Exchange Rates and Trade Myths

June 27, 2010

I haven’t been able to post much recently, but will be back in the saddle later this week. The big economic news of the past week has been China’s decision to un-peg its currency from the dollar, allowing it to float and be determined by market forces, as the Obama administration (like the previous administration) has been insisting.

This will, of course, have no effect on our trade deficit with China, contrary to what the president, his economic advisors and, indeed, nearly everyone in the world expects. In theory, it will make Chinese exports more expensive in the U.S. In reality, it won’t. China’s manufacturers will simply improve their productivity and cut costs to compensate, holding the line on prices. And, in theory, it will make American exports more affordable to Chinese consumers. In reality, it won’t. The downward pressure on Chinese wages will offset any reduction in the prices of American imports. In summary, while the yuan move will have no effect on our balance of trade with China, it will certainly make life tougher for the Chinese, as well it should.

But this is all old ground I’ve plowed before. However, the news did trigger an epiphany of sorts for me. I’ve gone to great lengths to prove the relationship between population density and trade imbalances. Because of this, I’ve long maintained that trade imbalances have virtually nothing to do with low wages and currency valuations. But I haven’t produced the data to prove it. If it’s important to prove the relationship between population density and trade imbalances, is it not equally as important to disprove the usual suspects?

So, I’ll soon start a new series of posts. One will compare trade imbalances to per capita purchasing power parity, the most often-used parameter for comparing the purchasing power (or incomes) of the people of various nations. We’ll see whether there’s any relationship at all. Secondly, I’ll begin tracking the U.S. trade imbalance vs. currency exchange rate for a number of countries, including the yen, the euro, the Chinese yuan, the Mexican peso, and the Canadian and Australian dollars, among others. (I hope I’m not biting off more than I can chew.) In both cases, I expect to find either no relationship, or a weak relationship that’s dwarfed by the effects of population density. Regardless, I’ll report the facts and let the data speak for itself. This should be an interesting exercise. Stay tuned.


Irrational Behavior at the Presidential Level

June 19, 2010

I just finished reading Sway: The Irresistible Pull of Irrational Behavior by Ori and Rom Brafman, the first a graduate of Stanford Business School and the latter a psychologist. It’s a book about the psychological forces that cause us to disregard facts and logic and behave in irrational ways. It may sound a bit dry, but is actually loaded with fascinating, real-world examples of these forces at work.

As I read the book, I couldn’t help but relate it to our leaders in Washington and the policies they enact, especially trade and immigration policy. But I’m getting ahead of myself.

The first and perhaps the most important of these forces identified in the book (and the most relevant to this discussion) are as follows:

  1. Fear of loss.
  2. Commitment, coupled with optimism.
  3. Value attribution.

As an example of the first force at work, the Brafmans offer the example of an investor who holds onto a certain stock as it falls, promising himself that he will sell once it rises back to a certain level. It never does and the investor is wiped out. Although it’s irrational to assume that any stock will always rise and is immune to the market forces that could drive it into bankruptcy and wipe out its investors, and is contrary to the proven advice of financial advisors to diversify, it was the perceived fear of loss that caused this investor to self-destruct.

As an example of the second force above – commitment coupled with optimism – the Brafmans offer two examples at the presidential level. The first was LBJ’s commitment to his Vietnam strategy, which ultimately destroyed his standing with the American people, precluding a run for a second term and dashing his hopes to finish his life-long dream of building the “Great Society.” Once commited to that strategy, LBJ judged it too politically destructive to change course and admit a mistake. He began to seize upon little victories as cause for optimism that the war would ultimately be won. The second example was George W Bush’s commitment to his Iraq war strategy, and his statements about staying the course that eerily mirrored similar statements made by LBJ.

Value attribution, the third force above, is our tendency to place greater weight on data and advice from those we perceive as being knowledgeable and influential, even if that data and advice are erroneous, while ignoring those whose reputations aren’t as well-established, regardless of how sensible and logical their data and advice may be. The Brafmans serve up the example of anthropologists who for decades ignored one of the greatest anthropological discoveries of all time because the discovery was by an unknown anthropologist, while quickly accepting a “discovery” by a well-respected anthropologist that later was proven to be a hoax.

