The order to reopen–who gives it?

Like all of us, President Trump is eager to reopen the economy. Does he have the authority to do so or do state governors? Fortunately, neither can force us to start eating out again, or return to our offices. We remain a country where those decisions rest with each of us individually (or jointly with your boss with regard to returning to your office, shop or factory). That means that those parts of the economy that have shut down will get going again when the affected businesses have taken measures to protect their customers and employees sufficient to regain their customers’ trust that they are safe places to visit. But as I argued last month, that should always have been the basis of social interactions.  “Beating-covid-19: Compulsion-or-Persuasion-and-guidance”

The broad-based, blunt instrument of sheltering at home unless your activities are vital (says who?) is imposing staggering damage to the economy.  The best way to minimize that damage is to restore public trust as quickly as possible that those with it are being isolated and treated.  A blanket shut down of non-essential activities is not the best approach. Each of us in our personal situation can better determine where we feel safe to go than can a government agency.  However, some of us will not give sufficient weight to the dangers of exposing our friends and the general public to the disease if we might have it.  Public policy should educate the public to the dangers of covid-19 and how best to protect ourselves and should minimize the financial incentive to continue working when sick. State coercion (mandatory quarantines) should only be applied to those testing positive for the virus.  This approach will allow all firms and stores to operate whose employees and customers judge them to be safe and will give businesses maximum incentive to make themselves safe.

Covid-19 will be around for at least another year or two until an effective vaccine is available and then distributed to more than 60 percent of the world population. The most effective way to contain its spread in the interim is to undertake widespread, quick, and accurate testing and to quarantine those who test positive with efficient contact tracing.  Adding the newly available tests for antibodies indicating immunity to the virus will identify those who are no longer susceptible to acquiring or spreading the disease. They should be safe in public.  Other corona viruses have created immunity in those who have had them and SARS-CoV-2 is expected to do the same, though this has not yet been established.

The U.S. has belatedly increased its testing for the virus. Initially it impeded the development and supply of test kits. As of April 16, the U.S. has tested 10,266 people per million while Germany has tested twice that. The U.S. by that date had 105 deaths per million while Germany had less than half that.  The Food and Drug Administration (FDA) should get out of the way and allow profit seeking entrepreneurs to flood the market with test kits.  The government should focus its (our) money on a large increase in testing for the virus and quarantining those testing positive and those they contacted and should offer significant financial prizes for an effective vaccine and for the development (or discovery) of effective treatments. Unlike patents as an incentive, this will encourage collaboration and knowledge sharing among those attempting to develop treatments.

On April 16 President Trump outlined guidance for the phased reopening of closed businesses and activities that is consistent with the approach outline above.  The government’s traditional public health role is important. But much more discretion should be given to individual case by case judgements about risks and entrepreneurial initiatives about remedies rather than broad based government edicts.

We will not return and cannot be required to return to the public square until we believe it is safe to do so. Individual shops and firms have a financial incentive to find convincing approaches to being safe and will get there quicker than even the best-intentioned government official issuing instructions and mandates. The government has an important role to play in fighting this virus and facilitating our return to normal life, but it should remove impediments it often creates to the private sector’s management of the related risks and the huge and unnecessary damage it imposes on the economy.

The Balance of Trade

President Trump has regularly called for bilateral trade balances with our trading partners. Though he prudently gave up his campaign promise to declare China a currency manipulator on his first day in office because of China’s large trade surpluses with the U.S., he more recently criticized Germany’s even larger surplus. The Trump administration’s objectives in renegotiating the North American Free Trade Agreement (NAFTA) published July 17th also call for reducing U.S. bilateral trade deficits with Mexico and Canada. Economists recognize these objectives as nonsensical, but it might be worthwhile to spell out to the broader public (if not to Trump’s protectionist White House wing) why that is so.

Let’s start with the U.S. trade balance with the rest of the world. As we pay for what we import with what we export, we would generally expect a balance between imports and exports over time, just as we expect a rough balance between our income and expenditures over time. But uniquely in the case of the U.S., we need to have a deficit (imports exceeding exports) paid for with U.S. dollars, because the rest of the world holds and uses our dollars to finance many international transactions. The dollar is the world’s primary international reserve currency and our trade deficit is the primary means by which we supply them to the rest of the world.

