I recently gave a podcast interview to Vox Day, a prominent Christian libertarian, explaining why free trade is bad for America.

He followed it up with an article making many of the same points.

Finally, a libertarian gets it.

This did not go over well with some of his followers.

I’m not qualified to speak to the “Christian” aspects of free trade – whatever those are – beyond observing that globalism, of which free trade is a part, certainly looks like the Tower of Babel. But as one prominent libertarian has now seen through the free trade delusion that generally grips his fellow libertarians, this is probably a good time to explain what he got and they didn’t.

The libertarian defense of free trade can get as complicated as anything in technical economics, but at bottom it comes down to ideas like this, which one can read all over the place in the comments posted after my articles – and now Vox Day’s:

“What right do you have to tell me who I may and may not buy things from?”

At first blush, that’s quite a challenge. Many libertarians certainly seem to think it’s decisive. It’s certainly a snappy quote.

But it’s wrong.

Let’s start by noting that I am not claiming any right at all. Protectionism, if implemented, wouldn’t be implemented by me. It would be implemented by the U.S. government, and would be legitimate – if it is legitimate – for the same reasons all our other legitimate laws are legitimate:

We have Constitution and a democratic process, and that’s where laws come from.

Some libertarians prefer to call themselves constitutionalists, so it is worth pointing out that Article I, Section 8 of the Constitution explicitly gives Congress the right “to regulate commerce with foreign nations.”

The second point in answer to the libertarian challenge stated above is this:

This isn’t just about you.

Like it or not, even a capitalist economy is a system, in which your actions affect other people. Your freedom to swing your fist ends, famously, at the tip of my nose, and what you buy and don’t buy affects other people.

Even more importantly, your own economic actions don’t mean anything except in the context of a system that you didn’t create. You don’t enjoy the income you enjoy – which is what gives you the very ability to buy things disputed above – solely because of your own efforts. You enjoy that income because, among other things, you were born into a society which had a per-capita GDP of $47,000 during your working lifetime.

If you’d been born in medieval Afghanistan, it would be a very different matter. And not because of anything you personally can claim credit (or deserve blame) for.

So you can’t claim that what you’ve got derives solely from your own efforts and that you are therefore entitled to do what you like with it. Robinson Crusoe can claim absolute economic freedom; you can’t.

None of this is to deny that a reasonable amount of economic freedom is a good thing. But you get into trouble when you elevate it, like any other good, into an absolute.

Try absolutizing national security, traditional values, law enforcement, self expression, religious piety, intellectual sophistication, social order … Get my point?

Here the plot thickens, because the nature of this economic system we are all a part of is the real key to why free trade doesn’t work even within libertarian assumptions.

The libertarian economic model is a model based on free markets. That is, it is based on the idea that free market economics describes both the way the economy is (insofar as it works well) and the way it should be.

The key idea of this free market economics is equilibrium. That is to say, free market economics holds that if market forces are allowed free play, then the prices and production of things will reach natural equilibria that are the most efficient outcome that could exist.

To a huge (but not total) extent, this is true. (I studied economics at the University of Chicago; trust me, I know this story.)

But there’s a catch. Equilibria only balance properly if nobody puts a “thumb on the scale” anywhere in the economic system and distorts it. If that happens, then all bets are off about the outcome being efficient at the level of the system as a whole.

All bets are also off – this is the key – about any individual “free” market decision being valid. Why? Because the market isn’t free anymore. You can’t play by free market rules when you’re not in a free market.

Try playing fair when the game is rigged. That’s not fairness, it’s suicide.

Unfortunately, there are a million “thumbs on the scale” in international trade right now. All of these distort market forces, so even if pure-free-market economics is right (it isn’t, but that’s another story), libertarian economic conclusions don’t follow.

How are markets distorted in trade? Don’t get me started. To name just a few ways:
China manipulates its currency. So does Japan, Germany, and a few others.

China keeps American goods out of its markets. So does Japan, yadda yadda yadda, albeit more politely.

China subsidizes (contravening its own WTO treaties) its industries in ways ranging from cheap credit to free land.

China steals American intellectual property. (Germany and Japan mostly quit doing this long ago, largely because they now have a lot of intellectual property of their own to protect.)

China uses slave labor. Even its non-slave labor is regimented in ways unimaginable in the U.S.
As a result, someone who buys cheap foreign goods isn’t exercising a free choice, they’re just taking advantage of someone else’s utterly coercive subsidy. The price system can’t tell the difference – cheap is cheap – and that’s why people make this choice thinking they’re practicing freedom. But the slaves keep on sweating. And the money changers keep cheating. And all the rest of it.

Whenever libertarians buy foreign goods that are cheaper because of all these practices, they encourage them.

And that actually diminishes, rather than increases, freedom.

So even from a libertarian point of view, free trade is a losing move.

One thing is for certain already: the present international trading order will not be here in ten years, and quite likely not in five. The unsustainable American trade deficit alone makes this a certainty.

Since the end of the Cold War, and accelerating after NAFTA in 1994, that order has consisted in ever-expanding “free” trade worldwide — which in reality is a curious mixture of genuinely free trade practiced by the United States and a few others with the technocratic mercantilism of surging East Asia and Germanic-Scandinavian Europe.

From America’s point of view, this order is free trade, at least on the import side of the equation, so it is as free trade that we must criticize it, prepare to celebrate its passing, and investigate what should replace it.

Our free trade policy is the answer to a question that currently has most mainstream economists scratching their heads: what killed the great American job machine? This policy has been partly responsible for increasing inequality in the United States and the gradual repudiation of our 200-year tradition of broadly shared middle-class prosperity. It is a major player in our rising indebtedness, community abandonment, and a weakening of the industrial sinews of our national security.

America’s economy today continues to struggle to emerge from recession because our trade deficit — fluctuating around $500 billion a year for a decade now — acts as a giant “reverse stimulus” to our economy. It causes a huge slice of domestic demand to flow not into domestic jobs, thus domestic wages and thus more demand, but into imports, therefore foreign wages, and therefore a boom in Guangdong, China; Seoul, South Korea; Yokohama, Japan; and even Munich — not Gary, Indiana; Fontana, California; and the other badlands of America’s industrial decline. Our response? Yet more stimulus, leading to an ever-increasing overhang of debt, both foreign and domestic, the cost of whose servicing then exerts its own drag on recovery.

