Sunday, September 18, 2011

WSJ Blunders over Romney smack-down on Free Trade

Open letter to WSJ over Romeny free-trade put-down

Dear sir,

Your asserting that Romney has made a blunder ( WSJ September 17, 2011 “Romney’s China Blunder”) is supported by the most vacuous logic.

You take Romney to task for not assesses the facts you then address those facts then dismiss them.

You say:

Any serious argument that China is running a mercantilist trade policy needs to look at the Chinese trade surplus with the rest of the world. That has grown dramatically over the last decade, due to policies that we have criticized. The crux of the issue is not the value of China's currency—every country has the right to pursue exchange-rate stability, and dozens of countries peg or somehow adjust their currencies to the dollar.’ (Emphasis added)

This is the warped logic of ‘free trade’ that actually undermines free trade.. For trade to be ‘FREE” and for the good things that flow from FREE TRADE to occur, exchange rates must be at their proper parity values not arbitrary or self-selected levels. Countries really DO NOT have the ‘right’ to choose any stability system they wish to choose or to peg to the dollar. This notion is sheer folly. It may be current practice but it still is folly. How can a competition-loving paper like the WSJ endorse national ‘price fixing’ as a means to free trade? What more important price to ‘fix’ than the exchange rate? The international trade literature is replete with papers about the damage from misaligned exchange rates and yet you dismiss it with a few taps on your keyboard and proceed to ignore all the evidence that misaligned trade is causing damage..

I’m sure after a few nanosecond of thought this is a position you will want to ‘re-think.’

Want more facts to support Mr. Romney? Exchange rate fixing is why developing nations own three-quarters of the world’s foreign exchange reserves. They buy dollars and other currencies to keep their own currencies competitive. This is why the US Current Account averages a deficit of 2.1% of GDP since 1971 when Bretton Woods collapsed, and why the US current account has not been in surplus in any quarter since 1991. If you believe in markets how is such a result consistent with exchange rate equilibrium?

Romney has a Tiger by the tail. Your lot would be better cast by getting on his side. The argument that China’s own domestic monetary policy has to blow up to get the Journal to realize that China (and others) are engaged in anti-competitive practices that WTO does not even address - practices that have helped to prevent the US current account from ‘ever adjusting’ - is an idea that stretches the limits of credulity. Free trade and exchange rate alignment are worth thinking about especially by a candidate for the office of president..

So many want to ‘perish the thought’ (actually, perish any thought) about the dollar because at the end of the day it leads to the conclusion that they do not want to make: that the dollar is STILL too strong. Or, put another way, US productivity is not high enough for the dollar to stay at this level. But these persisting current account deficits are signals from the marketplace. Do not ignore a lump in your breast or a persisting hacking cough or sustained current account imbalances: they all are valid signals of something gone wrong. Moreover, do not deny all the investment in China and the rest of Asia over the past twenty years that clearly has raised their productivity and should therefore raise the values of their respective currencies (and lower that of the dollar by implication).

This language that the WSJ uses that is dismissive in nature about how US firms have subsidiaries abroad to get the lowest prices is all just an end run around reality. Why aren’t those operations instead in AMERICA? That’s the real question! That they have to be overseas is the exact thing that is at issue here. That is not a part of the argument to ‘take for granted.’

Why do US firms have $2tln on their balance sheets they will not spend with US unemployment over 9%? Why do they invest overseas instead of in the US? Why does China have $3trln of foreign exchange reserves? And why did they raise those reserves by 30% over the past year all the while complaining about the dollar? SNL had some great skits about their dollar-investment angst yet they pilled on more dollars. Why doesn’t China, a poor country, spend those vast reserves at home and raise living standards? Why do countries pour $500-$600 bln into the US as capital flows each year while US banks have billions in excess reserves they can’t find borrowers for? What do foreign investors ‘know’ that our banks do not?

Give up the fantasy that the dollar is properly aligned ( and the yuan and so on…) and these question begins to have answers. Do that and many of our ‘vexing problems’ have solutions.

The drop off in US manufacturing output is the start of severe crisis. The US needs to pay for its foreign exchange and we will never do that even if services jobs come back. The US needs to export to earn its foreign exchange (that’s how it’s done) and that means manufacturing. Pretending that trade restrictions are the only impediment to better US trade performance just stands in defiance of the sorts of huge numbers we need to marshal to solve our current account financing problem. The real problems is competitiveness.

If the Journal really supports free trade it needs to support the formation of a world environment in which truly free trade can blossom- not a system in which China and other developing nations suckle at the teat of US wealth until it runs dry. Because it will run dry. No country can run current account deficits forever. Foreigners are not running up what may prove to be a stack of ‘worthless IOUs’ instead they are starting to OWN us. And that can’t be good

America needs to be competitive. Let’s BRING BACK free trade!

Mr. Romney is much more right in this debate than he is wrong. You, sir, need to look closer at the arguments that you make to dismiss him - and to look harder at the facts, even when that is uncomfortable. Intellectual honesty is not about comfort. It is often painful. But in the pain is often wisdom and that, too is a lesson from markets.

