Category: China

Preserving the Global Order

As the number of BRICS member countries grows, the international organizations through which countries cooperate are at risk of fragmenting.  To keep the IMF, World Bank, WTO, WHO, ITU and other international bodies together to perform their financial, standard setting, and coordination functions that have contributed so much to global prosperity, each member must believe that they are fairly represented in such bodies.

Unlike the UN’s one country one vote, members of the International Monetary Fund and World Bank, have votes (quotas) that reflect their economic importance. The fundamental criteria for the financial contribution and voting share of each member country in the IMF and WB are the economic size of its economy and its share of world trade and reserves.

When they were established after WWII in 1944, the total size of the IMF was 8.8 billion dollars of which $2.9 billion was pledged by the U.S. giving it a quota (and vote) of 33% of the total. Any major policy decisions or amendments to the IMF’s Article of Agreement require an 85% support. This gave, and continues to give, the U.S. a veto over any important measure it doesn’t like. At that time the U.K. quota of $1.3 billion was 15% of the total and that of France was $0.65 billion or 7.4% of the total.

The Republic of China was an original member of the IMF in 1944, whose seat was transferred to the Peoples Republic of China in 1980 with a quota of 1.2 billion SDR which was 3.1% of the total of SDR 39.0 billion. “What are SDRs?” This was promptly increased to 1.8 billion SDRs (4.6%). The quotas and voting strength of the IMF’s six largest members in 1980 and 2022 were:

                        1980               2022

U.S.           19.83%               16.08%

U.K.             6.94%               4.03%

Germany    5.13%               5.31%

China           4.62%              6.08%

France.        4.57%              4.03%

Japan.          3.96%              6.14%

Over the last 4 decades, China and many other lower income countries have grown significantly. U.S. GDP in 1980 was $9.7 trillion in 2022 dollars while China’s was $1.03 trillion in 2022 dollars.  But by 2022 the US economy had double while Chinas increased almost 14 times. The adjustments in member quotas failed miserably to reflect these changes. The US quota dropped from 19.8% to 16.5% while China’s increased from 4.62% to 6.08%

In 2022 GDPs of the top five were:

  1. United States: $20.89 trillion
  2. China: $14.72 trillion
  3. Japan: $5.06 trillion
  4. Germany: $3.85 trillion
  5. United Kingdom: $2.67 trillion
  6. India: $2.66 trillion

To quote from Wikipedia: “To further rebalance power in the IMF, China appealed for changes that would transfer voting power to developing economies. In 2010, the Chinese executive director of the Fund, Zhou Xiaochuan, addressed the board and asserted that giving more power to the emerging economies was critical for the group’s legitimacy, accountability and long-term health.”

In the IMF/WB annual meetings that just concluded in Morocco have called for an increase in IMF resources but distributed equiproportionately, i.e., with no change in members’ relative voting weight (quotas). This moves member quotas even further away from the basic formula for determining them. Why and what might be the consequence?

The U.S. has dominated the IMFs policies from its inception largely in furtherance of developing and preserving a liberal trading order that has benefited the world. But it is apparently unwilling to give up its veto power (a quota of more than 15%). Such dominance risks corruption over time: “Monopolies”   “The Dollar Again”

But if the governance of the IMF is not seen as fair by its members, they have an incentive to look elsewhere. China understandably wants the status and influence of its increased size. So, Brazil, Russia, India, China, and South Africa (BRICS) have started to go their own way with China’s Belt and Road Initiative, Asia Infrastructure Investment Bank, and other China lead initiatives. More countries are joining the BRICS. The fragmenting of international norms and rules for cross countries relations threatens to harm global prosperity. As an early example, sovereign debt restructuring agreements are now being held up because of China’s reluctance to play ball with the term agreed by the other sovereign lenders.

U.S. and IMF—wake up. “Goodbye unipolar world and good riddance”

Monopolies

A company that produces a really attractive product or service and does so efficiently and thus at lower cost than can potential competitors, will grow and potentially dominate and even monopolize that market. It is tempting for such very successful companies to seek laws and regulations that protect their dominance by making it harder for potential competitors to enter those markets with lower costs. But as a company enjoys its increasingly protected monopoly, it tends to lose the edge that put it on top in the first place. Its drive to innovate is reduced. It tends to become lazy and even corrupt in the defense of its monopoly position. While economist differ on what policies are best when dealing with a monopolist, there is generally consensus that monopolies are bad in the long run.