The American economy has, in fact, entirely lost the ability to create jobs in tradable sectors. This cheery fact comes straight from the Commerce Department. All our net new jobs are in nontradeable services: a few heart surgeons and a legion of bus boys and security guards, most of them without health insurance or retirement benefits. These are dead-end jobs, and our economy as a whole is also being similarly squeezed into dead-end industries. The green jobs of the future? Gone to places like China where governments bid sweeter subsidies than Massachusetts can afford. Nanotechnology? Perhaps the first major technology in a century where America is not the leading innovator. Foreign subsidies are illegal under WTO rules, but no matter: who’s going to enforce them when corporate America is happily lapping at their very trough?

All the complaints just mentioned are familiar to the public, but they fly in the face of a sanctified myth that the superiority of free trade is a known truth of social science. Supposedly, it was proved long ago that protectionism is just a racket for the benefit of special interests at the expense of consumers.

Never mind that every developed nation, from England to South Korea, and including the United States, became a developed nation by means of this policy. That little piece of economic history is airbrushed out of the picture in favor of the Cold War myth of the absolute superiority of perfectly free markets. America never embraced this myth on its merits, merely as a tactical device to prop up the non-communist economies of the world and make them dependent upon us.

The cycle repeats: China today is reenacting this 400-year-old mercantilist playbook, which was born among the city-states of Renaissance Italy and never quite forgotten.

Economic theory will be sorted out eventually. Thanks to the work of a small, brave group of dissident economists — scholars like Ralph Gomory, William Baumol, Erik Reinert, and Ha-Joon Chang — the credibility of free trade as a theoretical doctrine is crumbling, and the discipline will eventually change its mind. But it will almost certainly be a lagging indicator, ready to vindicate policy forged in crisis well after the dust has settled. Academia is a superb rationalizer, and will doubtless find a way to avoid embarrassing questions about its own past positions when it teaches undergraduates twenty years from now that free trade is a delusion and a mistake.

What’s wrong with free trade? A whole host of problems, many of them long known to economists but assumed in recent decades to be unimportant.

The technical plot thickens here fast, but we can begin by noting that any serious discussion of free trade must confront David Ricardo’s celebrated 1817 theory of comparative advantage, whose tale of English cloth and Portuguese wine is familiar to generations of economics students. According to a myth accepted by both laypeople and far too many professional economists, this theory proves that free trade is best, always and everywhere, regardless of whether a nation’s trading partners reciprocate.

Unfortunately for free traders, this theory is riddled with dubious assumptions, some of which even Ricardo acknowledged. If they held true, the hypothesis would hold water. But because they often don’t, it is largely inapplicable in the real world. Here’s why:

Ricardo’s first dubious assumption is that trade is sustainable. But when a nation imports so much that it runs a trade deficit, this means it is either selling assets to foreign nations or going into debt to them. These processes, while elastic, aren’t infinitely so. This is precisely the situation the United States is in today: not only does it risk an eventual crash, but in the meantime, every dollar of assets it sells and every dollar of debt it assumes reduces the nation’s net worth.

Ricardo’s second dubious assumption is that the productive assets used to generate goods and services can easily be shifted from declining to rising industries. But laid-off autoworkers and abandoned automobile plants don’t generally transition easily to making helicopters. Assistance payments can blunt the pain, but these costs must be counted against the purported benefits of free trade, and they make free trade an enlarger of big government.

The third dubious assumption is that free trade doesn’t worsen income inequality. But, in reality, it squeezes the wages of ordinary Americans because it expands the world’s effective supply of labor, which can move from rice paddy to factory overnight, faster than its supply of capital, which takes decades to accumulate at prevailing savings rates. As a result, free trade strengthens the bargaining position of capital relative to labor. And there is no guarantee that ordinary people’s gains from cheaper imports will outweigh their losses from lowered wages.

The fourth dubious assumption is that capital isn’t internationally mobile. If it can’t move between nations, then free trade will (if the other assumptions hold true) steer it to the most productive use in our own economy. But if capital can move between nations, then free trade may reveal that it can be used better somewhere else. This will benefit the nation that the capital migrates to, and the world economy as a whole, but it won’t always benefit us.

The fifth dubious assumption is that free trade won’t turn benign trading partners into dangerous trading rivals. But free trade often does do this, as we see today in China, whose growth is massively dependent upon exports. This is especially likely when trading partners practice mercantilism, the 400-year-old strategy of deliberately gaming the world trading system by methods like currency manipulation and hidden tariffs.

The sixth dubious assumption is that short-term efficiency leads to long-term growth. But such growth has more to do with creative destruction, innovation, and capital accumulation than it does with short-term efficiency. All developed nations, including the United States, industrialized by means of protectionist policies that were inefficient in the short run.

What is the implication of all these loopholes in Ricardo’s theory? That trade is good for America, but free trade, which is not the same thing at all, is a very dicey proposition.

Beyond the holes in Ricardo, there is an entire new way of looking at trade growing up around the theoretical insights of Ralph Gomory and William Baumol of New York University. The details are technical, but the upshot is they have managed to bridge the gap between the Pollyannaish “international trade is always win-win” Ricardian view and the overly pessimistic “international trade is war” view. The former view is naive; the latter ignores the fact that economics precisely isn’t war because it is a positive-sum game in which goods are produced, not just divided, making mutual gains possible.

So at long last, someone has given us a theoretical framework that can accommodate economic reality as we actually experience it, not just lecture us on what “must” happen as Ricardianism does. It’s both a dog-eat-dog and a scratch-my-back-and-I’ll-scratch-yours world. Economics has finally given common sense permission to be true. Ironically, their sophisticated mathematical models are actually closer to the thinking of the man on the street than those they replaced.

There is an appropriate policy response. For starters, the United States should apply compensatory tariffs against imports subsidized by currency manipulation, an idea that originated with Kevin Kearns of the U.S. Business and Industry Council and was passed by the House of Representatives in the previous Congress. Also essential is a border tax to counter foreign export rebates implemented by means of foreign value-added taxes.

