We thank readers for their thoughtful responses to David Blond’s guest paper on trade and tariffs, Winners and Losers from Global Trade. That paper triggered debate. Below is Bob Brusca’s rebuttal. Enjoy the debate as each person can decide her/his own viewpoint.
David R. Kotok
Chairman and Chief Investment Officer
Email | Bio
Why David Blond is Wrong on Trade
I have just been sent a link to this paper, Winners and Losers from Global Trade, by David Blond. Reading it so upset me that I have prepared a rejoinder…
There is nothing an economist likes more that to use a number of quantitative techniques and numbers to dazzle people when some simple understandable observations would do just fine.
I do not need to think about input-output tables or to look at employment output vectors to know that the US is more trade dependent on the import side than just about anybody else and will be hurt a lot by a trade war.
The US has been riding massive consistent deficits on current account since the early 1980s.
There are several points to be made about trade and Free trade quite apart from Mr. Blond’s approach.
The first is to note that however you want to think about a trade war, the best way is to consider that it is being contemplated by adults with some understanding of the process and not to plow straightaway into a ‘I hit you’, ‘you hit me’, so ‘I hit you back’ exchange. We know where that leads.
Before Daniel Ellsberg was known for the Pentagon Papers he was known for some insightful thinking about statistics and for thinking about thermonuclear war. Ellsberg pointed out that the ‘usual approach’ to look at the expected value from this conflict made no sense since the condition really had no real probability distribution. It was not an ‘experiment’ that would be run over and over. It either would happen or it would not. It was binary in nature. And that if it happened the destruction would be terrible all around and if it did not happen, life would go on untainted by it. So he concluded that you have to think about thermonuclear war in a different way and one cannot think in terms of expected values.
I would argue that the same is true of trade and trade wars. You do not threaten one to start one any more that Kim Jung Un is really threatening that he will launch a missile at the US. He has a different objective in mind. He is trying to get our attention. Job done.
Trump did push Europe over NATO. And this I think is the model for trade. The US was in the right on NATO. Europe and Germany were in the wrong. The US funds most of NATO but each member is supposed to spend monies on defense as well. Obama had pushed Germany to no avail. Other US presidents before him had pushed them to spend more too. But Trump put his foot down prompting Angela Merkel to call Trump and the US a bad ally. Really? I bet that that is not how history will see it.
So this is a similar strategy to the NATO gambit applied in another situation where the US (or Trump and his advisors if you prefer) think America has gotten a bad deal.
One thing Blond does not do is to look at the trade system or result and critique it. He runs models and accepts today’s factor prices as a baseline…WHY?
The export-led growth model
The world matrix of trade we have today is not what any free trader would have expected or would recognize. We have countries that run unstoppable deficits and others with relentless surpluses. The question is not can a country get better growth by having export led growth. It is think obvious that an export led growth economy is easy to maintain and one of the easiest ways to jump-start growth in an underdeveloped region. That does not make it right. You get foreign technology and capital to come in and combine it with your cheap labor. They train your labor force that uses their technology. If you are unscrupulous you also steal their technology… They make stuff export it cash rolls in, Viola! The exporting nation needs to manage its exchange rate so that it does not get too strong from all the exporting. And it needs to make sure wages do not rise too fast. But there is not much internal balancing required.
Unbalanced prices and wages stem from unbalanced development!
Blond speaks of the imbalance between wage and prices. Well this is a problem if you run a balanced growth model. You need wages cheap enough to continue to export but high enough to afford a domestic demand for your people to buy some of the things they make. I don’t think that because China wanted to develop so fast that it should be allowed to run roughshod over what used to be free trade rules. Blond seems to want to defend that. But in free trade with a market-determined exchange rate, rapid production in China would cause its exchange rate to rise and increases wealth in China would permit the consumption of more good including imports and likely undercut competitiveness and lower the proportion of growth that could be achieved by an export-led program. Blond seems to be looking at China’s numbers and arguing BACKWARD that because China has done this we have to let it go on because the export to price ratio is out of whack. Really? What else could have happened under that strategy?
