Trade and Taxes, an unorthodox view
Posted in Uncategorized by demandside on February 25th, 2009 We’ll employ the regular features Idiot of the Week in the exploration of trade and protectionism.
First the context
Corporate bond trading in the U.S. is rising to the highest level in two years, adding to evidence that credit markets are thawing even with stocks off to their worst start since the 1920s.
An average $17.1 billion of corporate bonds traded daily this month, following $17.7 billion in January, according to the Financial Industry Regulatory Authority. The business is up from last year’s low of $9.4 billion in August and reached the highest level since February 2007 …
Bonds are trading but yields are very high:
Investors are betting yields are high enough to compensate for defaults that Moody’s Investors Service forecast will rise to 16.4 percent by November, the highest since the Great Depression and about three times the current rate.
Case-Shiller house price index fell again.
The Composite 10 index is off 28.3% from the peak.
The Composite 20 index is off 27.0% from the peak.
Peak was January ‘07.
Prices are still falling, and will probably continue to fall for some time.
The Composite 10 is off 19.2% over the last year.
The Composite 20 is off 18.5% over the last year.
These are the worst year-over-year price declines for the Composite indices since the housing bubble burst, although only slightly worse (on a year-over-year basis) than November.
Michael Mandel:
A decade of despair. Michael Mandel. Over the past ten years, the S&P 500 is down 50% adjusted for inflation (February 17, 1999 to February 17, 2009). By my calculation, the stock market was down roughly 50%, adjusted for inflation, in the worst ten years of the Great Depression (September 1929 to September 1939).
When you add in the fact that real wages were stagnant over the past ten years and debt soared, I think we will look back at the last ten years as a decade of despair. As an optimist, I’m going to bet on the next ten years as being better. …
The Chicago Fed National Activity Index was –3.45 in January, up slightly from –3.65 in December. All four broad categories of indicators made negative contributions to the index in January.
TRADE
ROUBINI
Nouriel Roubini on Charlie Rose. We’ll have more Roubini next week on the Forecast edition of Demand Side.
And here from David Goldman, who wrote on his Inner Workings blog last week about the collapse of sovereign debt. The links are in the transcript. In March we’ll be revamping the blog and making it all easier.
http://blog.atimes.net/?p=601
Goldman writes quote:
The giant sucking sound
The battering of Eastern European credits and contagion in Western European sovereigns and financials with significant East European exposure validates my November warnings that the US administration’s borrowing spree would create a black hole in financial markets overseas.
Goldman has warned for some time that the US could not borrow a trillion and a half dollars without shifting capital flows away from the weakest sovereign markets. The threat of an Eastern European credit collapse and the nearly quarter-trillion exposure of Austrian banks to Eastern European names has pushed the cost of 5-year credit protection against Austrian default to LIBOR +227 basis points today, from +100 on January 7. Bank of America, by contrast, trades at +205. The difference is that the market believes that B of A, solvent or not, is under the protective umbrella of the US Treasury.
Dozens of countries have seen their credit spreads widen dramatically in the past two weeks. You may remember we ran Paul Krugman’s warning on Eastern Europe when he returned from his Nobel Prize ceremony. The nations on Goldman’s list are Ireland, Korea, Vietnam, Gulf states and countries in the former Warsaw Pact.
Goldman concludes:
The worst damage is being felt among issuers considered impregnable only weeks ago. Austria and Ireland still carry a AAA rating, while Abu Dhabi is rated AA and Bahrain is rated single A. It isn’t the shakier sovereigns but the solidest ones that now are in jeapordy.
…
the greatest danger to the US economy is NOT the subprime market, whose worst-case scenario already is more than priced into the securities universe, but the collapse of weaker sovereigns. Goldman characterizes the Treasury’s $2 trillion borrowing requirement as a vortex that sucks the world’s capital into the US.
Now from Paul Volcker, head of the President’s economic advisory board.
VOLCKER
We let Mr. Volcker get a little far from our subject because he agrees with us on the inappropriate use of mathematics and statistics. The economy is not a closed system. The economy does not have discrete independent variables. The economy will not obey the laws of thermodynamics.
Now, back to the subject. Some key facts.
First our opinion, then the facts. The reason the global economy is tanking is that the United States was the consumer to the world, and that has ended. That is, the demand side is the dog and the supply side is the tail.
Now the facts.