Perhaps even more important than the pure economics of free trade is its political economy (an older and more accurate term). For the fundamental reality of free trade is that it relieves corporate America from any substantial economic tie to the economic well-being of ordinary Americans. If corporate America can produce its products anywhere, and sell them anywhere, then it has no incentive to care about the capacity of Americans to produce or consume. Conversely, if it is tied to making a profit by selling goods made by Americans to Americans, then it has a natural incentive to care about American productivity and consumption.

Productivity and consumption are prosperity. The rest is details.

Right now, America is confronting any number of long- and short-term economic problems with one hand tied behind its back: corporate America is, increasingly, quietly indifferent to America’s economic success. This must change. While any proposals to end the K Street dictatorship in America’s public life are welcome, the reality is that mechanical reforms are less likely to touch on true fundamentals than realigning the economic incentives they reflect.

This is not a utopian project. In fact, it has already been accomplished, during the long 1790-1945 era of American protectionism. America wandered away from Founding Father Alexander Hamilton’s vision of a relatively self-contained American economy in order to win the Cold War. We threw our markets open to the world as a bribe not to go communist. If we fail to return to a policy of strategic, not unconditional, economic openness, we may lose the next Cold War — to a Confucian authoritarianism no less opposed to the idea of a free society than Marxism, and considerably more efficient.

The following article was written by Peter Morici, a professor at the Smith School of Business, University of Maryland School.

Press Advisory: Wednesday’s Trade Deficit Report

Tuesday, analysts expect the Commerce Department to report the deficit on international trade in goods and services was $47.7 billion in March, up from $45.8 billion in February.

This trade deficit subtracts from demand for U.S.-made goods and services, just as a large federal budget deficit adds to it. Consequently, a rising deficit slows economic recovery and jobs creation and limits how much Congress and the President may cut the deficit without sinking the economic recovery.

Rising oil prices and imports from China are driving the trade deficit up, and these are major barriers to creating enough jobs to pull unemployment down to acceptable levels over the next several years.

Jobs Creation

The economy added 244,000 jobs in April; however, 360,000 jobs must be added per month to bring unemployment down to 6 percent over the next 36 months. With federal and state governments trimming civil servants, private sector jobs growth must exceed 360,000 per month to accomplish this goal.

Americans have returned to the malls and new car showrooms but too many dollars go abroad to purchase Middle East oil and Chinese consumer goods that do not return to buy U.S. exports. This leaves too many Americans jobless and wages stagnant, and state and municipal governments with chronic budget woes.

Simply, policies regarding energy and trade with China are not creating conditions for 5 percent GDP growth that is needed and easily could be achieved to bring unemployment down to acceptable levels.

In April, the private sector has added 268,000 jobs per month, but many were in government subsidized health care and social services. Netting those out, core private sector jobs have increased only 229,000 in April—that comes to 73 non-government subsidized jobs per county for more than 5000 job seekers per county.

Early in a recovery, temporary jobs appear first, but 22 months into the expansion, permanent, non-government subsidized jobs creation should be much stronger.

Economic Growth

Since the recovery began in mid 2009, GDP growth has averaged 2.8 percent, disappointing Administration economists who have consistently assumed 4 percent growth in budget projections and forecasts for the job creating effects of stimulus spending.

Consumer spending, business technology and auto sales have added strongly to demand and growth, and exports have done quite well. However, soaring oil prices and the continued push of subsidized Chinese manufactures in U.S. markets have offset those positive trends.

Administration imposed regulatory limits on conventional oil and gas development are premised on false assumptions about the immediate potential of electric cars and alternative energy sources, such as solar panels and windmills. In combination, Administration energy policies are pushing up the cost of driving and making the United States even more dependent on imported oil and indebted to China and other overseas creditors to pay for it.

To keep Chinese products artificially inexpensive on U.S. store shelves, Beijing undervalues the yuan by 40 percent. It accomplishes this by printing yuan and selling those for dollars and other currencies in foreign exchange markets.

Presidents Bush and Obama have sought to alter Chinese policies through negotiations, but Beijing offers only token gestures and cultivates political support among U.S. multinationals producing in China and large banks seeking additional business in China.

The United States should impose a tax on dollar-yuan conversions in an amount equal to China’s currency market intervention divided by its exports—about 35 percent. That would neutralize China’s currency subsidies that steal U.S. factories and jobs. It is not protectionism; rather, in the face of virulent Chinese currency manipulation and mercantilism, it’s self defense.

The usual suspects are racing to debunk Donald Trump’s foray into the most serious protectionism—a 25% tariff on China—proposed by a major presidential candidate since Patrick Buchanan ran in 1992.

They know this is big.  Our long-delayed national trade debate has begun.

I have expressed reservations about getting obsessed with just China before.  But broadly speaking, Trump is right on the money here. Nothing less than an actual tariff or the equivalent is ever going to get Beijing to stop gaming the international trading system to America’s disadvantage.

This matters, big-time.  Because until we sort out America’s trade mess—which must start by zeroing out, or close to it, our $600 billion-a-year trade deficit—our economy will never truly be healthy again.

Jobs are the aspect of this everyone understands.  But what a lot of people miss is that the current budget fight, and the angst over our mounting national debt, are also intimately connected to trade.

So Trump is onto something even bigger than people realize.

The budget fight ultimately comes down to the fact that we don’t have an economy large enough to generate tax revenue commensurate with the spending we have voted for. But why isn’t our economy big enough? Start with the fact that, as economist William Bahr has estimated, America’s accumulated trade deficits since 1991 alone have caused our economy to be 13 percent smaller than it otherwise would be.  The trade deficit costs us about one percent in GDP growth every year, and that compounds over time.

As for our national debt, or, more properly, our bloating public and private indebtedness? As I explained at length in another article, borrowing money (and selling off existing wealth, which has the same net effect) is a mathematically inevitable result of running trade deficits. The only way this can not happen is if a) the aforementioned $600 billion isn’t real money, or b) America is trading with Santa’s elves.

