Financial Adviser Outlines Uncertainties About the Direction of the Economy

Financial Adviser Outlines Uncertainties About the Direction of the Economy

David Kotok, the chairman and chief investment officer at Sarasota’s Cumberland Advisors, recently shared his insights into the global economy.

Excerpt below:

According to business leaders Kotok spoke to, many endorse the Trump administration’s policies on taxes and deregulation, but are concerned about the possibility of future trade wars.

Read the short blurb at Sarasota Magazine or read the recent commentary they link to here: www.cumber.com/western-trip-part-1/




Western Trip-Part 1

We’re back. During travels in four states (CO, ID, UT, WY) and participating in the Rocky Mountain Summit public conference, two private roundtables, client meetings, and prospect presentations, I encountered hundreds of business-people, econ and financial types, legal and accounting professionals, and others.

Cumberland Advisors - Takeaways

They mostly leaned Republican; most were Trump voters; and most were high-income and high-net-worth individuals.

My Takeaways:

1. They like tax cuts, repatriation, and deregulation.

2. They don’t like uncivil, personal-attack politics.

3. They don’t like attacks on constitutional freedoms like religion or assembly or press. They resent the use of the term fake news.

4. They nearly all fear trade wars and believe they are real. They didn’t, however, fear Trump’s blustering trade war rhetoric.  They worry Trump’s trade war is giving back all the benefits of item 1.

5. Peter Navarro is seen as a powerful influence who has Trump’s ear, and people fear he is sinking the president.

6. They watch Fox, Bloomberg, CNBC – few watch CNN. However, they trust neither Fox nor CNN, which are viewed as polar opposites, and many think neither of them are neutrally honest.

7. They use electronic devices and newsfeeds to glean information, but they increasingly realize how seriously social media and machine learning are manipulating and distorting their information flow. And they don’t like it.

8. They are family-oriented, communal, and charitable. This is Western territory – you help people who need help.

9. They love the outdoors, the environment – horses, fly rods, hiking. They fear global warming, and most believe climate change is the result of human behavior, not just natural weather cycles.

Now to some direct business notes:

1. Some businesses employ undocumented labor, because they have to. The average among privately owned businesses seemed to be about 20% of total hires in the hospitality, maintenance, and construction sectors. Many of these businesspeople will not bid federal jobs because they cannot comply.

2. They are watching cost increases accelerate. This is a theme I heard repeatedly.

3. Those who are subject to global supply chains are starting to see trade war effects.

4. Foreign investment is being delayed or deferred, both outgoing and incoming. I learned of two foreign owned manufacturing facilities in Idaho whose construction has been canceled because of the Trump-Navarro trade war.  Other American owned are repositioning abroad.

5. Many travel to China or have supply-chain business with China. They say Navarro doesn’t get it. Here is a link to a Peter Navarro interview with Maria Bartiromo on Fox. All of his forecasts are now proven wrong. http://video.foxbusiness.com/v/5743778657001/?#sp=show-clips

6. They fear Trump’s ignoring input from political leaders in his own party. Here is a Bloomberg report on Kevin Brady, chair of the House Ways and Means Committee. https://waysandmeans.house.gov/chairman-brady-calls-for-trump-xi-face-to-face-meeting-to-craft-fair-trade-deal-with-china/

My conclusions:

1. Economic growth peaked in the just finished second quarter and after trade war rhetoric became trade war actual. The next six quarters will see the growth rate decline.  Decline in growth was a dominant view.  Some see recession in less than two years.

2. Inflation risk is rising due to the trade war.

3. Failure to solve immigration, DACA, and the status of 12 million undocumented people working in the US is a political failure that is now translating into an economic cost with rising uncertainty premia.

4. The flatter yield curve suggests the bond vigilantes agree with the prospect of a slowing economy.

5. I agree with many economist colleagues that it is going to take a considerable shock to jolt America hard enough that we make a political policy change.

6. The political direction of the country is at a crossroads. The Pelosi–Schumer–Maxine Waters Democrats are not getting traction. The Republican hard right is scaring other Republicans who are seeking solutions, not confrontational combat.

7. I end my four-state Western trip with reinforced deep respect for the many local people I met who are caring and patriotic and are genuinely worried about the behavior of their president but who are not being given an acceptable alternative.

8. An emerging alternative is Mitt Romney, who will win the Senate seat in Utah and be his own national voice. He owes nothing to Trump. He is becoming a deficit hawk.

For investors, Bonds are telling three stories. The Treasuries curve is flattening, the muni curve less so. High-yield and junk spreads are too tight and have no room for error. We would counsel to Avoid junk credit: You are not getting paid for the risk it involves. Avoid long Treasury debt: You are not getting paid for term-structure risk. Use barbells, not ladders, in munis. The middle of the curve is very expensive.

Stocks: Watch out for FAANMG. Stay domestic and exercise caution on internationals. Favor banks, biotech, and staples. And remember, trade war risks are rising every day.

It is nice to be back in Sarasota.

David R. Kotok
Chairman & Chief Investment Officer
Email | Bio


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.

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Trump Trade War, Soybeans, Danielle DiMartino Booth, Bill Poole

Former St. Louis Fed President Bill Poole who also was an economic adviser to Ronald Reagan has written about Trump-Trade policy and published this profoundly instructive commentary on July 2. He reveals the money conflict of interests that lurk behind some of the tariffs and he proposes a simple solution.  Here is the link: The New Tariff of Abominations?

The Trump-Navarro trade war is only just starting to bite, and the growing list of casualties spans Americans from businessmen, investors, bankers, and lenders of all types to beleaguered US farmers and workers in impacted industries. With Danielle DiMartino Booth’s permission, we are featuring her excellent analysis. She recently devoted a full research note to soybeans. If you are in Iowa or Illinois or other ag states, you are now seeing the start of the damage.

If you are in Maine or Massachusetts, you see it in lobsters. If you are an auto dealer or provide dealer software support, you see it nationwide. If you are building a pipeline and need certain steel, you see it. If you are a healthcare service provider, you see it. If you are administering a college or university, you see the drop in revenue as your student headcount declines. Add cheese and diary products.

The list of impacts grows daily. Trump-Navarro took punches at China and Canada and Europe and landed those punches on the US farmer and consumer. The fallout will get worse. We see GDP growth peaking right now. The next few quarters are likely to see sequentially slower growth. Fiscal pressures are likely to intensify in many states.

How quickly collateral damage mounts and what the resulting suffering will mean for the November midterm elections remain to be seen. Over 40 House Republicans are retiring. But those who observe markets also worry when they realize that Congresswoman Maxine Waters is the ranking Democrat on the House Financial Services Committee and wants to chair that committee if the House Democratic Caucus achieves a majority after the midterms.

Let’s get to Danielle and her brief on soybeans. Danielle has developed a national persona as a regular commentator on CNBC, Bloomberg, and Fox Business and is the publisher of Money Strong, an acclaimed weekly investing newsletter. Danielle is also CEO and Director of Intelligence at Quill Intelligence LLC, where she writes the Daily Feather, a daily briefing on the economy, market trends, inflection points, and transactions. This letter offers 5-minute daily briefings like those she used to prepare for Richard Fisher during the Great Recession, when Fisher served as President of the Dallas Fed and she as his advisor. The Daily Feather is incisive, substantive, and reasonably priced. It is a designed for investors, financial advisors, investment managers, CEOs, CFOs, corporate strategists, policy makers, academics, and indeed anyone who follows the global economy. You can learn more about it here: https://quillintelligence.com/welcome-cumberland-advisors/.

Here is Danielle DiMartino Booth on farmers and soybeans and trade war damage with who wins (Brazil and Argentina) and who loses (you, my dear reader, and me) in the recent Quill Intelligence Daily Feather, “Fireworks Over the Farm Belt”.

VIPs

• By the summer of 2012, top quality Iowa farmland that traded hands for about $4000 an acre in 2006 soared past $15,000 while farm income more than doubled from 2006 to 2013.

• In 2017, China took in 57% of US soybean exports. Early this year, the USDA estimated that within a decade, China would absorb 70% of US soybean exports.

• Accumulated exports of US soybeans to China for the marketing year have fallen 27 million metric tons, 20.5% less than this time last year.

• U.S. soybean prices have now fallen from about $10.50 per bushel in late May to $8.60 as of last Friday’s close.

• Call the U.S. farmer, and Illinois and Iowa in particular, collateral damage in what is now becoming a broader trade battle.

• Next, tariffs will begin to stifle U.S. economic growth as the price of affected goods begins to bite into household paychecks.

As if Illinois didn’t have enough fiscal fireworks to contend with this Independence Day, with market weakness further crippling the state’s pensions, budgeting in Lincoln’s home state will be crimped further by the 25% tariff on U.S. soybean exports to China, which becomes effective July 6th.

Illinois is the top-producing soybean state and exports about 60% of its crop. Half of that goes to China, which equates to $7.5 billion of the state’s economic output. Craig Ratajczyk, CEO of the Illinois Soybean Association, recently warned that smaller and rural communities would be hit the hardest and that the lower-tax-revenue “multiplier effect” would cut beyond lost industry into school and hospital funding.