I refuse to take the current ‘market’ prices and wages as given. Why do China’s actions that have created all these factor price relationships become enshrined? China has acted in a very, shall I say, China First fashion. And some will say that developing economies have always been allowed to play by ‘special rules.’ And I will not deny that. But China, as such a huge country, has a much more pronounced impact on the global economy than Thailand or Taiwan or South Korea.
The knock against Trump is not that he wants to start a trade war although I am aware that he says that they are good and easy to win. They are not good nor are they even winnable.
The fact that a tit-for tat trade war makes everyone worse off is not the point either. There is plenty of literature from collective bargaining that shows that strike behavior by unions usually makes both the firm and the union worse off in the long run even if the union gets better benefits for its members. There is the loss of income/output from having a strike to be considered.
Strike or trade confrontations are usually about a lack of information or about credibility. I think that as in the case of NATO, the US complaint that trade is not free or fair is obvious. That US jobs are lacking because of it is obvious- so obvious as to not even need any statistical work to prove it! What is it about 35 years of unrelenting current account deficits that does not look like free trade to you?
What has been expected?
When fluctuating exchange rates were considered it was thought that exchange rates would shift to balance current account deficits. But that is not the case. Countries with export-led growth models hang on to their ‘excess dollars and reinvest them in the US effectively doing an end run around the exchange rate adjustment mechanism. The Chinese do not buy our treasury securities because they are trying to help us. They are trying to help themselves (…to our demand and to our jobs). And if they could find a way to do it without buying so many US securities you can bet they would!
My point is that you cannot BEGIN to understand the current global trading system without understanding what drives it and what sustains it. And if you want to be an advocate for manipulated trade you can join Mr. Blond and support China and others. You may support Germany with the largest current account surplus to GDP ratio among all developed countries.
I suppose one problem with ex-ante thinking about the exchange rate system is that it was done by academics in a fixed rate regime/gold standard where current account balance really meant something.
Many actors and interests
The politics of trade are complicated. US multinational corporations have been active forces in using cheap production locations overseas to beat down unions in the US and curtail wages. Why do you think that the Phillips curve no longer works. XYZ Corp, Inc. can just pick up the phone and order output from China instead of paying a penny more in the US.
Chuck Schumer every year would rattle his saber on FX manipulation then do nothing as he and fellow Democrats pocketed millions in campaign donations from multinational ‘free trade loving’ (wink, wink) corporations.
If there were a real trade war I doubt that anyone would fare well – I don’t need a model to see that. China would be less affected because its import side is not so stacked, But its exports (read jobs, output and income generation) would come to a halt and that would not be good. Americans would spend more time trading with one another on eBay. We have so much surplus stuff a fashion industry could rise up on the idea of recirculation. We have food and oil. We are militarily strong. Really who is going to be hurt the most?
No I do not think the input-output tables tell the tale of who gets hurt in a trade war-not really.
But I still think that this is not about trade warfare. I think Trump picked a few innocuous industries to make a point. The Chinses previously were flooding the market with cheap solar panels. And yes it was nice to buy them cheap- but it’s not fair. China has been dumping steel made in outmoded plants forever!
I think it is very hard to envision a world with real fair trade.
As for the argument that we need to supply dollars to the world, that is bogus. Right now so many countries are adding dollar assets only because they have to in order to keep their desired foreign exchange peg. Dollars are not created by a current account deficit they are created by the Federal Reserve and by a fractional reserve banking system. His dollar supply argument is upside down and wrong. We do not need to ‘supply dollars through our current account deficit. Besides… the current account deficit implies a capital account surplus: monies are flowing INTO the US to fund our Current Account deficit and to fund our fiscal deficit and to keep our interest rates low and to keep the dollar from falling and becoming cheap and undercutting competiveness overseas.
A lot of observers try to salve our pain about having a large deficit by arguing that the strong dollar gives the US great purchasing power. Well that is great if you have dollar assets and dollar income and want to buy stuff. But if you are a worker and need a job that strong dollar prices you OUT of the global labor market. The strong dollar does make imports cheap and that encourages us to over consumer and to under save. And it reinforces a lot of bad habits we need to break. So where is the advantage?