So, Mr. Trump… How do we rebalance America’s trade, starting with China?

Forget about doing it by playing nice. China will only give up one-way free trade (free for America, protectionist for them) when they are coerced into doing so. They are making far too much money to ever give up this sweet racket voluntarily.

We are constantly warned that imposing a tariff on China would trigger a trade war. But the curious thing about the concept of trade war is that, unlike actual shooting war, it has no actual historical precedent. In fact, the reality is that there has never been a significant trade war.

Anyone who knows otherwise, please name one.

The usual example free traders give is America’s Smoot-Hawley tariff of 1930, which supposedly either caused the Great Depression or caused it to spread around the world. But this canard does not survive serious examination, and has actually been denied by almost every economist who has actually researched the question in depth—including many free traders and ranging from Paul Krugman on the left to Milton Friedman on the right. (I debunked this myth at length in this article.)

There is, in fact, a basic unresolved paradox at the bottom of the very concept of trade war. If, as free traders insist, free trade is beneficial whether or not one’s trading partners reciprocate, then why would any rational nation start one, no matter how provoked? Wouldn’t they just keep lapping up the benefits of one-way free trade, if it’s so good for them?

Furthermore, if the moneymen in Beijing, Tokyo, Berlin, and the other nations currently running trade surpluses against the U.S. start to ponder exaggerated retaliation against the U.S., they will soon discover the advantage is with us, not them. Because they are the ones with the trade surpluses to lose, not us.  What exactly does the U.S. have to lose in a trade war? The only way a deficit nation can “lose” a trade war is by having its trade balance get even worse. Given that the U.S. trade balance is already outlandish, it is hard to see how this could happen.

Supposedly, China could suddenly stop buying our Treasury Debt.

Indeed they could, but this would immediately reduce the value of the $1.15 trillion or so they already hold.  Furthermore, this would depress the value of the dollar—exactly the opposite of their currency manipulation strategy.

Then there is the awkward problem of what China would do with all the money it would get by selling off its dollars. There just aren’t that many good alternatives for parking that much money. Japan doesn’t want its currency used as an international reserve currency, and the Euro has huge problems. Assets like gold and minor currencies are volatile or in limited supply. Others, like real estate or corporate stocks, are still denominated in those pesky dollars and euros.

We are still a nuclear power, so at the end of the day, China cannot force us to do anything that we don’t want to. We could—a grossly irresponsible but not impossible hypothetical—repudiate our debt to them (or stop paying the interest) as the ultimate countermove.

More plausibly, we might simply restore the tax on the interest on foreign-held bonds that was repealed in 1984 thanks to Treasury Secretary Donald Regan.  We have lots of little cards like that up our sleeve.

So an understanding will, most likely, be reached.  A deal (one of Mr. Trump’s favorite words!) will be struck. I think Mr. Trump understands this better than anyone else.  That’s one of the things I like about him.

The reality is that the United States is already in a trade war with China. Kowtowing to China today is economic appeasement, with the same result as political appeasement in the 1930s: a few more years of relative quiet with a bigger explosion at the end.

At some point, America’s ability to run gigantic deficits must end, due to a prolonged slide or sudden crash in the value of the dollar.  The longer we wait, the greater the likelihood that it will come as a sudden and destabilizing shock, rather than a managed, more gradual adjustment.

This issue is bigger than China alone. How America deals with China will set the precedent, and establish or destroy America’s credibility, for dealing with a long list of other nations.

Believe me, they’re watching Trump now in Tokyo, Berlin, and Brussels.

The following article by Taras Berezowsky appeared on the Metal Miner site here.

“Why don’t pro football players mow their own lawns?”

Ian Fletcher puts this provocative question forth in an article for the Coalition for a Prosperous America (CPA), for which he serves as senior economist, as the centerpiece for his argument on why comparative advantage, in practice, doesn’t really work. In the first part of his argument, he lays out the difference between absolute and comparative advantage; obviously, in answering the above question, the football player has more power and ability to mow his lawn faster than a run-of-the-mill, suburban landscaping contractor – but he’s got better things to do with his time.

It seems the US has had “better things to do with its time” for several decades now – and arguably, this has not improved our long-term growth prospects. Following our coverage of what the World Trade Organization thinks international trade will look like in 2011, Fletcher’s arguments against free trade (or, rephrased, why it is fundamentally flawed in the world we live in today) seem rather poignant; if only to draw attention to inherent problems, so that we can begin seriously considering potential solutions. “This is why we must analyze trade in terms of not absolute but comparative advantage,” Fletcher writes. “If we don’t, we will never obtain a theory that accurately describes what does happen in international trade, which is a prerequisite for our arguing about what should happen—or how to make it happen.”

In the second part of his argument, Fletcher lists a number of “dubious assumptions” about comparative advantage working properly, poking holes in the “free trade is best” argument – enough holes, as he says, “to sink a container ship.” He lists seven –

“Trade is sustainable”
“There are no externalities”
“Productive resources move easily between industries”
“Trade does not raise income inequality”
“Capital is not internationally mobile”
“Short-term efficiency causes long-term growth”
“Trade does not induce adverse productivity growth abroad”

– and although he gives a treatment for each, two stand out: trade is sustainable (it really isn’t) and “short-term efficiency causes long-term growth” (comparative advantage is not built to even consider the long term). As far as the first point, let’s look no further than the trade deficit. Potential solutions to balance out the US trade deficit, which didn’t drop in February as much as analysts predicted/hoped, must stem from reducing consumption – which seems paradoxical, as consuming imports is what this country has been, for better or worse, built on. (In fact, Bloomberg reported that a government report showed the cost of imported goods rose in March to a two-year high.) The percent change in the deficit that the mainstream media monitors, whether increases or decreases, all stem from ‘small-potatoes’ changes (an increase in oil demand here, a decrease in the value of the dollar there, etc.), rather than systemic implementation of sustainable policy.

