PUTTING THE NATIONAL INTEREST FIRST

A few months ago, I advanced my personal “Top 10 Reasons Why America Needs a Consumption Tax” (Comments on the News, March 18, 2008). Most of the reactions were positive, although there was a well founded concern about the potential for overburdening lower-income folks (“regressivity” in tax talk).

Since then, I’ve read 100 Million Unnecessary Returns: A Simple, Fair, and Competitive Tax Plan for the United States by Michael Graetz of Yale Law School. He advances a comprehensive plan for fundamental tax reform, built around a value added tax. As part of the deal, income taxes would be radically simplified so that only the most profitable companies and the highest-earning individuals would have to file – hence, the “100 million unnecessary returns.” In addition, Graetz advances an innovative idea to deal with regressivity -- a “payroll adjustment” or “smart card” (actually, a debit card) to offset the impact of the VAT on lower-incomer workers. His plan is comprehensive and makes eminently good sense in terms of the objectives I had set forth. Moreover, he’s worked out the numbers, so that readers can understand the full implications of his plan.

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.

Charles Blum

CURRENCY SWAP

Knee-jerk critics of the WTO might have overlooked an intriguing exchange that took place in Geneva on June 11. If I understand it correctly, the China flipped and the US flopped.

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?

Charles Blum

COMPOUNDING THE CURRENCY PROBLEM

In an interesting op ed piece (“The Fed and the Price of Rice”) in today’s Wall Street Journal, Steve Hanke and David Ranson, aptly concluded that the “rice-price problem is a weak dollar problem.” They added: “Until the dollar strengthens, the nominal dollar prices of rice and other commodities will remain elevated.” This is not a new phenomenon, as they deduce from data dating back to 1949.

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 Shanghai and Shenzhen fell by more than 8 percent. The steep decline was attributed to investor concerns the rising prices of food and oil, among other worries. Yet China’s cheap renminbi problem only compounds the problems caused by the weak dollar. As the lower greenback pushes commodity prices up, Chinese importers are forced by their government’s currency policy to pay extra RMB for each extra dollar in the international price. Is it any wonder that that China has an inflation problem?

In just two months, someone in Beijing will proclaim: “Let the Games begin.” On currency, the (blame) game is already underway. There is no individual gold medal in this game, however. In the long run, managing the world monetary system is a team sport in which there are only winners or only losers. Debating points are no substitute for real solutions.

Charles Blum

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.

Consider the numbers in the following table, prepared by IAS staff using official data through the IMF:

Foreign Exchange Reserves

Top Ten Countries in Asia (Valued in Billions of USD)

	2005 Q2	2005 Q4	2006 Q2	2006 Q4	2007 Q2	2007 Q4	2008 Q1
China (Total)	838.71	949.84	1075.63	1208.69	1480.06	1694.18	1857.29
*Mainland	710.97	818.87	941.12	1066.34	1332.63	1528.25	1682.18
*Hong Kong	122.00	124.28	126.63	133.21	136.31	152.70	160.78
*Macau	5.74	6.69	7.88	9.13	11.13	13.23	14.34
Japan	843.54	846.90	864.88	895.32	913.57	973.37	1015.59
India	138.37	142.82	162.91	177.25	213.35	275.32	309.72
Taiwan	253.62	253.29	260.35	266.15	266.05	270.31	289.38
South Korea	204.99	210.39	224.36	238.96	250.70	262.22	264.25
Singapore	114.90	116.17	128.32	136.26	144.06	162.96	177.46
Malaysia	74.76	70.18	78.77	82.46	98.40	101.34	120.29
Thailand	48.36	52.07	58.06	66.98	73.00	87.46	109.97
Indonesia	33.87	34.72	40.11	42.59	50.92	56.92	58.99
Philippines	17.70	18.49	21.12	22.97	26.38	33.75	36.62
TOTAL	2568.81	2694.88	2914.49	3137.62	3516.50	3917.82	4239.55

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 China, Japan and Korea (at least) have taken measures since 2004-5 that were supposed to ameliorate what was then perceived to be a dangerous imbalance in payments. Unless something is done sooner, the Asian holdings of foreign reserves will shoot past five trillion dollars before the next American president gets his feet on the ground.

