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4th Quarter GDP Shows Economy Heading Upward
Howard Richman, 1/29/2010

Real GDP grew at an annual rate of 5.9% according to the January 29 press release from the Bureau of Economic Analysis:

Real gross domestic product -- the output of goods and services produced by labor and property located in the United States -- increased at an annual rate of 5.7 percent in the fourth quarter of 2009, (that is, from the third quarter to the fourth quarter), according to the "advance" estimate released by the Bureau of Economic Analysis. In the third quarter, real GDP increased 2.2 percent.

The Bureau emphasized that the fourth-quarter advance estimate released today is based on source data that are incomplete or subject to further revision by the source agency (see the box on page 4). The "second" estimate for the fourth quarter, based on more complete data, will be released on February 26, 2010.

The increase in real GDP in the fourth quarter primarily reflected positive contributions from private inventory investment, exports, and personal consumption expenditures (PCE). Imports, which are a subtraction in the calculation of GDP, increased.

Back in November, most predictors expected that GDP would grow at less than a 3% rate, according to a November 16  survey published by the Federal Reserve Bank of Philadelphia:

The U.S. economy will grow over each of the next five quarters, according to 41 forecasters surveyed by the Federal Reserve Bank of Philadelphia. The forecasters see real GDP growing at an annual rate of 2.7 percent this quarter. On an annual-average over annual-average basis, forecasters see real GDP falling 2.5 percent in 2009 before rebounding in each of the following three years. Real GDP will grow 2.4 percent in 2010, 3.1 percent in 2011, and 3.3 percent in 2012. As the table below shows, these estimates are a bit higher than those the forecasters projected in last quarter's survey.

I was the worst predictor. In a November 23 Seeking Alpha commentary, I predicted that GDP would shrink during the fourth quarter. I gave the following reasons:

  1. Trade. The widely reported statistic that real GDP rose by 3.5% during the fourth quarter was obtained by multiplying the actual increase of 0.87% by four (by assuming that the same rate of increase would continue for the next four quarters). And that was before the September trade deficit data came in much worse than expected. It will be revised downward when the final estimates are reported.
  2. Housing Starts. During the third quarter, first time home buyers moved forward purchases planned for future quarters because they thought that the tax subsidies for first time home buyers would expire. The 0.87% increase in GDP during the third quarter was led by a 5.4% rise in fixed investment in residential structures. But housing starts declined by an "unexpected" 10.8% from September to October. As a result, there will be a decrease in fixed investment in residential structures during the fourth quarter.
  3. Exchange Rates. There is no prospect for further exchange rate fall for the dollar. The dollar-euro exchange rate has stabilized at below $1.50 per euro. The dollar-yen exchange rate has stabilized at above 88 yen per dollar. President Obama just came back from an Asian trip during which he failed to persuade Chinese leaders to stop pegging the dollar-yuan exchange rate. Nonresidential fixed investment in the American economy fell by 0.64% during the third quarter. It has now fallen for five straight quarters and is likely to fall during the fourth quarter of 2009.

How did my specific predictions do?

1. Trade. Indeed, as I predicted, the third quarter statistics were revised downward, largely due to a revision of the trade numbers. That's one of the main reasons that the 3rd Q GDP declined from 3.5% in the initial estimate to 2.2% in the final estimate.

2. Residential Fixed Investment. I predicted that residential investment would fall during the fourth quarter, but it actually increased, albeit at a slower rate than the third quarter. The initial estimate of the third quarter growth was 5.4%, which was eventually revised down to 4.4%. The initial estimate of the fourth quarter growth rate in this statistic was 1.4%. The residential construction surge that began during the third quarter is continuing, but at a much slower rate.

3, Exchange Rates. I was correct that the dollar would not continue to fall against other currencies. The dollar-euro exchange rate has indeed stabilized at below $1.50 per euro, the latest is $1.40 per euro. . The dollar-yen exchange rate has indeed stabilized at above 88 yen per dollar. It is now 90.3 yen per dollar. But despite the lack of improvement in the exchange rate, business fixed investment increased at an annual rate of 0.7% during the fourth quarter, the first increase in many quarters, as shown in the graph below:


A large part of the GDP surge was due to an increase in automobile inventories by car dealers. Car dealers apparently waited until the 2010 models were available during the fourth quarter before they replenished inventory following the sales surge caused by cash for clunkers. This surge will not be sustained.

But don't expect falling GDP this year. The economy has turned the corner. Fixed investment started heading up. The rise in residential fixed investment (1.4% annual rate during the fourth quarter) and in business fixed investment in structures and tools (0.7% annual rate during the fourth quarter) bodes well for the future.