This is inevitably where government comes in. In a theoretical world, nations can simply trade as people would, with their own mores and assumptions and prerogatives. But inevitably, there are losers. In playing the free trade game with other nations – some with governments that are involved in subsidizing elements related to trade – there will surely be inequalities. But for the US to play with cheaters, it will need more than the WTO to play the referee. In addition to the pro-active government policies (across the board 33-percent tariffs on all imports, anyone?), we’ve got to look at our own consumption, break addictions not just to ‘foreign oil’ but also to all sorts of cheaply made goods, and brace ourselves for the point in time when foreign societies will attain higher-earning, more specialized workforces – much like ours.

At that point, what will the US be able to offer? Even in manufacturing, are there goods made domestically that other countries can’t make themselves – or can’t buy from someone else more cheaply? How can US citizens envision a sustainable future from selling our goods, instead of buying others’? Of course, to stop short of advocating pure protectionism, there is a global trade landscape that is already in place that cannot easily be broken. But adding independent WTO-style mediation as a stopgap for unfair trade practices sometimes seem a nominal, not a real, fix.

As Fletcher mentions in yet another article, we can’t keep treating real trade problems – such as the deficit – as though they’re abstract. We’ve done that before with the financial securities markets, and we all saw how nebulous abstractions got the global economy into some real, real trouble.

Feel free to leave any comments/additional suggestions on how both business and government can better work together to improve the trade landscape.

The following article was written by Peter Morici, a professor at the Smith School of Business, University of Maryland School.

Inflation Moves to Center Stage, Highlights Fed and G20 Impotence

Today, the Labor Department reported consumer prices were up 0.5 percent in March, driven by 3.5 and 0.8 percent jumps in energy and food prices.

This is the fourth straight month of large gains in consumer prices. While food and energy prices may be volatile, international conditions indicate commodity prices will continue surging, and the Fed’s emphasis on core inflation is absolutely misplaced.

With inflation running at 6 percent a year, it will be tough for the Federal Reserve to deny inflation and continue quantitative easing and low interest rates generally. Similarly, with unemployment likely to remain above 8 percent for the balance of the year, the Fed will find it tough to raise interest rates too much.

The U.S. economy is headed for stagflation thanks to failed banking and international economic policies that lie largely beyond the Fed’s control.

At the heart of the Great Recession and now stagflation are two dysfunctions—problems in U.S. banking, and China’s currency policy and Germany’s privileged position in the EU. For different reasons, but with the same effect, China and Germany enjoy undervalued currencies and protected domestic markets, and are creating imbalances in demand for goods, services and workers globally.

Recent banking reforms have not changed how Wall Street does business—the emphasis is still on trading instead of making sound loans. Whereas before the recession banks made reckless loans—based on the shady practice of pushing loan-backed securities on unwitting investors—now they are starving small and medium-sized businesses for the credit needed to create jobs.

Also, Beijing subsidizes imports of oil and other commodities with the dollars it obtains selling yuan to keep its value low. In the case of oil, it gives to refineries dollars it obtains selling yuan to offset the high price of imported oil. That pushes up oil and other commodity prices globally. Simply, China’s currency policy is a global inflation machine.

In combination, China’s currency policy starves its trading partners of demand for goods, services and workers with subsidized exports of consumer goods and pushes up inflation in those economies by elevating oil and other commodity prices. That makes China’s currency policy a global stagflation machine too.

This week the G20 Finance Ministers, representing the largest developed and developing countries, are meeting in Washington. And again China and Germany block progress. Instead, they prefer to lecture other countries about the genius of their policies, when those policies are nothing more than beggar thy neighbor protectionism, exporting unemployment and fiscal crisis to their trading partners.

The Obama Administration needs to give up on failed multilateral groups and lead concerted action with a few other major nations in responding directly, or as necessarily, act unilaterally to respond to Chinese and German protectionism. If not, Americans can look forward to high unemployment, damaging inflation, falling real incomes, and continuing economic woes.

The following was written by Peter Morici, a professor at the Smith School of Business, University of Maryland School.

Thursday, analysts expect the Commerce Department to report the deficit on international trade in goods and services was $41.0 billion in January, up from $40.6 billion in December and $27 billion in mid 2009, when the recovery began.

This rising deficit subtracts from demand for U.S. goods and services, just as stimulus spending and additional temporary tax cuts add to it. Consequently, a rising deficit slows economic recovery and jobs creation, and the Obama Administration and Republican leadership in Congress have offered little to address it.

Rising oil prices and imports from China are driving the trade deficit, and these are major barriers to creating enough jobs to pull unemployment down to 6 percent over the next several years.

Jobs Creation

The economy added 192,000 jobs in February, and that was encouraging, after it gained only 63,000 in January; however, that is hardly enough. The economy must add 360,000 jobs per month over the next 36 months to bring unemployment down to 6 percent.

Americans have returned to the malls and new car showrooms but too many dollars go abroad to purchase imports and do not return to buy U.S. exports. This leaves too many Americans jobless and wages stagnant, and state and municipal governments with chronic budget woes.

Simply, current policies are not creating conditions for 5 percent GDP growth that could be achieved to bring unemployment down to acceptable levels.

Over the last three months, the private sector has added 152,000 jobs per month, but many of those have been in government subsidized health care and social services, and temporary business services. Netting those out, core private sector jobs have increased only 110,000 per month-that comes to 25 permanent, non-government subsidized jobs per county for more than 5000 job seekers per county.

Early in a recovery, temporary jobs appear first, but 20 months into the expansion, permanent, non-government subsidized jobs creation should be much stronger.

Economic Growth

Commerce Department preliminary estimates indicate GDP growth was only 2.8 percent, significantly disappointing Wall Street economists.

Consumer spending, business technology and auto sales all added strongly to demand and growth, and exports actually outpaced imports for the first time in a year. Pessimism, inspired by rising gasoline prices, health care reforms that drive up insurance costs, and import competition, caused businesses to run down inventories rather than add new capacity and employees.

Fourth quarter exports got a boost from a weaker dollar against the euro earlier in 2010-the export effect of a weaker dollar occurs with a lag of several months. In 2011, this situation is likely to reverse, owing in particular to Europe’s continuing sovereign debt woes and instability in North Africa and the Middle East. The trade deficit will grow, as oil import costs and consumer goods from China overwhelm further progress in U.S. export growth.