Though its state’s finances aren’t nearly as fragile as those of Illinois, farmers in the second-biggest soybean-producing state, Iowa, would suffer a similarly damaging setback. Life across the farm belt is already volatile enough with the whims of Mother Nature. Though they are a boon to several South American mega-soybean exporters, tariffs are the last thing American farmers need.

While it’s always been feast or famine for the American farmer (pun intended), farming has been a particularly wild ride these past few decades. By the mid-1980s, the commodity bull market of the 1970s had faded to recession. Crop prices crashed, and farmers folded under the weight of too and $10 per bushel. Imagine the challenge of your main crop’s either doubling in price or halving with zero predictability.

The tables turned in 2006, a year that marked the advent of a glorious era in farming. Soybean prices recovered and by 2007 had broken free of a 30-year price range. A bonus: the price of farmland went haywire. By the summer of 2012, top quality Iowa farmland that traded hands for about $4000 an acre in 2006 soared past $15,000 amid wildly overheated auctions. As per the USDA, farm income more than doubled from 2006 to 2013.

It’s no chronological coincidence that China’s appetite for every natural resource on the planet, including food and grain exports, skyrocketed over the same period. This was especially the case for soybeans, a robust source of nutrition with which to feed a vast population that powered a historic industrial revolution. In 2017, China took in 57% of US soybean exports. Early this year, the USDA estimated that within a decade, China would absorb 70% of US soybean exports.

Did someone mention the vagaries of Mother Nature? As welcome as the Chinese demand no doubt is, it’s been anything but a smooth ride for American soybean farmers. First came the summer drought of 2012, which sent soybean prices to historic highs. The snapback was equally vicious. By 2016, prices had sunk to 50% of their peak levels. And that same prime acre of farmland in central Iowa now goes for about $9000. Farm income has been cut in half.

As for this week’s tariff imposition, it’s apparent China has seen no need to wait out the deadline. Last month, CNBC reported that, “China canceled 136,000 metric tons of U.S. soybean purchases in the week ended May 24…. That brings accumulated exports of US soybeans to China for the marketing year to 27 million metric tons, 20.5% less than this time last year.”

While beleaguered Brazil and Argentina count their blessings as China’s new “it girl” soybean exporters, U.S. soybean prices have fallen from about $10.50 per bushel in late May to $8.60 as of Friday’s close.

Call the U.S. farmer, and Illinois and Iowa in particular, collateral damage in what is now becoming a broader trade battle. If the result is a more level playing field on trade, we can optimistically conclude that American farming communities are taking one for the team. But good sportsmanship won’t pay the bills come harvest time this fall.

In the coming weeks, as second-quarter earnings roll out, we’ll likely hear countless lamentations about the implementation of tariffs on hundreds of products by not just China, but Canada, Mexico, the EU, and others. We hope this too shall pass, and soon.

In the meantime, the tariffs will begin to stifle U.S. economic growth as the price of affected goods begins to bite into household paychecks. You are correct to deduce that the stock market will not like any combination of these factors – lower earnings, slower economic growth, and rising inflation.

But just imagine how much worse it could be. You could be the state comptroller of Illinois where it “Ain’t That America” for residents of this textbook example of fiscal dysfunctionality. Given its broken pensions and reliance on Chinese soybean exports, the state will soon sustain not one, but two fiscal body blows.




Minute By Minute

The FOMC June minutes were released this past week, along with the Committee’s most recent predictions as detailed in its Summary of Economic Projections (SEPs).

Although the press gave attention to the Committee’s views on the implications that the tariffs soon to be implemented might have for growth, in reality the minutes devoted only a couple of sentences to concerns that district contacts had about tariffs. Specifically, “… many District contacts expressed concern about the possible adverse effects of tariffs and other proposed trade restrictions, both domestically and abroad, on future investment activity; contacts in some Districts indicated that plans for capital spending had been scaled back or postponed as a result of uncertainty over trade policy.” Potential impacts on steel, aluminum, and agricultural prices and exports were noted.

While the minutes were largely unremarkable overall, there were a couple of points of emphasis that were different and potentially interesting. For example, the manager of the Open Market Desk pointed out that paydowns and maturing MBS were likely to fall short of the caps that had been established (the max for MBS being $20 billion per month), indicating that reinvestment in MBS was likely to be unnecessary and implying that shrinkage of the MBS segment of the System Open Market Account portfolio would be less than planned. Indeed, as of the end of June, the shrinkage of the aggregate portfolio was about $22 billion short of target, and at the present pace the shortfall will be much greater by the end of July.  Having said that, paydowns could, depending upon what happens to rates, again exceed the target reductions in MBS. So as a contingency, the Desk staff proposed continuing to make small MBS purchases to maintain operational readiness should redemptions exceed the targets and purchases again become necessary.

Additionally, the Committee appeared to have spent considerable time discussing the strength of labor markets and the implications that had for potential wage increases. As for risks, the Committee again noted policy uncertainty, especially with respect to trade policy and the negative implications for investment and business sentiment.

The most interesting discussion, however, in the entire set of minutes was the attention that was paid to the flattening of the yield curve and what, if any, signal that trend may have as a harbinger of a future recession. Several factors in addition to the tightening of policy were seen as possible contributors, including a reduction in the longer-run equilibrium rate of interest, lower inflation expectations, and a lower term premium, in part related to central bank asset purchases. Views appeared to be mixed and relatively split between those who felt that the above factors reduce the meaningfulness of a flattened term structure as an indicator of recession probabilities and those who felt that the flattening curve is still a useful indicator. Staff apparently presented research looking at the usefulness of measures of the spread between the current and expected federal funds rate derived from futures markets as predictors of recessions. In general, the System has continually devoted attention to yield-curve inversions as predictors of recessions, and the general conclusion is that a negative yield curve has led all but one recession since 1955, with a lag of between 6 and 24 months.[1] Bauer and Mertens’ most recent work shows two key things. First, while inversions may signal an increase in the probability of a recession, at the critical threshold of a zero spread, the probability of a recession 12 months ahead is still only 24%.[2] They also note that as of February 2018 the estimated probability based upon the spread that existed at that time was still only 11%, which they viewed as “… comfortably below the critical threshold….”

As for the risks to the economy associated with the potential trade war initiated by the US, it is interesting to look at statistics on US and China trade relative to the size of their respective economies. Current estimates suggest that China’s GDP is about $12.2 trillion, while that of the US is about $19.4 trillion.[3] Of that, US exports of $1.4 trillion are about 7% of US GDP, and imports of $2.4 trillion are about 12.4% of US GDP. Trade is much more important to China than it is to the US. Chinese exports are 17.2% of GDP, and imports (which historically have consisted of raw materials and intermediate inputs to their exports) are about 15.6% of GDP.

US trade with China, especially the deficit, has gotten a lot of attention. However, US exports to China are less than 1% of US GDP, and imports are about 2.5% of GDP. As of this writing, the administration has imposed tariffs on about $35 billion of US China imports, or about 0.2% of US GDP. While these appear to be small numbers, the impacts on certain US industries in many parts of the country, such as soybean farmers in the Midwest, are critically important to their well-being. Unfortunately, what the present approach to trade implies is picking winners and losers who bear the brunt of attempts to rationalize international trade policies, but is based upon the faulty logic that the US must have bi-lateral trade balances  with each of our trading partners.[4]  The political fallout from the coming trade war will be significant, but the immediate worry is not the overall economic impact, which by most measures is small.  Rather the more significant effects will be the impacts that tariffs may have on market psychology and business investment attitudes and decision-making. The emotional impacts may drown the real economic impacts.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] As but a small snapshot see: Bauer, Michael D., and Glenn D. Rudebusch. 2016. “Why Are Long-Term Interest Rates So Low?” FRBSF Economic Letter 2016-36 (December 5); Berge, Travis J., and Oscar Jorda. 2011. “Evaluating the Classification of Economic Activity into Recessions and Expansions.” American Economic Journal: Macroeconomics 3(2), pp. 246–277; Estrella, Arturo, and Frederic S. Mishkin. 1997. “The Predictive Power of the Term Structure of Interest Rates in Europe and the United States: Implications for the European Central Bank.” European Economic Review 41(7), pp. 1,375–1,401; Mertens, Thomas, Patrick Shultz, and Michael Tubbs. 2018. “Valuation Ratios for Households and Businesses.” FRBSF Economic Letter 2018-01 (January 8); and Rudebusch, Glenn D., and John C. Williams. 2009. “Forecasting Recessions: The Puzzle of the Enduring Power of the Yield Curve.” Journal of Business and Economic Statistics 27(4), pp. 492–503.
[2] See Bauer, Michael D. and Thomas Mertens, “Economic Forecasts with the Yield Curve,” FRBSF Economic Letter, March 5, 2018. https://www.frbsf.org/economic-research/publications/economic-letter/2018/march/economic-forecasts-with-yield-curve/
[3] https://tradingeconomics.com/china/gdp; https://tradingeconomics.com/united-states/gdp
[4] Alan Blinder has a useful discussion of what we know about trade balances in WSJ July 9, 2018.

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.

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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.