This is an over simplification, however, because dollars are also supplied to the rest of the world via our capital account, i.e. Americans investing abroad. At the end of 2016 Americans had invested about $24 trillion USD equivalent. However, the rest of the world had invested over $32 trillion USD in the U.S. Roughly $5 trillion of this net investment in the U.S. of $8 trillion represented official foreign exchange reserves held by foreign governments in U.S. dollars out of total foreign exchange reserves of about $8 trillion.

Something also needs to be said about the relationship between foreign holdings of dollars and changes in those holdings. Any increase in the demand for foreign exchange reserves by foreign governments, something that tends to happen naturally as economies grow, must be met by the balance of payments deficits of the countries supplying those reserves. Thus the U.S. trade deficit last year (2016) of about $500 billion USD more or less reflects the addition to the dollar reserves of foreign governments.

So the use of the U.S. dollar in foreign exchange reserves implies that the U.S. will have, and need to have, a balance of trade deficit of a similar amount. But let’s simplify and assume that U.S. trade with the rest of the world is balanced (zero trade balance as well as zero current and capital account balances), perhaps because the U.S. dollar is replaced in international reserves by the SDR as I have long recommended. See my: Real SDR Currency Board What about the trade balance with Mexico and Canada? Should we want and expect each bilateral trade relationship to be balanced?

The error of such thinking can be easily illustrated with a simple, hypothetical example. Assume that within NAFTA the U.S.’s comparative advantage is in manufacturing all the pieces that make up an automobile and growing wheat, Mexico’s comparative advantage is using its “cheap” labor to assemble those pieces into cars, and Canada’s is growing and milling lumber. Assume that that is all they do that crosses their borders. The U.S. sells its car parts to Mexico, which puts them together and sells the cars to the U.S. and Canada. The value of the parts sold to Mexico is less than the value of the cars (which incorporates the parts from the U.S.) Mexico sells to the U.S. so that on net the U.S. has a trade deficit with Mexico. The U.S. sells wheat to Canadians buying a lesser value of lumber in return and Canada sells its lumber to the U.S. and to Mexico buying a few cars but of less value. Looking at bilateral trade balances, Mexico has a surplus vs. the U.S. and a deficit vs. Canada. Canada has a surplus vs. Mexico just sufficient to cover its deficit vs. the U.S. These bilateral deficits and surpluses are not a problem because the U.S. has a trade balance vs. Mexico and Canada combined and indeed with all of the rest of the world. The same is true for Mexico and Canada. What really matters is whether the value of a country’s exports to the rest of the world match and thus pay for the value of its imports from the rest of the world. As someone noted, no one worries that you have a large trade deficit with the grocery store as long as your total spending everywhere is covered by your income (the sale of your labor to your employer).

Being the eternal optimist, I trust that there are enough people in the Trump administration that understand that seeking bilateral trade balances with each and every country would be a terrible mistake to keep him from trying to do so.

Berlin: Then and Now

The first time I saw Berlin was in 1960, just 15 years after the end of World War II in Europe. I came for a week of exploring with the other participants in the International Christian Youth Exchange living in Germany for the school year of 1959 – 60, during which I lived with a German family in the small village of Rasdorf near the somewhat larger village of Hünfeld, near the small city of Fulda. Though Rasdorf was on the border between East and West Germany, we had to fly to Berlin, as it was an island of West Germany within the Deutsche Democratic Republic (DDR), commonly referred to as East Germany. While Berlin was technically divided into four zones (American, British, French and Russian), it was administratively divided into the Western Zone, which was part of the Federal Republic of Germany, and the Eastern Zone controlled by a puppet government installed by the Soviet Union. The wall that separated the two had not yet been built nor even thought of at the time.

By then I had lived for the better part of a year within walking distance of a ten meter wide strip of plowed earth that separated East and West Germany – the communist world from the free world – and our village from the next one to the east. The physical scars of the Great Patriotic War, as the Russians called it, were little in evidence in Germany’s villages such as Rasdorf. Berlin, however, was a very different matter.