Policies limiting development of conventional oil and gas are premised on false assumptions about the immediate potential of electric cars and alternative energy sources, such as solar panels and windmills. In combination, limits on conventional energy development and excessive optimism about alternative energy technologies are making the United States even more dependent on imported oil and more indebted to China and other overseas creditors to pay for it.

To keep Chinese products artificially inexpensive on U.S. store shelves, Beijing undervalues the yuan by 40 percent. It accomplishes this by printing yuan and selling those for dollars and other currencies in foreign exchange markets.

Presidents Bush and Obama have sought to alter Chinese policies through negotiations, but Beijing offers only token gestures and cultivates political support among U.S. multinationals producing in China and large banks seeking additional business in China.

The United States should impose a tax on dollar-yuan conversions in an amount equal to China’s currency market intervention divided by its exports-about 35 percent. That would neutralize China’s currency subsidies that steal U.S. factories and jobs. It is not protectionism; rather, in the face of virulent Chinese currency manipulation and mercantilism, it’s self defense.

The following was written by Ian Fletcher, Senior Economist of the Coalition for a Prosperous America. He was previously Research Fellow at the U.S. Business and Industry Council, a Washington think tank founded in 1933 and before that, an economist in private practice serving mainly hedge funds and private equity firms. Educated at Columbia University and the University of Chicago, he lives in San Francisco. He is the author of Free Trade Doesn’t Work: What Should Replace It and Why.

I wrote in a previous article about why America’s manufacturing sector, despite record output, is actually in very deep trouble: record output doesn’t prove the sector healthy when we are running a huge trade deficit in manufactured goods, i.e. consuming more goods than we produce and plugging the gap with asset sales and debt.

But this analysis of the problem only touches the quantitative surface of our ongoing industrial decline. Real industries are not abstract aggregates; they are complex ecosystems of suppliers and supply chains, skills and customer relationships, long-term investments and returns. Deindustrialization is thus a more complex process than is usually realized. It is not just layoffs and crumbling buildings; industries sicken and die in complicated ways.

To take just one example, when American producers are pushed out of foreign markets by protectionism abroad and out of domestic markets by the export subsidies of foreign nations, it is not just immediate profits that are lost. Declining sales undermine their scale economies, driving up their costs and making them even less competitive. Less profit means less money to plow into future technology development. Less access to sophisticated foreign markets means less exposure to sophisticated foreign technology and diverse foreign buyer needs.

When an industry shrinks, it ceases to support the complex web of skills, many of them outside the industry itself, upon which it depends. These skills often take years to master, so they only survive if the industry (and its supporting industries, several tiers deep into the supply chain) remain in continuous operation. The same goes for specialized suppliers. Thus, for example, in the words of the Financial Times’s James Kynge:

The more Boeing outsourced, the quicker the machine-tool companies that supplied it went bust, providing opportunities for Chinese competitors to buy the technology they needed, better to supply companies like Boeing.

Similarly, America starts being invisibly shut out of future industries which struggling or dying industries would have spawned. For example, in the words of tech CEO Richard Elkus:

Just as the loss of the VCR wiped out America’s ability to participate in the design and manufacture of broadcast video-recording equipment, the loss of the design and manufacturing of consumer electronic cameras in the United States virtually guaranteed the demise of its professional camera market… Thus, as the United States lost its position in consumer electronics, it began to lose its competitive base in commercial electronics as well. The losses in these related infrastructures would begin to negatively affect other down-stream industries, not the least of which was the automobile… Like an ecosystem, a competitive economy is a holistic entity, far greater than the sum of its parts. (Emphasis added.)

One important example of this is the decline of the once-supreme American semiconductor industry, visible in declining plant investment relative to the rest of the world. In 2009, the whole of North America received only 21% of the world’s investment in semiconductor capital equipment, compared to 64% going to China, Japan, South Korea, and Taiwan. The U.S. now has virtually no position in photolithographic steppers, the ultra-expensive machines, among the most sophisticated technological devices in existence, that “print” the microscopic circuits of computer chips on silicon wafers. America’s lack of a position in steppers means that close collaboration between the makers of these machines and the companies that use them is no longer easy in the U.S. This collaboration traditionally drove both the chip and the stepper industries to new heights of performance. American companies had 90% of the world market in 1980, but have less than 10% today.

The decay of the related printed circuit board (PCB) industry tells a similar tale. An extended 2008 excerpt from Manufacturing & Technology News is worth reading on this score:

The state of this industry has gone further downhill from what seems to be eons ago in 2005. The bare printed circuit industry is extremely sick in North America. Many equipment manufacturers have disappeared or are a shallow shell of their former selves. Many have opted to follow their customers to Asia, building machines there. Many raw material vendors have also gone.

What is basically left in the United States are very fragile manufacturers, weak in capital, struggling to supply [Original Equipment Manufacturers] at prices that do not contribute to profit. The majority of the remaining manufacturers should be called ‘shops.’ They are owner operated and employ themselves. They are small. They barely survive. They cannot invest. Most offer only small lot, quick-turn delivery. There is very little R&D, if any at all. They can’t afford equipment. They are stale. The larger companies simply get into deeper debt loads. The profits aren’t there to reinvest. Talent is no longer attracted to a dying industry and the remaining manufacturers have cut all incentives.

PCB manufacturers need raw materials with which to produce their wares. There is hardly a copper clad lamination industry. Drill bits are coming from offshore. Imaging materials, specialty chemicals, metal finishing chemistry, film and capital equipment have disappeared from the United States. Saving a PCB shop isn’t saving anything if its raw materials must come from offshore. As the mass exodus of PCB manufacturers heads east, so is their supply chain.

All over America, other industries are quietly falling apart in similar ways.

Losing positions in key technologies means that whatever brilliant innovations Americans may dream up in small start-up companies in the future, large-scale commercialization of those innovations will increasingly take place abroad. A similar fate befell Great Britain, which invented such staples of the postwar era as radar, the jet passenger plane, and the CAT scanner, only to see huge industries based on each end up in the U.S. For example, the U.S. invented photovoltaic cells, and was number one in their production as recently as 1998, but has now dropped to fifth behind Japan, China, Germany, and Taiwan. Of the world’s 10 largest wind turbine makers, only one (General Electric) is American. Over time, the industries of the future inexorably become the industries of the present, so this is a formula for automatic economic decline. Case in point: nanotechnology is probably the first major new industry in a century in which the U.S. is not the undisputed world leader.

