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.

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