost in a year and a half.
--According to the US Department of Labor, the natural rate of increase in the work force is approximately 100,000 persons. Thus, every 24 months, 2.4 million jobs would be needed just to stand still.
--So, merely to get back to the June 2007 level will require 2.6 million jobs plus 100,000 for each month thereafter. Eighteen months later, we’re already 4.4 million jobs short – and digging deeper.
--By the mid-point of the first next administration the deficit compared to mid-2007 will be 6.8 million jobs.
When facing the worst economic crisis in 80 years, it may be good politics to lowball expectations. Of course, Obama isn’t the first politician to try to lower expectations. Recall that in far less challenging times Bill Clinton pledged to produce ten million jobs by 2000. It sounded bolder than it was (the natural increase in the workforce would have been expected to eat up almost all the 10 million jobs), and he overshot his target: while the civilian workforce grew by 14.5 million in his two terms, the ranks of the employed soared by 18.4 million. Unemployment fell by 3.9 million workers, pushing the unemployment rate to below 4 percent.
Monday, December 22, 2008
PRIMING THE INVESTMENT PUMP
We all learned this basic accounting identity in school. C stands for household consumption expenditures. I stands for gross private domestic investment. G stands for government spending whether for consumption or investment . X – M stands for exports minus imports, or net exports.
If you want to increase national production and income – as we all do – you have only four choices: increase C, I, G, and/or X - M.
The Congress and the new administration seem largely focused on expanding consumption, even though excessive reliance on consumption-led growth helped bring about the current calamity in the first place. Until the rest of the economy recovers and credit becomes available again on reasonable terms, there is reason to question the efficacy of measures aimed at expanding household spending. Let’s hope they rethink this before pulling the trigger on the next “recovery” package.
They also seem agreed on a sizable increase in government spending. I’ve got no problem with funding “shovel-ready” infrastructure projects. Many are long overdue. However, realistically even such projects will take years to start and finish. Moreover, we need to do than just repair and rebuild our broken-down roads and bridges if we want to restructure our economy. We need to commit to massive new spending on intercity rail, electricity distribution, and broadband service, among other major public investments.
I’ve written and spoken a lot about expanding net exports without yet hearing any echo from the Congress or the next administration. But let’s face the facts: we owe the rest of the world a huge sum that grows daily by several billion dollars, even in this recessionary period. Replacing imports (especially energy) with domestically produced goods and expanding exports (particularly capital goods) are essential if we are to avoid settling our unbalanced accounts through a massive inflation.
The more “bail-out” money we throw around, the greater the risk of inflation and the sooner the day or reckoning. This is not so much an argument against doing what’s needed to stabilize the financial sector and key industries like the automotive sector (and don’t overlook escalating cuts in state and local government services and employment). Rather, it is a plea to use the recovery to rebuild the productive capacity of the United States.
Like government infrastructure projects, private investment projects produce jobs immediately, even before the new plant and equipment becomes operational. How to prime the private investment pump?
In my last post, I promised to propose a way to do so. Thanks to an op ed piece in this morning’s Financial Times, today I’m not alone in suggesting that the answer lies in the US tax code. Fred Smith,ceo of FedEx, urged that we use the leverage of expensing, that is, allowing private investors to write off their full investment in the tax year in which they incur the expense without any dollar limitation. Quite naturally, he sees spending $150 million on a new Boeing 777 is a “big risk.” “The best way to mitigate that risk,’ he argues, “is to allow the company to get that money back quicker. It reduces risk and encourages investment more quickly in equipment, facilities and jobs.” Smith cites tax experts Ernie Christian and Gary Robbins on the multiplier effect of expensing: for every dollar of tax cuts for expensing, the economy gains nine dollars of GDP growth.
Why not go one or two steps farther? Add bonus depreciation for investments made earlier as a means of accelerating the private sector’s decision-making. Instead of just 100 percent write-off, why not consider an extra 30 or even 50 percent in the first year to be reduced by ten percent in each subsequent year? Then lengthen the period for carrying forward losses so that future profits are sheltered by current losses including the expensing and bonus expensing.
The effects of such a tax approach would stimulate the economy in the short term. They would help restructure the economy in the medium term by expanding our productive capacity with state-of-the-art facilities. They would do so with no up-front government expenditure or borrowing. Government revenues would be reduced in the out-years, but they would grow in the near term and beyond as people returned to work to produce the equipment, components, and materials needed for each new investment. Construction and transportation companies would be revived at the same time. This approach maximizes the reliance on market forces and minimizes the growth of government buy avoiding new subsidy programs.
Finally, such a program would provide an outlet for nervous foreign holders of dollars. Investing in Treasurys that produce a negative real return is obviously only a short-run strategy for those with no other place to run to. Let’s use expensing to give them a reason to invest in America and, by helping us rebuild our productive capacity, to restore value to the dollars they continue to hold.
Thursday, December 18, 2008
A stronger dollar raises the price of US exports in terms of freely traded foreign currencies. Over time, that reduces our access to foreign markets. It also tends to lower the dollar price of imports, adding to our deficit. At the same time, a stronger dollar tends to lower the price of imported oil and gas and is more attractive to foreign suppliers of capital. It reduces inflationary and can spur deflationary pressures.
By contrast, a weaker dollar lowers the price of US exports and raises the price of our imports, reducing our trade deficit and the need to borrow to finance it. At the same time, it tends to raise the price of oil and gas imports and prompts foreign suppliers of capital to park their cash in some other currency.
So, it should be clear that any gains from dollar movements: 1) are accompanied by losses in other parts of our economic life; 2) are temporary and subject to reversal, perhaps even in the short-run; and 3) cannot be relied upon to solve our long-term competitive problems. (Mercantilist currency policies, a pet policy peeve of mine, are simply price-fixing schemes that subvert the working of free markets, thwarting the short-term adjustment function of exchange rates.)
To achieve lasting competitive gains, we need smart policies in all the areas that impact our trade performance. The on-going recovery and rescue packages under consideration are our best opportunity to get some of that right. If we don’t, we’re just wasting trillions of dollars that we’ll be unable to repay – a recipe for massive inflation.
In my next post, I’ll advance one simple idea for getting it right, starting immediately, without any up-front government expenditure, and in a way that maximizes reliance on market forces.
Tuesday, December 16, 2008
As huge as the scam was, it is not so surprising that personal greed overcame good judgment in a lot of people who might have and should have known better. What’s shocking is the extent to which reputable banks, insurance companies and other financial institutions fell prey to the same instincts.
That list is long and international: Belgium’s floundering Fortis Bank; France’s BNP Paribas which is supposed to rescue Fortis; Spain’s Grupo Santander; the Royal Bank of Scotland; Japan’s Nomura Securities; MassMutual’s Tremont; and more around the world.