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Book Review of Weyrich and Lind, The Next Conservatism
Raymond Richman, 1/26/2010

Paul M. Weyrich & William S. Lind, The Next Conservatism (South Bend, Indiana: St. Augustine’s Press, 2009)

In a column he wrote on the day he died at the age of 66 in December, 2008, Paul Weyrich wrote, “It is the worst of times because conservatives appear lost and without a serious agenda or a means of explaining such an agenda to the Public. It is the best of times because … the Next Conservatism .. should ignite a meaningful debate about the future.” This review joins that debate.

The simplest way to define conservatism is that it is the policy of preserving institutions and policies that are good and resisting changes that are bad. Some environmentalists consider themselves conservatives, wanting to retain nature in its pristine form wherever it can. At the same time, they want to roll back man’s intrusions into that pristine environment. There is cultural conservatism that wants to preserve Judeo-Christian religious values and beliefs and rejects challenges that weaken such values and beliefs. Then there is political conservatism which wants to preserve the policies that have made the U.S. powerful, our constitution and the free market that have enabled our economy to innovate and create the highest living standards in the world.

The “next conservatism” includes most of the social and political positions of the old conservatism. It opposes abortion but the authors would not make abortion illegal. It supports traditional marriage. It advocates lower marginal tax rates and reduced government spending and a balanced budget. It advocates a strong national defense. It wants better control of our borders and wants English to be the only official language. These old goals remain important but there are new challenges, they believe, that require changes which they call the “next conservatism.”

The “next conservatism” must deal not only with dangers by the state but dangers to the state. The dangers by the state, we agree, are constant. The continuing growth of government and weakening of the constitutional restraints on government’s growing intervention in the economy require strong action by conservatives. But we disagree fighting terrorists poses a threat to our liberties. They ask, “What indignities will we have to undergo to get on an airplane after the first terrorist employs an explosive suppository.”  [How prescient!] But we believe the greater danger is from those who want to extend our civil rights to enemy terrorists and try them in our civil courts. In our view, they should have no right to trial or release until the war is over; in this case, the war on terror. As for invasion of our privacy and civil liberties believed by the government to be necessary to expose and fight terrorism, conservatives can argue against the abuse of the information collected, i.e., using it for purposes other than the war on terror.   

The authors rightly ascribe many societal ills to multi-culturalism which equates good cultures and bad ones. It equates a culture based on Judea-Christian values with voodooism; it equates an economy that brought hundreds of millions of people out of poverty with one with communist-fascist values that murdered tens of  millions and impoverished hundreds of millions on its way to failure. They believe there is a need for “retroculture,” restoration of Judeo-Christian culture to counteract cultural conservatism. Conservatism they write is a way of life, not ideology. We believe that conservatism is essential both to progress and stability.

They argue that we need to substitute conservation for environmentalism, conservatives should support family farms, farmers’ markets, and organic farming, that conservatives should be against autos and favor trolleys. We believe that none of the foregoing are a matter of conservatism. All of these have to justify themselves. Conservatives should ask, “Do these require a government subsidy to sustain themselves?” If so, there have to be other reasons why taxpayers should support them. We do not see a conservative position on conservation versus environmentalism. Any government policy must justify itself by an evaluation of all its benefits and costs. These need not be monetary, but social benefits should not be overvalued.   

They argue against foreign wars and adventures. They write that we cannot force democracy on the rest of the world. But there are some just wars, World War II for example. They argue that our invasions of Iraq and Afghanistan were wrong. Some of those advancing that argument approved of our invasion of Kosovo and the bombardment of Bosnia. These are all political, not conservative decisions. The conservative position is don’t go to war unless you can win it at a justifiable cost and your reason for going must meet the test of the first conservative principle: conserve what is good and be careful about what you change.

They reject the national security state, as represented by the Patriot Act enacted after 9-11which increased the ability of law enforcement agencies to search telephone, e-mail communications, and financial records and gave law enforcement authorities the power to detain immigrants suspected of terrorism-related acts. How far the state should go domestically in fighting its foreign and domestic enemies is a policy issue that has to do with survival. We believe that this is not a conservative vs. leftist issue.

The ACLU position appears to be that even terrorists are entitled to civil rights.  The authors do not go that far but believe conservatives should oppose invasion of the privacy of Americans. Pres. Lincoln suspended the right of habeas corpus. His action is still being debated. Fortunately  for him (and the country), the Union won the war. What if we lose the war on terror? We would lose all our rights, including the right to speak English!

They appear to be for term limits, for referendum, initiative, and recall, and a level playing field for elections. In our opinion, these often run counter to conservative values.  Sometimes, they achieve results that conservatives support. But they are not intrinsically conservative values. We believe that the essence of government in the U.S. is that it is a republic, that our representatives make the laws.

They believe our failure to achieve conservative values may force conservatives to secede and create our own homogenous islands like the home-schoolers, the Amish, and so on. We understand homeschoolers wanting to avoid the brain-washing of the multi-culturists and the Amish wanting to preserve their culture, but that is no solution to the national need to promote conservative values for the preservation of the United States.