Man Bites Dog by Bob Brusca

With all the Trumpian hullabaloo over trade, I want to share with readers a balanced, well-reasoned analysis of US trade issues penned by my good friend Bob Brusca, Chief Economist of FAO Economics. Bob makes it clear that while there are pros and cons to the US’s longtime propensity to run trade deficits, there is one overriding danger in doing so, and there are consequences that are affecting our economy today and will affect it even more seriously in the future.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Man Bites Dog; Dog Gets Tetanus Shot
by Bob Brusca
(Or how our fellow G-7 members learned to whine about trade)

All six of our fellow G-7 members are now complaining about the US and the ‘National Security’ tariffs being imposed by the Trump Administration. I will admit that I do not like this specific strategy. But on the issue of trade confrontation the US’s becoming more aggressive is long overdue. These countries among others have long taken advantage of the US and are provided in general much better access to the US market than US firms are provided access to their markets. In the case of Canada, trade is governed by the NAFTA agreement, for better or worse.

Los Seis Caballeros: The US is an unfair trader?

First let’s look at the complainants: In this corner stands the group consisting of Canada, Germany, France, Italy, the UK and Japan. The US stands alone.

Man Bites Dog Dog Gets Tetanus Shot 01

These countries (summed) have tended to run $200 billion worth of surpluses (US deficits) annually over the past decade on their bilateral accounts with the US (ten-year average is $196.5b, made smaller by the US import contraction in the Great Recession).

Why does this matter?

International economists (full disclosure: I am one) will tell you that having a bilateral deficit does not matter. They will go on to say that whether a country has a surplus or a deficit does not matter. This latter point is ‘evolutional.’ Old economics texts refer to running a current account deficit as ‘living beyond your means.’ That is hardly a statement of ‘neutrality.’ But the real point is this: WHY are so many countries running a surplus vs. the US and why are US deficits so intractable? In the case of the US, where GDP is 70% made of consumption, it is to take advantage of cheap consumer goods made abroad, NOT to invest. As a result the US more easily can finance its fiscal deficits and keep interest rates low. It can carry a higher debt load, and citizens benefit from cheaper goods today as future generations are saddled with the debt whose accumulation permits this state of affairs. Milton Friedman is reported to have said, if someone is willing to sell to you below cost you should buy as much of it as you can. Well, we have been doing that; and living for the short run has consequences. There is still a question of damage and distortion. The damage and distortion include the fact that in this instance there is intergenerational unfairness. We do the excessive consuming while future generations do the excessive paying.

The real point is that our deficits do matter and are bad because they represent consumption not investment. If the US were investing for its future these capital inflows that finance the deficit would finance themselves. But when we only use them to pay off and sustain high fiscal debt or corporate debt and to fuel consumption, then the deficits are bad.

Deficits being good or bad should not be a function of the currency regime. Under the gold standard countries WOULD NOT run deficits because they would have to pay for them in gold. Now that we only pay with fiat money IOUs, economists are no longer so concerned about whether it’s a deficit or a surplus on current account – but that is wrong. The gold standard was too restrictive, but that does not make the anything-goes floating currency regime right regardless of the outcome. Countries still need to mind their balance of payments and to run deficits for the right reason… and duration.

It should be lost on no one that the most fiscally sound countries do not run strings of current account deficits. They run surpluses.

Under a fluctuating exchange rate system, exchange rates are supposed to move to put current accounts back in equilibrium – has this happened?

The Kvetching Six

Man Bites Dog Dog Gets Tetanus Shot 02

We do not even have to look at exchange rates to answer this question. Only the UK metrics are close to a balanced position with surpluses sometimes and deficits other times. Everyone else runs only surpluses (US deficits) all the time on their bilateral accounts.

My position on this [issue] is that this is proof that WTO has got it wrong and these countries are foreign exchange manipulators that do not allow their currencies to RISE (undercutting their competitiveness and increasing their purchasing power). As a result they stay too competitive. The US remains uncompetitive. And US demand serves to stimulate growth in these countries. And, yes, the US gets more and cheaper goods as a result. It also gets higher unemployment (or less labor force participation), lower wages, lower inflation, lower interest rates, and is encouraged to carry more debt financed by foreign capital inflows (the counterpart of current account surpluses).

Of course, I do not even have on this chart some of the Asian countries that maintain an economic agenda of export-led growth.

Under FREE TRADE each country is supposed to produce according to its comparative advantage. But the US is producing less; Asia is producing more; and the US is consuming more as the structural US current account gap leaches US income off and stimulates growth overseas while taking away from growth in the US. US spending stimulates growth abroad as US citizens buy imports (foreigners’ exports) and their exporters thrive on these payments. This is NOT FREE TRADE.

It is also true that the US has fewer commercial policy (tariffs quotas and other restrictions) impediments for foreign goods, making the US an easy export target compared to other countries where US goods DO NOT face the same level playing field.

Trump’s ‘National Security’ tariffs do not remedy any of this, but they do put the rest of the world on notice that the US is finally going to stick up for its firms and that US commercial policy may be used even when the problem is not a specific foreign commercial policy.

You see, it is impossible to force a nation to appreciate its currency. But if it keeps its currency too low and keeps an unfair advantage from that, what recourse is there? Foreigners blame the US. We consume too much and save too little. But it’s the natural thing to do when faced with the choices they give us. Foreigners buy a lot of US-based financial investments, which keeps their own currencies weak. Capital flows into the dollar strengthen the dollar and weaken the currency they come from. In this way foreign holdings of US Treasury securities in particular (allegedly made to beef up needed foreign exchange reserves) are instruments of long-term currency manipulation.

Man Bites Dog Dog Gets Tetanus Shot 03

Looking at the G7 (putting the US back into this group), the chart above shows current account positions as a percentage of GDP by country. From early 1996 through 2008 the US ran the largest deficits relative to GDP. Since then Canada and the UK have surpassed the US. France has run deficits from 2008 (no data before then). Italy is back to running surpluses; so is Japan in the wake of its natural disasters, when it unexpectedly needed to import oil when it had to shut down its nuclear reactors. Germany has a surplus at 8% of GDP and may still be growing it larger.

So how is the US a trade pariah with this record?

The specifics of the Trump action are poorly chosen. The national security ruse is thin gruel, but it is legal and accessible. The US has much stronger grounds to pressure even our closest allies to shape up and be fair.

To be really fair we can step up and shoulder our share of the blame. US economists for years were in denial about the damage that global unfair trade was doing to the economy. They called it ‘fair trade’ or said it was close enough to it. Well, it is not close enough to it. The US balance of payments currently is being repaired by oil and fracking. We should not let the illusion of a smaller trade and current account deficit, because of our selling our natural resources, mask the fact that US firms are not as competitive as they need to be AT THESE EXCHANGE RATES.

There is no foolproof way to get other countries to revalue their currencies. Forcing current-account-surplus countries to make changes is nearly impossible. But Trump’s actual use of commercial policy to go after imbalances caused by other issues may have merit. Trade needs to be fair. Americans have enough ‘stuff.’ We don’t need more cheap stuff; we need jobs. And while there are gobs and gobs of jobs, there are not enough good ones. A weaker dollar would help that. But of course one aspect of Trump’s policy is that the dollar has actually been rising. And this is in part because the Federal Reserve has a program of steadily raising rates.

I hope this discussion puts the trade issues in perspective. One big problem is that no one really can observe and identify an equilibrium exchange rate. Also that an exchange rate is necessarily a bilateral thing – it takes two to tango. And it is often hard to get agreement on what it should be. But over long periods of time we can look back and see what misaligned currency rates have done. The trail of US current account deficits is such a thing. Viewing it as a problem unfortunately gets us caught up in a crossfire in which some push for a strong dollar for political or geopolitical reasons or just for what they think are patriotic issues. And if you are the greatest, best, most productive economy on earth, you will have the strongest currency, and it would not kill you. But if you are no longer that dominant economically and if you still push for such a strong dollar, bad results will follow… as we have seen. So the US situation has been the result of US misunderstandings about the facts regarding its international competitiveness and foreign opportunism. But US deficits are leaching wealth from the US. We are living off of our ‘former greatness.’ Our labor market lacks skills. The dollar can’t be the strongest currency in the world unless our capital is the newest and the best, operated by the brightest. And now the only way we get there is with H1B visas. That is not the answer.

We have many needs as a country. And you can’t start by boasting. You can trash talk before the game, but if you don’t bring it during the game, in the end you will be embarrassed. That is what is happening to the US in the wake of all this strong-dollar talk. We should aspire to a strong dollar someday. But not today. You can’t impose that on an economy that is not ready for it without some very adverse results.


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.