Aren’t these the very institutions that are supposed to know all about risk? Don’t they make ordinary borrowers jump through hoops to provide detailed information and pledge collateral before lending sums that by comparison to the eleven figure fraud perpetrated by Madoff are paltry? Aren’t these the very organizations – the financial professionals -- that want to be entrusted with our money because they know best how to manage it?
By the same token, the performance of the Securities and Exchange Commission does little to relieve our fears. The SEC apparently was asked to look into Madoff’s empire in the 1990s and never launched an investigation. Aspiring crooks everywhere may draw the lesson that if the scheme is sufficiently complicated, your reputation impressive enough, and your political contributions well placed, the regulators can’t regulate and might not even try to.
The ongoing meltdown demonstrates that resolving liquidity problems may just be a matter of cash. Restoring confidence is another matter entirely in a financial system that has betrayed the values of honesty and integrity while celebrating “success” that turns out to be based on elaborate fraud and systematic abuse of trust.
Thursday, December 11, 2008
SECOND KICK OF THE MULE
To make matters worse, the Treasury this week closed the book on eight years of missed opportunities by once again – for the sixteenth time – issuing a semiannual report to the Congress that failed to cite a single country for mercantilist currency practices. To be fair, the Clinton administration record after 1994 was no better. We might know obscenity when we see it, but some people just can’t detect currency manipulation anywhere by anybody despite a mountain of factual and statistical evidence.
In the meantime, Beijing seems paralyzed by internal dissensus on monetary policy. There is open talk from the top of the government about the need to stimulate domestic growth, to reduce the dependence on export-led growth, to keep inflation in check, and to meet the rising expectations of average Chinese for a viable social safety net, affordable homes, and more. The government constantly fiddles with tax rebates, export taxes, price controls, and credit restrictions; it loosens and tightens these crude policy tools in a frantic effort to keep Chinese economic growth on a stable path. Yet it constantly refuses to make use of the one sensible and available macroeconomic tool -- the rate of exchange for the renminbi.
There are many things about the Chinese I may not understand all that well, but I do know they respect strength. Not brute force, but a clear sense of national purpose and a willingness to stand up for legitimate rights and interests. Lacking that, diplomacy is just an empty exercise in rhetoric. Until and unless the US is ready and willing to back its often strong words with some meaningful leverage, “negotiations” over currency matters will produce no meaningful and lasting result.
As I’ve tried to express in earlier postings, five years of diplomatic dithering has produced no real progress toward rebalancing a dangerously out of kilter world economy. Rather, it has allowed a problem that in 2003 was essentially a bilateral trade problem to mushroom into a mammoth mercantilist threat to the world economy.
Thanks to a beloved former client, I have on my desk a small momento quoting Abraham Lincoln: “There is no lesson in the second kick of a mule.” I’ve been pondering this small bit of wisdom from our sixteenth president, wishing that somehow our forty-fourth president, an open admirer and close student of Lincoln, will benefit from the abject failure of his immediate predecessor to confront the currency problem. Let’s hope we don’t have to relive the past before we can escape it.
Wednesday, December 10, 2008
NEIL ARMSTRONG VS. ROSIE THE RIVETER
Yet on reflection, I’ve come to realize that Neil Armstrong is the wrong icon for what lies ahead us as a country. Instead, I’d propose Rosie the Riveter. After Pearl Harbor, she moved from the farm to places like Detroit after Pearl Harbor and used her brain and brawn to produce the hardware that won a world war.
The Apollo program was a national achievement, to be sure. It helped us catch up with the Russians’ lead in space technology, lifted our spirits after a botched invasion of Cuba, and helped the country get over a series of political assassinations that shook confidence in our democracy.
But what did Apollo require of us as individuals? Sure, some of our tax dollars were devoted to the space program. And we watched the big events on television, awestruck by the take-offs, splashdowns and that glorious July night adventure on the lunar surface. But we didn’t have to change a single thing in the way we lived, earned our incomes, or managed our expenses.
During World War II by contrast, we saved, conserved, rationed, reused, substituted, and melted down unneeded metal – all for the war effort. Ordinary people as exemplified by Rosie did extraordinary things. In a period shorter than the current conflict in Iraq, we won a global world and laid the basis for a period of spectacular growth and prosperity.
In the midst of the meltdown of the postwar system, we need to emulate Rosie and all the ordinary citizens who won the WWII on the home front. We need to change many aspects of our lives, learning new skills and developing new habits. While we’ve been profligate and irresponsible, these changes shouldn’t be regarded as a form of punishment or purgatory. If we see them that way, we’ll get over them as quickly as we seem to have $4 a gallon gasoline. Rather we need to dedicate ourselves individually and our country collectively to the pursuit of a new, overriding national objective.
As I’ve written before, the goal for me is clear: Invest. Produce. Export. Pay down our massive foreign debt. Organizing our policies and our personal behavior to pursue those goals will pay off in terms of better jobs, higher incomes, a cleaner environment, a legitimately strong dollar, a more secure country, and a legacy for future generations that we can take pride in. Like World War II, this is a challenge we must accept and conquer. And as Rosie would say: We Can Do It.
Thursday, November 13, 2008
APPRECIATING THE RENMINBI
One would think that such a change would produce substantial effects in the real world. In theory, at least, currency appreciation is expected to reduce trade and current account surpluses and to slow growth in the domestic economy. That’s why overheated economies often seek to strengthen their currencies.
In the case of China, these results have been extraordinarily slow in materializing. In fact, as summarized in the table below, China’s appreciating currency has actually led over the past 39 months to substantially larger imbalances in its bilateral trade with the United States, its overall trade with all trading partners, its current account surplus, and – most shockingly – in the build up of official reserves, which have grown by 168 percent as the RMB was strengthening.
Now by far the largest in the world, China’s reserve position is a matter of concern for the rest of the world. China’s hard currency glut is a destabilizing factor in the shaky world economy. As we discussed in the previous post (“The Mercantilist Menace vs. The Protectionist Peril,” November 11), China’s recently announced stimulus package will not reduce these imbalances unless and until there is a much greater appreciation of the RMB.
Unfortunately, appreciation of the RMB stalled out around the end of July, freezing its value at around 6.85 to the dollar. Since then, foreign money has continued to pour into China by means of its trade surplus (more than $35 billion in October), foreign investment and speculative “hot money.” While the growth in official reserves has tapered off, China is stashing dollars in places not captured by that statistic: the China Investment Corporation (China’s sovereign wealth fund), the Social Security Investment Fund, and commercial banks that are still largely under government control.