We are in full agreement with their position on international trade. They write:

If economic efficiency means, for example, that America should send all its manufacturing jobs overseas, as free trade seems to demand, the next conservatism should not say, “Oh, well, I guess we have to go along with it.” Better we toss our sabots into free trade’s grinding gears. Economic security requires that people be able to get good-paying jobs, which means manufacturing jobs.

As economists, we maintain that nothing in economic theory justifies the foolish unilateral free trade policy we’ve followed the past three decades which cost millions of industrial workers their good-paying jobs, caused the wages of American workers to stagnate, worsened the distribution of income, and contributed to the current recession. That is the case we made in our book, Trading Away Our Future (Pittsburgh, PA., Ideal Taxes Association,  2008)

On the other hand, we take exception to their approval of  “a new infrastructure of bus routes, streetcar line, electric interurban railways,”  as a means of freeing America from dependence on foreign oil. The environmental extremists say the same but they are not conservatives. Let the free market and freely fluctuating prices decide which mode of transportation is most efficient and let American households and businesses decide for themselves. The authors are on a slippery slope here.

We believe we have plenty of domestic energy resources but the man-made climate change environmentalists have been successful in preventing the successful exploitation of our oil and gas reserves and nuclear energy production. Eventually we shall begin to run-out of fossil fuels and the ensuing rise in prices will encourage the exploitation of alternative fuel sources. But to do it prematurely is like building an apartment building and keeping it vacant for fifty years.

They argue for tort reform and so do we, and not only because it increases the cost of health care. Our opposition is based on the fact that juries are awarding punitive damages to plaintiffs. But punishment should be decided in a criminal proceeding with the fine paid into the government treasury, not into the pockets of the plaintiff.  Civil proceedings should be based upon the principle of fairness, and should not involve punishment.

Weyrich and Lind have opened a debate that should be joined by all who consider themselves conservatives. They have put forward a number of arguments that conservatism has to change to meet the changing conditions that our country faces. They have suggested changes they call the “next conservatism.” Some are true conservative principles but others are policy issues that need to be evaluated based upon a careful analysis of the costs and benefits.

True conservatism never changes. It is the system of thought that tells us that the past has much to teach us about the present. It is the study of the good forces that have contributed to human well-being and of the bad forces that have been harmful. Conservatism doesn't provide all of the answers. Often we must engage in a careful analysis of the costs and benefits of a policy action, including the unintended consequences. But conservatism allows us to conserve what is good in the world, and fight what it is evil.

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Ha-Joon Chang takes on Free Trade in his book The Bad Samaritans
Howard Richman, 1/26/2010

For an excellent interview with the author, see The Free Trade Heretic by David Sirota at Partly, Chang is taking on the economics profession. Here's a selection from the interview. Here's Sirota's question:

Bad Samaritans claims that most trade “experts” ignore the history of trade policy in building up industrialized countries. Specifically, you assert that protection and tariffs — not free trade — have always been a cornerstone of any successful industrial policy. Why do you think these experts ignore this history?

And here is part of Chang's answer:

When 99 percent of economists believe in free trade, it is easy to pretend that the 1 percent does not exist or that they are incompetent. With their numerical advantage, free-trade economists can always assert that professional consensus is on their side. Of course, if the numerical majority was always right, the sun would still be going around the earth and the earth would still be flat.

Reminds me of what I wrote in my April 10 2009 posting The Age of Scientific Conformity

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Ralph Gomory: The time has come to take Warren Buffett's Import Certificates plan seriously
Howard Richman, 1/24/2010

Ralph Gomory called for balanced trade in today's Huffington Post. The Obama administration could still succeed if they would just start listening to him. Here's a selection:

We may very well need to tackle the trade issue in the direct and head on way that Warren Buffet suggested in his insightful Fortune article in 2003. In this article he described his Import Certificates plan. The Buffet plan is something that we can carry out without the agreement of other nations, and it is something that would actually balance trade. The time has come to take this plan seriously in place of the endless talk that only postpones the day of reckoning.

The entire commentary is worth reading. Here's the link:

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The Age of Scientific Conformity
Howard Richman, 1/23/2010

[originally published on our old blog on April 10, 2009]

We live in an age of scientific conformity that is the result of the peer-review system for determining whether a scientific paper is worth publishing and whether scientific research is worth funding.

There are two types of standards that can be used in judging science: (1) objective standards based upon a theory's ability to make predictions and (2) subjective standards based upon the popularity of a theory among scientists. In this age of scientific conformity, objective standards are often ignored.