The same is true of countries that grow to international dominance. With the collapse of the Soviet Union and the resulting unipolar dominance of the United States, the U.S. increasingly behaves like a bully and disregards the rules of international commerce and diplomacy that it helped establish and demands that others follow.

The United States was founded on an extremely well-conceived set of principles designed to protect its individual citizens to lead their own lives and pursue their own flourishing as they each saw fit. The American constitution limited what the government may do to enumerated powers and provided checks and balances on the actions of each branch of government. For the most part these restrictions have held, and our government has provided the defense, protection, and framework needed for our individual flourishing.

But as we gained strength and dominance and especial during our brief period of unipolarity, we increasingly violated the rules we demanded that others follow. For example, we joined others to sponsor the World Trade Organization to establish the rules of fair trade in order to maximize the benefits of higher incomes for everyone made possible by trade.  We properly challenged China for dumping its excess steel on the market as a violation of WTO rules. But President Trump’s tariffs on Canadian, European, as well as Chinese steel in the name of national defense violated WTO rules as well as common sense. And how do President Biden’s multibillion dollar subsidies for domestic semiconductor chip production differ from “China’s state-led, non-market approach to the economy and trade” we object to?

Though the U.S. won most of the cases it brought to the WTO Appellate Body, the WTO’s dispute resolution body, that Body has not been able to function since December 2019 because the US has blocked the appoint of new judges.

But it gets worse. We have rightly condemned Russia for violating the sovereignty of Ukraine by invading it, while overlooking our equally illegal violations or attempted violations of the sovereignty of Cuba, Iraq, and Libya among others.  

But it gets worse still. In reaction to Canadian Prime Minister Justin Trudeau’s accusation that the government of India was responsible for the assassination of Canadian Sikh activist Hardeep Singh Nijjar on Canadian soil, Adrienne Watson, the White House National Security Council spokesperson, said “targeting dissidents in other countries is absolutely unacceptable and we will keep taking steps to push back on this practice.” Had she forgotten the dozens of such assassinations carried out by the U.S. on foreign soil? Of the more recent was the drone attack in Yemen that killed Anwar al-Awlaki and his young grandson on September 30, 2011. Al-Awlaki was an Islamic scholar and lecturing living here in Arlington Va.  Our assassination of Qasem Soleimani in Baghdad on January 3, 2020, again with a drone attack, raised considerable international criticism. Soleimani was the Commander of the Quds Force of the Islamic Revolutionary Guard Corps. We were not at war with either Iran or (at that time) Iraq.

With our near monopoly of political power in the world, the ability of our defense industry to protect and promote its profitable supply of weapons is strong. We can be thankful of their capacity to produce the weapons that defend us. But our military industrial complex that President Eisenhower warned us of profits however and by whom ever its products are used. Its profits are strengthened and sustained by our forever wars and those we supply. Ike knew of what he spoke.

Of the 2023 FY budget (ending next week) of $1.7 trillion in discretionary spending (yes trillions if you can swallow that), $860 billion (or 50.6%) was for defense. Half of that was paid to the defense industry. Most of that is for weapons. But they provide other services as well. When I was living in Baghdad as part of the Coalition Provisional Authority in 2004, Halliburton (the company Dick Chaney had been Chairman and CEO of) provided our meals in the Embassy mess hall (Saddam Hussein’s Presidential Palace). Lockheed alone gets more of its annual revenue from the federal government than the annual GDP of all but the top 81 countries (about half) in the world.

While our constitution’s checks and balances go a long way to protect our government from capture by the defense and other industries, the honestly of our elected representatives (devotion to the interests of their constituents and our country rather than to the size of their corporate contributions) still matters. It is hard to understand otherwise why we send our sons and daughters off to fight and die in foreign lands or encourage Ukraine to fight to the last Ukrainian.

Our government and foreign policy have been corrupted by our unipolar dominance. But our very arrogance—abide by our rules while we do what we want—has and will increasingly weaken our global influence. There are faint signs that we are being to recognize this new reality and tempering our behavior. The demise of our monopoly behavior and our return to fair and proper competition should be encouraged.

