Posted on 12/21/2004 1:26:51 PM PST by Willie Green
For education and discussion only. Not for commercial use.
Since the dawn of time - or so it seems - supporters of traditional trade liberalization policies have emphasized that keeping markets wide open raises living standards by giving consumers the widest possible choice of goods and services along with the lowest possible prices.
Have various trade agreements been net job and wage losers? Have they boosted imports much more than exports, thus producing huge trade deficits and foreign debts? No problem in either case, say the globalization cheerleaders. The price reductions fostered by open markets and import competition always outweigh any actual or conceivable economic costs.
Now the cheerleaders, and the whole U.S. economy, could be in for a nasty surprise. After years of simultaneously huge and rising trade deficits and falling import and consumer prices, Americans seem about to learn that standard trade liberalization can produce such results only when their currency remains unnaturally strong.
The dollar's recent weakness is likely to expose Americans to the fate of other populations that live way beyond their means, buying much more from the rest of the world than they sell to it - not only lousy job-creation performance but sharply higher import prices and general inflation, and, as a result, rapidly falling living standards.
Countries that run big, chronic trade deficits encounter these problems - often suddenly - because these deficits can only be financed by selling assets, by borrowing from abroad and taking on more debt, or some combination of the two. If this borrowing is used productively, for investments that improve competitiveness, then trade deficits can truly be beneficial.
Large and chronic trade deficits, however, signal that international borrowing is not being used productively - or at least not productively enough to enable domestically produced goods and services replace imports, and gain market share abroad.
When the deficits grow too large and last too long, a country's financial foundations start to look awfully shaky to its creditors, who wonder if their assets will keep their value and if their loans can be repaid. Unless the lenders find ground for optimism, they often balk at holding onto such assets and making new loans. They may even try to unload the assets and debt they do hold - whether in the form of financial holdings, real holdings, or currency.
Unloading of all these forms of assets and debt winds up weakening the debtor nation's currency by increasing its already bloated global supply. After all, the debtor's currency becomes abundant because the imports it purchases require buying the producer/creditor country's currency, and such purchases are paid for in the debtor's currency. By definition, debtor countries are buying more of the currencies of creditor countries than vice versa, thereby fueling net demand for these currencies and boosting their value. The reverse is also true: Demand for the debtor countries' currencies is relatively low, depressing their value.
Even worse, unless the debtor country quickly turns its finances around, all heck can quickly break loose. When the price of anything that is bought and sold begins to fall because of economic fundamentals or perceptions, the price drop often continues until the fundamentals or perceptions change. If they don't, falling prices tend to feed on themselves. Each new sale of a debtor currency or asset increases the supply of that currency or asset, further depressing its value. Remaining holders of these currencies or assets become tempted to sell their holdings before the value falls even further - and so on, until price stability is finally reached at a new, much lower level. If you think this sounds like the stock market on an especially bad day, you're right.
The debtor country's population can suffer greatly, because they don't use their currency mainly as a financial investment. They use it as a means of exchange. The weaker their currency becomes, the less their ability to buy imported goods and services. Domestic goods with high levels of foreign content become much more expensive, too.
If these imports have displaced much of their domestic supply, especially for essentials, their plight can be especially dire. They either have to do without these essentials, or at least without as many of them. Or the debtor countries' inhabitants can sustain their consumption by borrowing more from abroad - typically at exorbitant interest rates - and taking on truly reckless levels of debt. To add insult to injury, attracting the investment to replace the lost production can be difficult, because creditors often understandably fear investing in a highly inflationary environment.
Ever since currency values began to be set largely by market forces - in the mid-1970s - Americans have been largely immune from the costs of big trade deficits. Numerous forces and factors have supported the dollar's value despite the nation's huge debts and deficits. Foreigners have wanted to invest in America - i.e., buy dollars and American assets - because the nation's political stability and trustworthy legal system make it a safe harbor. The U.S. economy's high productivity has rewarded investors with high rates of return. America's currency and assets, moreover, are very easy to buy and sell.
Thanks to this convenience and to its stability, the dollar also became the currency of choice for much global commerce, further increasing the demand for the greenback and supporting its value. In this vein, a huge specific prop for the dollar has been OPEC's insistence that oil be paid for in dollars.
Now it seems that a U.S. trade deficit heading towards six percent of the nation's output for 2004 is sweeping away these props for the dollar. Since its February, 2002 peak, the dollar has fallen by 13 percent on a global, trade-weighted basis, and 25 percent against the currencies of America's seven biggest industrialized-country trade partners. The greenback has actually strengthened by 5 percent against the currencies of a group of 26 emerging market countries, but many of these (including China) have been manipulating their exchange rates.
Despite these largely Asian efforts to maintain artificially cheap currencies (to give goods from these countries price advantages in world markets), the weaker dollar has already produced impressive rises in import prices. Since early 2002, prices of imports from the world as a whole are up 5.2 percent - but this figure includes imports from countries trying to depress the value of their currencies. In fact, imports from low-income Asian countries have actually gotten cheaper since early 2002. And prices of Japanese imports have barely budged.