Take the case of Gioacchino Giuliani, a researcher at the Gran Sasso Physics Institute in Italy. He predicted the recent Itallian earthquake and tried to warn the populace. But scientists who oppposed his theory convinced the local politicians to suppress Giuliani's warnings while convincing the local press to ignore his alarms. Wikinews reports the story. Here is a selection:
Giuliani claims to have predicted the quake by monitoring radon gas emissions. Last month, cars with loudspeakers drove around the area, broadcasting the researcher's warning that a quake would soon strike. He was then reported to the authorities for making false alarms, and was obliged to remove his findings from the Internet....

Giuliani holds a patent on a device measuring atmospheric levels of radon in order to predict earthquakes. In 2005 he gave a seminar at Gran Sasso discussing the device and its use to predict tremors in the area of L'Aquila, but has not published papers on the topic....

The use of radon levels to anticipate seismic events has been under study by the seismological community since the 1970s, but a generally-accepted proven link has not been established.
Or take climate change. The carbon dioxide global warming theory has been unable to make accurate predictions. Michael Crichton, author of many science fiction books about man-made disasters, started out to write a book about the coming climate disaster. But when he did his research, he discovered that the predictions made by the carbon dioxide theory were not coming true. He ended up writing State of Fear, a book that debunks that theory. He drew heavily from the writing of retired professors who no longer had to conform.

There is now an alternative climate change theory, cosmoclimatology, which is being developed by scientists from countries where peer pressure is less powerful than it is in the United States. Cosmoclimatology has been able to make many accurate predictions. Every step of the theory has been proven: (1) cosmic rays cause ionization, (2) ionization causes cloud formation, (3) low lying clouds reflect sunlight and heat back into space, and (4) solar activity wards off cosmic rays. This theory precisely predicts the periodic ice ages and greenhouse ages of the geological past as well as the opposite temperature trends in the northern hemisphere and Antartica. It also successfully predicts the current cooling period resulting from low solar activity. But the entire field of cosmoclimatology is ignored by the American press.

For example, Marilyn Head wrote a report this week for ABC Science about the current cooling of the earth in correspondence to the quieter sun, a prediction made by cosmoclimatology. But instead of interviewing a cosmoclimatologist, she interviewed a New Zealand mathematician who claimed that there was no scientific basis for a link between solar activity and earth temperatures. Here is a selection:
Dr Sean Oughton, an associate professor of mathematics at New Zealand's Waikato University, says the sun's lack of solar activity is expected.

"What we are experiencing is a very deep solar minimum, but it is still completely within the bounds of what is normal," he says....

He says no mechanism has been found which would prove a connection between minimal sunspot activity and cooler temperatures.
There you have it. The refuge of the subjective scientists is to claim that “no proven link" has been found or that “no mechanism has been found which could prove a connection.” What they mean is that they have not yet been subjectively persuaded by the arguments of the theory's adherents.

In the field of economics, there is a similar phenomena. You can't get tenure as an economist in academia if you disagree with the consensus that unilateral free trade is always the best policy. Economists invariably "prove" the benefit of unilateral free trade with examples in which trade is in balance. They never consider what would be the effect of unilateral free trade upon on a country running trade deficits.

My father broke with the conformist thinking of the economics profession in a September 2003 commentary in the Pittsburgh Tribune Review which advocated balanced trade. He did not have to fear that he would lose out on publications, promotions, or research money because he had already retired.

We expanded his 2003 piece and brought it up to date as part of our 2008 book Trading Away Our Future. Even though we predicted what is happening now and will happen in the next several years, nobody in the economics profession will review our book because doing so might encourage "protectionism."

The problem is the over-conformity encouraged by the peer-review process. Government research grants should no longer be authorized by peer review. Instead, they should be contest awards for the research work that makes the best predictions or achieves engineering goals. Predictions and achievements are the measure of objective theory. Peer review is the conformity-enforcing process that is currently corrupting science.

I am not the only researcher to identify this problem. Scientists all over the country are arriving at the same conclusion. University of Washington professor of surgery, Donald W. Miller, and University of Washington professor of bioengineering Gerald Pollack were two of the scientists from the Seattle area who hold the same belief as noted in an March 2008 editorial column about enforced scientific conformity in the Seattle Times by Bruce Ramsey. Here is a selection:
Here is a list of beliefs in the biomedical and climate sciences that must not be questioned if you're applying for a government grant:
  • That global warming is caused by humans;

  • That AIDS is caused by a virus;

  • That radiation, cigarette smoke and other toxins are dangerous in proportion to their strength, no matter how small the dose;

  • That heart disease is caused by saturated fats;

  • That cancer is caused by mutations.
This is part of a list offered by a University of Washington professor of surgery, Donald W. Miller, who is a heart surgeon at the VA Medical Center in Seattle....

What that means, Miller says, is that "If you say low doses of radiation aren't bad for you, or that global warming is due to variations in the sun, you can't get funded."

