U.S. Foreign Trade: A Tale of Two Worlds

When I wrote Five Short Blasts, one of the key pieces of evidence I presented in support of my claim that the U.S. balance of trade in manufactured products is heavily influenced by the disparity in population density between the U.S. and its trading partners was Figure 7-4 on page 125.  This was a chart that compared America’s balance of trade in manufactured goods for those nations above the median population density to those nations below the median population density.  The difference in results was truly striking.

I’ve now updated that chart to include the results for 2011:  Deficits Above & Below Median Pop Density.

As you can see, it seems that, with each passing year that the U.S. adheres to the blind application of free trade policy, the effect of population density is intensifying.  With the half of nations with population densities below the world’s median population density, the U.S. has a surplus of trade in manufactured products of $153 billion.  However, with those nations more densely populated – same number of nations – it had a trade deficit of $577 billion.  Both figures are the highest since I began tracking this data. 

And here’s a piece of data that may be even more striking.  If we sort the nations of the world by population density and begin totaling the U.S. balance of trade in manufactured goods, starting with the least densely populated nations, and simultaneously begin totaling the land surface area of these nations, the U.S. has a trade surplus in manufactured goods with 86% of the land surface area of the earth (excluding the U.S. itself and Antarctica).  (We didn’t have a surplus with all of these nations, but the total remains on the surplus side of the tally sheet.)  At that point, the U.S. has a trade surplus in manufactured goods of $82 billion, and a trade deficit with the remaining 14% of the earth’s land surface area of $505 billion! 

Only when we reach China does the balance of trade turn negative.  Our trade deficit with China accounts for $302 billion of that deficit.  Now, China occupies 8% of the worlds land mass (again, excluding the U.S. and Antarctica).  That means that with the last 6% of the world’s land mass, the U.S. still has a trade deficit of $203 billion.  Included in that 6% of land mass are Japan, Germany, South Korea, Taiwan and India – some of the most densely populated nations on earth. 

America’s trade results are truly a tale of two worlds – the positive experience we have with the vast majority of the world (in terms of land mass) – vs. the horribly negative and destructive results we experience with the 14% of the world that is so badly overpopulated.  Yet, as we have for the last 65 years – since the signing of the Global Agreement on Tariffs and Trade in 1947 – we stubbornly and stupidly contine in our efforts to apply the same free trade policy to both worlds, hoping that, some day, free trade with overpopulated nations will yield different results.  Einstein once famously said that the very definition of insanity is doing the same thing over and over and expecting different results.  The application of free trade theory to overcrowded nations is truly insane.

Surprising Facts About 2011 U.S. Trade Data!

I haven’t posted much lately because I’ve been working hard on analyzing the 2011 trade data, which was released by the BEA (Bureau of Economic Analysis) in late February.  My focus, of course, is on manufactured products, since that’s where the jobs are.  Separating the trade in manufactured goods from total trade for each nation is no small undertaking, since nowhere does the BEA report on “manufactured products” as a separate category.  It has to be done nation-by-nation, combing through hundreds of product end-use codes for each.  I’m now ready to begin reporting on what I’ve found, beginning with some interesting, surprising facts.  (More posts will follow.)

For those of you new to this web site and the concepts presented here, my goal is to create an understanding of the forces that drive global trade imbalances, especially America’s very large trade deficit in manufactured products with the rest of the world.  Why manufactured goods?  There are two kinds of “goods”:  natural resources and the products into which those resources are transformed through manufacturing. 

The reason for trade imbalances in natural resources is no mystery.  Nations deficient in a particular natural resource, as is the case with the U.S. and oil, will experience a trade deficit in that resource.  Nations with a surplus of such resources will have a trade surplus.  It’s as simple as that.  But there are also very large imbalances in the trade of manufactured products that aren’t so easily explained.  Economists blame many factors including low wages, currency manipulation, trade barriers and lax labor and environmental standards.  Yet, in spite of decades of efforts to address these issues, imbalances have only grown worse. 

In Five Short Blasts, I presented an entirely new explanation for trade imbalances:  the role of population density.  And, since publication of that book, I’ve also presented on this blog data that debunks the role of the traditional scapegoats – low wages and currency exchange rates.  Now we have a fresh batch of data for 2011.  Let’s examine whether population density still holds up as an explanation and whether wages and exchange rates have played any role at all. 

First, some explanation of my methodology is in order.  In my research prior to publishing Five Short Blasts in 2007, I discovered that the inclusion of tiny island nations and city-states in the data tends to obscure the relationship between population density and trade imbalances.  Almost without exception, tiny island nations have unique economies that are totally dependent on tourism.  Because such nations use tourist dollars to purchase manufactured products, the U.S. has a surplus of trade in manufactured goods with virtually every one of them, regardless of their population density.  And the trade with all of these nations taken together is so minuscule that it has no measurable effect on America’s balance of trade.  For those reasons, those nations are omitted from the study. 

Also, tiny city-states are somewhat similar in that they tend to have economies skewed by their imbalance between urban and rural settings and their nearly total lack of resources.  For this reason, I have rolled the data for such city-states into the data of their much larger, surrounding (or neighboring) nations.  (These city-states are Andorra, Gibraltar, Hong Kong, Macao, San Marino, Vatican City, Liechtenstein, Luxembourg, Monaco and Singapore.)  What’s left is a total of 165 nations. 

With all of that background, let’s begin with some basic facts about America’s balance of trade in 2011:

• In 2011, the U.S. balance of trade worsened by almost $60 billion, with the trade deficit increasing to $560.0 billion – a 12% increase.  Of this increase in the trade deficit, $46.3 billion was due to an increase in the deficit in manufactured products. 
• The U.S. had a trade deficit of $423.4 billion in manufactured products in 2011, compared to $377 billion in 2010.
• It’s natural to expect, then, that our balance of trade worsened (trade deficits grew larger or surpluses grew smaller) with the majority of nations.  But that’s not what happened.  Of the 165 nations examined, our balance of trade in manufactured products worsened with only 76 nations (46%).  It actually improved with 88 nations (54%).  (South Sudan is new to the study and did not exist in 2010.) 