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 “China cheats.”

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, America is pursuing a cynical weak dollar policy precisely to promote inflation. The Asians are acting so as to keep the dollar overvalued against their currencies, so it’s clear she’s talking about the weakness of the greenback in terms of euros, Canadian dollars, British pounds and other more or less freely floating currencies. Listen to her tough words:

“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?

“That’s not competing. It’s cheating.”

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 noon 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?

Charles Blum

McCain's New Trade Theory

In rereading John McCain's June 3 speech in New Orleans, I was struck in particular by one sentence in the prepared text. "Lowering trade barriers to American goods and services," he said, does four things: "creates more and better jobs; keeps inflation under control; keeps interest rates low; and makes more goods affordable to more Americans."

This version of Straight Talk went right over my head. As I see it:

• The first claim is the most defensible. Increased exports would create more and better jobs if the access were real. Lower tariffs are usually touted by "free traders" as the principal gain from "free trade" agreements. But what about the factors that neither the FTAs nor the multilateral rules address: currency misalignment, border tax adjustments, other subsidy practices, unsafe products and processes, etc.? How can the proverbial playing field be said to level if these obstacles to, and distortions of, free trade go uncorrected and even unaddressed? Their impact can be, and often is, far more significant than the barriers that are eliminated. (Border tax adjustments alone create a two-way disadvantage for American producers that averages 15-20 percent. China's undervalued renminbi creates an additional two-way disadvantage that may be as much as double the level of its 17 percent value added tax.) Knowing that I will be branded a protectionist for saying so, the free trade emperor has no clothes. I'm not arguing that free trade is not a worthy goal, only that the much touted FTAs are seriously deficient, sometimes for what they include and in every case for what they ignore.
• Improving market access for US exports does not reduce inflationary pressure in the US. On the contrary, everything else being equal, they increase it. Exports are a "leakage" from the domestic economy that leave more money chasing fewer goods in our market. That's inflationary.
  
• Improving market access for US exports also does not keep interest rates low. Actually, the US has kept its rates low by running trade deficits, shipping dollars abroad to settle our accounts, and then borrowing back what we need to cover the budget deficits of government and households. Massive borrowing from our trading partners in Asia and the Mid East is what accounts for our "success" in this reagrad.
• Improving market access for US exports also does not make more goods affordable to more Americans. On the contrary, they remove goods from the domestic economy, thus making fewer goods available and raising prices, everything else being equal.

What Sen. McCain might have wanted to say, but didn't, was that he seeks to continue the Bush administration's mindless pursuit of FTAs, its dereliction of duty with respect to currency policy, and aiding and abetting of off-shoring. This would be a great issue for the two candidates to hash out with one another in front a national television audience.

Charles Blum

Regrets to McCain's Invitation to Debate

Not to be finicky, I find John McCain's "invitation" for Obama to join in town hall meetings to be a distinctly second best alternative. Everyone has their own favorite example of media grandstanding in moderated debates, so it's easy to agree that we might do better without them. But would it be better to turn that role over to whichever citizens were to gain access to a town hall debate? Just recall the often dreadful YouTube questioners or the infamous "boxers or briefs" silliness.

If we're going to change the way we campaign -- an idea whose time came long ago -- why not go for a "real reform," as McCain himself might put it? Why not take up the original idea of Newt Gingrich to have a series of unmoderated one-on-one discussions in front of TV cameras? No questioners except the two candidates. No one in the room to react except the two candidates. No one standing between those two and the one hundred million voters who are looking for the best person to lead this country in a new direction.

Why not go all the way to a real change?

Charles Blum