He says this happened to University of California scientist Peter Duesberg, who challenged the viral theory of AIDS, and to Harvard's Willie Soon, who challenged the pollution theory of global warming, and to others. In a paper published in 2007 in the Journal of Information Ethics, Miller argued that conformity is built into the system of government grants....

In 2005, in the scientific journal Cellular and Molecular Biology, Pollack made an argument similar to Miller's. American science, he wrote, has become "a culture of believers" whose rule is, "just keep it safe and get your funding."
The press has an important role here. Reporters must learn to ignore the scientists who are trying to suppress the predictive theories. They should no longer ignore earthquake warnings. They should no longer ignore cosmoclimatology. They should no longer ignore plans that would achieve balanced trade. Instead, they must learn to ignore barriers set up by incompetent scientists and give a hearing to those scientists whose predictions are coming true.

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A Review of Ron Paul's End the Fed
Raymond Richman, 1/23/2010

[This review was initially published on our old blog on October 12, 2009]

Congressman Ron Paul has just published his latest book, entitled End the Fed (NY: Grand Central Publishing, 2009). He writes:
The Federal Reserve should be abolished because it is immoral, unconstitutional, impractical, promotes bad economics, and undermines liberty. Its destructive nature makes it a tool of tyrannical government. … The Federal Reserve’s monetary policy has brought us to where we are today – in a tragic economic mess.

Not a word of this is true. What brought us to the mess we are in is without doubt the economically illiterate Presidents of the United States and economically illiterate majority of Senators and Representatives of the Congress of the United States, in which “august” group Rep. Paul finds himself.

The Federal Reserve is the central bank of the United States, a quasi independent institution that Congress established in 1913 to regulate the supply of money and supervise the banks. Until its creation, money consisted of the banknotes issued by the individual private national banks which by law were redeemable in gold or in the coins and currency issued by the U.S. Department of the Treasury. When a recession occurred, caused usually by too many private banks making too many risky loans, they were faced with bankruptcy as they began to run out of gold or Treasury money. Most of the money in circulation or in the banks today consists of banknotes issued by the Fed.

Rep. Paul ignores the fact that while we were on the gold standard, we experienced the Great Depression, the panic of 1907, often credited as the principal reason for the creation of the Fed, not to mention the recessions in the 1890s, the 1870s, and the panic of 1857 and earlier periods of recession.

The Fed consists of a Board of Governors appointed by the President, currently chaired by Chairman Ben Bernanke, the Federal Open Market Committee which buys government bonds when the Board votes to increase the money supply and vice versa when it wants to decrease the money supply, twelve Federal Reserve Banks owned by the member banks in their districts, and the private member banks which are required to subscribe to non-transferable stock in the Federal Reserve Bank of its district.

Under the Full Employment and Balanced Growth Act of 1978, the Fed is charged in Section 108 with making an annual report to the Congress setting forth a review and analysis of recent economic trends, the objectives and plans of the Board and the FOMC with respect to the ranges of growth or diminution of the monetary and credit aggregates, and submit the report to the Senate and House committees on banking, finance, and urban affairs. The purpose of the act was to achieve and maintain full employment, growth, and “reasonable” price stability, with proper attention to national priorities.

Congress Caused this Mess, Not the Fed

Rep. Paul states, “I’ve written this book to explain why I think the system of Fed domination must come to an end.” According to the Full Employment Act, the Fed reports to the Congress. It is Congress that dominates the Fed not vice versa. You could make a much better case to abolish the Congress than the Fed. The Fed did not cause this mess; Congress did. It was Congress that passed the Community Reinvestment Act in 1977 and Presidents GHW Bush, Clinton, and GWBush who strengthened it.

Fannie Mae and Freddie Mac were encouraged to provide a secondary market for bad mortgages. Congress brought pressure on banks to make mortgage loans to unqualified borrowers. Why not make mortgages available to everyone? Democrats wanted the poor to own their own homes and Republicans wanted every family to own its own home because homeowners tend to be conservative.

The CRA enabled community groups like ACORN to blackmail the banks and to get paid by the U.S. government to do so! Wall Street soon saw a way to profit from such government policies, but when the housing bubble burst, the entire financial system was about to go under.

The Treasury used TARP money to bail out the banks and the Fed did as much as it could to reduce interest rates and increase the money supply to prevent a collapse of the economy. It has little to apologize for. Congress should apologize; the CRA has not even been repealed.

It is Congress that does the decision-making and the appropriating. And the Fed is bound by the rules of the game to do the best it can to minimize the harm that wasteful government expenditures cause.

Ron Paul Ignores Trade Deficits

The other major causes of our economics problems are our chronic trade deficits, which are also the primary cause of the dollar's weakness. These trade deficits on goods rose to the enormous sum of over $800 billion dollars in 2008, and cost 5 to 7 million industrial jobs, thus worsening the distribution of income.