America’s increasingly patchy technological base also renders it vulnerable to foreign suppliers of “key” or “chokepoint” technologies. These, though obscure and of small dollar value in themselves, are technologies without which major other technologies cannot function. For example, China recently restricted export of the rare-earth minerals required to make advanced magnets for everything from headphones to electric cars. Another form this problem takes is the refusal of oligopoly suppliers to sell their best technology to American companies as quickly as they make it available to their own corporate partners. It doesn’t take much imagination to see how foreign industrial policy could turn this into a potent competitive weapon against American industry. For another example, Japan now supplies over 70 percent of the world’s nickel-metal hydride batteries and 60-70 percent of the world’s lithium-ion batteries. This will give Japan a key advantage in electric cars.

The Obama administration shows no awareness of any of this, despite scratching a hole in its head over why job creation has stalled. (Hint: it hasn’t stalled in the nations, from China to Germany, running trade surpluses with us in manufactured goods.) It is not yet too late to reverse these dynamics, but we are definitely running out of time. So the sooner we start questioning the sacred myth of free trade, which is largely responsible for this mess, the better.

The following article by Mike Zapler appeared at Politico today here.

Desperate to crack the U.S. market, Chinese telecom giant Huawei Technologies Co. has tried to play the Washington influence game, hiring big-name lobbying firms, lawyers and PR outfits to counter perceptions that it’s an arm of the Chinese government.

Now it’s taking its fight to the Oval Office.

Huawei refused Monday to go along with a request from the federal government’s Committee on Foreign Investment in the United States, an interagency panel that reviews the national security implications of foreign investments and operations in the U.S., to divest itself of parts of 3Leaf Systems Inc., a California-based server company.

The company’s refusal puts the matter in the hands of President Barack Obama, who now has 15 days to decide whether to force Huawei to give up its investment on national security grounds.

Huawei has been shadowed by suspicions that it is controlled by the Chinese military — concerns that have inhibited the company from gaining a significant foothold in the U.S. market even as it ranks No. 2 in the world among telecom equipment makers.

The company denies any connection to the People’s Liberation Army and says it is the victim of anti-China sentiment.

William Plummer, Huawei’s vice president of external affairs, said the 3Leaf deal is small potatoes for the $30 billion-a-year company but that it decided to force the issue as a matter of principle, even though that means forcing the hand of U.S. officials who already have a skeptical view of the company.

“From our perspective, this is a very modest patent acquisition,” Plummer told POLITICO. “If we were to withdraw and divest, that would be damaging to our brand and our reputation and our honor.”

Huawei’s decision to take its case to Obama comes on the heels of its failed bid last fall for a multibillion-dollar contract to upgrade Sprint Nextel’s network — a rejection hastened after Commerce Secretary Gary Locke reportedly asked Sprint’s CEO not to award the deal to Huawei.

Whether Huawei’s problems entering the U.S. market stem from legitimate national security concerns or misplaced anti-China sentiment, as a spokesman contends, is difficult to assess. What’s clear is that the company’s efforts to ingratiate itself in Washington have a long way to go.

In a letter last week, Sens. Jon Kyl (R-Ariz.) and Jim Webb (D-Va.) and a trio of House members accused Huawei of having “well-established ties” to the People’s Liberation Army, supplying equipment to Saddam Hussein and the Taliban and “working extensively” in Iran. “In addition to its questionable ties, we are concerned about Huawei’s history of illegal behavior,” the letter stated, mentioning alleged patent and trademark infringement, among other charges.

Plummer called the missive unfounded, inflammatory rhetoric. “It’s like, ‘Pick as many boogeymen as you can and throw them into the same sentence,’” Plummer said. “The Taliban is hardly operating a wireless network.”

He said much of the criticism of Huawei amounts to “knee-jerk protectionism behind a veil of security concerns” and “Sinophobia.”

But Huawei has failed to convince lawmakers or administration officials, despite enlisting former congressmen to lobby Capitol Hill and hiring a top PR firm to do communications.

Huawei spent $750,000 in 2009-10 on lobbying, according to disclosure forms. Its hires included former Reps. Don Bonker (D-Wash.) of APCO Worldwide and Max Sandlin (D-Texas) of International Government Relations Group. Fleishman-Hillard was brought on board for PR. (Burson-Marsteller is doing some communications work on a lawsuit the company filed recently against Motorola.).

Huawei also has or recently had some prominent Washington law firms on its payroll, including Arnold Porter, Skadden Arps and Covington & Burling.

Foreign companies are barred from contributing to U.S. campaigns, but a handful of Huawei’s U.S.-based employees made $2,550 in political donations from 2007 to 2010, including $1,000 to Rep. Fred Upton (R-Mich.) last year and $300 to Obama in 2008.

Meanwhile, Amerilink Telecom Corp., a Kansas startup that teamed with Huawei on its Sprint bid and attempted to assuage security concerns, boasted a roster of Washington dignitaries. Among those appointed to its board last year were former House Democratic leader Dick Gephardt of Missouri, former World Bank President James Wolfensohn and former Deputy Secretary of Defense Gordon England. Amerilink paid $110,000 to Glover Park Group last year for lobbying, reports show.

Plummer is quick to rattle off statistics that he says should win Huawei respect. The company employs 1,200 in the U.S., split between Texas and California. It purchased more than $6 billion in equipment and services last year from U.S. multinationals such as Qualcomm, Oracle and IBM, he said. And there have been no major security issues, Plummer said, in the many other countries where it has done work.
“Huawei should be a poster child for a 21st-century multinational with a Chinese heritage,” Plummer said.

But two experts in U.S.-China relations told POLITICO that allowing Huawei to install major telecom infrastructure raises legitimate security issues for the U.S. Those concerns aren’t likely to subside anytime soon, given the strained and complicated relationship between the two economic superpowers and the global nature of the telecom equipment supply chain. China is a major manufacturer of components of telecom equipment sold by other firms.