When China tries to take credit for its ”stable” currency policy at this weekend’s G-20 meeting, it would be on point if someone would remind China of its obligations under the IMF Articles of Agreement. Article 4 binds China and every other IMF member to “avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.” To maintain an exchange rate that does not reflect market values is to be part of the problem, not the solution.
China may object, but the reality behind these numbers seems to be precisely what meets the eye: Its “stable” currency policy has destabilizing effects for the rest of the world and needs to be abandoned if we are to work our way out of the global financial mess.
Tuesday, November 11, 2008
THE MERCANTILIST MENACE VS. THE PROTECTIOIST PERIL
A few things seem clear:
• It’s no coincidence that the package was announced a week before the G-20 meeting next weekend. China now has a ringing answer to those who might argue that it is “not doing its part” to deal with the global contraction of demand.
• A substantial portion of the package consists of infrastructure spending on rail, roads and bridges. Much of this is aimed at the countryside. As such, it is not really new, as the latest five year plan had promised this sort of assistance of the forgotten half of China’s population.
• Some portion of the funds will be used for earthquake relief in Sichuan. Initially, the government lamely claimed that budgetary constraints limited the size of the relief effort. However belatedly, it will make some amends for that now.
• Another substantial chunk will go to rebuilding the social safety net. That’s long overdue in a country that has allowed ordinary citizens to lose access to health care and dribbles out pensions in de minimis sums.
• The package includes an unspecified amount of commercial lending, reducing the drain on SAFE’s strong box.
• In the current quarter, only $19 billion will be expended. The rest of the package will be spent over the following 24 months (an average of less than $24 billion per month).
We all should rejoice that China is finally attending to some of those left behind by the coastal boom. We should also be grateful that China sees the need to stimulate its own economic growth at a time when many economies around the world are contracting. No doubt that this bundle of measures is a helpful step for Chinese and non-Chinese alike.
But let’s question two contentions. First, how can the managing director of the IMF claim as he did that the stimulus package will produce a significant reduction in the global imbalances that imperil the global financial system? Even if every last dollar in the package were to come from China’s official reserves (and it seems clear that they won’t), the $586 billion would be more than offset by the continued current account surplus. Since the ersatz appreciation of the RMB began in July 2005, China’s reserves have increased – just the opposite of what would be expected – at an average monthly rate in excess of $30 billion. So, if everything else remains the same, the hole in official reserves caused by such a stimulus package would be fully replenished in about 19 months, faster than it is to be expended. At the end of 2010, China’s reserves would be about $200 billion higher than the $1.9 trillion that China acknowledges today.
Without a substantial and immediate revaluation of the RMB, the stimulus package can hardly be termed a major contribution to a more balanced international monetary system.
This leads to a second observation relating to this weekend’s G-20 meeting. On November 10, British Prime Minister Gordon Brown praised the “global power of nations working together” and urged the rejection of “beggar-thy-neighbor protectionism that has been a feature in transforming past crises into deep recession.” I’m not sure why Brown shied away from calling the Great Depression by its common name, but I do wonder what protectionist pressures he is afraid of. Who in the world is seeking at this time to raise tariffs, impose import quotas, or erect new non-tariff barriers? Even if some would like to do so, international rules prohibit them. What was bad policy in 1929 would be illegal in today’s trading system. We have legal protections against protectionism.
Invoking the protectionist bogeyman – there’s one under every bed, it seems – serves as a smokescreen for the real menace in today’s world – the modern form of mercantilism practiced by China and other countries. It’s the mercantilists who generate massive trade and current account imbalances. To make excuses for them, to hold them to a lower standard, to suspend the rules of simple arithmetic for them is the real threat to the global system.
Monday, November 10, 2008
BACK TO BASICS
If we do not solve this problem and make ourselves fit for international competition again, the dollar will lose its value and we’ll have to balance our lopsided accounts through a massive inflation. Americans will “enjoy” a lower standard of living. However richly deserved, this sort of economic purgatory won’t be pleasant.
Yet that is the default setting for a debtor society. If we want to avoid it, we need to get back to basics:
• The central problem in our economy is a chronic lack of investment. Not in stocks, bonds, derivatives or any other paper asset. Not in existing assets. In new productive assets.
• With more such investment, we can expand our domestic production of services and especially goods.
• With expanded production, we can increase our exports. This should always be considered in net terms: that is, it is just as valuable to replace imports with domestically produced goods (think energy) as it is to ship surplus goods abroad. The cheerleaders for the mindless process of “competitive liberalization” -- one faulty “free trade” deal after another – value increased exports but seem to regard any effort to reduce imports as an unattainable or even undesirable goal. They are wrong.
• With increased net exports, we would require less borrowing from abroad. Eventually, increased savings in this country can help reverse the flow of capital and make the United States a creditor nation again.
It’s that simple: more investment leads to more production; more production to an improved trade position; and an improved trade position to reduced dependence on trading partners for financing. Let us hope the incoming administration will adopt a coherent, comprehensive national trade strategy – one that melds trade and domestic policy into a powerful force to transform our economy -- that gets back to basics and frees us, our children, and our grandchildren from the crippling burden of debt.
Wednesday, October 29, 2008
Here’s what the Times said: As the rest of the world “tips into recession,” China should give up its “old export strategy” and reorient its economy in the direction of satisfying domestic demand. The Times argued that “by raising Chinese imports and reducing its dependence on exports, it would also help the rest of the world” while reducing its own “overwhelming” vulnerability to changes in world markets. The key is to “unlock the savings of its citizens and encourage them to spend.” To facilitate that, China should step up public works, reduce taxes on housing and rebuild the tattered social safety net. Doing so wouldn’t be that difficult, The Times suggested, because Beijing is “running a huge budget surplus.”
The advice to the Chinese is basically sound and certainly welcome. The basic problem I see with it is that China’s new-found budget surpluses are not “huge.” After years of running budget deficits, China has in the past two years run modest surpluses on the order of one percent of its GDP – about $23 billion of black ink at current exchange rates. Compared to America’ s going-on-one-trillion dollar deficit, that might sound like the promised land. But a social safety net for 1.3 billion people cannot be stitched together for such paltry sums.
What is huge – and I suspect what the Times meant to say – are China’s official foreign exchange reserves. China admits to having over $1.9 trillion, the largest in the world and far in excess of what it or any other country would need. As impressive as that figure sounds, it’s just the beginning of the story. When you include China’s sovereign wealth fund, its social security investment fund, and unknown quantities squirreled away in China’s state-owned commercial banks, the available hard currency surely approaches 2.5 trillion dollars. A trillion here, a trillion there, and pretty soon you’re talking about real money, as Everett Dirksen might say. China could use a portion of these vast sums to build safe schools, rebuild its health care system, accelerate urbanization, clean up its polluted water supply, put scrubbers on every coal-fired power plant – and more.