It makes sense to restrict trade of important military products. National Security Advisor Jake Sullivan was right to claim that we should aim for a “small yard with a high fence” to protect military supplies while otherwise maximizing beneficial trade. But the profit motive of our defense industries to expand the size of that yard as much as possible is strong and has been and will be hard to resist.

More on constructive competition

In contrasting our treatment of others as competitors or enemies in my blog on “What to do About China”  I am reminded of the 120 days I spent in Baghdad as an advisor to the Central Bank of Iraq paid for by the USAID and supervised by the US Treasury. Our occupation of Iraq included staff from the US Treasury, USAID, Commerce Dept, State Department, and, of course, the Dept. of Defense. Competition by each of them to do a better job than the others would clearly be win-win making our overall occupation more successful. But too often one agency treated the others as enemies diminishing and undermining their efforts rather than supporting them. My biggest fear with my dual association with USAID and Treasury was that each would see me as on the other side, which would have undermined my effectiveness. Luckily the each saw me as on their own side.  “Iraq-An American Tragedy-My Travels to Baghdad”

What to do about China?

“China’s much anticipated post-pandemic recovery appears to have flopped, with signs of a significant slowdown after decades of supercharged growth and data flashing warning signs.” Bloomberg “China’s failing recovery”

“Signs of deflation are becoming more prevalent across China, heaping extra pressure on Beijing to reignite growth or risk falling into an economic trap it could find hard to escape.”

What, if anything, should the U.S. response be? That depends on whether we see China as a competitor or an enemy. That should depend on our assessment of China’s objectives. Does China want to expand its territory one way or another, or to expand its influence in the global order? China’s behavior might support either assessment.

China claims sovereignty over almost the entire South China Sea, including the Paracel and Spratly islands, which are also claimed by Vietnam, the Philippines, Malaysia, Brunei, and Taiwan. In 1947 China asserted its claims with a map depicting a U-shaped line covering almost 70 percent of the South China Sea, known as the nine-dash line. In 2016, an Arbitration Tribunal rejected many of China’s maritime claims as lacking a basis in international law.

The UK returned Hong Kong to China July 1, 1997, with the understanding that it would be self-governed independently of the Peoples Republic of China for fifty years. China violated this agreement with its full takeover in 2020.

In 1972 President Richard Nixon confirmed that Taiwan was part of the People’s Republic of China but would continue to govern itself independently until it agreed to merge its government with the mainland’s. In the Taiwan Relations Act of 1979, the U.S. committed to providing defensive weapons to Taiwan to defend itself from invasion (as opposed to the volunteer absorption into the Peoples Republic envisioned in the One China Act). What we provided instead were heavy weapons irrelevant to Taiwan’s defense but prized by America’s defense industries. “Taiwan-China policy assurances military” The U.S. has more recently seemed to even question its commitment to the One China agreement.

These aggressive moves by China are better seen as solidifying its borders (much in the same way the US worries about its borders with Cuba) than military expansions. On the other hand, China joining the World Trade Organization, pressing for representation in the IMF and World Bank that is more reflective of its economic size, and its Belt and Road, Asian Infrastructure Bank and BRICS initiatives reflect China’s desire to gain status in the global system comparable to that of the U.S. In short, they reflect the behavior of a rising economic competitor.

We seem to be treating China as an enemy rather than the trade and economic competitor they see themselves as. Among sportsmen, competition takes the form of doing your best—of being the best you are capable of. Within our economy we rightly see competition as good and healthy. With fair competition, both sides benefit. The world is made wealthier. Kneecapping our competition is the approach of bad guys. I explored this more fully in my blog “Competing with China”

But China is not competing fairly either. We would be wiser to use the mechanisms of the global system of rules to push and pull them into compliance. We should end our own tariff—industrial policy violation of these rules as well. We might start by restoring the dispute resolution body of the WTO. While there will be genuine security justifications for trade restrictions, they should be very limited.  They should not include taxing steel purchased from Canada. Trade is win, win.

A recent G-7 statement clarified that: “We are not decoupling or turning inwards. At the same time, we recognize that economic resilience requires de-risking and diversifying.” US Treasury Secretary Janet Yellen stressed this message during her recent visit to China. We should facilitate and encourage China’s economic rise as it contributes to our own. The opposite direction—treating China as an enemy—ends in war.