The U.S. has run enormous trade deficits for twenty-five years — since the Reagan Supply Side revolution and the Volcker Monetarist experiment.
In standard economic theory, such trade deficits cannot continue for such a period because the currency values will adjust to bring goods prices and thus quantities into balance.
The IMF has a cookie cutter economic template, or used to, to force fiscal austerity and export-led growth. Deficits such as the U.S. has run are completely opposite to what we have been preaching to the rest of the world through our wholly-owned subsidiary the International Monetary Fund.
The United States has been the major importer to all export economies — Japan, China, and elsewhere. The trade surpluses of all other countries, when toted up, equal the U.S. deficit — in broad terms.
This has been possible because the U.S. possesses the “hard currency,” the dollar, the equivalent of gold, the reserve currency to the world, the safe haven of all safe havens. The U.S. thus has mastered alchemy, and if it wants to, can create treasure from cellulose.
Recreating the American consumption pattern is the hope of the world. It will not happen. No matter how good the stimulus program of the president, the best it can do is create a stable economy with a balanced budget and balanced current account, along with energy and economic policies that allow the planet to remain an appropriate location for human life.
As we’ve pointed out, the rest of the world depends on a huge, and really obscene, materialistic excess from America. The process of re-balancing the rest of the world means, among other things, the U.S. producing goods for the rest of the world — perhaps clean energy goods or basic human services for the world’s poor. Something frivolous like that.
This is the Demand Side working proposition, that the decline of the American consumer economy is inevitable. The imbalances have to be redressed and trying to return to the Gilded Age would be like trying to push the tide back.
Which is not to say we won’t try.
Other working propositions are that the fundamentally healthy way to deal with the housing crisis is to write down the principle on mortgage debt. Let the lenders bail out the borrowers, not the government. The corollary is that we need to abandon the financial zombies that currently clog the credit mechanisms and form new, smaller financial structures.
The sooner we acknowledge these policy mandates, the better for us all and the quicker a rebuilt America can emerge. The engine of growth for this new America is the large scale creation of public goods in education, health care, transportation, energy and infrastructure.
The proper international action would be to replicate this focus in as many places as possible. The likely international action will be to wait to see if it works in the United States and then try to sell things to the consumer sector that grows up. This cannot work.
Idiot of the Week
BEFORE WE GO ANY FURTHER INTO TRADE, LET’S DO “IDIOT OF THE WEEK,” THE SEGMENT IN EACH SHOW WHERE WE LISTEN TO SOMEONE WHO IS CLEARLY OUT OF THEIR DEPTH AND TRY TO URGE THEM BACK TOWARD THE SHALLOW END.
TODAY:
BERNSTEIN
Let us be clear, the great majority of economists would agree with the following hypothetical proposition: If all the gains from trade were distributed appropriately, the winners could make the losers whole and have some left over.
I’m not sure if you could find one economist who thinks that this has been done. In fact, the gains from trade tend to be concentrated and the losses widespread. Far from every economist thinks the current trade regime is fair.
What about a mechanism that could collect some of the gains from trade at the border to make the losers whole? We’ll talk about that in a moment. It is a long-standing, albeit quite disreputable mechanism. Hint. It begins with a “T”.
It is extremely galling to listen to this rendition of history, however, bent to the purpose of supporting free trade. To suggest protectionism made Germany unable to quote export its way out of its reparations obligations unquote is to ignore economic arithmetic and to be full of quote bull unquote. I’ve mentioned before that John Maynard Keynes’ first point of notoriety was his book, The Economic Consequences of the Peace. This book was written shortly after his resignation from the negotiating staff at Versailles.
The book pointed out that Germany could not meet the reparations requirements as a matter of not being able to obtain the foreign exchange necessary. No amount of exporting could have obtained the needed currency because of the dynamics of trade.
We are going to switch horses on the history note in Mr. Bernstein’s favor, just to make this point very clear. Look for that in a couple of minutes.
To ascribe any meaningful part of the current downturn to trade restrictions is completely fallacious. Mr. Bernstein may list the protectionist measures and tut-tut, but he cannot pretend that they have caused any of the problem. In fact, it is the freedom of the movement of capital, which we are not going to discuss today, that is creating the catastrophe in Eastern Europe. Capital controls could have prevented some of this carnage. In a very meaningful way, it is the freedom of markets that is making them more fragile.