Rep. Paul is proud of being a free trader. Free trade works when there are no barriers to trade as in the USA. It does not work when our trading partners like China pursue mercantilism as a policy, with all kinds of barriers to our exports and all kinds of subsidies to their exports to us, including refusal to let her currency fluctuate and to allow her citizens the dollars to buy our goods. (See our book, Trading Away Our Future, 2008).

Unilateral free trade is not a sound policy no matter what Ron Paul and his teachers of the Austrian school say. The purpose of trade is to buy goods one values more in exchange for goods of equal value one values less. Most American economists in academia unfortunately have been brain-washed to extol free trade. None of them face international competition, the same goes for Congressmen and their staffs and government employees.

The Fed and Money

Rep. Paul states that his great teachers belonged to the Austrian school of economics. I am in total agreement with the Austrian school that the growth of government is a threat to individual liberty. Yet someone has to produce goods and services that are worth doing and which the private sector cannot do, will not do, or cannot do as well, like public goods.

One of the services that the government must do if it is to be done well is to maintain the quantity of money at a level that promotes price stability and is adequate for sustained growth and full employment. An independent agency free from political bias is required. The Fed was created to do the job. I know of no agency or institution, certainly not the free market that is better structured to do the job. Federal consumption of goods and services plus investment as a proportion of GDP was 7.5 times greater in 2008 than it was in 1929. Not too bad a record.

The Fed when it creates money does so because it believes it to be necessary for growth of the economy, or to prevent unemployment, or to stimulate investment or consumption or both. Its decisions may be wrong but they are not always wrong. Given the growth of the economy since 1929, it has erred more by making money easier that by keeping the expansion in check. The median change in GDP from 1929 to 2008 was 3.6 percent annually. Not a bad record, we believe, given the number of negative years in depression and recession.

The Fed and War

Rep. Paul argues that central banks facilitate war: "It is no coincidence,” he argues, “that the century of total war coincided with the century of central banking.”

In his view, central banks make it easy for governments to raise money. Aside from the fact that nothing stops a government from printing money itself without issuing debt, the reason for wars has nothing to do with the supply of money. It would be more accurate to say that economic growth creates the ability to wage expensive wars. Financing wars by domestic debt or printing money simply allocates a larger share of the national income to the government to use as it sees fit.”

Governments do often finance their war on borrowed money. What is the central bank supposed to do? Veto the government?

Hitler argued that Germany needed “lebensraum” which he thought could only be accomplished by force. Economic growth is what enabled Germany to do as well or better post-war as territorial acquisition could or would have. Wars are the result of political decisions. We were involved in WW II? Did our central bank cause it? The German, the Bank of England, the French?

The Way Out

What does Ron Paul suggest we do after we abolish the Fed? He fails to make a philosophical or economic case for ending the Fed. His chapter entitled “The Way Out” continues to blame the Fed for our debt when it clearly was the Congress and the Executives that must bear the responsibility. He writes: “In a post-Fed world, we will still have the dollar, banks, ATMs, online trading, Web-based systems of fund transfer” and so on. “What will be added to the system will be vastly more financial options that are currently being kept at bay, including trading and contracting in many different currencies and new, sounder investment opportunities.”

Money would be “a market-created good that emerged out of trade … whether that be beads or animal skins or jewels or precious metals. Gold became money because it had all the properties people look for in a good money. Government had nothing to do with it.” “At the same time, the dollar would be reformed so that it again would be redeemable in gold.” Where will the gold come from?

Whatever this is, it is not economics. Physician, heal thyself, or take some courses in money and banking or even Econ 101 from a teacher who is not a member of the Austrian school. This book makes the Austrian school look bad. The book has no index, no footnotes. It is not a book worth reading.

We are attracted by the Rep. Paul’s consistent conservative record in the Congress on spending. We disagree on some foreign policy issues including his view that wars are all bad. We’re glad that we are not forced to speak German or pray to Allah. But thanks to the Congress, not the Fed, all of us had better be learning Chinese!

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Volcker may have replaced Summers as Obama's chief economic advisor
Howard Richman, 1/22/2010

Possibly as a result of the Republican victory in the Massachusetts Senate race, President Obama appears to have changed economic advisors. His bank reform ideas come from the previously-ignored Paul Volcker, not Larry Summers, who made economic policy last year. The White House's January 21 Press Release features Paul Volcker, but does not even mention Summers by name. It begins:

WASHINGTON, DC- President Obama joined Paul Volcker, former chairman of the Federal Reserve; Bill Donaldson, former chairman of the Securities and Exchange Commission; Congressman Barney Frank, House Financial Services Chairman; Senator Chris Dodd, Chairman of the Banking Committee and the President's economic team to call for new restrictions on the size and scope of banks and other financial institutions to rein in excessive risk taking and to protect taxpayers.