 

Evidence of The Role of Population Density in Trade Imbalances

Now, let’s break this down by population density – or, more precisely, by population density relative to that of the U.S. – to see if some relationship emerges.  Of these 165 nations, 111 are more densely populated than the U.S.; 54 are less densely populated.  If population density is not a factor in trade imbalances, then the number of nations with whom the U.S. experienced a worsening in its trade balance – 76 nations – should be distributed proportionately among these two groups – 51 nations among the more densely populated nations and 25 among the less densely populated nations.  But here’s what actually happened:

• Of the 76 nations with whom our balance of trade worsened, 62 were nations more densely populated than the U.S.; only 14 were among the less densely populated nations.
• Although only 33% of nations are less densely populated than the U.S., of the 88 nations with whom our balance of trade improved, 44% (39) were among that group. 
• Of the 54 nations less densely populated than the U.S., the balance of trade improved with 39. 

That data on the change in our trade imbalance from 2010 to 2011 seems to show a relationship with population density.  But that’s just the change in the imbalance.  What about the imbalances themselves?  Of the 165 nations included in the study, the U.S. had a trade deficit in manufactured products with only 51 of them.  Since 67% of these nations are more densely populated than the U.S., we should find 34 of these trade deficits among the more densely populated nations and 17 of them among the less densely populated ones.  But here’s what actually happened in 2011:

• Of the 111 nations that are more densely populated than the U.S., the U.S. had a trade deficit with 47.
• Of the 54 nations less densely populated than the U.S., the U.S. had a trade deficit in manufactured goods with only 4. 
• Of the 51 nations with whom the U.S. had a trade deficit in manufactured goods, 47 (or 92.2%) were with nations more densely populated than the U.S.  The four less densely populated nations with whom we had a trade deficit in manufactured goods were Estonia, Laos, Sweden and Finland.

That is powerful evidence of a a strong relationship between population density and trade imbalances in manufactured goods. 

 

What about Low Wages as a Cause for Trade Deficits?

Unfortunately, it’s not possible to evaluate the role of wages directly.  This would require knowing the unit labor costs for every product imported and exported, and doing a complicated calculation to determine the average unit labor costs for the sum total of imports and exports.  However, we do know the “purchasing power parity” (“PPP,” roughly the nation’s gross domestic product divided by its population) for each nation, and PPP gives us a pretty good way to compare relative wage rates of one nation vs. another. 

In terms of PPP, the U.S. is one of the wealthiest nations in the world and, therefore, its workers are among the best-paid.  With a PPP of $48,100, the U.S. ranks fifth among the 165 nations included in the study.  Only Qatar, the Falkland Islands, Norway and United Arab Emirates have higher PPP.  So 161 of the 165 nations included in the study have lower-paid workers than the U.S.  But, since we have a trade deficit with only 51 nations, this immediately casts doubt on the claim that low wages cause trade deficits.  If lower wages cause trade deficits, then we should be experiencing trade deficits with 161 nations – not a mere 51. 

OK, maybe much lower wages are required.  So let’s divide these nations around the median PPP of $8,000 – 82 nations above the median and 83 nations below.  Surely we will find our 51 trade deficits concentrated among the low PPP nations.  Right?  That’s the theory.  Now here’s the facts:

• Of the 82 nations above the median PPP, the U.S. had a trade deficit in manufactured goods with 32. 
• Of the 83 nations below the median, the U.S. had a trade deficit in manufactured goods with only 19. 

Not only does this data not support the claim that low wages cause trade deficits, it seems to be solid evidence that either exactly the opposite is true or, more likely, that the cause and effect are reversed.  It may be that a large trade deficit with a nation tends to boost wages in that nation by driving up the demand for labor to fill manufacturing jobs.  As an example, consider Germany and Japan – two relatively high wage nations.  When put in per capita terms (thus adjusting for the relative size of a nation), our trade deficit with each is far larger than our trade deficit with lower-wage China.  Why?  Because their high wages are the result of a prolonged, strong demand for manufacturing labor created by our demand for their exports.  Wages in China, much newer to the stage of world trade, are rising fast.  If something besides low wages is the cause of a trade deficit (like population density?), then it’s logical to expect that high wages in the surplus country will follow, as happened in Germany and Japan and as is happening now in China.

 

What about Currency Exchange Rates as a Cause of Trade Imbalances? 

Finally, let’s examine what role, if any, currency exchange rates play in driving trade imbalances.  Economists and political leaders have been blaming “currency manipulation” by China for their enormous trade surplus with the U.S.  By keeping the value of the Chinese yuan artificially low, they claim, China’s exports are cheaper while imports into China are more expensive to Chinese consumers.  On the surface, this argument seems to make sense.  But because it seems to make sense, perhaps too little effort has been made to validate that theory.  If that theory holds water, then an examination of changes in currency exchange rates for all 165 nations should find that our balance of trade has tended to improve with those nations whose currencies rose relative to the dollar, while worsening among those nations whose currencies declined.  Here’s what actually happened in 2011:

• Of the 165 nations studied, 99 had a stronger currency in 2011 than in 2010.  19 experienced no change in exchange rate with the dollar.  Only 46 had weaker currencies. 

That fact alone already casts doubt on the currency theory since, as noted earlier, our overall balance of trade worsened in 2011.  Since the currencies of 99 nations (60%) – including China – rose in 2011 while only 46 nations (28%) saw a decline in their currencies, the U.S. should have experienced an overall improvement in its balance of trade.  It did not.  More facts: 

• With the 99 nations who had stronger currencies, the U.S. experienced an improvement in the balance of trade in manufactured goods with 52 of them (52.5%). 
• With the 19 nations with unchanged currency exchange rates, the U.S. experienced an improvement in the balance of trade with 12 of them.
• With the 46 nations who had weaker currencies in 2011, the U.S. experienced an improvement in the balance of trade with 24 of them (52%). 