This past week I wrote about the consumer sentiment index with some record high standing components. How is that possible? Real wage growth has been stunted. Real wages are not growing well at all. There are myriad jobs available but few of them good. Yet since Trump took office and started to verbally warn companies about going overseas and targeting Mexico and trying to stop the outflow of manufacturing, the growth in manufacturing employment has been rising more rapidly. The service sector job creation rate has slowed but goods sector job creation is up. Still, it is such a small portion of the economy that it will win Trump few plaudits and does not explain the reading for consumer sentiment which to me is a reflection of reduced expectations. Young people do not realize how much the President and Congress are mortgaging their future based on the debit profile we now have and the off balance sheet liabilities of government. How can people claim to feel so good when things are so mediocre?
I do not think that the markets the public or the Fed have much of a handle on what is going on. And I think that many people dislike our President and for that reason have too easily fallen into the trap of hatting Trump and hating what he does.
But I not think he is wrong on trade. The unemployment rate does not tell the real story because too many people have dropped out of the labor force. It’s become a labor farce.
In Adam Smith’s famous treatise known by its short title ‘The Wealth of Nations’ at the very beginning cites ‘the proportion of the population that is engaged in commerce’ as an important determinant of the wealth of a nation. The chart above recasts the unemployment rate as a ‘not employed rate (red). I plot the conventional U3 number of unemployed VS the whole of the age 16+ non institutional population eschewing the notion of a labor force. Then also, using the same denominator, I calculate the number of people NOT employed (those unemployed plus those not in the labor force and not working). The result is stunning. Since the early 1980s the two series have roughly the same behavior but for very different rates (note the right sale left scale differences). But until this cycle the signals for each one for policy were roughly the same. Now the signals are very different.
Trade and technology together have been huge disruptive forces. Some nations have used very self-serving policies to preserve or to expand their growth environment at home while pushing the adjustment off to the overseas markets. The Trump Administration has just terminated a set of ongoing trade talks with China because it no longer sees China as making progress but as backtracking. I agree with this my article (here). In it I argue that China’s belt and road policy is big red herring for backsliding. I think that taking a more aggressive posture on trade is appropriate.
Let me close with an example. I love basketball and ‘tis the season for it. But it is more than one kind of game. The game you see on TV is one kind of basketball. In that game there are officials and they interpret and enforce the rules. If someone slaps you while you are shooting the referee does not blow the whistle, then you were not fouled. Its simple: what the refs say goes. But there is another kind of basketball called pick-up, it’s played informally without referees. If someone grabs your shirt while you are shooting then you grab his while he is shooting. If someone steps in your foot to keep you from jumping and you let him get away with it then that’s on you, not on him. Trade is more like a pick-up game even though there is a WTO. Some of the rules and market practices are hard to enforce. The most difficult one is about exchange rate values. But there is nothing in trade like the study of Industrial Organization and its mantra of “structure conduct and performance.” If there were, maybe more people would look at long strings of surpluses and smell a rat. But people are instead schooled in the counterargument to protect and defend our current system and to call it free trade. Well you can call my cat a dog he still is not going to bark. In this scheme of things the US must stick up for its own interests or it will be exploited and marginalized.
When we were a wealthier country and before we had gotten used to our economic mortality there was a lot that we used to do that we can no longer afford. Some want Trump to continue to dole out foreign aid in fistfuls and for the US to continue to be the great benevolent nation it used to be. But the government’s own deficits are huge; its off-balance sheet liabilities are shockingly large. And our ability to the play the role we used to play is more limited. We need our allies to pitch in and pay their fair share. We no longer can look the other way when they game us on trade. I understand that other countries like playing the game under the old rules, but they just do not work for us anymore. If America is going to keep its place in the world it must first preserve its own economic strength. And having 2% to 5% worth of GDP siphoned off into foreign economies each year through a hole in the current account no longer works for us. Trade/Current Account deficits are neither good nor bad. But these deficits of ours have only financed current consumption at an excessive pace and at the cost of leaving a bigger legacy of debt for future generations. That violates a whole lot of economic rules on fair play. Our deficits are bad because they do bad things to us now and because they are instrumental in placing the debt for today’s good times on the backs of future generations. Something has got to give and Trump is on the right track. It may be for the wrong reasons but he is the right track.
Robert Brusca – Chief Economist – FAO Economics
Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.
Sign up for our FREE Cumberland Market Commentaries
Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.