America’s Unipolar period has corrupted us. We demand that others follow rules that we violate ourselves when we don’t find them convenient. We have become a bully. My hope is that we adjust to the fact that we are no longer the world’s sole superpower by strengthening the rules we helped develop and competing fairly under them: “Goodbye unipolar world and good riddance”

Goodbye Unipolar World, and Good Riddance

“Power tends to corrupt and absolute power corrupts absolutely.” Lord Acton. The United States has accomplished a lot—a lot of it good—as the world’s indispensable nation.  But as Lord Acton said, power tends to corrupt and as the time of American dominance has gone on its diplomatic skills have eroded. It behaves more and more like a bully that expects to get its way. It is in our interest to recognize and adjust to our diminished relative power and to rebuild our diplomatic, soft power skills of persuasion. It will help us better adhere to the values and rules we preach to others but increasingly ignore ourselves.

In the July, 2023 issue of Foreign Affairs, Justin Winokur offers an excellent review of the adjustments we need to make in The Cold War Trap How the Memory of America’s Era of Dominance Stunts U.S. Foreign Policy “Cold war trap-America foreign policy”

These days our most important international challenge is our relationship with China. While each sovereign nation is entitled to its own approach to its internal governance, its interactions with the rest of the world require mutual understandings and/or agreements. Following World War II, the rules for such cross border interactions have generally been developed by international organizations to which all or most countries are members, such as the UN and its many agencies, the World Bank and regional development banks, and the IMF. To take but one example, the skies full of telecommunications satellites would not be able to serve anyone properly without the rules and spectrum allocations via the International Telecommunications Union.

It is in America’s interest, as well as the interest of most countries, to draw China more fully into the international organizations established after World War II—the Bretton Woods and UN Institutions. “Chinese competition-Asia stability-institutional balancing”  But China is increasingly going its own way and creating its own international organizations. BRICS, China’s Belt and Road Initiative, Asian Development Bank, The Shanghai Cooperation Organization, Asian Infrastructure Investment Bank. Why?

Why have we failed to convince China that its interests are also serviced by joining and cooperating with the liberal international order? When China was admitted to the World Trade Organization on December 11, 2001, and requested help from the IMF with how best to satisfy the WTO’s rules, the IMF sent me. The officials I met with in China told me over and over that there was no differences of opinion in China over where it wanted to go (in joining the liberal international order). The debate was only over how fast to get there. In recent years this has changed. It has changed, in my view, in part because the U.S. has abused its dominance in the world and failed to yield (balance) appropriate power to China.

As I have spent most of my professional life with the International Monetary Fund, let me illustrate these points with the determination of IMF quota’s which is meant to reflect its members voting strength and financial contribution to world trade. A member country’s quota reflects its size and position in the world economy. The basic formula, which provided the base line for quota decisions is:  Quota = (0.50*GDP + 0.30*Openness+ 0.15*Variability  +0.05*Reserves)^K.

But when the IMF was created, the US wanted to ensure that it would dominate it. It insured that some important decisions could only be taken with super majorities. A few even required an 85% majority, such as to adjust quotas, or amend the IMF’s Article of Agreement.  The U.S. was initially given a quota well above that 15% that gave it veto power over these limited policies. As the rest of the world has grown, the size of the US economy relative to the whole world’s output has fallen from 40% in 1960 to 24% in 2019. “US share of global economy over time”  China’s GDP relative to world GDP, on the other hand, rose from 4.5% in 1960 to 16.3% in 2020. Thus, a strict adherence to the IMF’s quota formula should have significantly increased China’s quota and reduced the US quota.

Quoting from Wikipedia: “China has been trying to expand its political and decision-making power within the IMF. The IMF’s voting system weights each country’s vote based on the amount of that country’s monetary contribution to the Fund. China has been trying to raise its quota. In May 1980, the Chinese government appealed to adjust its IMF quota. With approval from the IMF board, the quota of China was increased from 1.2 billion SDRs to 1.8 billion SDRs. China also obtained a single-country seat on the IMF executive board, which expanded the number of IMF directors to 22 members. As of 2017 the quota of China in the IMF was 30.5 billion SDRs, giving it 6.09% of the total vote.

“To further rebalance power in the IMF, China appealed for changes that would transfer voting power to developing economies.[5] In 2010, the Chinese executive director of the Fund, Zhou Xiaochuan, addressed the board and asserted that giving more power to the emerging economies was critical for the group’s legitimacy, accountability and long-term health.” China and the International Monetary Fund – Wikipedia

Currently the IMF quota for the US is 17.43%, remaining well above the critical 15% needed to retain its veto power, while those of other larger economies are China 6.40%, Canada 2.31%, Germany 5.59%, Japan 6.47%, and UK 4.23%. This is not in keeping with the IMF’s base line quota formula.