So an increase in a nation’s currency was just as likely to produce a worsening of our trade imbalance as an improvement, and vice versa.  In other words, there’s absolutely no relationship between currency valuation and trade imbalance evident here. 

I’ll be the first to admit that a one-year move in currency exchange rate may not be enough to change the momentum of trade imbalances.  However, I’ve previously conducted a similar study of the effect of 18-year changes in currency exchange rates and found exactly the same thing.  (See http://petemurphy.wordpress.com/2010/11/17/study-finds-no-relationship-between-currency-exchange-rate-and-trade-imbalance/.)

How can this be?  Perhaps looking at it from another angle will shed some light. 

• Of the 51 nations with whom the U.S. had a trade deficit in manufactured goods in 2011, 40 nations’ currencies rose in value.  Two were unchanged.  Only 9 experienced a decline in their currency.
• Of the 114 nations with whom the U.S. had a trade surpluse in manufactured goods in 2011, 37 experienced a decline in their currency. 

From this we can conclude that currencies rise relative to the dollar in response to trade surpluses with the U.S.  However, changing exchange rates have absolutely no effect in reversing trade imbalances.  Therefore, those who pin their hopes on a rising Chinese yuan to bring manufacturing jobs home from China are going to be sorely disappointed, just as they have been as the yuan has risen in value for years.  Our trade deficit with China has only grown worse, just as our trade deficit with Japan only grew worse as Japan’s yen rose by over 300% over the past three decades. 

Conclusion:

From the United States’ 2011 trade data we can conclude two things: 

• it’s population density that drives our trade imbalances.
• wages and currency exchange rates play absolutely no role in those imbalances. 

I’ll be presenting some even more fascinating facts from the 2011 trade data in upcoming posts.  Unfortunately, those posts will probably have to wait for a couple of weeks.  But stay tuned!  You won’t want to miss them.

Failures of Economics

http://blogs.reuters.com/chrystia-freeland/2012/03/29/manufacturing-redux/?pending=1&cp=0#comment-2884

I found this Reuters op-ed piece by Chrystia Freeland interesting, not so much because of the reported championing of manufacturing by the director of the National Economic Council, but because it sheds light on some fundamental flaws in the field of economics.  The following sentence near the end of the piece sums it up well:

Unless you have a doctorate in economics, your intuition probably accords with Sperling’s point that building things is essential to a country’s economic well-being.

Economics is all about meeting wants and needs.  Vital economies are built around the processes of meeting those wants and needs.  It’s intuitively obvious that manufacturing plays a key role in that process.  But not to economists, for that doesn’t accord well with the real results of the practical application of their free trade theory.  How to explain away that failure?  They do it by mis-applying another theory – creative destruction.  It seems we are to believe that, through the process of creative destruction, new needs (apparently for services) will materialize out of thin air to fill the void created when the manufacturing sector of the economy was carved out and handed over to someone else.

That begs the question:  if such needs for services can materialize and result in an economy that was better than the one that relied on manufacturing, then why didn’t China (and Japan and Germany and others before them) build their economies around those needs for services, instead of plundering the manufacturing sector of our economy?  (See my comment on the op-ed piece – the 6th comment down – for more thoughts on the subject.)

And speaking of “creative destruction” – the process by which each product and service is eventually replaced by one that is more efficient and requires less labor to create and utilize - what will people do for a living, ultimately, when every product and service can be made available without any labor input at all?  It’s like other axioms of economics – that economic growth can go on indefinitely in a finite world, that mankind is clever enough to overcome every obstacle to further population growth, and so on.  Every one of them fails when tested at its limits.

How do economists respond to such challenges?  By changing the subject.  They’ve moved on from such matters to new distractions, like “game theory” and “behavioral economics.”   They can’t be bothered with the shortcomings and failures of classical and neo-classical economics.  Those issues are so “yesterday.” 

So our political leaders are stuck with failed economic axioms to guide economic policy.  Although it was obviously failed trade theory that decimated the manufacturing sector of our economy, we dare not admit to such and alter trade policy, for that would constitute an admission of failure and a case for rethinking trade theory altogether, something economists simply aren’t willing to do.  Better to tinker at the margins, boosting tax breaks for R&D and manufacturing, as though our entire manufacturing sector fled the U.S. because their insignificant tax breaks were infinitesimally too small. 

It never ceases to astonish me that, in the 21st century, the field of economics still gets a free pass on its obvious and numerous failures. 

* * * * *

Another commenter on Freeland’s piece provided an interesting link that will be the subject of my next post. 

Analysis of Trade Data Exposes Flaw in U.S. Trade Policy

No nation on earth is more devoted to the concept of “free trade” than the United States.  And no nation on earth pays more dearly for that misguided policy.  America’s trade deficit is the worst in the world – six times worse than the 2nd ranked nation – India.  Because of that trade deficit and the need to draw dollars back into the economy through the issuance of debt, its external debt is also the worst in the world – 50% worse than the next most indebted country – the U.K.

China accounts for the lion’s share of the U.S. trade deficit.  Economists and political leaders would like you to believe that our deficit with China is the result of low wages, currency manipulation and unfair trade practices because, if you believe this, then you believe that a “level playing field” can be achieved with China by addressing those issues, thus restoring a balance of trade and bringing manufacturing jobs back to the U.S.  What they don’t want you to believe is that the entire concept of “free trade,” at least in many situations, may be fatally flawed. 