According to Wikipedia: “Up to the end of March 1945 there had been a total of 314 air raids on Berlin, with 85 of those coming in the last twelve months. Half of all houses were damaged and around a third uninhabitable, as much as 16 km² of the city was simply rubble.” Estimates of the total number of dead in Berlin from air raids range from 20,000 to 30,000. To put it into perspective, the total U.S. causalities in Iraq from March 19, 2003 to May 26, 2015 were 4493.

By 1960 West Berlin had enjoyed considerable rebuilding. But vast areas remained flattened and uninhabitable, though generally cleared of rubble. The now thriving hot spot of Potsdamer Platz, just west of what was about to become the Berlin Wall, was a large vacant space. The Kurfürstendamm, on the other hand, was largely rebuilt and thriving with the steeple of the bombed out Kaiser Wilhelm memorial church still standing, as it is today, as a memorial to the horrors of war.

The 17 Juni strasse in the West becomes the Unter der Linden strasse as it passes through the Brandenburg Tor to the East. Its buildings also had been fully restored to their prewar appearance. But not more than one or two blocks on either side was nothing but gutted buildings and ruble. It was a shocking sight. Coming from America, I had never seen such massive devastation before in my life. Of course, today no evidence of the war exists anymore except in memorials and museums. And even the Berlin Wall, which existed from 1961 to 1989, is gone; a small portion of the Wall still remains as a historical reminder for visitors but mainly it has been broken up into inch-size fragments for sale to tourists or used as decorations in hotel lobbies, one of which sits on my office bookshelf.

The apartment building Ito and I are now staying in on Behrenstrasse is just one block south of Unter der Linden strasse and has replaced the gutted buildings I had seen 55 years earlier. As far as I can see in every direction now the area has been fully rebuilt, as very little was restorable. The exceptions are the grand buildings of Berlin’s original and once again city center (Humboldt University, several concert halls, Museums, the Berliner Dom and some other churches).

During our day trip to East Berlin during that first visit in 1960 our group went to the Opera House, which had survived the war, and saw a performance of a portion of opera. I remember the concert very well. They performed the Polovtsian Dances from Alexander Borodin’s Prince Igor. It was very familiar to me from the American musical Kismet. Being the naive and skeptical 18 year old that I was at the time, I complained to my companions that those damn Russian’s had stolen these songs. They will steal anything, I said. Learning that the reverse was true soon there after was eye opening.

I returned to Berlin, now divided by the Berlin Wall, in 1976 or so to visit my former wife’s sister Jean and her husband Tom, and then again for the Mont Pelerin Society meetings in 1982 with Milton Friedman and other economists in attendance. By then I was in my mid 30s. Reconstruction continued in the West but little had changed in the East. During the first of these two visits I saw, with Jean and Tom, my first ever full opera, this time in the Western Zone. The opera was Madam Butterfly, a nice introduction to the world of opera. I marveled at the music, of course, but also found it fascinating that I was watching an opera sung in Italian about a geisha who had fallen in love with an American Captain in Japan and I was watching it in Germany.

I returned to a reunited Berlin (and a reunited Germany) after the fall of the Berlin Wall in 1989 and the subsequent collapse of the USSR several times again for one reason or another. Once was to visit my German friend Moritz Schularick, with whom I will meet again here for dinner on Monday. The burst of construction and development in the newly freed Eastern Zone was amazing. The transformation with each of my subsequence visits was quite pronounced. Younger people no longer refer to the Eastern Zone. The hotel where we are now staying is in what was once part of the Eastern Zone, and is now called Mid Town (Mitte).

We are now vacationing in Berlin because Ito has been reading a lot about Winston Churchill and the Germans in the Nazi government such as Albert Speer, Joseph Goebbels, Rudolf Hess, and Hermann Göring, and WWII in general and he wanted to see the places he has read about. So here I am 55 years after my first visit in 1959 astonished at the city’s history of glory, infamy, courage and pain, destruction and eventual reconstruction and rebirth. Hitler’s famous bunker here where he ended his life together with his new wife Eva Braun and his dog Blondi has been filled in and covered over, but the Germans have gone out of their way not to cover up their treatment of the Jews in what came to be called the holocaust. Still, it feels a bid odd walking and riding around this historic city with its many Nazi ghosts. It is also the city in which brave Germans sought freedom in the West by jumping out of windows over the Wall, digging tunnels under it, and by risking their lives in order to escape the Eastern Zone to live in the West.

