Balanced Trade A Quick Fix

Balanced Trade, a Quick Fix to our Economic Malaise

Raymond L. Richman

History will wonder how it was possible for the country which won nearly all the Nobel prizes in economics 1) to allow its trade deficits to grow in three short decades from chronic trade surpluses to a trade deficit on goods of $790 billion in 2007, 2) to witness factory after factory close down and move to Asia at the cost of laying off millions of industrial workers, causing wages to stagnate and the distribution of income to worsen, 3) allow the dollar to fall from $0.90 per Euro to $1.55, 4) to observe without flinching the escalation in the price of petroleum, The explanation is simple, the economists advising the Bill Clinton administration and the economists advising the G.W. Bush administration were all blind-sided free-traders, ideologues who did not want free trade challenged.

Why have the Congress and the Clinton and Bush administrations done nothing about a problem that cost us factories and jobs and a host of other ills. Because, as Lee Iacocca writes, “We worship at the altar of free trade, and it’s killing us. At the very least, it’s time we started charging admission to the American market. And the price of a ticket has to be a little fairness and reciprocity.”

Few economists asked themselves what the consequences would be if free trade were one-sided and trade deficits became chronic. I exchanged e-mails with one of Pittsburgh’s free-market gurus this spring writing him about some of my concerns and this is what he said: “If China wants to send us goods for our paper, what do we have to lose?” He blithely ignored what had happened to the U.S. economy as the result of a world flooded in dollars by the trade deficits.

The millions of Americans who lost their jobs believed it was due to uncontrollable market forces. The millions of others whose wages stagnated had no reason to believe that it was the result of something so esoteric as trade deficits.. And there were some who benefited. These latter include Wall Streeters and bankers, albeit temporarily as it turned out, and people with guaranteed incomes such as government employees and university professors and those on fixed incomes.

Economists blamed the worsening distribution of income on a lack of a skilled workforce as though the sophisticated computers, electronic goods, and luxury automobiles we have been importing require only unskilled labor.

Faith in the forces at work in free markets became the pied piper of America’s decline. It has been obvious for sixty years that Japan was not reciprocating our free trade policy and that China, with her controlled capitalistic economy has not been doing so either.

It has been obvious since the 1973 oil embargo that we were becoming dependent for most of our oil on foreign sources, some of them hostile or potentially hostile. Thanks to Pres. Clinton’s veto of the Energy Bill in 1995 and repeated successful Democratic opposition to bills that would have authorized drilling in the ANWR and offshore, some of the world’s largest oil reserves could not be exploited.

Exports and Imports of Goods, incl. Petroleum

(Billions of Dollars)

	1996	2000	2004	2006	2007
Exports of goods\1\	618.3	784.3	818.3	1030.5	1152.9
Imports of goods\1\	807.4	1243.5	1499.5	1880.4	1979.4
Trade deficit on goods (-)	-189.1	-459.2	-681.2	-849.9	-826.5
Less: Petroleum imports	72.7	120.2	180.5	302.4	330.7
Trade deficit excl. petroleum imports (-)	-116.4	-339	-500.7	-547.5	-495.8

At the beginning of 2002 Americans could buy a Euro for ninety cents but as of June 2008, it requires $1.55, seventy-one percent more. The European Union allows the Euro to float in the foreign exchange market but China and Japan do not. China allowed the yuan to rise in value, from 8.3 to the dollar to 7.3 between 2000 and 2008, a rise of 12 percent, while Japan allowed the yen to rise from 102 to the dollar, to 135 in 2002 (32 percent) and down to 108 in 2008 (6 % over 2000). Indeed, the strength of the Euro is the result of the flow of dollars to the purchase of Euro-denominated assets, garnered from trade surpluses with the U.S. (and Americans fleeing the dollar, too). The fall in the dollar relative to the Euro makes American goods cheap relative to European goods and encourages U.S. exports by making European goods more costly discouraging U.S. imports from Europe. That’s the way free trade is supposed to work. The low values of the yen and yuan versus the dollar puts no pressure on the deficits with Japan and China.