Trump, Trade, Will Rogers

“It was a tumultuous first week of the quarter that has left the markets caught between more truculent tweets on trade from President Trump, and slightly more diplomatic messages from his advisors. Predictably China countered with $50 bln in tariffs of their own against a variety of U.S. imports, while the White House threatened to lump on another $100 bln tariffs to the $50 bln already on the table. Advisors Navarro and Kudlow, along with Treasury’s Mnuchin, said this was not a full blown “trade war,” but were vague as to whether negotiations had even begun, while China’s commerce ministry denied any talks had been launched.” – Action Weekly! Global Edition, April 9

“Trump’s ‘Good’ And ‘Easy To Win’ Trade War Actually Might Be Neither. States that had voted for Obama and then swung Trump’s way could be hit the hardest.” – Huffington Post headline, April 4

“White House Press Secretary Sarah Sanders said Friday that the president doesn’t want to enter a trade war with China, but if he does, he’ll win. Key quote: President Trump ‘absolutely’ still believes trade wars are easy to win. ‘If he is in charge of those negotiations, then absolutely. He’s the best negotiator…’” – Axios.com, April 6

“Donald Trump is right – the United States is not in a trade war with China. At least, not yet. As the rhetoric has flown back and forth between Washington and Beijing, breathless news coverage has made it seem as though the war of tariffs has already begun. It has not – hardly any new duties have been levied. At most, the world is in its July 1914 moment, with the clouds of trade war gathering but shots not yet fired. We’ll know soon enough whether that is indeed the correct historical analogy. For now, the war is just words, and it would be best for the planet if that’s as far as it goes, because the only way to win a trade war is not to fight it.” – Politico, April 7

“Just six words suffice to sum up President Trump’s approach to trade (and, you may mutter, too much else): make threats, strike deals, declare victory.” The Economist, March 31

We thank our friends at TLR (The Liscio Report) for their kind words about our commentaries about trade (and we thank David Blond, Bob Brusca, and Mike Drury for their guest pieces on trade and Trump). By the way, in our opinion TLR is one of the highest-frequency reports (it’s weekly) that might discern some impact on the US economy from the trade war or trade rhetoric. This research publication tracks employment data in each of the 50 states. I read it regularly and recommend it highly. Call 518-827-7094 to obtain subscription information or a trial. So far it is too soon to see any signs of trade war talk-induced change in the employment data. Our view is that it won’t be long before we see the first signs of negative impacts from Trump’s destructive bluster.

That is why the White House has already started to warn about some short-term pain for the sake of long-term gain. Larry Kudlow knows the pain is coming. He has seen the impact on the stock market, and he has seen the dramatic swings in certain commodity prices. He knows that an expectations-induced retrenchment is underway. Why would a farmer order a tractor today to plant a legume crop tomorrow when he is uncertain about future demand and prices? Why would a pig farmer build a new barn? If you made a specialty part for an airplane that was purchased by Chinese users, would you adjust your business model? Would you still order that new robot, or would you delay?

The first negative reactions to a trade war threat are changes in business expectations. And they are happening fast now.

US exports to China are varied and substantial:

“American exports of agricultural and other primary products to China totaled nearly $20 billion in 2016, which accounted for 25 percent of the industry’s exports in that year. There were also significant amounts of exports of aircraft (nearly $15 billion), motor vehicles and parts (about $11 billion) and chemicals (more than $13 billion) in 2016.” – Wells Fargo special commentary, April 5

Remember that these figures represent only exports to China, which receives just 7.8% of total US exports. Also remember that the US economy is 70% services, and services are a minuscule part of exports. The pain mentioned by President Trump and his advisers will be levied directly on the American manufacturing and goods-producing sectors and on American agriculture. My dentist in Sarasota is not impacted, but my friends in the heartland of America are already hurt because of the price changes in their markets. And every 401k in the United States has been hurt by an amount that equals all it gained in anticipation of economic growth and the benefits of tax cuts, repatriation, and fiscal stimulus. Yes, Mr. President Trump, there will be pain. You have brought it upon us.

It is clear that nobody wins a trade war. No credible person can point to net gains. A trade war is never a zero-sum game; it’s a loser’s game on both sides. So the big talk about who wins is actually a debate about who will lose more, and that’s about as dumb a debate as anyone can imagine.

Okay, what happens next? The US would like to see a negotiation and an agreement so Trump can declare victory and tell everybody how great a negotiator he is. He might get to that result with some of his other trade talks, for example those regarding NAFTA or trade with Europe; and he did enjoy a positive outcome in his talks with South Korea.

But with China the test is different.

Chinese policymakers know the US system and thoroughly understand US politics. They know what the midterm elections mean, and they see how Trump has intensified the political activism of the Trump haters while not energizing the Trump lovers. They know that presidents are vulnerable in midterms to start with – history demonstrates that fact. They know that a Democratic party swing in the midterms means a Pelosi-led House and a bill of impeachment on Trump. And they know the midterm elections are only six months away.

The Chinese political leadership doesn’t face midterms. Xi is now president for life if he wants to be and is commander in chief of the armed forces and the head of his political party, which is the only party in China. He is patient. He also knows that in another 5–6 years the Chinese economy will be the largest in the world, and the US will be second. And he knows that China is already the largest if you measure by manufacturing alone rather than including services. He knows that in the US 17% of GDP is produced by the healthcare sector. Xi knows. His advisers know. Many of them were trained in the US. Those of us in the economics field and financial markets know several of those key people. We have met with them and have visited them in China and hosted them in the US.

Rest assured that Chinese policymakers have a multi-year war plan for trade-related conflicts with the US.

We refer the president’s advisers to the Bully Buster Program. The program emphasizes control and prevention. The purpose of control is to reduce occurrences of bullying. The aim of prevention is to promote conditions in which bullying is less likely to occur. You can check it out, too. Read Bully Busters: A Teacher’s Manual for Helping Bullies, Victims, and Bystandershttps://www.researchpress.com/books/455/bully-busters.

By the way, Mr. President, the Koch brothers have read this book, too.

For our market comments let’s just summarize. We remain invested in our US stock market ETF accounts. We think the power of the tax cuts, repatriation, and fiscal stimulus may be blunted by the Trump trade rhetoric, but it won’t be killed. And a midterm election swing will not be enough to repeal those laws. A midterm swing means a stalemate in Washington and an ugly political scene – if one can imagine it more ugly than it is at present. But the economics of the new tax law will not change.

Finally, we want to leave our readers with a bit of wisdom that has been attributed to Will Rogers. We are drawn to this quote because our president is reputed not to read much and to limit his viewing to only one TV channel:

“There are three kinds of men: The ones that learn by reading. The few who learn by observation. The rest of them have to pee on the electric fence and find out for themselves.”




Suncoast FYI talks with Michael McNiven & James Curran about Financial Literacy Day

Dr. Michael D. McNiven,  Managing Director and Portfolio Manager at Cumberland Advisors, joins Dr. James Curran, Dean of College of Business at USF Sarasota-Manatee, to discuss their upcoming event, Financial Literacy Day.

Attendees of Financial Literacy Day: An Update on the Financial Markets & Economy can receive continuing ed credit from the following orgs:

• AFCPE Post Certification (7 credits)

• CFP Board (7 CE credit hours)

For a detailed agenda and registration information, please visit: www.Interdependence.org




More on Trade Wars

Well, well! Who’d a thunk it?

First we must thank David Blond and Bob Brusca for engaging in a debate for our readers. For those who missed it, the links to the David Blond essay and the Bob Brusca response are here:

Blond: “Winners and Losers from Global Trade” – http://www.cumber.com/winners-and-losers-from-global-trade/

Brusca: “Why David Blond Is Wrong on Trade” – http://www.cumber.com/why-david-blond-is-wrong-on-trade/

We also want to thank our readers for the array of views articulated on all sides of this discussion. We thank the pro-Trump and the pro-Obama and the anti-Trump and the anti-Obama readers and the others who cited history. We had a minimal number of nasties this time. Maybe that is because we block them and have culled some of those people off our lists. We invite debate and discussion and ask only that discussion be respectful and polite. In other words, disagree but not with sharp knives and loaded guns. We have enough of that in our daily life in America without adding to it.

Today we want to add two points to the debate.

The first is our agreement with both Blond and Brusca. Neither supports a trade war. Both see the risks in such a contest. Both agree that no one wins a trade war and that all sides lose in the end. My friend Megan Greene and I discussed this hard reality during our panel at the GIC conference in Salt Lake City. She reminded me of the famous line about the direction in which the guns are pointed in a trade war.  That observation leads me to muster a few quotes in support of this viewpoint.

Mar. 5, 2018 – “In particular, we should avoid the urge to levy tit-for-tat tariffs on imports of products from the United States, such as the Europeans are threatening to impose on American motorcycles, blue jeans and bourbon. Trade war is unlike real war in one crucial respect: the guns are pointed inward.”
Source: http://nationalpost.com/opinion/andrew-coyne-how-should-canada-respond-to-trumps-tariffs-there-arent-many-options

Mar. 2, 2018 – “So if there’s one thing that most economists agree upon, it’s no one wins a trade war. But President Trump doesn’t believe that. He tweeted out Friday morning that for the United States, a trade war is ‘good’ and ‘easy to win.’”
Source: http://money.cnn.com/2018/03/02/news/economy/why-no-one-wins-trade-war/index.html

Mar. 23, 2018 – “Historically, both sides usually lose in trade wars. But, one side often loses more than the other. While China could be hurt by the Trump administration tariffs, U.S. consumers, companies and our allies could end up being damaged more.”
Source: https://www.npr.org/2018/03/23/596529795/trade-war-could-damage-u-s-consumers-more-than-china

Mar. 15, 2018 – “President Donald Trump has not yet started a global trade war. But he has started a frenzy of special pleading and spluttered threats. In the week since he announced tariffs on steel and aluminium imports, countries have scrambled to win reprieves.”
Source: https://www.economist.com/news/finance-and-economics/21738906-if-china-cannot-placate-donald-trump-it-will-fight-him-instead-lose-lose-trade

Five days ago – “Why China Will Lose a Trade War With Trump. Beijing can huff and puff, but America holds the high cards. Expect the Chinese to back down quickly – or watch their economy and political system fall apart.”
Source: https://www.thedailybeast.com/why-china-will-lose-a-trade-war-with-trump

Four days ago – “The overwhelmingly negative reaction from US businesses and lawmakers to this abrupt policy shift tells the real story — a trade war with China will hit the US where it hurts, and will do far more harm than good to consumers.” Source: http://www.chinadaily.com.cn/a/201803/28/WS5abae5d7a3105cdcf6514b62.html

Mar. 23, 2018 – “Boeing has become an unofficial proxy for fears about an escalating U.S.-China trade war. Investors are right to be worried.”
Source: https://www.wsj.com/articles/what-boeing-has-to-lose-in-a-u-s-china-trade-war-1521823499

Let me move to my second point.