For those of you who are new to this site and who haven’t read my book, the data that I present below will come as a surprise, for no economist has ever made the linkage between balance of trade and population density.  For those of you familiar with this site, the chart below is a new, concise way of presenting an analysis of U.S. trade data that exposes the real flaw in our trade policy.

I’ve just completed an analysis of our trade results with America’s top 15 trade partners, breaking down the balance of trade in goods into several categories of natural resources and manufactured products.  The following chart tracks the balance of trade in manufactured products for those 15 nations, from 2001 through 2011.  But the trade data is presented in per capita terms instead of in raw dollars in order to factor out the sheer size of nations like China.  Of course China dominates our balance of trade.  They account for one fifth of the entire world’s population.  Would the results be any different if China was actually a cluster of smaller nations?  Probably not.  So how can we tell whether our trade policy with China is any less effective than the same policy applied to a much smaller nation?  The way to do it is by dividing the balance of trade by the population of that nation and expressing it in per capita terms.

On this chart you’ll find each nation identified on the right axis, next to its 2011 data point.  Below each nation, you’ll see two numbers.  The first number is the ratio of that nation’s population density compared to the U.S.  For example, the top nation on the chart – Canada – is 0.11 times as densely populated as the U.S.  The second number is that nation’s “purchasing power parity,” a figure that approximates each nation’s GDP (gross domestic product), divided by its population.  It’s a good measure of the wealth of each nation and a good indication of wages paid there. 

The list of America’s top 15 trade partners was taken directly from the Census Bureau’s “Foreign Trade” web site.  They are determined by the total of both imports from and exports to each country and account for 96% of all U.S. trade.  Those top 15 trading partners are:

1. Canada
2. China
3. Mexico
4. Japan
5. Germany
6. U.K.
7. South Korea
8. Brazil
9. France
10. Taiwan
11. Netherlands
12. Saudi Arabia
13. India
14. Venezuela
15. Singapore

With that explanation, here’s the chart:  Trade in Manfd Goods with Top 15 Partners

Some observations are in order:

• Of these 15 nations, the U.S. has a trade deficit in manufactured goods with eight of them:  India, France, China, Mexico, South Korea, Germany, Japan and Taiwan.  Every one of these eight nations is more densely populated than the U.S.  Mexico is almost twice as densely populated.  France is more than 3 times as densely populated.  China is more than four times as densely populated.  The rest are much more so.
• In per capita terms, our trade deficit with China is rather unremarkable.  In 2011, the deficit with Taiwan was four times worse.  The deficits with Germany and Japan were three times worse. 
• These deficits are not one-year anomalies.  In every case, they have been consistent or worsening over this 11-year span. 
• The worst per capita trade deficits are with wealthy nations.  Among our four worst per capita trade deficits, all of those nations rank among the top 20% of the world’s wealthiest nations.  This debunks the myth that large trade deficits are caused by low wages.  As I’ve reported before, the cause and effect is exactly the opposite of what economists claim.  High wages among these trade partners are the result of their trade surplus with the U.S. Wages in China are rising fast as their trade surplus with the U.S. expands.  The trade deficits are caused by the disparity in population density.  Wages are the result of the trade imbalance, not the cause.
• It’s often said that a lack of competitiveness is also a cause of our trade deficit.  Yet, in per capita terms, we have a trade deficit with France, arguably the least competitive nation in the developed world, that’s nearly as large as our per capita deficit with China.  It has nothing to do with competitiveness.  It has everything to do with population density.
• Our deficit with India, in per capita terms, is very small; yet, they’re nearly three times more densely populated than China.  Why?  It’s difficult to explain.  There was never the rush of manufacturers into India like we saw with China.  Perhaps India’s hyper-population density and accompanying poverty made corporations skeptical of India’s ability to develop into western style consumers.  Perhaps there’s a limit to the conditions that wealthy corporate executives are willing to endure in their quest to grow profits.  And now that China has cannibalized virtually all of the world’s manufacturing capacity, especially America’s, there’s little left for India. 
• Now, turning our attention to the positive, surplus side of the chart, we find that of these seven nations – Canada, Singapore, the Netherlands, Saudi Arabia, Venezuela, Brazil and the U.K. – four are less densely populated than the U.S.:  Canada, Saudi Arabia, Venezuela and Brazil. 
• Of the three more densely populated nations that appear on the surplus side of the chart, the one with whom we have the highest per capita surplus is also the tiniest:  Singapore.  Singapore is actually a city state, with a population of about 5 million people – smaller than some U.S. cities and metropolitan areas.  Such tiny city states represent only a thin slice of what constitutes a real economy.  In such cases, the relationship between population density and trade imbalances isn’t valid.  However, if the trade results with Singapore were rolled into the surrounding nations of Malaysia and Indonesia, the U.S. would still have a large trade deficit with those nations, just as the population density relationship would predict.
• The Netherlands is a similar situation – a tiny state consisting of two large cities:  Amsterdam and Rotterdam.  However, with the only seaport on the Atlantic coast of Europe, the Netherlands has develped their economy around trade and financial services and enjoys a unique trade surplus in spite of their extreme population density.  Singapore and the Netherlands combined account for only 0.3% of the world’s population.
• That leaves the U.K. as the only densely populated country of any significant size with whom the U.S. has a very slight surplus of trade in manufactured goods.  The U.K. has one of the most unique economies in the world in that they are the only nation of any significant size (in terms of population) that still manages to be a net oil exporter.  Most nations with large populations are unable to meet their oil needs from domestic sources.  This oil income, combined with the powerful financial sector of their economy, provides them with a stream of income that can be spent on imports, including imports from the U.S. – primarily civilian aircraft and pharmaceuticals. 