But it’s not just the size of the funds that matters. Consider the differential economic impact of budget and current account surpluses. A budget surplus is based on tax revenues in excess of expenditures; the government taking out of the economy more than it puts back in. A current account surplus comes from surpluses in trade, foreign investment and other international payments; more local currency goes into the economy than goes out. While a budget surplus is deflationary and helps to cool an overheated economy, the current account surplus is inflationary and helps ensure an excessive reliance on exports and too little domestic consumption – the very problems The Times correctly wants China to solve.
Better advice to China would start with a substantial revaluation of its currency. That would move China’s import and export prices more in line with their real value and allow market forces, as imperfect as they are in China, to reshape its economy in ways that have thus far eluded Beijing’s bureaucrats.
Saturday, October 25, 2008
In fact, the available evidence points to other causes. Most importantly:
• The timing is off. The credit crisis and stock market meltdown erupted in September, too late to affect orders, production and exports in the long toy trade pipeline for this Christmas retail season.
• After a series of product recalls last year, the Chinese government revoked the licenses of 600 exporters at the beginning of 2008. One-sixth of this year’s attrition thus was the result of Chinese government action nine months ago.
• The cost of plastics has risen strongly this year, largely driven by the dizzying spiral in petroleum costs over the first nine months of the year. China’s weak currency compounds the problem by forcing importers to pay extra renminbi for each extra dollar in the world price.
• China’s toy production has actually increased this year. Read the press items carefully: they report that the rate of increase in export sales has fallen (to “only” 1.3 percent over the first eight months of 2008), not the actual sales. Far fewer factories are in fact producing more toys. Overwhelmingly, the closures involve smaller, less efficient, less well run companies that lacked adequate capitalization and could not meet customer or environmental standards. Their disappearance is a sign of progress, not distress.
• The China Customs report speaks of “protectionism,” as a problem. Wait just a minute! Where in the world do Chinese toy exports face increased tariffs or quotas? To refer to product recalls as “protectionism” is unfounded, illogical and destructive of China’s image as a supplier to the world market.
• US imports of Chinese toys did in fact decrease by 5 percent over the first seven months, reflecting shifts in consumer demand (traditional toys like Barbie are declining in popularity) and perhaps some concerns about the quality and safety of Chinese-made toys but not the credit crisis. Moreover, China’s loss of sales to America has been more than offset by increased Chinese shipments to Europe.
• The biggest American toy “makers” – actually marketing companies, first and foremost – have enjoyed a terrific year thus far, despite the looming retail slump. Mattel and Hasbro, which together account for more than 13 percent of the world’s annual sales of toys – are enjoying stronger sales through the first nine months. About half those sales are international. A global recession may leave them with no good market for a while, of course, but thus far they have repositioned themselves quite effectively.
So, let’s not shed too many tears for the 3,500 surviving members of China’s toy industry. In a future post, I’ll address the larger issue of the slowdown of China’s growth. Please keep the instructive story of the toy industry in mind when you read that.
Sunday, September 28, 2008
But when it comes to economics, bad advice seems to go unpunished. Throughout the Wall Street meltdown, an opinion piece published September 10 in the Washington Times has been gnawing at me. The article in question, “Another Nonproblem,” was penned by Richard Rahn, Ph.D., a regular contributor to that paper’s op ed page. Rahn is a senior fellow at The Cato Institute, former chief economist at the US Chamber of Commerce, and a university professor.
His sterling credentials didn’t speak to me as loudly as his argument, which in essence is:
• The United States can run a trade deficit, importing more than it exports, “forever.”
• Citing a study by the Federal Reserve, he bases this startling contention on one statistic: “U.S. investment in other countries receives, on average, a higher rate of return (because more of it is in equities) than foreign investment does in the United States (because more of it is in bonds).”
• Thus, he concludes: “As long as the United States is politically and economically more stable than many other countries, the trade deficit can persist without doing any damage to the U.S. economy – for many decades or even centuries. [emphasis mine] So drop this from your list of worries.”
Now, Dr. Rahn wrote his opinion without once mentioning “China,” “renminbi,” or even “debt.” Instead, he makes a lot of the aggregate “net asset position” of US citizens. In his view, our net asset deficit – debt in straight talk -- is “only” $2.5 trillion or 17 percent of GDP. Rahn suggests that this level will remain constant because the US will grow so strongly that the economy will double by 2023.
Wait a minute! Our current account deficits, which include the net return on foreign investments, have been piling up for decades. Foreigners are holding huge stocks of dollars beyond what they owe us. Every one of those dollars is a claim on goods or services that we can produce or assets that we own. Our capacity to produce is now so limited that we rely on imports to fill our own needs. The value of what we own – especially real estate and shares of stocks – has fallen dramatically. Moreover, we have a chronic savings deficit; exactly where are the future foreign investments that Rahn assumes will be made supposed to come from?
Trade deficits have sapped strength out of the US economy, hollowing it out for a lack of investment in productive assets and supplying vast amounts of foreign funding for the Wall Street Ponzi scheme that has just come crashing down on us and the rest of the world. Trillions of loose dollars are held by foreigners now anxious to do something with them before they lose more of their value. America is ripe for a fire sale. It’s a question of “confidence” in America, says Dr. Rahn. Does that mean confidence in Fannie Mae, Freddie Mac, Bear Stearns, AIG, Lehman Brothers? Just whom are foreigners with ready cash supposed to trust now?
Should we place our confidence in economists trading in snake oil? Not me. They are prescribing more of what’s been ailing us – for centuries to come. So, caveat lector. The stuff in this bottle surely won’t cure you, but it might kill you – not in a matter of centuries, either, but any day, week or month now.
Monday, September 22, 2008
STOPPING THE MERCANTILIST MADNESS
In particular, the Journal lashed out at the Federal Reserve. After questioning the validity of the "savings glut" theory of the US trade deficit, the editorial commented: "The savings glut was in large part a creation of the Fed, which flooded the world with too many dollars that often found their way into housing markets in the U.S., the U.K. and elsewhere."
Fair enough. There's no question that the world is awash in dollars. But the Fed didn't decide who would get how many of the excess dollars. That decision was left to oil exporters who fix the price of petroleum and the mercantilists who fix the price of their currencies. In effect, the US policy of malign neglect allowed the modern mercantilists to decide how much to take.
But enough of the blame game. What can be done to stop the mercantilist madness before it consumes us? Here's a simple four-part strategy, the first three steps being matters of urgency:
First, enact legislation to make prolonged currency misalignment actionable under U.S. trade laws. Bipartisan bills have been languishing in each house: H.R. 2942 introduced by Reps. Tim Ryan and Duncan Hunter and S. 796, introduced by Senators Bunning, Stabenow and Bayh. Merge them, pass them and challenge the mercantilists to cease and desist.