The selection of words is a powerful tool in the hands of politicians. It is really part of the skill set, just as style also helps establish a politician’s rapport with his/her “base.” In the trade debate the selection of the word deficit is a key example.

I tried this question by asking for a show of hands at the GIC conference in Salt Lake City. When I asked the audience “How many think a deficit of some type is bad?” most of the hands in the room went up. The word deficit has a pejorative connotation.

I then asked how many thought the word surplus was good. Again, most of the hands went up. I then asked the questions in reverse. Only three thought the word surplus could be bad. A similar number thought the word deficit could have a positive connotation.

Now let’s get to the economic issue. No politician stands up and says, “We have to shrink the capital account surplus.” They like to say we have to reduce the current account deficit. The term deficit is alarmist. The term surplus gives comfort.

But we’re talking about an economic identity, and so to say either one of these things is to say the same thing. The difference is how it sounds to the unskilled (in economic terms) listener.

No politician says it is “unfair” to have the money we spend abroad recycled into the US domestic economy by foreign parties buying US Treasury bills, notes, or bonds. Or by their buying American stocks or real estate or other ventures. Nope. That side of the identity is not deemed unfair.

But the same politician, who calls trade policy unfair and wants to shrink trade and, therefore, the current account deficit, doesn’t offer the other side of the money flows to the listener. But with an identity you cannot have it both ways. If you want the flows of foreigners to be invested in your country and its enterprises, you have to get the money to them by buying their stuff or investing in their enterprises. This is a two-way proposition.

It seems that there is more bluster about trade than there is an actual full-scale trade war. But we are not sure. These things progress, and history shows they worsen in a tit-for tat manner. History is very unkind to those who launch trade wars and trade war threats and likewise to those who respond in kind. The debate has raised risk premia in markets. When that happens, every investor and every business loses.

We again think the Blond / Brusca duo for their words, and we think readers for their responses. More is coming from us on this subject, as a trade war poses a major economic risk that is evolving. We cannot yet size up the trouble that lies ahead down a thorny and ill-advised policy path.


Today’s comments were written before the last 24 hours’ news flow.  The most recent round of China-US tariffs war is alarming. Trump’s trade policy is failing and harming the United States.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


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.

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Why David Blond is Wrong on Trade

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.

Dollar supply?
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?

Hoodwinked?
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
Email: Robert.Brusca@verizon.net


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Winners and Losers from Global Trade

David L. Blond, Ph.D, has a distinguished career in international economics and particularly on the issues of trade. He is the president of QuERI-International, Washington, D.C.

He has assessed President Trump’s Tariff and Trade barrier initiative and has articulated some strong opinions. His views are his. They are worth reading and considering in what is about a ten page paper on this subject. Readers may note the documentation and data depiction which are his work.

When it comes to the views of a number of us at Cumberland you can find them here at www.cumber.com/category/market-commentary/.

We thank David Blond for permission to offer his paper to our readers.

A rebuttal to David Blond’s commentary has added to the conversation. You can read that here: Why David Blond is Wrong on Trade

David R. Kotok
Chairman and Chief Investment Officer
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Winners and Losers from Global Trade

In a grand effort to change the subject of the political discussion from Russia to something else, President Trump fired the opening shots in a new trade war. Not content to destroy the solar industry by adding costs without adding supply to solar panels, or making South Korean washing machines more expensive without making American consumers more willing to buy US made (with foreign parts) machines from the one remaining American producer, President Trump fired off the big guns to try to save what remains of the US steel and aluminum industries with new tariffs. The response was, of course, expected.

Over the past twenty years or more I’ve tried to slow the steady erosion of the US industrial base against the tide of history, but right now, at this time, it is far too late to stop what is the inevitable shift in the global distribution of manufacturing. To have saved the US Steel industry we would have had to force US companies to invest in the new furnaces and the US steel workers to cut their wages in a vain effort to gain advantages of scale and compete on price. Our companies chose not to try to fight against the subsidies – from government direct aid to massive amounts of nearly free capital – but to regroup around a few, higher profit, subspecialties. Steel has become highly specialized in more technology interesting and profitable alloys, leaving the lower end, construction steel and non-specialty steel to foreign producers with their massive scale economies. The cost of this change has been, felt, in the secondary industries that transformed commodity steel in small operations scattered across the industrial rust belt. The downstream industries have failed as the few remaining US steel companies with specialized products have maintained their shares. The US Aluminum industry also has made changes that allow it to maintain its position in the world while fulfill its obligations to the environment. Less aluminum for cans, but more for aircraft and even military vehicles has left the industry largely with the same share of the world as it had in the past.

Looking at the chart we can see that while the US lost its nearly preeminent position in both industries that it had coming out of the Second World War over a long period of decline. Over this period the US companies shifted capital from less productive to more productive and profitable industries and also invested overseas. The failure of US capitalism has been borne by the workers and the communities that have been damaged by this neglect. Social morays matter and US capitalism with its emphasis on shareholders value rather than that of all stake-holders is to blame, but what we see today, as the graph illustrates, is a slow erosion, but not the disappearance of entire industries.

In the chart all values have been corrected for changes in prices and in changes in exchange rates. The US share of world output of steel and aluminum metals stabilized around 2010. In the case of US steel the import share is forecast to decline relative to demand for steel in US manufactures as the product mix changes. There is also some growth in import share in non-ferrous manufactures demand. Tariffs will not suddenly return either industry to health. Based on the factors driving consumption the import share of foreign aluminum will likely continue to increase as overall demand shifts from aluminum to more exotic low weight materials like carbon fiber while the foreign aluminum may continue to be imported for low value uses such as cans and other commodity materials made of aluminum. Again not all aluminum is the same for all uses and American companies remaining in the industry have shifted to the higher value output. This is a natural progression as we should see as countries move towards more service and information/science intensive specialties and away from the high impact on the environment and low skill product categories within the industry classification code.

Winners and Losers from Global Trade Chart (1)

What Happens If Trump Gets His Way on Trade

Global trade patterns have been modified over the last fifty years by a series of trade agreements. Largely tariffs in the richest and most important markets are low enough to be barely noticeable in most manufactured commodities. Tariffs against emerging markets have been reduced through special efforts by advance countries to open potential flows to help in the development process. Efforts to reduce tariffs have been, as a result, concentrated on eliminating tariffs on agricultural commodities with limited results since food, unlike manufactures, is one of the essentials to guarantee along with shelter to a people. Much of the progress on reducing tariffs has concentrated on reducing prohibitive tariffs in the emerging and developing country markets.

America has been at the forefront of this effort. But tariffs and non-tariff barriers not just rules for companies to deal with, they are also part of the nation’s foreign strategy. The Trans-Pacific Partnership Agreement was less about tariff levels and more about maintaining long-term trading and political connections. The failure of President Trump to see America’s role as the essential nation for global cooperation is a problem. His rhetoric has damaged our standing with our natural trading partners. But in this article we are looking less at the political and social implications of the failure to keep the momentum going, and more at how difficult reversing the trends that have reduced American manufacturing in some sectors. The reason for this is that industrial capacity has been lost in many industries and technology has made replacing suppliers far more complicated. When I was the Senior Economist at the Pentagon and studying our capability to expand rapidly our defense industrial base, this problem of technological interplay became readily apparent. A landing gear on an F-15 takes at least a year to produce even as the labor hours may be just a third or less of that time. Each time a cut is made in the high tensile alloy, the unfinished billet had to be slowly heated and slowly cooled to release the tension to allow more machining. The unique parts used on military aircraft had to meet mil-specs that made it costly to replace one supplier or open a second source without testing of the replacements. The same is true for much of what passes as new products. While consumer goods might be easier to copy, the margins on these make the cost of the new factory expensive. The advantage of Asian suppliers was not just their low labor costs, but their excess, flexible, engineering and manufacturing capabilities that are not easily duplicated. America’s manufacturing capacity has not declined even as employment in manufacturing has collapsed. Productivity explains most of the loss of jobs , but gains in productivity have come from the inclusion of more foreign sourced inputs in finished products thus real gains in productivity may be an illusion induced by this shift from a vertical to horizontal company organizational approach. The result is that fewer workers are needed as the foreign labor inputs once made in-house or with locally sourced suppliers is not counted when measuring total factor productivity. This pattern of hollowing out companies is likely responsible for most of the gains in productivity and fewer workers producing products for sale domestically.