While these 15 nations account for the bulk of U.S. trade, the U.S. engages in robust trade with nearly every nation, and if we expand this analysis to include them, the same pattern is evident.  With most densely populated nations – including most of Asia and Europe – the U.S. suffers trade deficits in manufactured goods.  With most more sparsely populated nations – including all of South America and most nations of Africa – the U.S. enjoys a surplus of trade in manufactured goods.  With poor nations, our trade imbalance (whether a deficit or surplus) tends to be very small.  With wealthy nations, the imbalance (again, whether surplus or deficit) tends to be large.  Whether a nation is poor or wealthy has no effect in determining whether the balance will be a surplus or deficit. 

If you’re new to this site and this concept, I encourage you to read further to learn more about how population density supresses per capita consumption and, consequently, drives global trade imbalances.

Trade Deficit with China Hits Record in 2011 in Spite of Rising Yuan and Chinese Incomes

Our economists and political leaders say that the weak Chinese yuan, held at an artificially low level by China, is to blame for our trade deficit with China.  They also say that trade deficits are caused by low wages. 

The yuan ended 2011 at 6.45 to the dollar, rising 5% in 2011 and 22% since 2005.  And incomes in China have risen by 115% since 2001 to $8,400 per person.  That’s not high relative to American incomes, but it’s high enough to place China in the top 50% of nations ranked according to income. 

So in 2011 we should have seen some decline in our trade deficit with China, or at least signs that it was beginning to level off.  Right?  Well, not only did it not decline, there is no sign of it leveling off, either.  In fact, our trade deficit with China grew to a new record of $295.5 billion in 2011, blowing past the previous record set just last year by another $22 billion.  And the trade deficit in manufactured products soared to almost $322 billion.  Here’s a chart of our balance of trade with China since 2001:

China Trade

As you can see, there has been no slow-down in the growth of our trade deficit with China whatsoever.  (There was only a tiny dip in 2009 when all global trade slowed dramatically during the recession.)  How can this be?  If economists are right, with the Chinese yuan on the rise and with Chinese incomes growing dramatically, we should at least see some effect.  But there is absolutely none.

That’s because currency exchange rates have absolutely nothing to do with trade imbalances.  The only thing a rising yuan will do is make the Chinese cut costs and become more productive in order to hang onto their market share.  A leaner, more productive Chinese work force is the last thing we need to help cut our trade deficit with them. 

And while there is a relationship between incomes and balance of trade, it’s exactly the opposite of what economists have maintained, which they’d soon discover if they put a little effort into gathering actual data.  In trade with nations much more densely populated than the U.S., low incomes correlate to small imbalances of trade (including surpluses!), while high incomes correlate with high U.S. trade deficits.  That’s because it’s through exports to the U.S. that the people of badly overpopulated nations are able to raise their incomes.  It’s the very reason that, in per capita terms, our trade deficits with wealthy nations like Japan and Germany are far worse than our trade deficit with China.  Take away free trade and their huge trade surpluses with the U.S. and their incomes would decline and their unemployment would rise precipitously. 

The data is clear that trade imbalances are caused by disparities in population density which cause disparities in per capita consumption.  We have trade deficits with badly overpopulated nations not because of currency exchange rates, low incomes or a lack of competitiveness.  We have trade deficits because they consume too little while being just as productive as we are.  The only way to restore a balance of trade with such badly overpopulated nations is through the use of tariffs. 

In all likelihood, our trade deficit with China will level off in the next few years, not because of a rising yuan or rising Chinese incomes, and certainly not because of any intelligent U.S. trade policy moves, but because there’s little manufacturing left in the U.S. to cannibalize.

Want Less Federal Government Intrusion? Focus on Trade Policy.

One of the biggest rallying cries of the right these days is ever-greater intrusion by the federal government into our lives.  They have a point, and the health care reform enacted in President Obama’s first year in office is a case in point.  It’s instructive to examine that case to gain insight into just why the federal government plays an ever-larger role in our lives.

Why was health care  reform enacted?  Well, the fact that Democrats held both branches of Congress and the White House certainly played a part; there’s no denying that.  But public sentiment also played a big part.  Employers had been jacking up premiums for health care insurance for years until they were no longer affordable.  More recently, in the wake of the near-depression, more employers were simply canceling such benefits altogether.  More people were faced with the only option left – buying individual policies on the open market - a real eye-opener for people who’d been used to paying group rates. 

People had had enough.  They wanted something done.  Something was.  And the mandates necessary to make it work – especially the mandate for everyone to obtain insurance – especially the young and healthy – came as a bitter pill to swallow.  (Of course, no one complained when they were mandated by their employers to participate in the plan.) 

So, in this case, this “intrusion” by the federal government into our lives was precipitated by slow but steady growth in the imbalance in the supply and demand for labor that made it possible for employers to cut benefits without fear of losing employees.  And the same is true for many federal spending programs.  As state and local budgets force cuts in education, in police and fire protection, in infrastructure spending, etc., the federal government steps in with grants and stimulus spending to make up the difference.  Otherwise our society would slowly collapse.  And, as is the case with all money, federal money comes with strings attached. 

Ultimately, it is the trade deficit that lies at the root of ever-more pervasive federal intrusion into our lives.  To better understand this, you need to understand the international flow of dollars caused by trade.  This won’t be anything new to those of you who have read Five Short Blasts. (See Figure 8-1 on page 143.)  For the benefit of others, that understanding begins with the simple fact that every dollar that is shipped overseas to purchase imported goods must eventually return to the U.S. – one way or another – since the U.S. is the only place where U.S. dollars can be spent.

“Not so,” you might say.  “Oil is priced in dollars.  China can use their dollars to buy oil.”  Very true.  However, that leaves oil exporters like Saudi Arabia with a growing mountain of dollars that still can only find a home in the U.S. 

Dollars come back to the U.S. in various ways:

1. For the purchase of American exports
2. For direct investment in the U.S., as in the case of a foreign automaker building a plant in the U.S.
3. Indirect private investment, such as the purchase of corporate stocks and bonds.
4. Indirect public investment, such as the purchase of government bonds. 