Volcker was America's most competent Federal Reserve Chairman ever. He slowed the increase in the money supply in order to reduce the inflation rate from 10.4% in the first quarter of 1981 down to 3.3% in the third quarter of 1984.

In contrast, Summers may be America's most incompetent economic advisor ever. He let Congress take most of the infrastructure spending out of Obama's recovery plan. He let China grow by stealing our manufacturing jobs. He has wasted hundreds of billions of dollars in taxpaper money in a doomed attempt to keep house prices from falling to their normal values. He has added more than a trillion dollars to the American government debt, creating huge problems for the future.

I don't know whether Volcker will be able to get America out of the Great Recession. But I do know that the policies that he will suggest will be based upon America's long-term good, not just short-term considerations.

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Why There Has Been No Keynesian Multiplier
Raymond Richman, 1/21/2010

The Keynesian multiplier posited that an increase (decrease) in investment (I) or in government purchases (G) will cause an increase (decrease) in national output equal to 1/(1-MPC) where MPC is the percent change in consumption that results from an increase in income.  To illustrate, an increase in domestic investment of $10 billion will increase income directly by $10 billion. If the MPC is 80 percent, the recipients will spend $8 billion on increased consumption, the recipients of the $8 billion will increase their consumption by $6.4 billion, which in turn will increase consumption by $ 5.12, and so on. The increase in I plus the successive increases in consumption amount to $50 billion. We believe there is no multiplier effect from governmnent-financed temporary employment. Mulltiplier effects can be expected only when enduring jobs are created increasing expected lifetime income, a conclusion that follows from Prof. Milton Friedman's hypothesis that consumption depends on expected lifetime income. Jobs that are expected to be temporary do not have multiplier effects.

The Bush and Obama administrations spent several hundred billions in the TARP program to stabilize the banking system in the belief that the banks in turn would make  loans to businesses. No demand for loans for investment in factories and equipment materialized and there was no increase in private investment and therefore no multiplier effects. Pres. Obama's so-called economic stimulus program spent a couple of hundred millions to stimulate public works which created no expected increase in lifetime income because of the temporary natrure of the jobs created and spent  hundreds of billions more on programs that simply supported existing state government budgets. No job creation there! It subsidized some school construction but created few jobs. Unemployment continued to rise throughout Pres. Obama’s first year which accords with the permanent income hypothesis.

We have no quarrel with the idea of the multiplier when it is applied to increases in productive investment. Our quarrel is with those who believe the multiplier applies to purchase of financial assets of financial institutions, to support of state and local government budgets, to subsidies like “klunkers”, to buying mortgages, to nationalizing businesses and insurance companies, to the gifts made to households by the Bush and Obama administrations, or to payments of unemployment compensation, etc., etc. None of the legislation that the administration has been pushing – health care, capping carbon emissions, man-made global warming grants and subsidies -- create enduring jobs.

There would be a multiplier only if there were increased private investment in enduring productive facilities. Unfortunately, private investment in manufacturing and construction in the United States has been nil. Investment in renewable resources subsidized by government is offset by the inefficiency of such enterprises which for all practical purposed produce nothing of value. The electricity they produce if valued at the cost of electricity produced by fossil fuels, hydro-electric, and nuclear plants would result in a negative return on investment which means they are equivalent to digging trenches and then re-filling them. The higher prices of electricity reduce the income of households and raise the costs of producing goods. Lowering demand and leading to a negative multiplier. 

Nothing that either administration has done has positive multiplier effects.

Here are some of the things we have been recommending that do have multiplier effects:

  1. Stop the blood-letting of the enormous trade deficits. We recommend a cross-the-board uniform tariff to apply only to those countries with which we have been experiencing large chronic deficits. The purpose of trade is to exchange a basket of goods we value less for a basket of goods we value more. The rule should be balanced trade. Unilateral U.S. free trade is an abomination and has cost us millions of good industrial job s, caused wages to stagnate, and worsened the U.S. distribution of income.

  2. Drill, drill, drill. We have billions of barrels of oil, unlimited natural gas, and successive administrations, on behalf of environmentalist extremists, have barred drilling on public lands, offshore in the Atlantic, Pacific, and the Arctic. Millions of jobs can be created drilling, distributing, and processing. Our dependence of foreign oil would diminish.

  3. Repeal the Corporate Income Tax. Replace it with a value-added or other tax that can be rebated to     exporters under international rules. This will help level the playing field. Currently nearly all countries impose the value-added tax and rebate the tax to their exporters and impose the tax on our exports to them.

  4. The current and proposed tax treatments of capital gains by both parties are full of economic mischief. They encourage disinvestment, i.e. the sale  and consumption of capital gains. We want to encourage investment, not disinvestment. The only treatment that capital gains require is the “roll-over”. When capital assets, including houses, are sold, the capital gain should not be taxed if it is reinvested. When the gains are consumed, they should be taxed as ordinary income.