Second, armed with the leverage of potential trade law remedies, the Treasury should screw up its courage and, for the first time since 1994, name a country for currency manipulation. In fact, it should name them all -- China, Japan, Korea, Taiwan, Malaysia, Singapore and any others who are piling up massive foreign currency reserves through undervaluation of their currencies.
Third, convene a meeting of all those countries in an undisclosed location and don't come out until a series of coordinated currency corrections has been agreed. This will help restore sanity and confidence to the world financial system and give harried policymakers in the U.S. and elsewhere time to develop thoughtful, workable responses to the meltdown.
Fourth, the next administration should begin planning now to ensure that the global monetary system gets a long overdue and thorough overhaul. The IMF needs to be given the tools it needs to maintain discipline among its members. Moral suasion obviously is no match for mercantilism. For the sake of all its members, the IMF needs to be equipped to play a meaningful role in curbing exchange rate abuses and the excessive expansion of credit by any of its members, regardless of their size. In addition, we need to face up to the fact that neither the United States nor any other single country can afford to run trade surpluses indefinitely. The world needs another, more sustainable source of liquidity to complement the role played for so long by the American dollar. It's not by any means premature to start laying the groundwork for a new reserve currency -- perhaps the long neglected SDRs (special drawing rights) that almost 40 years ago were touted for that role and still exist in limited amounts.
Also 40 years ago, Robert Kennedy would conclude his campaign stump speech with this thought: "Some see things as they are and ask, why? I dream of things that never were and ask, why not?" Given the mess of things as they are, isn't it time for us all to ask, why not?
Sunday, September 21, 2008
FROM MERCANTILISM TO MELTDOWN
For many people, that phrase just doesn’t roll off the tongue, and the connection may not be readily apparent. So, here’s a simple step-by-step connection between mercantilist policies and the currency financial meltdown:
1. Mercantilist countries such as Japan and China use a variety of means to ensure that their currencies are traded at exchange rates well below their true market value.
2. The undervalued (read “cheap”) currency serves as a subsidy to all exports from that country: the exporter gets a bonus of extra home market currency for every international sale. At the same time, an undervalued currency imposes a hidden tariff or tax on all imports: the importer must ante up extra amounts of home market currency to pay for goods from abroad. The result is a chronic trade surplus based on artificial advantages maintained by the mercantilist government. In cash terms, the trade surplus results in an equivalent transfer of funds from trading partners to the mercantilist government.
3. At the same time, cheap currencies induce extra investment. Why? The foreign investor gets more local currency for each dollar or euro. That bonus attracts investment that otherwise would be made somewhere else. So, investment flows are just as distorted as trade flows.
4. The trade surplus and the investment surplus are the main elements in the mercantilist’s current account surplus. Year after year, the cumulative surplus grows. Today, China alone probably has close to 2.5 trillion dollars; Japan, more than one trillion dollars.
5. The problem for the “winners” in this lop-sided current account relationship is to find profitable uses for the money. This has become such a burden that some Chinese openly speak of “unwanted dollars.” They restlessly search the globe for higher returns for their hard currency reserves than mere cash (zero return) or US Treasuries (low risk, low return).
6, That helps explain why Chinese and other foreign investors were easy marks for the Wall Street wizards who churned out new ways to “guarantee” higher and higher returns. Fannie Maes, Freddie Macs, syndicated mortgages – debt was piled upon debt in an elaborate Ponzi scheme that also sucked in pension funds, commercial banks and the proverbial little old ladies like my own mother.
7. In effect, mercantilists, oil exporters and Wall Street wizards got in bed with one another and produced … a huge bubble.
The dots are hereby connected. Mercantilism is not the sole cause of the current crisis, of course, but it one that policymakers around the world have chosen to ignore. Left unchecked, modern mercantilist rigs the game, subverting fair competitive, distorting free markets, and flooding financial markets with funds in search of higher returns.
If monetary authorities in so many countries can cooperate as closely as they have this month to try to stem the tide of imminent financial collapse, why can’t they start cooperating to prevent more, possibly greater, damage from occurring in the future? How to get there will be the subject of my next posting.
Tuesday, September 16, 2008
THE ARCH ENEMY OF FREE TRADE
Then along came Adam Smith and The Wealth of Nations in 1776. Followed by Ricardo, Hume, and other free marketers, Smith preached the virtues of consumption, efficiency, and freer -- in effect balanced -- trade. Progressive “free trade” became the trump card over backward mercantilism.
Perfectly free trade, of course, depends on a set of assumptions rarely if ever seen in the real world. Nonetheless, the powerful logic of greater economic freedom and efficiency helped to raise living standards among industrial countries over the past two and half centuries. Mercantilism came to be debunked as a benighted relic of a by-gone era, both unfashionable and thoroughly discredited.
Today’s economists see “protectionism” as the enemy of free trade. Like obscenity, protectionism is immediately recognizable to the individual observer. However, reasonable people rarely are in complete agreement on what they are looking at. I see predatory pricing and trade-distorting subsidies as protectionist; others may not. I see government ownership and control over key sectors of commerce and finance as protectionist; others may not.
As Robert Samuelson posited in a notable Newsweek column more than a year ago:
It is not "protectionist" (I am a longstanding free trader) to complain about policies that are predatory; China's are just that. The logic of free trade is that comparative advantage ultimately benefits everyone. Countries specialize in what they do best. Production and living standards rise. But the logic does not allow for one country's trade systematically to depress its trading partners' production and employment. Down that path lies resentment and political backlash.
So, after all this time a funny thing has happened. Mercantilism refuses to die in Japan, China, and other emerging economies. What Samuelson was complaining about is simply mercantilism by another name. Not unlike the French in the 16th, 17th and 18th Centuries, today’s “neo-mercantilists” promote national power by protecting their industries, promoting one-way trade, and piling up the hard currency assets far beyond the level required to finance needed to finance their imports.
Mercantilism and free trade are mortal enemies and have been for 500 years. Mercantilism subverts free markets, distorts competition and promotes the interests of the state over those of the people. Dedicated “free traders” should confront and contain mercantilism wherever it appears. If they turn a blind eye to the intrusions of mercantilist government policies in their own market, they are simply appeasing predators and marching backwards to the 17th Century.
Abraham Lincoln argued that a nation could not long endure half slave and half free. My friend Clyde Prestowitz of the Economic Strategy Institute argues that the world cannot endure half mercantilist and half free trade. Both are right.