Trade has collapsed, not because of any protectionism, but first because the tradable goods, the consumer discretionaries, are the first to go when people start conserving their cash. Second, there is plenty of opportunity for the credit freeze to mess with inventories, obtaining products, shipping, and that is happening.
From this evidence, we wonder if the original Smoot Hawley, passed under Hoover in 1930, was the great contributor to the Depression that has been suggested by the free traders.
Today salmon is caught in Alaska, shipped to China to be fileted, then reimported to the U.S. A factory in Canton, Ohio, cannot compete. It moves production offshore. A community built to support that factory takes heavy losses, but these do not appear in anybody’s bottom line, so they are ignored. Perhaps there is call for retraining assistance, to be financed, of course, not by the company, but by the government and the taxpayers who have just taken the brunt of the job cuts.
Often the savings from these moves is not enormous. While wage rates and wage costs may be widely different from Hanoi to Hanover, transportation costs — not including the damage to the environment — reduce them, and in many cases wages may be only a small part of total value.
In the 1800s, there were no income taxes, no payroll taxes, and a great part of government involved no taxes on citizens at all. Government was financed by tariffs, fees imposed on importers.
The argument for free trade was first formed by David Ricardo, and it is called comparative advantage. If Scotland produces sheep better than wine, and France produces wine just as well as sheep, it will pay the two to trade, because there will be a larger pie of wool and wine to share. When the principle exporters are resource poor countries like Japan and China, the comparative advantage argument becomes weaker.
While the political angle seems always to mention the Democrats and labor unions, a Wall Street Journal article pre-Great Recession, from October 2007, came under this nose last week.
http://online.wsj.com/public/article/SB119144942897748150-8r3rp2iBHlVlYeV4fB_56VVpKYw_20071103.html?mod=tff_main_tff_top
Republicans Grow Skeptical On Free Trade
By JOHN HARWOOD
By a nearly two-to-one margin, Republican voters believe free trade is bad for the U.S. economy, a shift in opinion that mirrors Democratic views and suggests trade deals could face high hurdles under a new president.
The sign of broadening resistance to globalization came in a new Wall Street Journal-NBC News Poll that showed a fraying of Republican Party orthodoxy on the economy. … Six in 10 Republicans in the poll agreed with a statement that free trade has been bad for the U.S. and said they would agree with a Republican candidate who favored tougher regulations to limit foreign imports. …
The key dynamic of trade in goods is the fact that the gains are collected by the gatekeepers. The traders, the WalMarts, corporations who can monetize their gains. The losses are borne by a wider swath of communities and individuals less able to create a financial stream of losses, other than, of course, those who lose jobs.
So why not tariffs? Universal ten or fifteen percent tariffs to reduce excess transportation, capture revenue for worker re-training, mitigate the losses of communities, and keep jobs at home that are fleeing for relatively small advantages compared to the costs? In effect, trade currently is not free, it is subsidized. We assume cheaper goods from overseas are balanced by reduced incomes at home.
While the gains of trade can no doubt be proven, these gains go to relatively few and the costs are borne by others. A tariff is a way of collecting some of the gains for the benefit of the others.
Of course, and again, the current problem is not a problem of protectionism, but a problem of incomes. Incomes have plumeted, consumer wealth has taken a big hit, so cosumers have cut back and we think they are permanently cut back. This means the tradable goods are taking a hit.
We also suspect that the current debacle will permanently discourage exporting countries from trading goods for pictures of dead presidents on green paper.
The immense imbalances in trade are absurd from a fundamental point of view. It involves massive lending from the poorer countries to the wealthier. The flow of investment ought to be in the opposite direction. Surely it is not too hard to see that a telephone line or road in an undeveloped country has a value far greater than another telephone line or road in a developed country.
But because the amount of monetized activity in the developed country is greater, it will have a larger dollar value. This results from no other cause than the money flows to the power, not to the value. Thanks to John Kenneth Galbraith, who we’ll hear from in a moment.
But before we leave the subject of revenues, with tariffs, we need to examine the proposition that all stimulus must come with deficits.
Repeating a theme of ours.
Contrary to popular opininon, this is not necessarily so. Spending from government can be stimulative and economically efficient and still be fully financed by taxes. Let’s take a couple of cases.
Taxes on the wealthy.