Thursday, September 8, 2011

Trade, the real fool’s game

Trade, the real fool’s game

I would like to underline one aspect of the trade report that is not getting much attention- well ANY attention.

Although the deficit fell this month, at $44bln it can be annualized to a deficit of $528bln.

When we have a deficit in our trade account (more correctly, the current account) we obtain an equal amount of capital inflows to finance that deficit.

So here is the question:

So,why, when US banks have billions and billions of dollars in excess reserves, empowering them to make billions and billions of dollars in loans which they DO NOT MAKE are foreign investors pouring capital into the US at a pace of over $500 bln per year?

How do you reconcile that paradox?

We argue that there is no great attraction that 'pulls' foreign funds into the US. Instead we view capital flows as being 'pushed' by foreign investors who have other objectives.

That is we do not think that 'high US interest rates' are sucking capital in or that 'high rates of return in business investment' or in 'real estate' are attracting inflows.

We see the inflows as the result of foreign government's decisions to accumulate dollars in order to support the dollar at a relatively high level so they can pursue a policy of export led growth by keeping their currencies relatively weak and exports cheap.

These policies have caused the US current account deficit to persist. Developing countries have amassed the build-up of world foreign exchange reserves an action that can only be regarded as one that supports them in achieving their objective of keeping their respective currencies 'too cheap' and the currencies that they buy 'too strong'. Developing countries do not need FX reserves as much as they need to put those monies to work in their own countries to further their development. But they don't do that...

China's FX reserves rose 30% over the past year and stand at $3trillion. How does that accumulation not act to keep the yuan too weak and to perpetuate the US-with-China trade deficit? How else can it be interpreted?

By 2007 China had comprised over 30% of the annual US trade deficit and in 2009 and 2010 that percentage has moved up to 44%. Despite the US need to buy oil at high world prices China takes up 44% of the US global trade deficit.

A proper functioning exchange rate system would not keep a country's current account in a state of perpetual deficit. Yet, since 1971 the US current account has been in deficit for all by 24 quarters (24 out of 159; or 15%). The current account has averaged since 1971 a deficit that is 2.1% of GDP. The US has not seen a current account surplus since 1991Q2 a twenty year span. Currently, the current account deficit is 3% of GDP after reaching a peak percentage of 6.5% of GDP in in 2005. Interestingly the US had shrunk is current account deficit to 2.4% of GDP by the end of the recent recession, but in recovery even with GDP growth at 2.2% the current account deficit relative to GDP is rising again.

Since 1982 the US current account has been in surplus only two quarters. The ONLY progress in shrinking the deficit has come as the economy has slowed either just ahead of a recession or in a recession. For example from Q3 of 2006 to Q3 of 2007 when recession started, the US current account deficit shrank because GDP growth slipped below 2.5% and then the economy fell into outright recession. That caused the current account to shrink much faster. But it remains in deficit and a larger deficit than what has been normal. Since the last US current account surplus in 1991 the summation of the current account relative to GDP is 65%- no compounding.

Clearly this international monetary system is not working. It may not need to equilibrate the US current account immediately but we do need some signs of progress and improved fundamentals to support progress in that direction. The US current account deficit is huge and is hardly getting better; at 3% of GDP it is 50% above its average since 1971. Pumping the US economy full of debt is not helping. Even S&P can see the risk. The danger is that only debt saturation will stop this madness (bankruptcy). That is what happens if a well-functioning exchange rate system cannot be imposed on this dysfunctional process that perpetuates US debt accumulation (current account deficit). No wonder gold bugs are trying to push a gold standard. It would stop this madness, but would create and entirely new madness. Imagine moving to a gold stand and losing $500bln of gold reserves a year (the current account deficit). What sort of recession would you have to run to eradicate that and to stop losing gold? And with unemployment already at 9%?

Many economists reject this analysis and blame the US for its 'addiction' to debt but I see the US being force-fed debt because foreigners will not let the US mount any consistent export growth. In short the US does not enforce its exchange rate, on the markets. Markets do the ‘enforcing’ and right now markets are being manipulated by foreign governments. The foreign capital inflows (debt accumulation) by the US and the accumulation of massive foreign exchange reserves by foreign exporter countries far in excess of needs are the forensic evidence, the finger prints, of this ongoing currency manipulation.

The excess bank reserves are evidence that those flows are not being attracted by an insatiable US appetite for debt. We could slake that thirst at home with the banks.

If this were CSI I'd be ready to go to court.

Root of all evil (well, most of it anyway...)

In other words, this is not free trade. This is not fair trade. This is a fool's game and it is coming to an end one way or another. It is a process that is responsible for many other Ills in the economy that the fiscal deficit folk and the monetary mavens are trying to solve. It is at the root of our many and varied asset bubbles. But we are unlikely to fix either US fiscal policy or monetary policy until we deal with international monetary problem because it greatly exacerbates the other problems. Don't look for the G-7 to go there because no one seems to have a clue.