Monday, September 15, 2008
CREDIT WHERE CREDIT IS DUE
Tellingly, Treasury is conducting its multimedia, bilingual campaign in conjunction with the Ad Council. The latter presumably knows a thing or two about how less than fully literate Americans of all ages were duped into sub-prime loans they could not afford, into investing in securities issued by Fannie Mae and Freddy Mac “backed by the government,” and into zero-interest balance transfers from one credit card to another – with a lead balloon attached. Yes, they should know what they’re talking about.
Now I have nothing against financial literacy among young adults. Seems like a splendid idea. My question is when will Treasury launch a financial literacy campaign for:
• the surviving Wall Street hot shots to ensure that, MBA or not, they might never again be so blinded by greed as to repeat the foolish Ponzi-schemimg of this decade?
• America’s credit-card gougers so that they might learn that jacking interest rates on struggling customers only helps top hurtle them toward bankruptcy?
• America’s off-shoring multinationals so they might learn how to make a profit without accepting huge bribes in the form of subsidies, targeted tax holidays, and undervalued currencies?
• the budget experts at the Office of Management and the Budget to ensure that they might finally produce balanced budget proposals without accounting gimmickry?
• the members of Congress who collectively seem to have no clue as to how they or the country might live within their own means?
• high government officials and so-called experts who argue that deficits “don’t matter,” because we can always borrow more?
I could go on, but you get the point. Nothing against financial literacy for the few, but dare we stop there? If the US and the world economies are to be righted any time soon, we need a crash course in adult literacy for Wall Street and Washington, starting at the top.
Saturday, September 6, 2008
DENIAL – THE 51st STATE
How else can one explain the steep descent of the political debate this year, the most crucial national election in 76 years? Democrats have reverted to promising spending programs and targeted tax breaks for deserving folks, knowing all the while that they can’t be paid for. They tell their base: watch out for Republicans; they don’t care about folks like you. Republicans have reverted to promising tax cuts for the wealthy and spewing out fierce rhetoric about cutting spending, knowing that only a small portion of which is discretionary. They tell their base: watch out for the Democrats; they tax you and spend the money on others.
Nowhere in this empty debate is there any concept of the national interest. Nowhere is there a recognition that we are engaged in a global competition with governments that do have gobs of discretionary funds. China alone is sitting on piles of hard cash in the form of official reserves, sovereign wealth funds, social security investment funds and forced dollar holdings by commercial banks – in all, almost 2.5 trillion off-budget dollars that flowed into the country without the need to levy a tax on its citizens. They simply rig the price of their currency and let “the market” do the rest. The result is a slush fund large enough to cripple our producers for a long time.
How are we going to compete with that? How are we going to re build the productive capacity of this country? How are we going to start saving, investing and paying our own way in the world again? How can we be a strong, respected leader in the world with the rickety Ponzi-scheme economy that those geniuses on Wall Street have foisted on us? How can we hope to reverse our decline by denying it?
Monday, August 18, 2008
TWO VOICES, ONE NATIONAL INTEREST
This is not an earthshaking episode in international entertainment history; nothing like the infamous wardrobe malfunction, let’s admit. But it does tell us a lot abut the Chinese system. Astoundingly, this was a high-level political decision in China. The Politburo – the highest body of the Chinese Communist Party -- intervened with Chen Qigang, the musical director of the opening night extravaganza, to make clear that getting cute little Miaoke on TV was, as he told the media, a “matter of national interest.”
That’s like the national committee of one of our major parties “suggesting” to the networks who should sing the national anthem at next year’s Superbowl. That’s a matter of “national interest”? Any network eager to recoup its investment in the event will of course make that decision on its own without regard to the wishes of the government or any political party.
That hypothetical comparison might suggest two important lessons to be learned from an otherwise inconsequential blip. First and most obvious, the Chinese Communist Party still tries to micromanage its vast and complex country. Not just the economy or news coverage, but which little girl scores higher on its cuteness scale. You don’t have to be a Westerner to see the ridiculous excess in that. The second lesson is more subtle. If Beijing goes too far in asserting the national interest, Washington stops way short of what’s needed. On this side of the Pacific, the “national interest” seems to begin and end with national and homeland security.
I’m happy to let the networks decide who shall sing the anthem while I’m still in the kitchen getting ready for kick-off, but I’m eager to see someone in Washington accept responsibility for defining the American national interest in economic terms. Somewhere between the excesses in Beijing and the deficiencies in Washington lies a happy medium that would serve each country far better.
Wednesday, August 6, 2008
We need to commit ourselves as a society to reduce our foreign debt, restore the value of the dollar, and expand investment and production in this country. Without protectionism or isolationism, America could then once again be financially strong and enjoy the strategic benefits that flow from being a creditor nation. Those changes would enhance our leadership in the world while restoring faith in the American Dream.
Recently, I’ve sat through dozens of discussions about the need for such a strategy to meld all the factors – traditional trade policy as well as tax, energy, environment, health care, infrastructure, education, and other policies – into a coherent, comprehensive program that would unleash the competitive brilliance of American workers and entrepreneurs. The overall concept seems to be gaining in acceptance. There is no lack of interesting ideas about the various components of an effective national strategy. We have numerous studies and ample data in hand.
Intellectually, molding these inputs into a strategy is challenging work, but it’s not impossible. Virtually every other economy of any size has a clear idea of what it is tying to accomplish economically and how that advances their national security. If they’ve “connected the dots” for themselves, why can’t we, too?
The core of the American problem lies in the very nature of our system of government. A key to our constitutional design is the broad diffusion of power. The good news is that such diffusion protects citizens very well (albeit not perfectly) against abuses of government power. The bad news is that it makes fundamental reform quite difficult and, in peacetime, nearly impossible.
Only strong, sustained and dedicated White House leadership can overcome the political, institutional and bureaucratic barriers to fundamental reform. To change things for real, the next administration needs to commit itself and its resources to that task as a matter of the highest priority. In other words, we need to deal with our international economic performance with the same serious sense of purpose that we expect from the national security team headed by the commander-in-chief.
So, here is a simple scenario for either candidate to give America a fair chance to develop an effective national trade strategy:
1. Pick a vice presidential running mate with background and experience fit to be the “competitor-in-chief.” This would include knowledge of the inner workings of the Congress, the executive branch and the real as well as the financial economy.
2. Announce now that you will designate the vice president as the head of a new, improved National Economic Council. Naming the second highest elected official in the land as its head would empower the NEC to delegate tasks to executive agencies, to ensure effective coordination and strategic coherence, and to stop turf battles before they can disrupt the effort.
3. Task the NEC with devising a comprehensive plan within six months of Inauguration Day.
A decision now to address our international competitive and debt problems as a top priority of the next administration would help either candidate assure the voting public that he is serious about fundamental economic reform. It would give him a mandate for change without which he could not hope to overcome vested interests. It would give the next vice president the chance to get a running start on the agenda that could be of make-or-break importance to the administration – and the country.