In fact, there is little evidence that the lower value of the dollar relative to the Euro has affected trade with Europe at all. As can be seen in the following table, our trade deficit with Germany, was about the same in both years, about $45 billion. Our trade deficit with China grew from $162 billion to $256 billion, an increase of 58 percent and with Japan from $75 billion to $83 billion, about ten percent. With all countries, the deficit increased twenty percent. No doubt, much of the increase consisted of petroleum imports. But no oil was imported from China, Japan, or Europe.

Trade Deficits with Selected Countries, 2004 – 2007

(billions of dollars)

Country	X – M 2007	X – M 2006	X – M 2005	X – M 2004
Total, All Countries	-790.30	-818.10	-767.10	-652.00
Canada	-64.20	-72.80	-76.60	-65.70
China	-256.30	-232.60	-201.70	-162.00
Mexico	-74.30	-64.10	-50.20	-45.00
Japan	-82.80	-88.50	-82.70	-75.20
Germany	-44.70	-47.80	-50.70	-45.80
France	-14.20	-12.90	-12.80	-17.30
Netherlands		13.80	-19.50	-19.20
Brazil	-1.00	-7.20	-27.60	4.30
Italy	-20.90	-20.10	-9.10	11.70

Our leaders, who rely on economic advisers, are acting as though our principal economic problem were a Keynesian insufficiency of domestic demand. Were that the problem, increased expenditures like the so-called rebate would indeed be helpful; it would increase effective demand 1.1 percent if it were all spent on domestically produced goods. But what can you buy that is produced in America? We need to produce the computers, the luxury autos, TVs, and other high-valued products we are now importing. Stimulating consumption now may have a temporary modest effect but what we face is a long-term slide into oblivion. We desperately need investment at home. We have been over-consuming and under-investing for two decades. Last year, according to government statistics, Americans saved 4/10ths of one percent of their disposable income (income after taxes). In most Asian countries, households save 15 percent or more. American business investment in 2006 barely exceeded depreciation allowances. We need net investment of 15 percent of GDP, just to have a three percent rate of real growth. Business investment is strong only in the health sector and technology sectors where the firms are protected from foreign competition.

It was easy. It was all done because American economists made an ideology of free trade. Since the classical economist, Smith, Ricardo, Economists denounce any action to restrict imports as protectionism. They sat, and continue to sit and pontificate in their ivory towers on the benefits of free trade while the trade deficits accelerated America’s de-industrialization causing the loss of U.S. factory jobs, wage stagnation, a worsening distribution of income, soaring commodity prices, and economic stagnation, as well as a depreciating dollar.

For many years trade surplus countries like Japan, China and the oil-exporting countries invested their surplus dollars in American assets such as U.S. Treasury bonds. The flow of these funds to the U.S. prevented any downward pressure on the dollar but as the dollar began to show weakness, they reduced their purchases of U.S. assets and increased their purchases of Euro assets and assets in other countries. This strengthened the Euro and precipitated the decline in the dollar. The trade deficits are the real cause of the weak dollar. The falling dollar is the result of the fact that the trade surplus countries did not use the dollars they earned to buy U.S. goods or services but used them to buy financial assets here and increasingly abroad.

The U.S. government in the person of Treasury Secretary Henry Paulson, has been trying to bring down the price of oil by treating its symptom, the low value of the dollar relative to the Euro, trying to get foreign central banks to support the dollar. That would do nothing to correct the cause of the dollar’s decline. The cause of the collapse of the dollar is the trade deficit.

Unfortunately, neither the Fed nor the Treasury has any solution to the problem of the falling dollar and its cause, the trade deficits. Dr. Bernanke himself said in a speech while he was Chairman of the Council of Economic Advisors that market forces cannot be relied upon to get the trade deficits under control but has offered no alternative

We can easily reduce the trade deficits. As we show in our recently published book, Trading Away Our Future, we need to inform all of our trading partners with whom we have chronic trade deficits that they must purchase as much from us as we purchase from them or we will enforce a trade balance by reducing our imports from them. If necessary, we may have to ration some oil uses, particularly gasoline.

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Dr. Raymond L. Richman is Professor Emeritus of Public and International Affairs at the University of Pittsburgh. Together with Dr. Howard B. Richman, a teacher of economics on the internet and Dr. Jesse T. Richman, Asst. Professor of political science at Old Dominion University, they recently published, Trading Away Our Future, (Ideal Taxes Association, 2008, a book which deals with many of the above issues.