This exploitation of American dominance is driving China away and dividing global cooperation to the detriment of the whole world, including the U.S. The current U.S. approach to “competing” with China is not consistent with our values nor our long run interest. “Competing with China”

Our economic and political success—the beacon on the hill that has attracted the best and the brightest to our shores—is the result of our individual freedom and rule of law, not our coercive power and its bullyish use. I hope that we wake up before it is too late. “Why do we promote growth in other countries?”

The politics of Trade

The post WWII history of international trade and the World Trade Organization has been one of gradual liberalization, i.e., a gradual roll back of tariffs and other trade restrictions. Each side offering freer imports in exchange for freer exports. But the game can work in revers as well. The U.S. has restricted –actually banned—the export to China of high end semiconductors that it fears might have military uses in China. China has responded by banning the export to the U.S. of rare materials needed to produce these chips. It sounds a bit like a joke—a bad joke.

Poor Janet Yellen, who is now visiting China. The Secretary is as sharp as they come but is in the middle of this impossible game.

“U.S. Treasury Secretary Janet Yellen criticized China during a visit to Beijing for imposing export controls on critical metals, expanding subsidies for state-owned firms, and imposing punitive measures on foreign businesses. Her harsh remarks spotlight the gulf between the U.S. and China, and the difficulty of translating calls for improved ties into actual improved ties. A top Chinese official told China Daily that the curbs on metals exports were “just the beginning” of efforts to combat U.S. restrictions on China’s semiconductor sector, and warned that Beijing could yet “escalate” if Washington were to toughen its rules further, a move it is reportedly considering” Semafor Flagship July 7, 2023

But as reported by Bloomberg she had more positive things to say as well:

“Yellen Says US-China Rivalry Not ‘Winner-Take-All’ Situation (Bloomberg)

U.S. Treasury Secretary Janet Yellen said competition between the world’s biggest economies is not a “winner-take-all” situation, and called for both sides to manage their rivalry with a fair set of rules. Yellen’s comments were delivered today during a meeting with Chinese Premier Li Qiang as she made a long-anticipated trip to Beijing, aimed at finding some common ground between the two superpowers. “We seek healthy economic competition that is not winner-take-all but that, with a fair set of rules, can benefit both countries over time,” the Treasury chief told China’s No. 2 official, adding that U.S. actions to protect national security should be “targeted.” Li also struck a note of optimism, telling Yellen he believed bilateral ties would eventually see a “rainbow,” after going through a period of “wind and rain.” He also urged Chinese entrepreneurs to brace themselves for “hardships” and “look further to the horizon.” From IMF News Report, July 7, 2023

Yes, these are from the same trip. How it turns out is anyone’s guess. But a return to freer trade is in everyone’s best interest—win win as we say. National security can be a legitimate (sensible) reason for restricting trade. But it must be very carefully applied if it is not to degenerate into counterproductive protectionism.

Independence Day

Six years ago, Ito and I celebrated the 4th of July at the American Ambassador’s residence in Rome as the guest of our friend David Zimov (Economic Councilor at the American Embassy in Rome). It was a very fun event with lots of hamburgers and hot dogs, beer, and a concert by the US Marine Band. The cost of this extravaganza to us taxpayers was truly trivial compared to the cost of one day of our many wars (or our “special military operations” as Russia likes to call its wars). And the benefit to America in the form of international good will, far exceeds any American benefit from our wars, if there is any.

Janet Yellen’s upcoming trip to China will also cost a small drop in the bucket compared to sending the Sixth Fleet with a benefit for American security and wellbeing many times greater. At the same time, the US Senate continues to stall the confirmation of nominees to critical diplomatic positions. Go figure.