Measuring the Cost of Anti-Globalization

Simulations are one of the few ways to measure the cost of retreating from the world that has emerged from the steady advance of trade liberalization. As we have shown, the benefits and the costs of this advance are not evenly shared opening the door to protectionist sentiments. But reversing the course also comes with costs. The QuERI Integrated Global Model measures this interconnectivity through a series of equations linking trade with production. Statistically based, econometrically derived, equations reflect the production function including stock of capital to labor ratios, and two major trade components – imports which are in nearly all cases negative to domestic production and exports which are positive. In rare cases the positive export elasticity is greater than the negative import one. Unlike most macroeconomic model for a single country, the QuERI model set is based on a 72 country and 25 year sample of data that allows for countries to pass through various stages of economic development. Lastly results are linked together across industries using input-output linkages and across the world using international trade relationships. Like the best econometric models, the coefficients are related to one another independent of prices and exchange rates. The underlying QuERI data set is likely the largest and most fully integrated long-term reading on industrial, trade, employment, prices, and consumption patterns available anywhere in the world.

The question at hand then is what would be the impact of a full blown, 1930’s style, trade war. The tariffs President Trump has initiated against good advice will not lead to a recovery in US manufacturing or in the core industries he’s targeted. As I said at the start, the train left the station long ago, and it is too late to reverse the integration, only to slow it, adding risk, rather than supporting faster growth in all countries. A model like the QuERI model, however, can be used more selectively to measure the effect of tariffs on a single industry or on a collection of industries. In the example below we want to not pick any one industry, but rather to assume that all countries apply the same tariff increase across all products. We can then measure two things – the impact on exports and imports and the impact on production.

A 10% Tariff Increase – the Global Implications

Integrated global supply chains are not simply between advanced countries and emerging markets, they also exist between countries in each group so any disruption is a major change and can lead to loss of irreplaceable capacity and capabilities. The cost of qualifying a new supplier is often high and the risk to existing business increases if the replacement products are more prone to error or failure. In this example we assume that the imposition of a 10% tariff in the United States creates a chain of causality that expands so that a similar tariff is applied in all other countries. The goal is to find out what the costs of this kind of modest increase in international prices pose to trade and production.

The broad based assumption is that globalization reverses slightly as a result of this added cost for imports. The impact is greatest within the group of advanced country due to their greater integration with the world. The calculated impact is based on the point elasticities for imports and export prices against changes in trade. To insure that we are not over or undercounting the effect we average the total export adjustment from the model and the total import adjustment for each ISIC3 commodity. The share of global trade adjustment is based on the share of the adjustment in individual country imports or exports against the average global trade adjustment. Not all countries are sensitive to changes in price for trade goods. We assume that higher prices will not increase imports although it is possible there is some precautionary trade influenced higher prices. When the price elasticity for imports is positive it suggests that demand is not sensitive to price changes. The assumption of the model is that these changes are modest and it is likely that temporary reductions can take place if the price shoots up too rapidly to be accommodated in the overall cost function for the finished products. The price sensitivity of a country on a rapid development trajectory, like China, is less than for advanced countries with more flexibility of supply or simply to reduce domestic production and import more of the finished manufactures for resale and rebranding (common practices).

Emerging and Developing Nations Came to the Party Late

The pooled-cross sectional model for trade and industry used in my model is based on a “stage of development” so that countries at the start of period of rapid industrialization are assumed to follow paths similar to more advanced countries. In the early stages a country is more dependent on foreign sources of supply. The actual volume of imports is defined by the countries capacity to export or attract inbound foreign investment. Tariffs in these countries tend to be supportive of local business and often are higher than they need to be and these limits can impede real growth and development. Much of the theoretical literature on tariffs is based on the assumption that tariffs dampen imports, but may limit the growth of domestic industries despite the intent. The higher prices for the locally manufactured products may limit the market size and limit growth of the economy as a whole. It was factually true that in the early periods of industrialization the advanced countries had high tariffs to encouraged industrialization. That strategy is not replicable despite the fact that globalization as it stands has failed the emerging and developing nations primarily because the price of finished goods is influenced by the higher prices of the advanced countries. Thus the steel that might have gone into an automobile is priced at the world market prices consistent with the costs of finished products sold in advanced countries. For a country to grow rapidly then wages and prices have to be in line. Today the cost of living in rich and poor countries is often significantly different. We measure these differences through the purchasing power parity index. The cost of living in China is today around .33, while the wages paid to workers even at $ 5.00 an hour (2016) is just .13 of the wages in the United States. In the next graph we see how the advanced countries prices and wages generally are in line so that growth can be sustained from domestic demand and supply alone if need be.

Why is this critical – without a strong alignment between real wages and real prices then internalized, self-initiated, growth is difficult to be maintained without external sources of demand. Export-led growth encourages the import of new technologies while suppressing wages and encouraging the import of foreign luxury goods suppressing local supply. The result is that for many emerging and developing countries there is no simple solution and higher tariffs may not encourage the development of domestic sources of supply. Of course there are exceptions—protection of agricultural products may be important for reasons of the keeping peasants on the farm and insuring that domestic producers continue to stay in the rural communities and maintain food self-sufficiency.

In the charts we can see how the wage rate, represented by 1/wageindex (1.0 = US wages) and the PPP Price index are not fully in line in the emerging markets group. It costs less to live in China than the United States, but the wages in the United States are in line with the cost of living, the wages in China today are suppressed by the need to be competitive on world markets by international trade, so it is hard to sustain growth without exports or government subsidies. If that were not the case then the index for wages and the index for prices would be equal to one another.

Using the Model to Measure the Impact of Tariffs on Trade –the Cost of Reversing Sixty Years of International Trade Liberalization

The QuERI Global Model has a number of advantages when measuring the impact of changes in prices, in this case, ad valorem tariff changes, on trade, industrial activity, and employment. The two charts illustrate the disconnect between relative wages and relative prices. Globalization has widened this gap in rich and poor countries alike. At the same time the dependency between countries for vital raw materials, energy supplies, and intermediate inputs has increased. Disturbing markets and plans can only lead to a disruption in an economy until companies and economies adapt. But during the period of adaptation production is impacted, employment growth reverses, and real wages may decline further as companies attempt to maintain profits.

Trade and Industrial Production Linkages

Within the model there are a number of links between trade and production. The industrial production of traded products includes a variable reflecting the foreign content of factor inputs based on estimates from the QuERI IO models. Foreign content is based on the import share of apparent consumption times the total factor input. For example if to make a car in the United States it takes $ 1000 worth of steel based on the IO column coefficient at the intersection of steel (selling) and automobiles (buying) and if import share of foreign steel is 50%, then $ 500 is allocated to foreign content of steel. Going further down the column of the IO for automobiles we see the share of electronics is $ 1500 and the foreign share of imports of these products is 65% then the foreign content is $975. Adding all of the foreign content value up the total import value is used as an independent variable in the industry production function for automobiles. Repeating this process we can calculate then the likely sensitivity of the industry to the replacement of foreign with domestic sources of supply. In the US the foreign content share for automobiles is 40% of the total value of automobile production. For footwear the foreign share is over 78%. For China the foreign share of production for automobiles is just over 5%. So in any trade war who’s domestic companies would be more seriously impacted?

Reducing foreign inputs to US production will slow growth or even reverse growth in US manufactures so long as substitutes are not available. Given the complexity of much of what is sold as factors of production or as finished goods in retailers, replacement of foreign content will be a slow, painful and possibly impossible process. Adding tariffs will in the short-run reduce demand as some American production may be lost. In the model then the production function has three elements whose interplay determines if production will increase or decrease.

(1) Net Change in Production = Net Change in Foreign Content $ + Net Change in Exports – Net Change in Imports.
(2) Net Change in Exports = function of Impact of Foreign Tariff Changes on US Exports (positive)
(3) Net Change in Imports = function of Impact of US Tariff Changes on Imports (negative)

President’s Trump’s idea that a tariff might reduce or eliminate or dependence on foreign suppliers is a myth born as much out of ignorance as political calculation. The American manufacturing base has been hollowed out and is a part of the global supply chain of global companies with markets in all parts of the world. Fifty years of continuous efforts to reduce tariffs have been successful creating a world market and worldwide production system. But the emergence of China and its low cost wages and lower cost capital and ideal location in the heart of an emerging Asia has changed the balance. Higher tariffs will end up damaging the American economy more than China. The foreign content in US manufacturing, investment goods purchased, and consumer products sold by retail and wholesalers makes any effort to disrupt trade self-destructive. The next table illustrates this in the starkest terms – the share of foreign content in US domestic manufacturing has been growing year by year. The share of foreign content in US investment expenditures for machinery and equipment has also been growing over this period. Any effort to enter into a broad based trade war would lead to the destruction of American industries ability in the short-run to manufacture almost anything except, perhaps, rubber mats for automobiles.

Foreign content in finished products is significant. Clothing and apparel 71% in 2015, household operations 48%, furniture, finishing and other equipment 37%, other transportation and communications 48%, medical care and health including pharmaceuticals 45%, entertainment and cultural expenditures 48%. Place tariffs on imports from China and in the short-run there will be empty shelves and limited consumer choices in the stores, ultimately small and large stores will close leaving millions of people from warehouse workers to sales people out of work.

Foreign content in finished products is significant.
Foreign content in finished products is significant.

Foreign content in finished products is significant.
Foreign content in finished products is significant.