With all of that said, let’s see how these forces might be influencing President Obama and his strategies and policies as they relate to trade and immigration. I think the most obvious is the effect of the third force – value attribution – on his trade policy. With no experience in economics, it was natural that Obama would turn to someone that he and his advisors held in the highest regard in that field – Larry Summers, noted economist, former Treasury Secretary and former president of Harvard University. The credentials don’t get any better. And Summers’ advice regarding trade is to stay the course. It’s a fundamental precept of economics that free trade benefits all, and Summers is one of the world’s preeminent practitioners of economics.

The problem is that Obama is placing all of his faith in the purveyors of theory that have no basis in fact. Economics is all models and theories. Facts are the realm of the demigods and mortals of accounting and finance. Economists couldn’t be bothered. Free trade theory is no different. Because Summers says it works is good enough for Obama, in spite of a gathering mountain of evidence over decades that it generates imbalances that nearly collapsed the global economy just before he took office, and in spite of a growing chorus of voices among some economists and the majority of the American people that it’s a failure.

Obama rose to power on populist rhetoric about changing the course of trade policy – populist because most people saw a need for a change of course. Yet, once in office, he ignored the majority opinion and the facts that supported it and opted upon a stay-the-course strategy based solely on the value he places on his advisor. And now that he has chosen such a strategy, he’s committed, regardless if each new piece of data suggests that his strategy is failing. Beyond that, there’s the matter of the commitment made by the U.S. When it signed the Global Agreement on Tariffs and Trade in 1947 and now its commitment to the World Trade Organization. Although it becomes ever more clear that sticking with these commitments is an irrational course of action if he is truly interested in serving the American people and changing the American economy for the better, the level of courage required to step away from these commitments is almost insurmountable.

When it comes to immigration policy, there’s not only the matter of commitment to a tradition of welcoming immigrants, but also a fear of loss – loss of the support of the Hispanic voting bloc. Never mind the irrationality of sticking to a policy that is guaranteed to exacerbate virtually every major problem the nation faces today – unemployment, an over-dependence on foreign supplies of energy and the challenge of reducing carbon emissions – we’re committed to piling on more and more people each year for some reason that remains absolutely inexplicable. Like each president before him, Obama can’t bring himself to risk the loss of support of the Hispanic voting bloc in return for the potential gain in support that would result from enacting policies that make meaningful, measurable progress on the aforementioned challenges.

As voters, when evaluating potential policy-makers, perhaps we need to look past party affiliation, platforms and rhetoric and give more weight to a demonstrated ability to resist the pull of psychological forces toward irrational behavior and make policy decisions based on data and logic.

Obama’s Trade Strategy Going Nowhere

June 14, 2010

As evidenced by April’s trade figures, released on Thursday by the U.S. Bureau of Economic Analysis (BEA), Obama’s strategy of rebalancing trade by doubling exports in the next five years is going nowhere fast. The trade deficit in April inched up to its highest level since December of 2008, rising $0.2 billion to $40.3 billion. (Here’s a link to the BEA report.)

Though Obama’s goal of doubling exports in five years is more or less on track (though falling slightly behind in April), imports continue to outpace exports, driving the deficit higher. The following are charts of exports vs. Obama’s goal, imports and the balance of trade.

Obama’s Goal to Double Exports U.S. Balance of Trade

U.S. trade remains stuck in a rut, which corroborates other economic indicators, especially employment data, that have shown no improvement at all. Give Obama credit for recognizing that rebalancing trade is critical to rejuvenating the economy, but give him a big, fat “F” for the strategy he’s chosen – taking no action on imports, the only factor over which he has control, while trying to jawbone other nations into importing more American-made products, something he has no control over whatsoever. It doesn’t work.

Recently, follwing the March release of trade data that showed China’s surplus with the U.S. At a relatively modest $16.9 billion, U.S. Treasury Secretary Tim Geithner praised China for their progress in rebalancing trade. So what happened in April? Our deficit with China shot up to $19.3 billion, resuming its upward climb to pre-recession record levels.

