Friday, June 27, 2008

A Quick Fix to Our Economic Malaise

A Quick Fix to our Economic Malaise
Raymond L. Richman

The current weakness of the U.S economy is attributable to the goods trade deficits that have grown from $189 billion in 1996 to $826 billion in 2007, the latter equal to the value-added of nearly 8 million industrial workers. In other words, it would take the export of the goods produced by 8 million American workers to bring trade into balance. No wonder that wages have been stagnating, that income distribution has been worsening, that the dollar has been falling, and that the economy has been slowing. During the first quarter of 2008, the trade deficit continued to grow although less rapidly: goods imported grew $52.6 billion compared with the first quarter of 2007 while goods exported grew $47.6. One quick sure way is to bring the trade deficits under control is by reducing imports. Unfortunately, too many powerful groups have a vested interest in perpetuating the trade deficits and everything that has been proposed has been labeled “protectionist” by a huge majority of economists. To paraphrase the late Senator Goldwater, protectionism in pursuit of a trade balance is no vice and allowing the trade deficits to devastate our economy is no virtue.

Free trade has sounded good since Adam Smith wrote his Wealth of Nations in 1776. Indeed, so good that few economists ever asked themselves what the consequences would be if one party practiced free trade and the other trading partner practiced mercantilism. Since the early 19th century, economists have denounced any action to restrict imports as protectionism. They sat and pontificated in their ivory towers on the benefits of free trade while the trade deficits grew and grew. Faith in the forces at work in free markets became the pied piper of America’s descent into economic stagnation. 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. And the rise of oil prices, which accounted for 40 percent of the trade deficit in goods in 2007, met with no U.S. government response during its rise from $35/barrel in June, 2004 to $135 in June, 2008. While the supply of petroleum is highly inelastic, it is hard to believe that world demand has increased in four short years enough to send its price into the stratosphere. Unfortunately demand is highly inelastic, too. The solution to the game requires bargaining as in the case of monopsony versus monopoly.

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 located in the U.S. and off-shore could not be exploited.

Exports and Imports of Goods, incl. Petroleum
(Billions of Dollars)
YearExports of goodsImports of goodsTrade deficit on goodsLess: Petroleum importsDeficit excl. petroleum

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 head of OPEC may be close to the truth when he recently declared that the U.S. is responsible for the high price of oil. The increase in cost is not nearly so great for Europe as it is to us given the fact that the price of oil is calculated in U.S. dollars.

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 our imports from Japan and China.

In fact, there is little evidence that the lower value of the dollar relative to the Euro has affected trade at all. Our trade deficit with Germany was about the same in 2004 and 2007. 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 Germany.

Our leaders, following the advice of their economic advisors, are acting as though our principal economic problem were a Keynesian insufficiency of domestic demand. Were that the problem, a “rebate” would indeed be helpful; it would increase domestic demand to the extent households spent the rebate on domestically-produced goods. But what can you buy that is produced in America? We need to produce the computers, the luxury autos, the TVs, the cell phones, oil, and other high-valued products we are now importing. Stimulating consumption now may have a modest temporary effect but what we face is a long-term slide into oblivion. We desperately need investment spending 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 a quarter to one-half their incomes. 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 by patents. Indeed, many corporations have so much in retained earnings and nothing to invest in that are buying back their own stock, a practice that benefits managers whose bonuses are based less on earnings that on the rising price of shares. (Paying that same money out as dividends would really benefit their shareholders with dividends currently taxed at the same rate as long-term capital gains. These include some well-known names, e.g., IBM.

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 exchange value of the dollar. The trade deficits are the real cause of the weak dollar.
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 has said that market forces cannot be relied upon to get the trade deficits under control. We can easily reduce the trade deficits as we show in our recently published book, Trading Away Our Future. We have the legal right under WTO rules to impose barriers to imports from countries with which we are experiencing chronic trade deficits. 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 and that effective next year, importers will be limited to 90 percent of their prior year’s imports. This will be in effect until our exports reach 90 percent of our imports. Likewise, we should reduce our imports of petroleum from OPEC members by ten percent of the previous year’s imports. This will make it necessary to ration gasoline and other petroleum products. Each household would receive marketable ration coupons which would provide a financial incentive to use less than its ration. Reducing imports of oil from Venezuela and Saudi Arabia, both members of the illegal cartel, OPEC, would also lower the world price of oil inasmuch as the supply of oil is highly inelastic. A small decrease in demand for oil would lower its price disproportionately.

Moreover, announcing that we will lift the prohibitions to drilling in the ANWR, off-shore, and on public lands would have an immediate effect of lowering the world price of oil.

The effect of these measures will be to strengthen the dollar, encourage investment, and stimulate employment in well-paid jobs in oil production, pipeline construction, and transportation and have beneficial secondary effects throughout our economy. End of recession!

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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 and Dr. Jesse T. Richman, he recently published, Trading Away Our Future, (Ideal Taxes Association, 2008), a book which deals with many of the above issues.


Richard Jennings said...

Not to be a simpleton but I still see many high paying jobs posted on employment sites i.e.

There is still strong demand for professionals despite the stats

Raymond Richman said...

People are being hired and fired all the time. Some companies are laying off workers and a lesser number are being hired. During the past few months, unemployment increased from just over 4.6 percent to 5.5(?)percent or by roughly a million and a half workers. Technically, we are not in a recession but we'll be lucky if we avoid one. Unless we do something fast as I recommend, I would say the chances are we won't be lucky and we risk a depression.
I believe we are witnessing the end of the American century, the briefest reign of a superpower in history. Most of the world are enjoying the sight of Rome burning.