“You have a few wrinkles,” said Ken Lieberthal, director of the Brookings Institution’s John L. Thornton China Center. “One is that there have been very persistent suspicions that Huawei enjoys military backing in China of one sort or another. The owner and founder came out of the Chinese military. And their finances are not sufficiently transparent to fully clear up the question whether there is” excessive government involvement.

Huawei’s founder, Ren Zhengfei, served in the People’s Liberation Army from 1974 to 1984, Plummer said. “It was more than a quarter-century ago,” he said.

But there are also questions about whether the Chinese government is giving Huawei and ZTE Corp., another large telecom firm in China, an unfair competitive edge with big subsidies.

Plummer said that most of the state-owned bank loans at issue went to Huawei customers to buy its equipment and that the total amounts to a fraction of the company’s overall revenue. Any direct loans to the company from state-owned banks were on fair and reasonable terms, he said.

Dean Cheng, a research fellow at The Heritage Foundation’s Asian Studies Center, predicted that cybersecurity concerns will continue to dog Huawei. “As long as China is seen as one of the biggest sources of cyberintrusions and computer network attacks,” Cheng said, “there’s going to be very, very deep suspicions here.”

The Department of the Treasury, which oversees CFIUS, declined requests for comment. It’s unlikely that Obama would reverse the CFIUS ruling, but Huawei is holding out hope.

“We’ve got a lot of respect and trust in the U.S. government and its impartiality and fairness,” Plummer said, “and, frankly, we want to see the process through.”

The following piece is by Peter Morici, a professor at the Smith School of Business, University of Maryland School.

Trade Deficit Drags on Growth and Jobs Creation

Friday, the Commerce Department to reported the deficit on international trade in goods and services was $40.6 billion in December, up from $38.3 billion in November and $27.1 billion in mid 2009, when the economic recovery began.

This rising deficit subtracts from demand for U.S. goods and services, just as stimulus spending and additional temporary tax cuts add to it. The deficit is slowing the recovery and jobs creation, and the Obama Administration and Republicans in Congress have not offered a credible policy to significantly change it.

Jobs Creation

The economy added 36,000 jobs in January, and that was particularly disappointing after surges in holiday retail sales, business spending and auto sales.

Americans have returned to the malls and new car showrooms but too many dollars consumers spend go abroad to purchase imports but don’t return to buy U.S. exports. This leaves too many Americans jobless and wages stagnant, and the resulting slow growth leaves state and municipal governments with chronic budget woes.

By January 2014, the private sector must add more than 13 million jobs to bring unemployment down to 6 percent. Current policies are not creating conditions for 5 percent GDP growth that could be achieved and is necessary for businesses to hire 370,000 workers each month.

Since December 2009, the private sector has added 92,000 jobs per month, but most of those have been in government subsidized health care and social services, and temporary business services. Netting those out, core private sector jobs creation has been a meager 42,000 per month—that comes to less than 14 permanent, non-government subsidized jobs per county for more than 5000 job seekers per county.

During the early stages of an economic expansion, temporary jobs appear first, but 19 months into the recovery, permanent, non-government subsidized jobs creation should accelerate. Instead, core private sector jobs were up only 43,000 in January—down from 73,000 in the fourth quarter.

Economic Growth

Commerce Department preliminary estimates indicate GDP growth was only 3.2 percent, significantly disappointing Wall Street economists.

Consumer spending, and business technology and auto sales all added strongly to demand and growth, and exports actually outpaced imports for the first time in a year. Pessimism, caused by rising gasoline prices, health care reform, and import competition, caused businesses to run down inventories rather than add new capacity and employees.

Fourth quarter exports got a boost from a weaker dollar against the euro earlier in 2010—the export effect of a weaker or stronger dollar occurs with a lag of several months; however, this situation is likely to reverse in the 2011, owing in particular to Europe’s continuing sovereign debt woes. November will likely prove to be the low point for the trade deficit, as imports of oil and consumer goods from China overwhelm any further progress in U.S. export growth.

Oil and goods from China account for nearly the entire trade deficit, and without a dramatic change in energy and trade policies, the U.S. economy faces large trade deficits and unacceptably high unemployment indefinitely.

The de facto moratorium on new offshore drilling permits in the gulf, imposed by onerous licensing requirements, and policies that limit development of other conventional energy supplies are premised on false assumptions about the immediate potential of electric cars and alternative energy sources, such as solar panels and windmills. In combination, limits on conventional energy development and excessive optimism about alternative energy technologies are making the United States even more dependent on imported oil and more indebted to China and other overseas creditors to pay for it.

Led by Ford and GM, the automobile industry is demonstrating it can build many more attractive and efficient gasoline-powered vehicles than it is selling now, and a national policy to accelerate fleet replacement would spur growth and create jobs much more rapidly than investments in battery and electric technologies.

The trade gap with China did ease to $20.7 billion but remains the largest U.S. deficit with any country. This gap was affected by depletion in U.S. inventories in the fourth quarter and will likely head up again, especially in Spring, after the Chinese New Year. The latter celebration often effects the pace of Chinese exports, bunching shipments into March.

To keep Chinese products artificially inexpensive on U.S. store shelves, Beijing undervalues the yuan by 40 percent. It accomplishes this by printing yuan and selling those for dollars other currencies in foreign exchange markets. Annually, those purchases exceed $450 billion or 10 about percent of China’s GDP and 35 percent of its exports.

President Obama has pleaded with China to stop manipulating its currency, but Beijing shrewdly recognizes President Obama lacks the will to meaningfully counter Chinese mercantilism with strong, effective actions; hence, Beijing offers token gestures and cultivates political support among U.S. businesses like Caterpillar who lead in outsourcing jobs to China and profit from Chinese protectionism at the expense of American workers.

President Obama should impose a tax on dollar-yuan conversions in an amount equal to China’s currency market intervention divided by its exports—about 35 percent. That would neutralize China’s currency subsidies that steal U.S. factories and jobs. It is not protectionism; rather, in the face of virulent Chinese currency manipulation and mercantilism, it’s self defense.