This trade strategy – trying to coax other nations to buy more from us, to live up to their obligations, to stop manipulating their currencies, etc. – has been a proven failure for decades and now Obama’s finding out that it’s a failure for him as well.  Will he stick with it or just go down with the ship?  History suggests he’s not likely to change course.

Disastrous May Employment Report Sends Stock Futures Plunging

June 4, 2010

Though an increase of 431,000 jobs in May might seem like good news on the surface, May’s employment report was disastrous and sent stock futures plunging, S&P futures almost instantaneously falling from down about 2 points to over 20 points down.  Why?  The consensus among forecasters was that 540,000 jobs would be added, with about 425,000 being temporary census workers, leaving a growth in private sector employment of over 100,000.

That’s not what happened.  Almost all of the job growth was census workers.  Private sector employment grew only 41,000.  And if you look into the details, the news is even worse.  The total employment level actually fell by 35,000 workers.  (See column “E” in the following spreadsheet.)  The administration had to fall back on the excuse that people dropped out of the labor force in order to show a decline in unemployment.  Here’s the calculation, followed by charts:

Unemployment Calculation     Unemployment Chart     Labor Force & Employment Level     Unemployed Americans

What’s disastrous about this report is that, following some job growth in the early part of the year, all indications are that growth has stalled and may actually be headed back into decline.  Weekly jobless claims have held steady at unacceptably high levels.  Other private measures of employment, job growth and layoffs show that the labor market is stalled.  Continued economic recovery hinges on job growth, and now a double-dip recession looks more likely.

Brewer at The White House

June 4, 2010

Arizona governor Jan Brewer met with Obama at the White House yesterday to discuss Arizona’s new law allowing police to check the immigration status of people who have committed a crime and who give the police cause to suspect that they are in the country illegally. 

Clearly, Obama would like to head off a confrontation with Arizona.  Obama’s administration has talked of the possibility of challenging the law in court but, with the vast majority of Americans on Brewer’s side on this issue, he’d really like to see the whole issue go away.  If the reporting can be believed, Brewer didn’t give an inch. 

Jan Brewer has been catapulted onto the national stage with her gutsy action on an issue of great concern for all Americans, and not just the people of Arizona.  If she has any ambitions for the national stage, this is an ideal opportunity to build a following.  I wonder if, while she sat there in the Oval Office and took in the surroundings, she didn’t begin to think to herself, “I think I might like this.” 

Obama has proven that, contrary to his campaign promises, he’s unwilling to act on our trade imbalance and, by halting the effective crack-down on illegal immigration that Bush had begun, he’s come down on the wrong side of the immigration issue as well.  On these two most important of issues and on others as well, he’s vulnerable.  Brewer has demonstrated that she’s willing to take on and side with the American people on a contentious issue of national (even international) significance.  I don’t know where she stands on other issues like trade, but she bears watching as a potential challenger to Obama in ’12.

Rising Wages in China Having No Impact on U.S. Trade Deficit

June 4, 2010

The above-linked Reuters article takes note of growing labor unrest in China and makes the case for a silver lining – that such unrest will drive wages higher, ultimately leading to increased domestic consumption in China and the reduction or elimination of global trade imbalances.

A rare burst of labor unrest in China has been resolved with hefty pay increases, illustrating how the balance of power in the country’s vast factories is slowly but surely tilting toward workers.

Rising wages in the workshop of the world might seem to pose unsettling implications for the global economy in the form of thinning profits for companies and cost inflation for consumers.

But this disregards more important, positive developments. By spreading the fruits of China’s stunning growth more evenly, higher incomes will help to boost domestic consumption and rectify imbalances that have dogged the global economy.

Contrary to what most economists believe, wage increases in China will have little or no effect on trade imbalances, most notably the huge imbalance in trade between China and the U.S.  Yes, rising wages will boost consumption some in China.  But their over-crowding will keep a lid on those gains.  Consider the consumption of automobiles.  Rising per capita consumption of cars in a nation so densely populated will quickly make roadways so congested that people will soon eschew them in favor of public transit. 