Using the model we can simulate how a 10% change in tariffs as measured through a 10% change in import price will impact the world economy. In this example the 10% unilateral change in US tariffs – pushing them up to closer to 12 to 14% from around 2 to 4% where they currently are. In this scenario we assume that the world reciprocates and applies a similar increase in cost to imports from all sources. If globalization is the problem and its impact on countries ability to manufacture has been substantial, then we should expect that the change is universal, the beggar thy neighbor approach usually leads to higher tariffs across the board worldwide. The question we ask – who wins and who loses from this change. The degree of dependence, however, varies and the weights of imports and exports vary in all countries. The net impact then will be different for rich and poor, trade intensive and trade neutral countries.

10% Tariff Impact on All Countries & Regions
10% Tariff Impact on All Countries & Regions

As table shows if there is a trade war and it settles down to around a 10% increase in tariffs levied against all countries imports and exports, given the dependency, the impact of this symmetrical war (unlikely as countries will more selectively target the industries and countries imposing the added tariffs) which does not bias the impact against one country and not another, the United States with its greater dependence on foreign imports will be more directly impacted than other countries. The differences in shares between US and Germany are a function of the mix of products imported and not from differences in the product specific price elasticities. The cost of President Trump’s trade war for the United States could be a 1.1% decline in real production of manufactures, a nearly 1% decline in output of primary products including soybeans and corn exports. The most important loser from any trade war is the United States. Imports would be 5.5% less while exports would be 2.2% less so that the net trade deficit could be smaller as a result of the tariffs. It would cut around 1.1% from US manufacturing output and reduce employment in manufactures by 1.3%. These results are the build-up from the bottom-up at the industry level (more than 170 industries including services).

This modeling exercise only takes into account the impact on production from the reduction in imports used as intermediate inputs to production. A more complete analysis will use the full inter-relationships within the model to measure the effect on production of less foreign products for sales to consumers and less capital goods able to be deployed to growth productive capacity. It is likely that given the significant, sometimes 30 to 50% shares of foreign content for personal consumption and business investment that the full effect of a trade war will be greater. Perhaps more damaging is that the war would be concentrated against a single country, the United States, while other countries and groups of countries maintain their past trade relationships. Like dropping out of the Trans-Pacific Partnership, threatening to pull out of NAFTA, canceling negotiations on the European US trade agreement, the net result will be to isolate the United States from the world.

Benefits and Costs of Global Specialization – How to Measure Trade Displacement.

Much of the debate over the past years about the benefits and the costs global specialization, primarily the rapid advance of China as a major manufacturing center has been less about the financial costs – the $ 12 trillion dollars of additional liquidity that the US consumers offered to the world (the cumulative US trade deficit from 1990 through 2015 compared to the over $ 3 trillion dollars in trade surplus run-up by China over this same period—and more in terms of the jobs lost and the impact of foreign products on American wages in manufacturing.

The flow of US dollars has is the lubrication for the world economy adding liquidity to rich and poor countries alike. Without the US acting then as the little blue engine that ‘could’ for the world economy, the miracle that has lifted a billion people from poverty to wealth or near wealth could not have happened, it came at a cost to America’s massive, post-war, industrial base. It came as a benefit to American consumers and companies (and investors) in the form of supporting a higher standard of living at a lesser cost than internal resources alone could support, and a better margin on sales for companies supporting the growth in the stock market values of companies even as old name companies in commodity type industries such as steel and aluminum suffered.

There are many ways to measure the trade deficit. The nominal deficit is driven by differences in relative prices of exports and imports. A price index is an approximation of the changes in the price of the components of the commodity group. The BLS, the government agency that develops price and wage indices based on surveys, but there are some major product groups where absolute prices have declined even as the capabilities offered for these prices have increased. For example computers and chips available are multiples of prior computers and chips in terms of capabilities for the same basic prices paid in the past. In the BLS indices for these technology intensive products prices are assumed to decline so real value increases. This potentially distorts the relationship between nominal and real deficits. Another problem comes from exchange rates which vary over time distorting the real value changes from the nominal cost changes. Our primary focus then will be, like in the case of macroeconomic models, changes in real activity with price changes and exchange rate changes excluded.

With the dollar as the numeraire currency through which much of world trade flows, the need for dollars is great. If the US fails to run a large trade deficit each year, the cost of buying and selling dollars would necessarily increase leading to higher costs to support the larger amount of world trade that is dependent upon using dollars for the transaction. Dollars are also needed to repay debts denominated in dollars or support other financial flows. The following chart perhaps illustrates that there could be a causal link between the size of the US trade deficit in constant dollars as a share of total US exports and imports and the rate of change in world real GDP output excluding US real GDP growth. The Asian crisis that sent the Emerging Countries into a tailspin and collapsing stock markets over the 1997-99 period may have been due to a liquidity shortage as the US deficit pushed towards closer balance starting in 1993 and reaching an apex in 1996 with world output (excluding US) for three years between 1994 and 1997 was 3%, but as the US fiscal stimulus from our trade deficits declined over those years, and without alternatives to replace the extra liquidity, raw material prices growth collapsed and world output slowed dramatically from 3% to 1%, and 2% in the following year. Fearing a global depression, the Clinton economic team combined with the Federal Reserve stepped in to stimulate growth in US trade and the US deficit grew strongly as world trade growth reached over 10% and the deficit reached a low point of -3.5% while world output growth expanded strongly until as the US deficit relative to total trade declined year by year until we reached the Lehman Brothers in 2007-08 and world output suddenly went from positive to negative in one year. The US recovery has been followed by a return to past periods of the US running trade deficits. In the QuERI model, like non-US world output, these stabilize in the long term at around -25% and world output stabilizes in the 2-3% range.

If the global growth depends upon the US running a stable, long-term, trade deficit, then the industrial base in the US will necessarily suffer from a shortage of demand or a steady drum beat of competition that keeps real wage growth in check. In short we may be locked into a damned if we do and damned if we don’t pattern. When I was at the Pentagon during the period of the Reagan build-up, I would explain to the critiques back in 1982-84 that economies have a natural structure that may adjust over time as defense contractors shift resources form military to civilian needs, but no economy can adjust fast enough to accommodate a sudden cessation of demand without dire consequences. Thus the world depends upon US surplus demand. The Chinese government would gladly burn the excess reserves in dollars than spend them in buying US steel or aluminum. The demand for dollars is greater today than when the idea was first suggested back in the 1970’s. The dollar is not just the transaction currency for trade, but more importantly the transaction currency for world debt denominated in dollars. The failure to provide sufficient excess liquidity shrinks the amount available. It drives up the price of the currency, but even a strong dollar and a growing trade deficit will add enough free exchange especially if the US domestic demand increases from a stronger economy.

Renegotiating Trade Agreements Doesn’t Add Industrial Capacity in the United States

I pointed out in an earlier paper on the future of globalization, that there is nothing that President Trump has said or tweeted about the failure to protect American manufacturing from the ravages of unfair trade practices of some countries or the willingness of American companies to outsource supply to foreign subsidiaries at the cost to historic relationship with workers and communities. I have been saying for years. But I’m enough of a realist (or powerless) to know that these business decisions can’t be easily reversed. Once a company chooses to leave, shutters a factory, lays off workers, then the capacity is gone. If it is reformed it will be with more capital and fewer workers or a new advanced product no longer able to be built in an old style plant. The US government owns vast reserves of machine tools in massive factories built during World War II and no longer needed. When I was at the Pentagon I visited many of these factories mothballed except for a few, new, style machines doing what work remained. The private sector is less forgiving and older plants simply rust away or is torn down to build track houses(1).

Everything in the Republican plan for rebuilding American manufacturing hinges on stimulating investment in the US. In theory this should reduce demand in real terms, but in practice it may not. The significant share of foreign content in US made manufactures today – well over 25% in nearly every sector. A stronger dollar may come from the effort to protect US companies. If the trade deficit declines and if there is a surge of foreign investors taking advantage of the reduced tax burden and the threat of more American protection, then the stronger dollar will make imports cheaper and exports dearer, limiting the effect of the Trump-Republican plan for protecting US industry from foreign competition. It is the expected future strength of the dollar that make US exports uncompetitive in more markets and the less cost to foreign imports that changes the trade balance from negative to positive in dollars but adds to the problem caused by the real trade balance that impacts employment.

Don’t Mess with What’s Working – Mr. Trump, Do No Harm

We can measure the trade deficit in many different metrics. A more interesting approach to measuring the trade deficit or surplus is in terms of the total loss or gain associated with the intermediate inputs that are not included in the export and import data. If the United States or any country could make everything needed to manufacture all the products without trade it would be autarkic (standing alone). To make a car you need, however, the contribution of other companies selling the steel, plastic, engine parts, and even consulting services. If we add these indirect sales in we have a total full-in trade value for exports and imports. In the table following we summarize the impact of the trade balance on the United States economy including the direct and indirect trade and the total number of jobs in manufacturing and in other industries lost as a result of the deficit. The cost to the economy is just 3 million jobs.