Yet imports from the European Union, whose euro has strengthened by about 35 percent versus the dollar since early 2002, have become 13.9 percent more expensive in just under three years. And imports from Canada have become 23.67 percent more expensive during this period because the Canadian dollar has strengthened by nearly 30 percent versus the dollar since February, 2002. (The absence of a close correlation between these import price and exchange rate levels stems undoubtedly from the practice of many European exporters to try to hold the line on prices to remain competitive, and the large amount of oil that the United States buys from Canada.)
The figures for major sections of the economy tell a similar story. Even though import prices for computer equipment keep cratering (off by some 25 percent since February, 2002), imports prices for manufactures as a whole are up nearly nine percent during this period. And inflation in agricultural commodities has been twice has high - nearly 18 percent.
It would be great to report that workers' wages have outpaced these price rises since February, 2002, but no such luck. Nominal hourly wages for private sector production workers rose by 7.16 percent during this period, but overall inflation (including oil prices) was 7.4 percent. In other words, living standards fell. If volatile food and energy prices are removed, so-called core inflation since February, 2002 and the present was only 4.7 percent. But even that hardly translates into a robust increase in living standards during a period of economic recovery.
Obviously, none of the above figures reveals dangerous levels of inflation or sharp falls in living standards. At a time of soaring oil prices, we should all be grateful. Remember what happened to overall inflation rates, living standards, and economic growth after oil prices spiked in the 1970s?
But it's critical to remember who or what we should be grateful to. Recent U.S. inflation has been restrained largely not because world trade has become much freer in the last few years. It's been restrained because Asian central banks - including those of communist China, protectionist Japan, and many of the region's other countries - keep on accumulating the massive amounts of dollars they earn from their massive net exports to the United States and literally sitting on them, despite their continually declining value worldwide.
The result, as widely noted, is a huge prop for the dollar's value and an equally huge subsidy for the U.S. economy. It's also a prop over which Americans have almost no control, that can be yanked at any time, and that is growing less and less able to offset the global effects of U.S. deficits.
In other words, the still-low import prices Americans enjoy owe more to the ideas of Mao Zedong than to those of Adam Smith or David Ricardo. And the Great Helmsman's gift is looking a little more threadbare with each passing day.
ping
I have said for year the free trade would prove very costly to this country.
Free trade only works if the standard of living between two trading partners is similar.
But the problem isn't "free trade" (which we don't have anyway with tariffs and all sorts of regulations) but rather, deficit spending.
"Free trade" is a misnomer and a lie foisted on impressionable Americans who don't understand economics. The very concept cannot exist between heterogeneous economic systems since it assumes that everyone plays by the same rules. China has slave labor and plenty of it. There is no way the United States can compete without that advantage also. So the next time you go to your job that is threatened by extremely low cost overseas labor, just remember that your worst enemy is a twentyish woman convicted of having two children from Guangdong province chained to a three axis milling machine.
You mean, we can't export medicines and import lumber from a developing nation? Why not?
Both are hurting us greatly.
LOL. So when you get a home mortgage, you only benefit if you are as wealthy as your bank?
They simply don't get it.
People around the world aren't sending us money because we're holding them at gunpoint, forcing them to finance our profligate spending. They're sending us money because their governments have crippled their own economies - and made investing in the US a better investment.
So long as the US remains a more attractive place to invest, according to whatever combination of return and safety that foreign investors use to calculate what's "attractive" than the alternatives, they'll continue to send their capital here.
When the US no longer has that economic advantage, they'll stop doing so.
If we lose that advantage because we've elected a government that is as dedicated to screwing up our own economy as badly as the French and German governments do theirs, we'll have so many problems that the reduction in capital inflow will hardly be noticed.
If, OTOH, we lose that advantage because Europe becomes a free society, develops a healthy economy, and no longer operates at a competitive disadvantage to the US, we'll all be so much better off that the reduction in capital inflow will hardly be noticed.
I understand how deficit spending hurts us, but how does it hurt us to export medicine to a country that sends us raw lumber from a type of tree we don't have here, for example? Who is hurt, and how?
LOL indeed.
We can, but it'll cost us in the end when we lose tha ability to produce the basics on our own.
At that point the developing nations can name their price and we have to pay.
That doesn't make the least bit of sense.
We aren't borrowing from foreign countries, we're trading with them.
If you can't understand that simple difference then it's obvious how the bigger picture could be lost to you.
We can name our price with the medicines, too, no? They can't make them, and we can't grow their trees.
It doesn't take nearly as long to knock of a drug as it does to grow a tree.
Selling foreign countries our debt obligations (bonds) isn't borrowing from them? They pay us money now, so we will pay them more money in the future, that is, bonds pay interest until maturity, in addition to the face redemption value. This is different from a mortgage how?
"Free trade only works if the standard of living between two trading partners is similar."
This is absolutely wrong. The benefits of trade increase as the comparative advantage of the two countries increases. In other words, the bigger the differences between the countries, the larger the gains from trade.
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