Regarding item no. 1, only a little over half of the dollars spent on imports come back in the form of export purchases.  Regarding no. 2, net direct investment in the U.S. is actually negative.  More dollars are invested overseas than in the U.S., making the challenge of attracting dollars back to the U.S. that much greater.  Regarding no. 3, we already have heavy foreign ownership of American companies.  To continue to pour money into their stocks and bonds would simply create a market bubble that would soon collapse, as the stock market did in March of 2000.  (And, by the way, it was precisely this kind of foreign investment in mortgage-backed securities that led to the collapse of the housing market and financial institutions in 2008.) 

That leaves one option – no. 4 – the purchase of government issued debt, or Treasury bonds.  As long as we continue to run a trade deficit, it’s absolutely vital to the economy that the government issue debt to draw those dollars back into the U.S.  But that’s not enough.  The mere purchase of bonds does nothing to offset the harm done to the economy by imports.  The only way to actually plow those dollars back into the economy is through federal spending. 

Now, suppose that you’re a state – say California.  The citizens of California spend their money on imports – a net outflow of cash.  Like virtually every state, it is required by its constitution to balance its budget.  As it attempts to do so, imports steadily drain money from the state.  So each year, state revenues which are a fixed percentage of the state economy, continue to decline.  The state must cut more spending:  cut funding for schools, lay off police and firemen, cut pensions for state workers, etc. 

There is only one way to keep the economy of California (and every other state) from decline, and that’s for the federal government to inject money back into the economy.  To make a long story short, Californians’ money goes to China, Germany, Japan and others.  Those countries then use the money to purchase treasuries from the federal government.  The federal government then plows that money back into California in the form of federal grants to repair school district budgets, rehire police and firemen, pay unemployment benefits and, yes, to pay for new health programs to offset the cuts of those benefits in the private sector.  And the biggest program for injecting money back into the economy is tax cuts, offsetting the downward pressure on wages wrought by the imbalance in the supply of labor.

It’s a vicious circle, and there’s only one way to break it – by restoring a balance of trade.  No trade deficit – no need to issue federal debt.  No federal debt – no money to plow back into the economy.  No federal money (with strings attached) coming back into the economy – no more intrusion by the federal government in our lives.

What’s going on in Greece today is a perfect example of what would happen without this mechanism to plow federal dollars back into the economy.  Just like the U.S., Greece has a huge trade deficit.  It too relied upon debt to offset the negative consequences.  However, once it became a member of the European Union, it lost its ability to grow its debt further.  It became like a U.S. state.  But, in the case of the EU, its members don’t get money plowed back into the economy throught the issuance of EU debt.  The EU is loaning money to Greece, but demands that it be repaid.  The EU hasn’t yet figured out that this is an unsustainable recipe for depression for its members with trade deficits. 

Yes, it’s unsustainable for the U.S. to continue to grow its debt forever, too, but as long as the U.S. continues to run a trade deficit, it’s absolutely vital to keep the economy afloat.  The president recently proposed a budget for 2013 with a deficit of $900 billion.  Given that the trade deficit in 2011 was $737 billion and is growing fast, it’s very likely that the trade deficit will be about $900 billion in 2013.  It’s no coincidence that those two numbers match. 

The longer we run a trade deficit, it’s unavoidable that the federal government will play a bigger role in our lives.  Those who complain about such intrusion by the federal government into our lives are wasting their breath.  Unless we all turn our focus to the trade deficit, we’d just better learn to accept the strings that come attached to the federal money that keeps us all afloat.

Brazilian Company Awarded U.S. Defense Contract

http://www.reuters.com/article/2011/12/31/us-embraer-brazil-usdefense-idUSTRE7BU03Y20111231

As reported in the above-linked article on Reuters this morning, Brazilian aircraft manufacturer Embraer has been awarded a $355 million contract to provide small turbo-prop aircraft to the U.S. military. 

I’m using this report to illustrate how such trade deals would work under the trade policy I proposed in Five Short Blasts.  Those of you not familiar with that policy might assume that I, a real hawk on restoring a balance of trade, would be opposed to such a deal.  After all, here we have the federal government, led by a President who speaks incessantly about the need to create jobs, awarding a contract to a foreign company.  How can this be?  We should all be outraged!

Those who know me better know differently.  Under the trade policy I’ve proposed – one in which tariffs on manufactured products are indexed to population denisty, but one in which all other trade is essentially “free trade” – there would be no problem with this deal (assuming that there were no bidding irregularities).  With a relatively sparse population, and being rich in natural resources, Brazil is a perfect example of the kind of country we should engage in free trade.  And, in fact, Brazil is one of our best trade partners.  In 2010, our trade surplus in manufactured goods with Brazil soared to over $20 billion, shattering the record of $17 billion set in 2008. 

As one commenter to the Reuters article pointed out, these aircraft may actually be assembled at Embraer’s new plant in Melbourne, Florida.  But it’s likely that many, if not most parts, will be imported from Brazil and other countries.  But all of that is beside the point.  The point is that Brazil isn’t the problem when it comes to our trade deficit.  Neither is any other sparsely populated country. 

The real problem is attempting to trade freely with the likes of Japan, Germany, China, Mexico and other densely populated nations, desperate to find work for their badly bloated labor forces.  In November, the latest month for which trade data is available, we had a trade deficit of $20.9 billion.  Our trade deficit with China alone was far larger  – $26.9 billion.  Throw in Japan, Germany and Mexico and those three alone account for another $16.4 billion trade deficit.  Restore a balance of trade with those four nations and we swing to a $22.4 billion trade surplus.  That’s a swing of $43.3 billion per month, or $520 billion per year.  Assuming that 2/3 of that is labor, and assuming an average wage of about $50,000 per year, that’s 7 million high-paying manufacturing jobs.  And here I’ve limited this analysis to only four densely-populated countries in the interest of brevity.  I could have included two dozen more on the list and the numbers become even more staggering. 