To a very real extent, particularly in times of uncertainty, tax cuts on the wealthy are turned into purchases of Treasury debt. This means that the same stream of revenue contributes to an increasing rather than decreasing deficit and incurs interest charges. If a stimulus means spending rather than savings, which it does, it is possible to tap the savings of the wealthy by way of high marginal rates.
The supply side canard that low taxes on the wealthy lead to positive economic outcomes ought to be completely discredited by the last thirty years, and particularly, the Bush experiment.
Example two: Gasoline taxes, or carbon taxes.
This is economically efficient because there are costs in the consumption of carbon that are not now incorporated in the price. Yes, global warming. Insofar as these costs can be replicated by taxes, the result is a more efficient market outcome. Further, there are only one-third as many jobs supported by the mining and distribution of fossil fuels as may be supported by government services. More jobs, more stimulus, with taxes. And again, alternative energy is directly impacted by the price of gasoline and fossil fuels. We saw that in 1980 and now in 2009. Alternative energy is inherently less costly and produces more jobs per dollar. Finally, as we saw last year, a high price of gasoline motivates a turnover in the fleet, from gas guzzlers to gas misers. Right now it is hard to see the motivation to buy a new car.
This reasoning has not penetrated the new Transportation Secretary, Ray LaHood.
LaHood said he firmly opposes raising the federal gasoline tax in the current recession.
Last fall, Congress made an emergency infusion of $8 billion to make up for a shortfall between gas tax revenues and the amount of money promised to states for their projects. The gap between money raised by the gas tax and the cost of maintaining the nation’s highway system and expanding it to accommodate population growth is forecast to continue to widen.
A new proposal to use the GPS system on cars to calculate miles driven and charge in this way is an attempt to make a public good into a private good. It is not a good idea. Like the many attempts to electronically toll, it hurts those most vulnerable and allows public expenditure to benefit those with the most money.
This is an example of the disconnect between economics and politics. Economists, as John Kenneth Galbraith told President Kennedy, tell you what should be, and politicians must deal with what people want. In this case, politicians must create the politics for an energy revolution by demonizing fossil fuels. I guess. I’m a better economist than politician. And example three: health care.
Health care insurance could be replaced by health care contributions of the same sort as social security and medicare contributions. While the purpose of the insurance payments and the health care contributions is the same, because one produces a public good and the other a private good, one is called a tax and the other an insurance premium. Creating a single payer system is by all legitimate accounts more efficient economically. In a crashing economy, we may not be able to even afford the country club system any more.
Examples four through fifty-five. It is just not true that only the private sector produces wealth. If it were true, considering the extent to which the public sector has subsidized the private sector, we would be wealthy today instead of looking into the abyss where virtually all asset prices have fallen.
In case you forgot, Mr. Bernstein ended his little discussion of protectionism with this.
BERNSTEIN
It is a crime to make up facts to support
from JKG
FORECAST
So next week all we do is Forecast.
We’ll check out performance. In particular, how Demand Side is mopping the floor with the members of the Federal Reserve’s Open Market Committee. One of Mr. Bernanke’s first initiatives was the public forecasts of GDP, inflation, unemployment and interest rates. It was a thinly disguised attempt at inflation targeting.
It has turned into a display of how our nation’s central bankers are completely at sea with regard to the direction of the economy, as their forecasts migrate at a gallop with events.
Others, Nouriel Roubini, Joseph Stiglitz, Jeffrey Sachs, James Galbraith, and Demand Side largely following the lead of these folks have been more or less on the mark for a year out. The dismay in this group is that the orthodox conventional wisdom is so slow to adopt the policy measures that could change course.
Another is Robert Kuttner
An Open Letter to David Axelrod
Dear David,
President Obama faces two huge challenges in the next few months. One is dealing with the reality of an impending depression. It will take much stronger medicine to avert a depression than the measures taken to date, and the president needs to rally public opinion if he is to persuade Congress to act at the necessary scale.
The related challenge is about appearances — about whether middle America feels that the federal outlays are trickling down to regular people. So far, bankers seem to be getting too much and Main Street too little.
The two challenges are related. If the solutions are not bolder, they won’t cure the crisis. If the public isn’t persuaded of the need, Congress won’t act. If the economy keeps sinking, the people will lose confidence in the president’s leadership.
Robert Kuttner
But that’s next week. For today, this is Alan Harvey, from the Demand Side.
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