Is Trump killing his own re-election?

The Fed (Federal Open Market Committee) is meeting this week to review and set or reset monetary policy.  I don’t know whether it should increase its policy rate, leave it the same or reduce it. https://www.adamsmith.org/blog/returning-to-currencies-with-hard-anchors  The market expects a one quarter percent reduction in the rate.  President Trump is quoted yesterday as saying it should be reduced more than that. WSJ: the confusing Fed

There are several problems with Trump’s statement. One is that if the Fed reduces the rate, its claim to be reacting to the data and its mandate is undercut by the President’s interference. Is the Fed doing what seems best or responding to political pressure?

But if the U.S. economy is heading South, as it may be, it is probably because of the damaging effects on the U.S. and world economies of Trump’s trade wars with almost everyone but especially with China. Trump’s tariffs have imposed significant costs on the American consumers who pay them with higher prices for targeted imports. More importantly, his trade wars have injected significant uncertainty into the continued viability of the global supply chains that have helped lower costs here and abroad and increased world output.  Their retrenchment is lowering world income and pushing many economies, including potentially the U.S. economy into recession. A U.S. recession a year from now will seriously damage Trump’s chances of reelection.

Trump’s wars on trade seem to be motivated by his mistaken belief that the U.S. trade deficit with China, Germany and others reflects unfair trade practices on their part. His misuse of a national security concern to impose protectionist tariffs and restrictions on foreign competitors (protecting inefficient U.S. industries we would be better off allowing competition to shrink) seems motivated by vote buying. https://wcoats.blog/2018/09/28/trade-protection-and-corruption/  The result is a reduction in our income and potentially his electoral defeat. Our trade deficits largely reflect the use of the U.S. dollar in international reserves (which require a deficit to supply them) and our large and growing fiscal deficits (much of which is being financed by China and other trade surplus countries). Trump’s abandonment of government spending restraint is the cause of those twin deficits https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417

It’s not that we don’t have real issues with some of China’s trade related practices, but Trump’s approach to addressing them is not productive. Rather than working with the EU and Japan and others who share our concerns to confront China together, he is attacking all of them with threats of more tariffs. Rather than strengthening the WTO, he is weakening it. Rather than using the Trans Pacific Partnership (a significant advance in modern trade agreements) to encourage China to adopt its rules, Trump withdrew the U.S. from the agreement– a huge mistake. The real question is how much more damage will Trump inflict on the world economy before he surrenders and declares victory or is voted out of office. https://wcoats.blog/2019/06/07/the-sources-of-prosperity/

Have we been taken advantage of?

For as long as I can remember I have purchased food and household items from Safeway, Giant, and Whole Foods without any of them buying anything from me. Was I taken advantage of? Of course not. I voluntarily gave up part of my hard earned income in exchange for something I wanted more. I gained and was made better off by being able to make these trades just as they profited from providing them. In fact, I don’t know and I don’t care what those stores did with the money I paid them. Much of it, of course, was used to buy the goods they put on their shelves for me to buy.

These trades (my income for their goods) would only become a problem if I spent more at Safeway, Giant, and Whole Foods than I earned selling my labor. To do so I would need to borrow money from someone and go into debt. That might be OK temporarily, but obviously not on a permanent basis. In the long run, my purchases (imports) can’t exceed my income (export of my labor).

If you change my name to the United States and the names of Safeway, Giant, and Whole Foods to China, Japan and Germany (not necessarily in that order) nothing in this story changes fundamentally. Americans benefit from our purchases of Chinese goods and it doesn’t matter what they do with the money we paid to them (net of what they purchased from us—i.e., their trade surplus and our trade deficit). As I have explained in the following article, what they (all of them collectively) are largely doing with our money (our net global trade deficit) is finance our profligate government. https://nationalinterest.org/feature/who-pays-uncle-sams-deficits-26417

For some reason President Trump has trouble understanding these simple facts. He is upset by our trade deficit with China and Germany and others that his profligate, indebted government has caused. If the federal government balanced its budget (actually being at the top of the current business cycle it should be running a surplus in order to balance over the cycle), what would China and Germany do with their surplus of dollars? Rather than buying U.S. treasury securities, they might invest in the U.S. economy contributing to faster economic growth in the U.S. They might also choose to buy more goods and services from the U.S. thus reducing their dollar surpluses. In all likelihood they would do some of each. Given the resulting adjustments in their demand for dollars, the exchange rates of the dollar for Euros and RMB would adjust to produce the desired reduction in their surpluses.

Attacking China with tariffs and demanding a reduction in their trade surplus with the U.S. is counterproductive and wrong headed. But it does not follow that China is playing by the rules (WTO rules that we should be trying to strengthen rather than weaken). The EU, Japan, Canada, Mexico and others share this assessment and Trump would be much smarter to seek their cooperation in pressuring China to behave better rather than attacking them with tariffs and tariff threats as well. With the recent agreement with Jean-Claude Juncker, head of the European Commission, to deescalate the trade war with the EU and resume the negotiations over further trade liberalization started a few years ago (TTIP), perhaps Trump is changing tactics in a more promising direction. This should include concluding the updating of NAFTA and rejoining the TPP now the CPATPP.  We should all hope so.

Richard Rahn makes similar arguments in his Washington Times article today: https://www.washingtontimes.com/news/2018/jul/30/the-united-states-is-doing-better-than-it-did-duri/

Review of John Tamny’s attack on Jack Kemp Foundation article

By Dr. Warren Coats

Dr. Coats is retired from the International Monetary Fund, where he was Assistant Director of the Monetary and Capital Markets Department.

