Sunday, September 28, 2008


When physicians harm their patients, they face lawsuits, higher insurance premiums, and possibly loss of licenses as a result of their malpractice. When Wall Street wizards build a Ponzi scheme of worthless assets, some of them at least stand to lose their bonuses, their jobs and even their companies. It’s gratifying to hear reports that the FBI is investigating possible criminal wrong-doing at four of the failed companies. That might mean some degree of restitution and even jail time might result from their financial malpractice. There’d be a modest measure of justice in all that.

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.

Charles Blum

Monday, September 22, 2008


On September 22, the Wall Street Journal editorial page started apportioning blame for the still unfolding bloodbath on Wall Street. It connected some of the dots that we did on our previous posting ("From Mercantilism to the Meltdown," September 21).

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?

Charles Blum

Sunday, September 21, 2008


Engineers calculate that, for a major accident such as an airplane crash to occur, something like 20 things all have to go wrong. The on-going financial meltdown certainly has multiple causes, too. Greed, bad judgment, mismanagement, lack of effective government oversight, and more certainly were involved. But let’s not overlook the subject of my previous posting (“The Arch Enemy of Free Trade,” September 16): good old-fashioned mercantilism.

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.

Charles Blum

Tuesday, September 16, 2008


For two and a half centuries beginning in 1500, the Western world was mercantilist. That is, the prevailing economic system emphasized production over consumption, exports over imports, and the amassing of national treasure in the form of gold and silver.

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.

Charles Blum

Monday, September 15, 2008


You have to hand it to the U.S. Department of the Treasury. On a day (September 15) when the Dow Jones dropped more than 500 points, Wall Street began to triage the survivors from a weekend massacre, and nervous money skittered around the world in search of a safe haven, Treasury chose to announce the launch the following day of a new campaign “aimed at combating the issue of financial illiteracy among young adults.” The aim is to “teach young adults about credit.”

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.

Charles Blum

Saturday, September 6, 2008


The 51st state of the Union can’t be the District of Columbia nor Puerto Rico. No, we’ve already expanded the United States of America by the largest one ever – the State of Denial. Its vast territory, coextensive with the other 50 states, includes American men and women of all parties, races, religions, sexual orientations, and social classes.

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?

Charles Blum