Wednesday, October 19, 2011

Would Keynes Like the Trade Deficit?

            There were a couple of interesting articles in the media last week that call attention to our disastrous trade deficit.   One was a piece by Thomas Geohegan in the Oct 17 issue of The Nation Magazine entitled “What Would Keynes Do?”   It makes the point that Keynes’ ideas went far beyond “pump priming,” that is, deliberate deficit spending as an economic stimulus. If he were alive today, he might or might not be concerned about our budget deficit.   But he would be utterly appalled by the size of our trade deficit—and alarmed that few people in government, in the business community, or even in the economics profession seem to care.  Keynes felt that no country should ever run a large trade deficit or surplus except during a war or other temporary emergency.
            The global trading system we now have started in 1944 with the famous Bretton Woods Conference, and Keynes was one of the chief negotiators of that agreement.   He is often referred to as the architect of that agreement.  But what the world got out of Bretton Woods is far short of what Keynes had strongly advocated.   Keynes wanted a trading system where the currency moved between countries to settle balance of payments accounts would be a special international currency (he called it the Bancor) which could be used for no other purpose. And according to Keynes’ original proposal, if any country ran a large trade surplus in any year, they would be required to run a deficit the next year or pay massive punitive damages.  Private overseas investment by corporations would be prohibited.  Countries in need of capital could borrow from the World Bank only. But what Keynes wanted is not what we got.  We got a trading system where the U.S. Dollar became the main currency for international settlement. And the main source of capital for most countries is the private financial sector of some other country. 
            Keynes opposed trade deficits and sovereign borrowing from private banks for the same reason:  no society that owes money to foreigners is free—and he believed in freedom.  When any country runs a trade deficit, then someone in that country must incur debt to settle that deficit.  It works like this:   If we run a 400 billion dollar merchandise deficit with China, and China uses the money to buy 400 billion worth of U.S. Treasury bonds, then the balance of payments issue cancels out.  We bought something from them--and they bought something from us of equal value.  But someday those Treasury bonds will be cashed.  We owe that money.  But what if the Chinese purchased private sector corporate bonds instead?  Then our private sector would owe them the money.  Whether foreigners end up owning our government or our industry, either way we become further indebted as a society, eventually becoming a country of debt slaves.  Keynes understood this.
            Geohegan points out that another reason Keynes opposed trade deficits is that they undermine “pump priming” efforts,   because the Keynesian pump ends up leaking.   When the administration spent 700+ billion dollars on a stimulus, this probably helped.  The official unemployment rate is still 10%, but without the stimulus it could have gone much higher.  In the Hoover Administration, the gov’t took no action at all and the unemployment rate reached 25%.   And yet, if all that 700 billion had been spent on things made in the U.S., it surely would have been a much more effective stimulus. Our deficit spending still puts people to work, but not always in this country.  We have been running large merchandise trade deficits now for many years, and the resultant decline in American economic strength is nothing short of a disaster.
             Another article last week which touches on the trade deficit was a guest editorial in the Oct 16 Waterloo Courier by Coleen Rowley, the ex-FBI agent who wrote a “whistleblower” memo in 2002 and testified before the Senate Judiciary Committee concerning the FBI’s pre-9/11 failure to protect us.   Most of her article is taken up with statistics showing that our two wars have not made us any safer, but precipitously less safe.   But toward the end of the article she quotes Professor Robert Pape, the world’s foremost expert on suicide terrorism. Pape says, among other things, that our decline in safety is partly related to “America’s massive decline in power” since 9/11.
            Pape says, “A nation’s relative power is based on its economic wealth compared to the rest of the world.  In 2000, the U.S. controlled 31% of the world economy; in 2008, that figure had fallen to 23 percent and, according to the International Monetary Fund, the projection for 2013 is 21%.  In the past eight years, the United States has lost one-third of its economic wealth or, put another way, since 2000, the U.S. has lost nearly a third of its relative power in international politics while China’s has doubled and Russia’s has tripled. This decline represents the largest drop in the history books.”
            Our two foreign wars and the fact that we are financing these wars by foreign borrowing rather than taxing ourselves is only one cause of this decline.   The other is our massive trade deficit.  But the two are inextricably related.  The hundreds of billions of excess American dollars which the Chinese invest in our government debt is what makes the budget deficit possible. Without this annual infusion of money, the U.S. could never borrow that much, and taxes would have to be raised to cover our war spending, our stimulus, our interest payments, and all other spending.  But all of the increase in taxation would have to fall on the top 1%, because those earning under $150,000 a year are already overtaxed, if payroll taxes, state income taxes, property taxes, sales taxes, and miscellaneous other taxes are considered. The only under-taxed wealth left in the country is held by the top 1%, and they know it. That’s why they don’t want to end the trade deficit.  Yet every time we move another million jobs to China, they become more of an 800 pound gorilla and we become more of an insignificant, comic opera state, trembling at the mercy of its foreign creditors.