As tempting as it is to malign free trade in general and to be critical of all trade deals like the one illustrated in this report, that would make no more sense than the blind application of free trade to every situation like we have now.  We don’t need to eliminate trade.  We need to apply trade policy that is aligned with economic realities, especially the inverse relationship between population density and per capita consumption, and its role in driving global trade imbalances.  We need to make smart use of tariffs where it makes sense and apply free trade principles where those make sense.

Current trade policy – confining ourselves to the extreme free trade end of the trade policy spectrum – makes no sense at all, and the results bear that out.

Yuan Hits All-Time High; So Too Does U.S. Trade Deficit with China

http://www.reuters.com/article/2011/12/26/us-markets-china-yuan-idUSTRE7BP03220111226

The above-linked Reuters article reports on a 4% increase in the value of the yuan in 2011, now at a record high.  Why is this significant?  Because economists say that a stronger currency makes exports more expensive and imports cheaper, thus leading to a reduction in the U.S. trade deficit with China.  In fact, the article suggests that China is letting the yuan appreciate to accomplish exactly that – a “rebalancing of trade”:

The currency is likely to continue to appreciate next year as China continues to post big trade surpluses despite a slowdown in exports and amid pressure from the United States to let the yuan rise to balance bilateral trade, traders said.

… The yuan has appreciated 4.27 percent so far this year, with most of the gain being recorded in the first 10 months of the year as China tries to rebalance trade and use the currency to help fight high inflation.

Isn’t that nice of the Chinese?  They’re such good citizens of the global community, with nothing but the common good at heart.  That’s what makes the next sentence in the report so amusing:

While the government has recently halted yuan appreciation amid slowing exports, it also seems to be wary of a weaker yuan that may lead to capital outflows.

They’ve halted yuan appreciation because of slowing exports?  Wasn’t that the whole idea – to rebalance trade – which can only happen when exports slow and imports increase?  Maybe China isn’t so interested in rebalancing trade after all.  Maybe they’re just looking out for themselves.

The fact is that none of this matters.  In the same year that the yuan has appreciated by over 4% to a record high against the dollar – and has now appreciated 23% since 2005 – the U.S. trade deficit with China is on track for another record in 2011.  The following chart tracks the decline in the value of the dollar vs. the yuan against the U.S. trade deficit with China, both overall and for manufactured goods. 

$US-Yuan Rate vs Balance of Trade

(Note that the 2011 trade deficit is annualized based on data through October, the latest month for which data has been released.  Data for manufactured products isn’t yet available for 2011, since I haven’t yet gone through the tedious process of sorting it out.) 

The most logical conclusion that one can draw from the data is that the exchange rate has followed the trade deficit, with the dollar declining as the trade imbalance has worsened.

The least logical conclusion is that the falling dollar will reverse the trade imbalance.  That conclusion is defied by the data.  Last year I presented the results of a study of changes in exchange rates vs. change in the balance of trade with the U.S. for sixteen of America’s largest trading partners.  There was no correlation.  A change in exchange rate was as likely to have the opposite effect on balance of trade as it was to have economists’ predicted effect. 

Again, there is no correlation.  Never has been.  Never will be.  How can this be?  How can economists lob this theory out there and get it so wrong?  Because, they would likely respond, there’s no need to spend valuable time doing the donkey-work of gathering data to prove theories that are self-evident and intuitively obvious.  Economists have much better things to do, like constructing sophisticated mathematical growth models, writing paid-for reports and analyses that support political and corporate stances, and so on.  Nevertheless, the data proves them wrong. 

The data also proves that a disparity in population density is a very reliable predictor of balance of trade.  Once you understand that, the debunking of the exchange rate theory isn’t so surprising.  A change in exchange rate can easily be negated by cost-cutting and improvements in efficiency by the nation with the trade surplus.  But it’s impossible to negate the effects of population density without actually resorting to tariffs.

Still, economic ignorance prevails and our politicians follow the lead of their economists, pinning their hopes on exchange rate tinkering to rebalance global trade.  We’re still waiting for the predicted effects.  It hasn’t happened in six years with China, and we’re still waiting for it to happen with other nations, like Japan and Germany, after six decades.  Thirty-six consecutive years of trade deficits that are only getting worse.  Nice call, economists.

October Trade Deficit – Another Dismal Report

http://www.census.gov/foreign-trade/Press-Release/current_press_release/ft900.pdf

As reported by the U.S. Bureau of Economic Analysis (BEA) this morning, America’s trade deficit contracted only very slightly in October, but that’s only because the deficit for September was revised upward.  (See the above link to the report.) 

The overall trade deficit shrank for the 4th month in a row to -$43.47 billion, its lowest level in 10 months.  Here’s the chart:

Balance of Trade

But that overall figure can be deceptive.  In spite of a decline in oil prices and a corresponding decline in petroleum imports, petroleum exports continued to swell in October to a record level and are now 129% higher than in January, 2010.  In addition, something that I didn’t realize until I read this CNBC article this morning, exports are also being propped up by exports of gold:

… for the first 10 months of 2011, non-monetary gold exports totaled $27.8 billion, compared to $14.8 billion in the same period last year.

What really matters is the balance of trade in manufactured goods.  There, the news isn’t so hot.  Exports of manufactured goods have stalled, rising less than $1 billion in the last four months.  Our trade deficit in manufactured goods worsened in October for the 2nd month in a row.  So, while the Obama administration remains pretty much on track for meeting its goal of doubling exports in five years (again, propped up by petroleum and gold exports), progress in manufactured goods is lagging.  In fact, both imports and exports of manufactured goods seem to have flattened out and threaten to shrink, a clear red flag for the possibility of a coming recession.  Here’s the charts:

Obamas Goal to Double Exports        Manf’d Goods Balance

Other bad news in the report:

• Imports of food, feeds and beverages rose to a record in October.
• Imports from China rose to a record in October, and our trade deficit with China is on track to rise to a new record for 2011.
• Imports from Japan rose to their highest level in 3-1/2 years. 