In addition, as domestic consumption rises in China, more factories will be built and more people will be drawn in from rural areas, vastly increasing the overall productivity of China’s labor force.  In other words, their labor capacity will increase just as quickly as their domestic consumption. 

In fact, wages have been rising in China at a brisk pace for years now and there’s been no noticeable improvement in the U.S.-China trade imbalance.

Pay for China’s 150 million or so migrant workers increased 19 percent in 2008 and 16 percent in 2009, even though exporters were hit hard by the global financial crisis, …

… Chinese workers have made big strides in recent years in absolute terms as their wages rose about 8 percent a year.

After falling by almost 50% in February of 2009, thanks solely to the global near-depression, our trade deficit with China has since rebounded 25% and remains above $200 billion per year. 

If low wages are the driving force behind the trade imbalance with China, then how does one explain our much larger trade deficits in manaufactured products (expressed in per capita terms) with wealthy, high-wage nations like Japan and Germany?  Or how does one explain the fact that, of our top twenty trade deficits in manufactured goods (in per capita terms), fourteen (including all of the top ten) are with wealthy nations? 

The explanation is that nearly all of them are much more densely populated than the U.S.  It’s disparities in population density that drive trade deficits, not low wages or currency manipulation.  This assumption that China can boost its domestic consumption sufficiently to soak up its excess labor capacity and begin importing more U.S. products is naive and flies in the face of all the evidence to the contrary.  If wealthy, densely-populated  nations like Japan, Germany and a dozen others have never been able to boost their domestic consumption sufficiently to absorb their excess labor capacity, does anyone seriously believe that it will happen in China?

As with the well that gushes oil into the Gulf of Mexico day-after-day, week-after-week (and soon-to-be month-after month), Obama stands idly by and watches our trade dollars gush overseas, draining our financial resources faster every month, putting our economic fate into other nations’ hands and in blind faith in some magical trade fairy that will make our economic problems vanish.

Global Economy’s Achilles Heel: Unemployment

June 2, 2010

During the past couple of months, the world has been coming to grips with something that no world political or financial leaders want to admit – the global economy no longer works.  It’s collapsing under the weight of the one factor that economists never accounted for – unemployment. 

As reported in the above-linked article, the International Labor Organization (ILO), an agency of the U.N., is warning that measures being taken by governments around the world to reduce debt will likely lead to a recession, with rising unemployment potentially threatening social stability.  Yesterday, in an about-face from its recent lecturing of the U.S. to get its fiscal house in order, China also cautioned against moves to rein in debt.  (The Chinese are smart enought to know that every dollar or euro cut from government spending in the U.S. and Europe translates into lost exports for them.) 

But financial markets have become absolutely intolerant of high debt levels.  Ratings agencies like Moody’s and S&P, breathing a sigh of relief that they weren’t hammered harder with law suits and criminal prosecution for their role in the global financial collapse that began in 2008, are now ruthless in their slashing of credit ratings for anyone with the slightest potential of default. 

Without deficit spending, the global economy with its requisite trade imbalances doesn’t work.  Without trade imbalances, badly overpopulated nations like Germany, Japan and China face staggering unemployment.  With the trade imbalances, big importers like the U.S. face eventual default. 

The problem is that, with much of the world so densely populated that per capita consumption has been driven into decline, deficit spending is the only thing left in economists’ bag of tricks to prop up consumption and hold rising unemployment at bay.  Globalization is an unemployment sharing mechanism that spread unemployment away from overpopulated economies to the U.S., where gimmicks like the dot-com boom of the ’90s and the housing bubble of the ’00s could keep unemployment swept under a rug for a while.  But that ploy’s run its course.  Now, not all the king’s treasury secretaries or all the kings central bankers can put this Humpty Dumpty together again. 

It’ll probably take years for all of this to play out, but what we’ll see is an intensifying global battle for employment, World War III fought on an economic stage.  It’ll get worse as the world population soars by several billion more.  Whether the war can remain confined to the economic stage without spreading to the battlefield – only time will tell.