             When Warren Buffett says, “The trouble with this country is that rich people like me don’t pay enough taxes,” he’s absolutely right.  At the end of the Eisenhower administration, the top marginal tax rate was 92.5%.  Today it’s 35%, which is the same marginal rate paid by most working people.  And of course, the billionaires don't even pay the 35%--they arrange their affairs so that all income is a capital gain, taxed at 15%. Granted, only a handful of billionaires paid at the 92.5% rate, and they often avoided this tax by giving most of their earnings to charity.  But most working people back then paid less than 10%.  In 1959, I had a good union factory job and my gross wage was exactly $100.00 per week.  One hundred dollars was a lot of money then. You could buy a new six-cylinder Ford pickup truck for $1,800.00.   But my take home pay, after federal income tax, state income tax, FICA tax, and union dues was still $89.00.  As a percentage of GDP, the government took in more tax then—but not from working people.  The failure of economic elites to pay serious tax is now the cause of most of our problems.  Our failure to invest in infrastructure, in education, and in advanced research is the most visible outcome.  But our trade deficit and general industrial decline is another.
            The economic elites (the people which Justice Wm. O. Douglas once called “organized money,”) have been accumulating wealth since the Reagan administration.  What, besides hoarding it have they done with it?  They have invested it very wisely.  Besides buying factories in low wage countries, they now own all major media outlets and most of the United States Congress.   (A wise investment indeed!)  More campaign money flows from Wall Street to both parties in Congress now than from all other sources combined.  This being the case, it is axiomatic that no serious action will be taken to end the trade deficit anytime soon.  But if, by some political miracle, the American people were to regain control of their country, would there be any action that could be taken to end the trade deficit?
            One thing that Keynes was very clear about:  tariffs  don’t work.  If two countries each start raising tariffs on arbitrarily chosen targets of their competitor’s goods, as each responds, tit for tat with additional trade restrictions,  the result is a trade war that hurts both workers and consumers on both sides. Keynes also did not approve of currency devaluation as a solution, because eventually every country in the world would respond by cutting their own currency value, till all currency everywhere is worth nothing.  It’s a race to the bottom.
            Keynes demanded a trading system where no country could run a surplus, but he ruled out tariffs and currency manipulation as tools to achieve this end.  Instead, he envisioned a world order in which trade surpluses were simply outlawed by a commonly agreed upon trade treaty.  Having failed to implement such a treaty, is there anything which we could do unilaterally at this point?  I believe there is.
            On Nov 10, 2003, Fortune Magazine published an article by Warren Buffett about the trade deficit.  He briefly outlined the damage now being done by our current trade policy, and the disastrous consequences which will result if we try to pursue this policy much longer.  Then he explained what our alternatives are. His suggestion is that we enact an “Import Certificate” plan.   In this plan, at some point in time, we would begin issuing to American exporters, certificates for every trade transaction in which American goods is sold to a foreign buyer. The certificates would be issued in proportion to the size of the sale.  Sell a thousand dollars worth and you get a one thousand dollar import certificate.  Then, a few months later, all goods entering the U.S. would have to be accompanied, dollar for dollar, by such certificates, to be surrendered to the U.S. customs service.  All other trade restrictions would be phased out.
            He then went on to explain that such a plan would have many advantages.   First, it recognizes the fact that trade is a multi-lateral exchange—not bi-lateral.   A country might run a large deficit with one country, but run a surplus with several others.  As long as the overall picture is in balance, there is no problem.  The import certificates would be negotiable, and could be traded on commodity markets like wheat or pork bellies.   Exporters could sell the certificates which they would accumulate to whoever wanted them, using the proceeds to lower the price of products offered to foreign buyers, thereby making American exports more competitive.  Another advantage is that such a plan would not subsidize or penalize any one particular industry or country.  What to buy and what to sell would still remain a market based decision.  But America as a whole would be exporting exactly as much as we would be importing. 
            One of the obvious flaws of tariff based strategies is that they are imposed piecemeal, and the tariffs which Congress is most likely to enact are those intended to protect the most vulnerable industry, usually an industry that might be in bad shape even without the unfair foreign competition.  And if our trading partner responds by a counter tariff on some American product, what will they target?  Probably the product that has penetrated their market most deeply, ergo, the product of our most efficient industry.   So we would end up punishing our most efficient industry to prop up one that will likely fail any way.              
            But the Import Certificate Plan would not do this—it would do the opposite.  If the demand for import certificates induces foreign companies buy goods from America, what will they choose to buy?  They would buy whatever is the best deal for the money, ergo, the product of our most efficient industry. And if a foreign competitor had to buy import certificates and add that cost to the price of his product, that fact alone would make American products more competitive at home, and allow some American manufacturers to stay in business who might otherwise fail. But if some American product were truly inferior or overpriced, it could still fail.  So an import certificate plan would boost our best industries, discipline our worst ones, and do so without having a trade war.
            Buffett concedes that such a plan might not be perfect, but our present deficit cannot continue forever.  When I first became aware of the Fortune article, I was quite surprised. A friend called me and said I would find it very interesting. That friend and I had been part of a grass roots effort twenty years earlier to prod Congress into doing something about the trade deficit—and we had proposed an initiative very similar to Buffett’s idea.  We sent copies of the plan to about fifty congressmen and a dozen senators.  Most of the replies were pro-forma responses, but a few were thoughtful replies that indicated that someone had actually read it and taken it seriously.  A few even suggested that if we ever get serious about solving the problem, this might be what we should try.