The story of Berlin, from then until now, is an example how a people can succumb to inhumane beliefs and behavior, recover their humanity and respect for freedom, and once again flourish. Germany’s long history includes both great and horrendous acts. Within my lifetime the Nazi’s rose to power and threatened the world in WWII, Berlin was completely and utterly destroyed by allied bombing near the end of that war, then occupied by the Red Army in 1945, the city butchered into four quadrants as part of the Allies’ Cold War with the USSR, the Berlin Wall was constructed in 1961 and torn down in 1989, and Germany was reunified in 1990, subsequently prospering as a free and democratic state. I am grateful to have been able to witness what seems to be a positive outcome to this complicated story.

Greece, Debt, and Parenting

If you are a parent, you may have experienced something like the following:

Son number 1 and his children live in a much nicer home than you did at his age. It is the biggest house he could qualify to buy and you put up the down payment to assist him in his purchase. He worked hard as an auto mechanic earning a decent income. His wage was increased modestly each year as his productivity gradually increased with experience, though barely keeping up with inflation. He and his wife were loving parents with three wonderful children and enjoyed their family time together spending what they earned on their children. However, they spent his income as he received it and borrowed the maximum possible to buy a nice second hand family van. When the car needed more than the normal repairs, he had no savings and borrowed the money from you. The occasional family illnesses were paid for by additional loans from you as well and rather than paying off their mortgage and other debts over time these debts grew larger. When his children reached college age they took jobs that did not require college educations as no money had been saved for college.

Son number 2 was also an auto mechanic but ran his own repair shop. His wife and two children lived in a more modest home with lower mortgage payments and they consumed his earnings carefully and modestly in order to save for emergencies, the children’s college fund, and his retirement, and to invest in equipment that would make his repair shop more productive. For a number of years they enjoyed a lower standard of living than did son number 1, but gradually paid down their mortgage without incurring additional debt. More importantly, his income rose more rapidly than did his brother’s because of his investments in tools and equipment. Within 24 years his income was twice his brothers as a result of its growing 3% per year faster.

With the bursting of the housing bubble in 2007 and having his hours of work reduced because of the slowing economy, son number 1 was forced to sell his house in a short sale arranged with the mortgage holder and you wrote off what he owned you. His family was forced to cut many of their expenditures because no one would lend them the money needed to continue living beyond their means. They were forced to cut their consumption even further in order to have some savings when the inevitable health and mechanical emergencies occurred because you decided that your earlier financial help had only perpetuated their shortsighted behavior and refused to lend him more. They complained about the fall in their standard of living as they were now forced to consume within their means. Your son number 1’s family was now poorer. Or more accurately, their standard of living matched reality and became sustainable. Their earlier, higher standard of living was an unsustainable illusion.

Needless to say, son number 2’s future was brighter. His family took advantage of the fall in housing prices by 2008 to buy a larger home, keeping their original one for its rental income. His two daughters went to and graduated from college. His higher standard of living was real and sustainable (i.e. he paid for his higher consumption fully out of his higher earnings).

If you rename son number 1 “Greece”, and son number 2 “Germany” you can begin to understand the difference between the situation of each economy and the difference between competitiveness (exports that match and pay for imports) and productivity (the level of wages and income). For a while Greece enjoyed an artificial and unsustainable standard of living. It needed to “adjust” to reality, i.e. to bring its expenditure in line with its income both internally (the government and each household better matching their incomes and expenditures) and externally (imports matched by –i.e., paid for by—exports) and thus to recognize that it is really poorer than it had pretended. This is what is meant by being competitive. To raise its standard of living it must become more productive by creating a more business friendly environment, reducing its blotted government bureaucracy, and liberalizing labor and product markets. For more details see my earlier articles on Greece: https://wcoats.wordpress.com/2010/05/30/greeces-debt-crisis-simplified/ and https://wcoats.wordpress.com/2012/02/26/saving-greece-austerity-andor-growth/