In an article titled, “When the Ideas of Thinkers and Great Statesmen Are Perverted,” John Tamny offers what he calls “a semi-brief response” to a Wall Street Journal op-ed by Sean Rushton from the Jack Kemp Foundation, “Monetary reform would rebalance trade.”

Mr. Tamny wastes no time in launching his attack with the following: “Worse were the myriad factual inaccuracies, including a Bretton Woods monetary agreement that took place after World War II. Except that it took place in 1944.”  This is his only valid criticism in his not so brief discussion. As we all know, the Bretton Woods conference was in anticipation of the end of WWII and did not actually take place “after” the war.  Devastating, right?

Mr. Tamny launches his more substantive critic by noting that, “To be clear, all trade balances. Always.” Whether that balance is healthy or not, however, depends on its composition. Mr. Rushton’s article is about that composition. He discusses the implications of the fact that one of the ways in which we pay for what we import is by exporting U.S. dollars. The others are exporting U.S. debt (largely government) and the ownership of American firms and other private assets. Many countries wish to hold our dollars (it is the primary international reserve asset held by central banks) because so much of world trade is priced in and paid for with USDs.

Given all the many factors that determine what we import and export, the global demand for USD as a reserve asset makes our trade deficits larger than they would otherwise be in order to supply (export) those dollars. Tamny correctly notes that “the U.S. has run ‘trade deficits’ for longer than it’s been the United States.” Obviously such deficits were not the result of the world’s demand for U.S. currency. “The U.S. always ran trade deficits precisely because it’s long been an attractive destination for investment.”  In other words, other countries sold us more than they purchased in goods and services (our trade deficit) in order to earn the dollars to invest in the U.S.

But times have changed. Today, and since the U.S. left the gold standard in early 1970, most of the dollars earn abroad from our trade deficits (their surpluses) are invested in U.S. treasury securities. In short, dollars earn abroad via our trade deficits (in addition to accumulating dollars in foreign exchange reserves) are now largely invested in financing our government’s deficit spending. Even Mr. Tamny would not argue that this inflow of investment in the U.S. is contributing to our increased growth and productivity.

On the contrary, Tamny seems to be arguing exactly that. He says that: “we have a so-called “trade deficit” as a country precisely because the U.S. is a magnet for investors the world over. When we “export” shares in American companies that are routinely the most valuable in the world.” He seems to applaud selling our firms to foreigners when our government crowds out the domestic financing of our industries in order to finance our irresponsible government deficits.

Mr. Tamny is not content to label Mr. Rushton’s analysis false. He calls it “obnoxiously false” and “comically false.” Unfortunately these labels apply more accurately to Mr. Tamny.

Rushton claims and provides evidence that U.S. fiscal discipline weakened when Nixon closed the gold window. “No longer bound by fixed exchange rates and dollar convertibility, the U.S. government’s fiscal discipline broke down.” Obviously other political and demographic factors have also contributed to the alarming increases in U.S. deficits, but no longer needed to defend the dollars exchange rate removed an important constraint. To rebut Rushton’s claim and data, Tamny notes that our deficits were even higher during WWII. Truly. I am not making this up.

Turning to the dollar’s role as an international reserve asset, Mr. Tamny notes that Mr. Rushton “argues that thanks to ’high global demand,’ the ’dollar’s international position is always stronger and U.S. interest rates are lower than they would be otherwise.’” Added to all of the other factors influencing the composition of our external financial flows (our balance of payments), the world’s demand for dollars in their foreign exchange reserve holdings must increase their trade surplus (our trade deficits) or their investments in the U.S., either of which will appreciate the dollar’s exchange rate and lower interest rates in the U.S. relative to what they would other wise be. Mr. Tamny doesn’t get this. He says that Mr. Rushton “wants us to believe that a devaluation of the income streams paid out by the U.S. Treasury actually made them more attractive to investors.” I don’t really know what he means by that either.

Another of Mr. Tamny’s “obnoxiously and comically false,” or perhaps merely nonsensical statements is that: “if we ignore the obvious, that the sole purpose of production is to import as much as possible….” If he is relating production to imports, he presumably means producing for export. What we import must be paid for one way or another, i. e., by exports of goods and services, U.S. dollars for reserves, U.S. government debt, or ownership of U.S. firms.

I leave it to the reader to sort out what Mr. Tamny might mean by: “the path to a lower ’trade deficit’ is only possible if we’re willing to accept being much poorer.”

As a parting shot, Tamny mischaracterizes the views of the late Jack Kemp. Here’s what Kemp actually said, speaking in 1987:

“Why do we keep having these cycles? I believe it has to do with the burdens and privileges of the dollar’s unique international role. First, the extra demand for dollars puts a premium on their value that makes American exports less competitive. And on world markets, only a few cents means the difference between a sale and a loss. This increases our merchandise trade deficit.

“Second, the dollar’s role helps fuel Congress’s deficit spending. Foreign central banks buy U.S. Treasury securities to hold as reserves and to keep their currencies from rising—almost $100 billion in the last year and a half. This amounts to a special ‘line of credit’ that lets Congress spend resources that would otherwise be used to farm or manufacture for export. President Reagan used to say that to get Congress to spend less you have to reduce its allowance. Well, we may have reduced its allowance but we haven’t taken away its charge card. That’s one reason why every tax dollar is spent without cutting the deficit.

“Trying to compete in world markets under these conditions is like trying to run a race with a ball and chain around your ankle. We face a constant choice between giving in to pressure to let the dollar fall at the risk of inflation, or keeping interest rates high at the expense of a trade deficit and growing pressure for protectionism. This dilemma will continue until we stabilize the dollar, end the inflation/deflation cycle, and bring down interest rates with the right kind of monetary reform.”

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