Revised Balance of Trade
Revised Balance of Trade

A Trump-like world view of “America First” might assume that everything you need should be made here. If the rest of the world assumed the same then we can measure the “Shadow” deficit or surplus by including the indirect or intermediate sales that are lost when an automobile is imported from Germany. As is indicated in the table following this one, the actual share of foreign content in US factor inputs that can be traded across borders is 35%. For purist, however, full independence from the world would mean that everything that is made here comes from here. The other side of the same coin is that US exports are zeroed out. Adding in the indirect sales the size of the deficit increases in the case of real trade, but actually decreases slightly in nominal terms. The difference is which industries benefit from the alternative. When all this is translated, industry-by-industry into employment losses due to the trade deficit the cost is around 3 million jobs. This works out to 2.2 employees per million dollars in deficit.

Productivity versus Trade – Where Did the Manufacturing Jobs Go?

Productivity is a dual edged sword, it gives with one hand and takes with another. In November 2002 I published an article in The Manufacturer titled “The Double Edged Sword” dealing with the give and take that comes from productivity improvements:

We live in a world where efficiency is God. Magazines — even The Manufacturer –glorify the benefits of “lean manufacturing”, yet productivity growth is a double-edged sword. It gives to some and takes from others. We are caught in a jobless recovery (2003-4) caused, in part, by the down side of productivity improvements in manufacturing and business services – over supply, low prices, and lay-offs.”

Unlike manufacturing in many other advanced and emerging markets, the share of traded goods in the United States economy is less than in other economies. Two forces are at work here – the United States economy has shifted towards a service intensive economy faster than others with specialization allowing efficiency gains as in-house or vertical parts of the production process are outsourced to more efficient or lower cost suppliers (some owned by these same companies and others at arm’s length). The second force is the specialization within the supply chains, breaking production into more sub elements with each of these made by companies with unique technologies or lower cost labor and capital. This means that the last step in the manufacturing process may be done in the United States but the inputs come from outside. The labor used to make these inputs is not counted in the employment totals with the labor associated with managing a worldwide supply chain (the non-traded goods inputs and the management costs) included. The output or domestic sales are the total sold so the full factor productivity is higher. For a country with a healthy export of these factors of production to other countries the traded good share of production is higher as these companies are being directed in their production by the firms they supply to and who sell their products.

In the tables following we see the share of traded goods in the United States versus some of its major competitors and then the foreign content share. In general China’s traded goods share is higher than for the United States while its foreign content share of traded goods is less so that a trade war will hurt the US more than it will China.

Traded Goods
Traded Goods

 

Measuring Employment Losses – Deficit versus Productivity

The hollowing out of the manufacturing sector for large companies has continued to reduce the share of traded goods in the domestic manufacturing input-output formula. The cookbook recipe described in tables for the US, China and Mexico illustrates this quite well. The proportion of factors needed to make something should be about the same in each country except it is not the same. The differences come in part from the degree to which the companies rely upon outside suppliers – domestic and foreign – to do what used to be done in-house. The vertical integration of the past has given way to a more distributed system relying upon global supply chains and outside sources of supply for semi-finished manufactures.

There are many ways to measure trade’s impact on employment. Given the better data available only from 1996 we use the employment/output factor for this year to fix the employment and compare this to the yearly employment per unit of output. If the productivity had stagnated then the actual damage to US employment from the deficit would have been significantly larger – 4.3 million jobs compared to 1.6 million direct employment losses alone. At most around 3 million jobs are lost due to the trade deficit. This is a full in cost including intermediate transactions lost. Productivity improvements in manufacturing, many due to the transfer of lower value intermediates to foreign suppliers may account for the drop in manufacturing employment. In 2015 if there had been no change in productivity the total employment would be 29.7 million compared to 10.9 million jobs actually reported. Jobs per million 1995 dollars declined from 4.3 to 1.69. Manufacturing job loss, while possibly as much as 3 million jobs in 2015 taking into account indirect measures, is only one factor in explaining the number of manufacturing jobs lost. In 1996 there were almost 17 million employed by the manufacturing sector. That number in 2015 is just 10.8 million. If productivity per unit of output had remained fixed at the productivity as of 1996 the total number of manufacturing jobs would have been 29.7 million. The trade deficit –$ 700 billion in 1995 $s ($ 1085 billion with indirect sales included) – reduces employment by 3 million jobs, however, looking at the table below we see without including the second order effects the employment costs of the trade deficit in 1996 was just 1.4 million jobs and in 2015 with the improvements in productivity it was 1.6 million.

Final Thoughts on Trade and Employment

We can’t disengage from the world, the US as we have observed is, at least in terms of trade, the one essential nation. Our currency is the underlying currency used for trade and finance, our companies are engaged in operations worldwide so that there is no single product group that can be made without some kind of foreign content included. The products we buy and sell are more complex, more protected by patents, and often relying on patented inputs that can be made only by one supplier in one country. So any effort to save a 1000 jobs in steel or aluminum will yield higher profits, temporarily for companies protected by these barriers, but in the long run they will be losers as well, as the open markets on which we depend become more compartmentalized.

Over the past forty years that I’ve been working with trade data and developing models to understand at the most basic level how the world operates, I’ve seen it all. I watched, when I built the first commercial model for trade at a commodity and bilateral or trade route level to help the ocean shipping and air freight industries plan, how changes in the Japanese yen’s price from 300 to 100 yielded little in the way of changes in the US-Japanese trade balance due to the Japanese exporters cutting prices to match the loss of dollar purchasing power in the Yen. At the same time, I observed too how discussing trade barriers against automobiles and semi-conductors shifted meant that Japanese companies began to build operations in the United States. Frictions with respect to trade caused by Trump like threats may be useful, at least in some cases, to change industry behavior.

As the chart shows the 1990’s into the first part of the next century were periods of rapid and sustained growth in world trade. The high point came in 1998-2000. The United States economy was booming and the formerly rapidly growing countries of Asia, Latin America, and Eastern Europe had slowed with currencies collapsing as roaring stock markets turned south. Over the next nearly ten years, until the 2007-09 financial crisis, there was a gradual increase in the share of world consumption of traded products that came from outside the country. This period of sustained integration helped more countries out of the poverty trap, but at a cost to jobs and incomes in the advanced countries. In some ways the slower growth observed since 2011 through today should have been expected. There is a maximum rate of substitution of traded products for domestically manufactured products and we are reaching a saturation point. The ratio of trade growth to GDP growth no longer averages to 2.0, but is now closer to 1.0. It may creep up after 2025 to around 1.3, but without some sudden explosion in demand and supply, it is unlikely to ever reach 2.0 or greater for more than one year or two over the next decade.

World Trade Share of Consumption / World Trade Real Growth
World Trade Share of Consumption / World Trade Real Growth

President Trump’s heart is in the right place with respect to wanting to rebuild manufacturing here as it once existed. That style of business organization is dead, not just here, but in other parts of the world as well. Everyone benefited from the specialization that has occurred over the past thirty years. It is not an impossible task, nor is it not prudent to try to reduce the imbalances we have in world trade as a longer term goal, perhaps replacing the dollar as the necessary underpinning to maintain global liquidity with IMF SDR’s as was once the goal. There are good ways of doing this that are less disruptive and less prescriptive. In the past I’ve suggested a couple solutions to reduce the US trade deficit and preserve US manufacturing by slowly winding down the size of the US trade deficit without selecting winners and losers:

(*) A system of import warrants given to exporters or directly issued by the government setting some limit to imports relative to exports. An importer would need to buy on the open market an import warrant before importing the products so that the free market price of the warrant is set by the market. Such a system could slowly push the trade deficit down without choosing winners and losers.
(*) Changing the corporate tax code so that companies buying more in the United States and selling more outside the country would pay a lower tax rate on profits, while companies selling more in the US and buying less here would pay a higher marginal tax rate.
(*) Working with the rest of the world to change WTO rules making it mandatory that countries running a trade deficit more than 1% of their GDP must impose a 10% surcharge on imports; while a country running a surplus more than 1% of GDP must impose a 10% surcharge on export prices. With these rules applying to both chronic deficit and chronic surplus countries we expect a gradual adjustment and reduction in global trade imbalances.

David L. Blond, Ph.D
President, QuERI-Internatonal, Washington, D.C.

Dr. David Blond has been studying, using sophisticated models and quantitative methods, the impact of trade on a countries growth and development for more than forty years. The QuERI Global Trade and Industry model is the most complex model of the global economy covering 72 countries and more than 400 industries. It can be used to more precisely measure the impact of tariffs, including the 25% steel and 10% aluminum tariffs on the US and other economies in a multi-sector world. For more information on the model and for developing consulting assignments, please contact David. Blond at 301-704-8942 or davidblond2000@gmail.com.

Queri-International specializes in developing models and providing analysis for companies and governments using econometric techniques using proprietary data from its large global data bases combined with other data from public and private sources. For more information contact Dr. Blond at davidblond2000@gmail.com, www.queriinternational.com.


(1) In my economic trilogy, The Phoenix Year, Wattle Publishing, 2014, fiction of course, I make companies in the final volume do what is unnatural, hire when there is a deep recession, invest and hire, all in the name of cooperative growth. To do this I have to destroy private wealth concentrating the ownership of 200 plus of the largest companies in a single Trust dedicated to solving problems globally. In the real world, however, no CEO can afford in this highly analytical financially driven economy to take losses in the hope that other companies follow the same path in order to grow the economy when there is a recession or worse, a depression.


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