The October trade deficit report also marks a very sad milestone, so significant that I’ll cover it in a subsequent post.  Stay tuned.

Groudhog Day at the APEC Summit

It’s difficult to know where to begin my criticism of Obama’s performance at the APEC summit in Honolulu this week.  First, there’s his meeting with Chinese President Hu Jintao.  (See http://www.reuters.com/article/2011/11/13/apec-obama-ceo-china-idUSN1E7AB0AF20111113.)  It seems that Obama “adopted a more steely tone” with the Chinese president in conveying Americans’ frustration with China. 

“What I have said since I first came into office and what we’ve exhibited in terms of our interactions with the Chinese is we want you to play by the rules. And currency is probably a good example,” Obama said.

“He made it very clear that the American people and the American business community were growing increasingly impatient and frustrated with the state of change in China economic policy and the evolution of the U.S.-China economic relationship,” senior White House aide Michael Froman told reporters.

Wow, that’s really tough.  The President didn’t just make his feelings clear, he made them very clear.  Maybe he felt he wasn’t clear enough the last time they had this discussion, or the time before that, or the time before that.  The next time, he’ll be very, very clear.  After that, he’ll make it abundantly clear.  And so on. 

I can just see the Chinese president, rolling his eyes and simultaneously stifling a condescending chuckle.  As long as Obama doesn’t talk about implementing tariffs, Hu couldn’t care less what Obama has to say.  He knows it’s just talk – the same talk he’s heard dozens of times before.  The same talk other nations like Japan heard countless times before China came along.  It’s all a performance designed to give the voters back in the states the impression that he’s doing something about the economy. 

Obama has also been meeting with some other APEC members, without China in attendance, to try to open up their markets and make China nervous about losing some of America’s business.  He’s sort of saying, “We’ll show you, China.”  “We’ll take our trade deficit elsewhere.”  Okay, that might make China a little nervous, but it doesn’t do anything to restore a balance of trade and bring jobs back to the U.S.  Anytime a U.S. president or his trade delegation tries to ”open up markets,” watch out.  As we’ve seen time and again, these nations want something in return, and that something is always the same thing – we open up our market first.  Goodbye jobs. 

Or how about the president calling the U.S. “lazy?” 

 in remarks that could cause political ripples back in Washington, Obama also took his own country to task, saying it needed to do more to encourage foreign investors to seek opportunities in the United States.

In a question-and-answer session at the business forum moderated by Boeing Co chief executive James McNerney, Obama said the United States is attractive to businesses because of its open economy, innovativeness and stability.

“But we’ve been a little bit lazy, I think, over the last couple of decades. We’ve kind of taken for granted — well, people will want to come here and we aren’t out there hungry, selling America and trying to attract new business into America,” Obama said.

Wow, that’ll really endear him to voters back home.  “New business?”  Get a clue, Mr. President.  Every “new business” that has come along in the last two decades began in America but was quickly outsourced.  Personal computers, cell phones, I-pods, I-pads – you name it.  But can you name one product that’s been invented here in the last two decades that’s still here?  Thanks to the trade policies implemented by your predecessors, policies which you now embrace, we can’t even keep our own new businesses here.  Why would somebody else bring their’s here? 

Finally, there’s this – Obama telling the APEC nations that our prosperity depends on them.  (See http://content.usatoday.com/communities/theoval/post/2011/11/obama-us-prosperity-depends-on-asia-pacific-nations/1.) 

President Obama opened the Asia-Pacific Economic Cooperation summit today by telling regional leaders that economic recovery in the United States depends on Asian-Pacific nations.

“We’re not going to be able to put our folks back to work and grow our economy and expand opportunity unless the Asia-Pacific region is also successful,” the president said.

That’s not what history tells us.  Back when China was still a stauchly communist nation, the U.S. had no trade with China whatsoever, and Americans were far better off for it.  Everyone knows that if China suddenly sank into the sea, America would enjoy an instantaneous economic revival. 

But I know what the president is saying – what he thinks.  He thinks like economists – that if these grossly overpopulated Asian nations would just transform themselves into American-style consumers, they’ll buy just as much from us as we buy from them, boosting exports and restoring a balance of trade. 

Never mind the obvious question about how much sense it makes to produce the same products on both sides of the Pacific and then burn billions of gallons of fuel in container ships in order to swap them.  The real problem is that it can never happen.  People who live in such badly overcrowded conditions found in many of these APEC nations, stacked like cord wood in rabbit hutches, have no room for home furnishings, no room to drive cars, no lawns to mow, no gardens to maintain and no recreation or sports facilities.  They only have enough room to dress, cram like sardines into their commuter trains and take up their posts at the factory jobs that they robbed from Americans because they’re incapable of having a healthy domestic economy of their own.

Our economy depends on growth in APEC nations?  In 2010, our trade deficit with APEC nations was $462 billion.  Our economy’s demise has been at the hands of APEC nations.  It’s recovery depends on restoring a balance of trade with those nations, and that depends on the use of tariffs to make it happen.  Decades of experience have proven that all the talk in the world – the same talk we heard again last week at the APEC summit – will make no difference whatsoever.

Albert Einstein once defined insanity as doing the same thing over and over again and expecting different results.  But that’s exactly what the U.S. does at every trade negotiation, every G8 meeting, every G20 meeting, every World Trade Organization meeting and every APEC summit.  Like in the movie “Groundhog Day,” the same idiotic scene plays out over and over and over, like a bad dream.  And, as Einstein noted, the results are always the same.  Obama will return home, feeling optimistic about the effect his performance will have on his poll numbers, and the economy will sink further along with Americans’ incomes.