We seem to favor military spending over diplomacy to the detriment of our security and to our wellbeing more generally. In testimony before the UN Security Council Max Blumenthal recently stated that “The Biden Administration knows that ‘it is escalating a proxy war against the world’s largest nuclear Power. Why are we tempting nuclear annihilation by flooding Ukraine with advanced weapons and sabotaging negotiations at every turn?’  For those US officials who personally benefit financially, ‘a negotiated settlement to this territorial dispute means an end to the cash cow of close to $150 billion in US aid to Ukraine.’”  https://expose-news.com/2023/07/03/us-officials-benefitting-from-ukraine-war/  

When I noticed that the small handheld American flags we were all given at the Embassy’s 4th of July party was made in China (they had a very conspicuous “made in China” tag on the handle) the person sitting next to us was appalled. I explained to him why he should celebrate a feature of American life that has helped make us freer and more prosperous: 1. Our tax dollars were prudently spent in buying the cheapest flags; 2. The money the government saved could be spent on other government priorities (or—God forgive—returned to us taxpayers); 3. The American workers who otherwise would have been diverted to make these flags at higher cost; would remain in their current more productive activities raising our standard of living; 4. The larger volume of world trade strengthened America’s standing in the world. Though I don’t know how the American Embassy was able to avoid the shortsighted “Buy American” requirement, I was glad that it had.

Why do we promote growth in other countries?

The world’s twenty largest economies give around $100 billion in aid to poorer countries each year, about 40% of which is to promote economic development. Promoting economic development and growth in other countries is not just charity or to buy peace. More prosperous countries, those that produce more, contribute to our own prosperity more directly as well. 

It is easiest to understand this fact if we think of growth within our own country or state or town. https://wcoats.blog/2023/01/22/trade-once-again/  When you sell something you made and/or own, you benefit from the sale or you wouldn’t have undertaken it. Similarly, the buyer benefits or it wouldn’t have made the purchase. As you have heard or read me and other economists state over and over again, trade is win-win.

But the benefits go beyond the win-win benefits of the transaction itself. Being able to buy some of what I need from others rather than having to make it myself frees up my time to specialize in producing for sale to others what I am best at. In short, and forgive me for repeating this for the umpteen time, world out increases from the specialization that trade enables. As the result of trade world GDP skyrocketed in just 50 years from $1.3 trillion in 1971 to $96.5 trillion in 2021. https://wcoats.blog/2018/03/03/econ-101-trade-in-very-simple-terms/

We benefit from the inventions of entrepreneurs anywhere in the world and should encourage such developments. Pfizer’s Covid vaccine was developing in Germany by BioNTech, with whom Pfizer partners to produce to large quantities demanded. China’s incredible growth over the last thirty years has contributed to our own growth as well. In 1991 the US exported to China $5.2 billion worth of goods, which had grown to $151.i billion in 2021. In 1991 the US imported $12.7 billion worth of goods, which had grown to $506.4 billion in 2021. Following Nixon’s famous trip to and recognition of China in 1972, I remember well a friend who asked “what would we possibly want to buy from China?” We should cheer the fact that China’s economy has grown dramatically to the benefit of us all.

In general, we should welcome and encourage the economic growth of all countries around the world. The exceptions might be for countries that threaten war on their neighbors or us. We might well block the export of our products and related technologies with clear military applications to countries that might pose a military threat. And we might be cautious not to rely on such products from such countries. While these would be sensible policies, they are also easily abused by domestic industries wanting to be protected from competition.

When I was in China in the summer of 2002 to help its compliance with the requirements of the World Trade Organization, those I met were excited about growing into the world trading system. China was a rising power, most certainly not an enemy. How did they become an enemy, if indeed they are. In a word, Taiwan. But I can see nothing China has done to violate their agree with the US about Taiwan as part of One China. If China has become an enemy—a threat to the US—we are largely responsible in my opinion by raising doubts about our commitment to the One China policy.

This is not to say that China has always behaved according to the rule. I and many others were there to help them move in the right direction. Now we have pushed them backward for no good reason. Hopefully the Biden administration is beginning to recognize this and we will return to promoting China’s growth rather than repressing it.   https://wcoats.blog/2022/10/23/competing-with-china/

The Dollar (again)

Any country selling its goods abroad could price and collect payment for them in its own currency. Foreign purchasers would have to buy the sellers currency in the foreign exchange market (a whole nether story) in order to make such payments.

To communicate with each other they could also learn each other’s language. To communicate with everyone in their own language would require learning 7,000 languages. The economy of everyone adding English as a second language to their own is self-evident.

Rather than each trader dealing with several hundred currencies, there is huge economy in everyone dealing in one intermediary (so called vehicle) currency for pricing and payments of their cross-border transactions. But what currency?