Sunday, August 3, 2008
TAKE THE MONEY AND RUN
That wasn’t the company’s original idea. Plan A was to produce the heavy batteries (a half ton per pack) in Thailand, ship them to the UK where they would be partly installed, and then ship them again to the US for final assembly. Plan A is a victim of high petroleum prices, which among other things are shooting ocean shipping costs through the roof. As the Times notes, the cost of shipping a 40-foor container from Shanghai to the West Coast has jumped to $8,000 compared to $3,000 just a few years ago.
The article goes on to recount how high transportation costs are beginning to force a rationalization of extensive global supply chains premised on perpetually cheap energy costs and a lack of concern about their environmental impact. While the carbon emissions-intensive supply chain may not yet be headed for history’s scrap heap, there is a serious move to make major revisions in them. One consequence is likely to be shorter, more fuel efficient supply chains wherever possible -- greater regionalization instead of globalization.
All this got me to thinking about John McCain’s excellent little idea a while back to offer a $300 million prize to someone who could come up with the best electric car battery. Let’s say, lighter, more efficient, and longer lasting than Tesla’s. Finding that kind of money in the federal budget wouldn’t be hard, and we could always borrow a little more from our oil-exporting trading partners for such a worthy cause.
But after the check was handed over in the Rose Garden, where would the budding entrepreneur decide to manufacture those (still heavy) batteries? I’d be not one bit surprised if the decision were to take the money and run, placing the new plant in a more investment-friendly place, say, Canada.
Tariffs, of course, are not the issue. We’ve enjoyed free trade with Canada in automotive products since the mid-1960s. More to the point, Canada provides several perfectly legal and powerfully attractive inducements to American investors. Canadians depreciate new investments aggressively – one-third of the remaining balance each year, starting from the date of expenditure rather than operation. That lowers the cost of capital. They rebate their consumption tax – the federal and the provincial goods and services tax – when a product is exported from Canada. Most countries offset that rebate with a tax of their own. Almost uniquely, the U.S. chooses not to tax imports. And they fund health care out of general tax revenues, reducing the burden on individual manufacturing enterprises.
I have no doubt that the American worker is as good -- and usually far, far more productive -- than his foreign competitors. Ditto for American entrepreneurs. But American public policy is a disservice to those workers and entrepreneurs, punishing them with policies better suited for the 1950s than for the 21st Century. Whether globalization cedes ground to regionalization or not, these policies will continue to be one of driving forces of America’s economic decline until we find the political will to change them.
Monday, July 28, 2008
Unfortunately, it’s not so simple. The downside of the good news is that the national highway trust fund is being depleted faster than revenues can replenish it. The trust fund, remember, is funded by the federal gasoline tax. Fewer miles driven means less revenue for the Feds. So, instead of being able to expand and accelerate spending on transportation infrastructure, Americans’ perfectly rational response to higher gas prices may actually put a crimp in plans to rebuild our crumbling highways and collapsing bridges.
This suggests to me a corollary to the rule that there is no free lunch: piecemeal economics can address only one problem at a time and, in so doing, often makes other matters worse.
A weaker dollar is another mixed blessing. Sure, it promotes exports from and foreign investment in the United States, as our commentary on the Ikea plant in Danville acknowledged. Cheerleaders for the current globalization model trumpet our rising exports as if they are, or at least could beocme, the solution to all that ails our eocnomy. But at the same time, a gimpy greenback pushes commodity prices, including importantly petroleum prices, up. That gets us right back to prices at the gas pump and the trust fund problem.
Moreover, a weaker dollar depresses wages and lowers the standard of living of Americans. Again the Danville plant illustrates the point. Or, just ask any tourist unlucky enough to feel the need for breakfast in London, Paris or Toronto with only dollars in his wallet.
Piecemeal economics is like that. Make one thing better; make others worse. America needs a coherent, smart national strategy to address systematically the full set of our fundamental economic weaknesses. A cheap dollar just isn’t the answer.
Tuesday, July 1, 2008
As a nation, we owe the rest of the world a net three trillion dollars and more. Our trade deficit pushes that figure higher by several billion dollars each day. Our budget deficit – once again spiraling upward as we go through our “rough patch” – adds to the burden and robs us of the means to pay for the kind of government we need. Consider that in FY 2007, nine percent of the budget went to interest payments while only two percent was spent on homeland security. If nothing is done, we’ll end up paying out more in interest than for national defense or non-defense discretionary spending (both 18 percent of the 2007 spending). By some calculations, the government has made a grand – really grand ! – total in excess of 57 trillion dollars in promises for future benefits. These are pensions, social security, Medicare and Medicaid benefits that folks are counting on. But where in the world are we to borrow that kind of money?
When Henry Paulson calls this economy “fundamentally sound,” I laugh out loud. But others seem to take the treasury secretary at his word. Just this week Chinese prime minister Wen Jiabao gave Condoleezza Rice some grandfatherly advice: “we hope the U.S. will quickly pass through the subprime crisis and stabilize the U.S. dollar; this is of great importance to the world economy.”
Would that it were so simple. When a nation has structural problems, it needs structural solutions. For starters, I propose:
1. urgent realignment of the world’s over- and under-valued currencies, including both the dollar and the renminbi.
2. adoption by the U.S. of a comprehensive national strategy to reduce our` foreign borrowing. That will require us to save and invest more, produce more, and export more. All good things that generate jobs. But jobs shouldn’t be the prime objective; production and saving should be. This is the only sure way to reduce our staggering debt without a big inflation.
3. acceleration of the inevitable tax reform as the key step in implementing such a strategy. Once we get our fiscal structure right, we can tackle health care, infrastructure, domestic energy development and other critical objectives.
When a baseball team starts to play badly, the manager often demands a return to fundamentals. It’s time for America to do the same.
Tuesday, June 24, 2008
PUTTING THE NATIONAL INTEREST FIRST
A few months ago, I advanced my personal “Top 10 Reasons Why
Since then, I’ve read 100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the
The book is full of interesting facts and arguments. (For a summary of his plan, go to http://www.iasworldtrade.com/Graetz_Memo.htm and http://www.iasworldtrade.com/Graetz_Chart.htm.) I’d like to highlight just two that seem highly relevant in view of the promises being bandied about in the current presidential campaign.