When an exporter gives up pricing its products in the currency it pays its workers, it takes on a valuation risk. The choice of its invoicing currency and currency of payment needs to be attractive to potential buyers and of minimal risk to itself. The currency needs to have a relatively stable value for a large number of goods. The U.S. economy is large, and its goods are priced in dollars, which has a relatively good track record of price stability.

But to pay for imports with someone else’s currency the importer must have some of it. He must either take the risk of buying it in the foreign exchange market at whatever its current exchange rate might be or keeping some in reserve. Keeping a reserve of the international pricing and payment currency requires having safe assets with stable values in that currency, with deep and liquid markets in which they can be bought and sold. Currently the US dollar wins hands down. The Empire and the Dollar – Warren’s space (wcoats.blog)

The militarization of the dollar to serve U.S. foreign policy objectives increases the risk to others of holding and using dollars. How much that potentially undermines the dollar’s reserve currency status depends on how broadly the foreign policy objectives of the U.S. are shared and how well alternative currencies measure up to the value and market advantages of the dollar.

Reducing CHIP Supply Risks

When semiconductors where invented in the U.S. in the late 1950 and began to replace vacuum tubes in electronic circuits, the world of electronic circuitry changed dramatically forever (from the computer I am composing this note on, to the mobile phone on which I might discuss it with you or the electronics in the car I might drive to meet you while listening to the radio these chips made possible, not to mention of submarines, planes, and satellites they empower).

American companies continue to lead the world in the design of the most sophisticate chips and semiconductor circuits. However, they have increasingly found it more economical to outsource their manufacture to facilities in foreign countries. Almost all the most sophisticated chips (still designed in the US) are now produced in Taiwan by TSMC, which produces about 56% of world output of semiconductors.  Especially given the increasing suggestion, even by the President of the United States, that the U.S. might renounce its acceptance of China’s claim to Taiwan, such reliance on TSMC for our most advanced chips is an economic and security risk we should reduce.

What is the best way to reduce the risk of our heavy dependance on Taiwan’s supply of such Chips? The rest of this note briefly compares the market approach with the government (socialist/industrial planning) approach to reducing that risk.

American and other firms concentrated the manufacturing of the chips they designed and/or needed where it was cheapest to produce (and deliver) them. Where China violated the WTO rules of fair trade via state subsidies, importing countries are allowed by WTO rules to impose tariffs at levels designed to neutralize such artificial advantages. WTO rules also allow the use of tariffs to diminish the risk to national security of dependance on foreign supplies.

The opposite approach is for a government to subsidize the otherwise uneconomical manufacture of semiconductors (or whatever) in their own country.  In the U.S., the CHIPS and Science Act of 2022 appropriated $280 billion in part to subsidize factories to produce such chips in the U.S. Why was so much needed to get firms to produce chips in the U.S.? “’It’s much cheaper to build the chips and the factories in Taiwan than it is in the United States,’ former Google CEO Eric Schmidt told Semafor. ‘Similarly, the workforce quality is not as good as it is in Taiwan.’” “Chip war-US-Taiwan”

The Biden administration’s industrial policy approach suffers all the well-known disadvantages of industrial policy. First, like China’s subsidies, it violates WTO trading rules, which the U.S. seems all too willing to do when it is the violator rather than someone else. Second, it, rather than market factors, must decide who gets the subsidies (and tax breaks), either by establishing the rules for access or by outright picking winners. Governments’ records at picking winners, especially picking technologies, have historically been poor compared with the search for profit by entrepreneurs, most of whom fail and quietly fade away without further cost or waste. Third, when governments pick winners, they establish an economic incentive for corruption by those seeking to be “picked”. Governments, like everyone else, tend to bend to such temptations.

Rather than paying hundreds of billions of American taxpayer’s money for more costly Made in American products, imposing tariffs on imported chips sufficient to reflect the existing sole source risk would leave it to the market to find the best alternative and more diversified sources (India, Korea, Japan, Viet Nam, etc.). The full cost of lower living standards from industrial policies will only be felt in the longer run. “The slippery slope”

The same economic forces and arguments apply to slowing or preventing further global warming. A carbon tax reflecting the global warming externality of carbon producing activities leaves to the market the search for the best technologies for reducing carbon emissions without loss or with minimal loss of output.