On the one hand, Graetz – who served in the Treasury Department under Bush 41 -- argues forcefully that a good tax system produces enough revenue to fund the government in normal times. He rightly abhors chronic deficit spending, deriding it as “catnip to politicians” and unfair to future generations who will get stuck with the unpaid bills. He’s not a tax and spend anything. On the contrary, he seeks real fiscal discipline. However, he recognizes that the government has made promises that, under the current system, it cannot keep. So, a combination of sustained fiscal restraint and realistic revenues are needed to lift the burgeoning burden of debt from the pocketbooks of the younger generations while keeping the word of a government to its people.
On the other hand, he attacks “targeted tax cuts” as a needless complication of the tax system that often produces a hodgepodge of incentives rather than a clear-cut policy. He aptly cites health care as an example. Businesses and individuals get a variety of tax incentives to behave one way or another. Yet we have a health care crisis marked by high costs, a mass of uninsured Americans, disgruntled doctors, and competitively disadvantaged businesses. This is a lousy way to make policy, and the national interest easily gets lost in a welter of special deals for targeted groups.
“The kind of comprehensive reform our tax system clearly needs,” writes Graetz, “will require politicians from both parties to put the national interest ahead of the short-run advantage of any particular segment of their supporters.” That’s pretty ambitious. But our system is unfair, costly and inefficient, complex to the point of bewilderment, ineffective as a public policy tool, and poisonous to our performance in international trade. With the AMT fix apparently unfundable and the expiration of the Bush tax cuts looming large for 2010, now is the time to aim high.
Thursday, June 12, 2008
The exchange arose in the course of the annual trade policy review of the United States conducted this week. China challenged the US to explain the “causal link between dollar depreciation and food price hike, and possibly global wide inflation,” according to a text used by the Chinese representative at the June 11 session.
The US took an obdurate stance in response. First, the dollar exchange rate is “wholly market determined.” China didn’t challenge this.
Second, the USTR-led delegation would not comment on activities of the Federal Reserve, referring the Chinese to the Fed’s Web site. The Chinese understandably found this irritating. The spokesman carped: “it has been the practice of the Review Mechanism that leading agency of a Member would coordinate with and seek response from all other relevant authorities, including those in charge of monetary policies.” That seems not only reasonable but essential to any sort of meaningful policy discussion.
Third, China says the US took the position that “international discussion of these topics would occur in the IMF and the WTO is not the appropriate forum to discuss the US monetary policy.” On this point, the Chinese took great umbrage. They noted that “a continuous depreciation of the US dollar … would obviously affect economy and trade of other [WTO] Members, particularly the developing ones.”
Recalling our comment on Steve Hanke’s analysis of the dollar/rice nexus, that point seems entirely fair. But then the Chinese unloaded on the American “double standard,” noting that at last month’s review of Chinese trade policies, the US had insisted repeatedly on tying to draw China into a defense of its currency policy. The US position, he chided, seemed to be that the “WTO is an appropriate forum to discuss monetary policies of other Members including China, but not of the US.” Ouch!
The WTO’s predecessor was sometimes derided as the Gentlemen’s Agreement to Talk and Talk. The Trade Policy Review Mechanism is one of the best features of the Uruguay Round reforms of the GATT. It forces each country to expose itself periodically to world public opinion. That’s not legally binding, of course, but it does have its uses.
In this case, it has helped China abandon its unreasonable position that exchange rates are “internal matters” that “fall within a country’s sovereignty.” Now, perhaps playing to the developing country majority in the WTO, Beijing takes the sounder position that exchange rates do affect commodity prices and trade and as such fall within the purview of the WTO. That is, exchange rates are a trade as well as a monetary issue. The Treasury would be wise to seize on this opening – whether completely sincere or not-- and convene a closed door meeting with China and other countries with undervalued currencies. An acceptable solution can only be found through negotiation. China’s new position has cracked open the door to real progress. Will the US be pragmatic enough to respond positively?
Tuesday, June 10, 2008
COMPOUNDING THE CURRENCY PROBLEM
Meanwhile, Chinese spokesmen are railing against the weak dollar, suggesting that we ought to do something about it. Sun Zhenyu, China’s WTO ambassador, jabbed his American counterparts with these sarcastic words: "We hope the U.S. will not tell us this time as they did in the early 1970s to the Europeans, to say that ‘it is our currency, but it is your problem.’"
Perhaps the ambassador was surprised this morning when share values in
In just two months, someone in
Monday, June 9, 2008
HEADING FOR A HARD LANDING?
As one of my intellectual heroes, Herb Stein, observed: “If a thing cannot go on forever, it will stop.” The growing financial imbalance in the world seems to be a strong candidate for the next chapter in Lessons Learned the Hard Way, a book I’ve been working on for 63 years now.
Foreign Exchange Reserves
Top Ten Countries in
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In other words, these ten Asian countries have piled up huge foreign exchange reserves – more than four trillion dollars’ worth as of March 31 of this year -- as the result of their continued massive current account surpluses. Those reserves are growing rapidly – up almost 70 percent in the eleven quarters since mid-2005. These numbers are shocking because
Under IMF Article 4, all members are obligated to avoid using exchange rates to prevent adjustment of imbalances in trade flows and balance of payments. It is no secret the IMF is a paper pussy cat, lacking any credible means of dissuasion to governments intent on a mercantilist mission. Still, ignoring an obligation opens one up to such charges as we’ve heard in the presidential campaign that “
The other side of the coin was argued in the Wall Street Journal of June 9 by economist Judy Shelton (“The Weak-Dollar Threat to World Order” at http://online.wsj.com). She insists that, current Treasury and Fed rhetoric notwithstanding,
“When the U.S. turns a blind eye to the consequences of diluting the value of its monetary unit, when we abuse the privilege of supplying the global currency by resorting to sleight-of-hand monetary policy to address our own economic problems – inflating our way out of the housing crisis, pushing taxpayers into higher brackets through stealth – it sends a disturbing message to the world.
“Why would a nation that espouses Adam Smith and the wisdom of the invisible hand permit its currency to confound the validity of price signals in the global marketplace? How can Americans champion the cause of free trade and exhort other nations to rid themselves of protectionist measures such as tariffs and subsidies – and then smugly claim that U.S. exports are becoming “more competitive” as the dollar sinks?
Oh, that's great! In the high-stakes poker game being played out in the waning months of the Bush administration, both sides think the other is cheating. Such scenarios must stop at some point and usually end in gunfights in which a lot of innocent bystanders are killed or wounded. Perhaps the Bush administration is betting it can bluff its way until on January 20 and then dump this unmanageable mess in the lap of the poor sucker who wins a majority in the Electoral College. What’s needed here is a heavy dose, not of altruism, but of enlightened self interest. Are there so few clear-headed governments that plurilateral negotiations can’t produce a rational solution to avert a hard landing? Can’t the Congress do something to persuade all the parties to come to the table? Won't someone please do something that makes sense?