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Obama's Anti-Bank Rhetoric Fails in Massachusetts
Howard Richman, 1/20/2010

Just before yesterday's Massachusetts election, President Obama tried to skewer Republican candidate Scott Brown for opposing a just-proposed $9 billion tax on some banks. President Obama was trying to save the U.S. Senate seat for the Democrats through populist rhetoric. Blomberg reported:

“Bankers don’t need another vote in the United States Senate -- they’ve got plenty,” Obama said in Boston, signaling a broader political strategy to tie Republicans in this year’s races to Wall Street greed.
But it didn't work. Scott Brown,the Republican candidate in an overwhelmingly Democratic state, still won an overwhelming victory. Obama's attempt to paint Brown as a Wall Street lackey failed because the voters knew that Obama is the phony populist, while Brown is the real thing. Brown is a man of the people who serves in the National Guard and drives a pick-up truck. To Obama, the American pick-up truck is a clunker that should be scrapped.

Obama thinks that typical Americans are motivated by a desire to see the rich hurt. But typical Americans don't hate bankers; they oppose handouts to Wall Street because they understand corrupt pay-offs to campaign contributors. They aren't the frustrated hatemongers of Obama's mind when he reportedly told his contributors at an April 2008 San Francisco fundraiser:

You go into these small towns in Pennsylvania and, like a lot of small towns in the Midwest, the jobs have been gone now for 25 years and nothing's replaced them. And they fell through the Clinton administration, and the Bush administration, and each successive administration has said that somehow these communities are gonna regenerate and they have not.

And it's not surprising then they get bitter, they cling to guns or religion or antipathy toward people who aren't like them or anti-immigrant sentiment or anti-trade sentiment as a way to explain their frustrations.

The Scott Browns of America will eventually figure out how to bring back American manufacturing jobs. But the Obamas of the world will never understand them.

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Obama now claims to be a populist!
Howard Richman, 1/19/2010

President Obama is trying to skewer the Republican Senate candidate in today's Massachusetts election for opposing his new proposal to place a special tax on some banks. Here's a selection from the Bloomberg article about the Massachusetts Senatorial campaign:

“Bankers don’t need another vote in the United States Senate -- they’ve got plenty,” Obama said in Boston, signaling a broader political strategy to tie Republicans in this year’s races to Wall Street greed.

In the world of Obama, proposing a $15 billion tax on banks makes him a populist! But on Christmas eve he raised the limit from $400 billion that he is willing to shovel out to banks as part of his mortgage bailout, and he has done nothing about Chinese currency manipulations, which benefit American banks (who get Chinese money to lend), while hurting American producers. And let's not forget the Geithner Plan to rescue the banks from their troubled assets, which, as Paul Krugman noted, invites banks to play  "heads I win, tails the taxpayers lose." 

The top 10 campaign contributors to President Obama's campaign included Goldman Sachs, Citigroup, and JP Morgan Chase & Co, yet Obama wants us to think of him as a populist, representing the people against the banks.

He is right, though, when he said "Bankers don't need another vote in the United States Senate." The bankers don't need another Senator; they've got the President!

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Google Has Its Rosa Parks Moment -- I'm published by Seeking Alpha today
Howard Richman, 1/18/2010

Here's how I begin:

On Martin Luther King’s birthday we should also remember Rosa Parks who started it all. She got on a public bus in Montgomery Alabama and refused to move to the back of the bus, where blacks were supposed to sit. Then Martin Luther King organized the bus boycott that changed history.

Similarly, American corporations have been forced to sit in the back of the bus in China. Google (GOOG) was being forced to censor democratic opinion in order to do business in China. But Google had its last straw when the Chinese government hacked its website in order to read the gmail e-mails of Chinese dissidents.

You can read my entire commentary at:

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Larry Ringler: Google's courage may turn the tide in our dealings with China
Howard Richman, 1/17/2010

American Economic Alert is carrying an interesting commentary by Larry Ringer from an Ohio newspaper, the Tribune Chronicle. Ringler predicts that Google's courage in standing up to the totalitarian government of China may lead to a changed attitude among American businesses in general. Here's a selection:

The tide may finally be turning in the United States' delicate dance with China.

Recent decisions to slap tariffs on tires and steel tubes was a promising first step by the government.

Most recently, the private sector is drawing its line in the sand, thanks to Internet search engine Google's threat to give up the lucrative China market in a dispute over censorship.

And here's a selection from the official Google blog posting that got everything started, following Google's discovery that the Chinese, probably the Chinese government, have been hacking Google's website in hopes of reading the gmail e-mails of Chinese dissidents:

These attacks and the surveillance they have uncovered--combined with the attempts over the past year to further limit free speech on the web--have led us to conclude that we should review the feasibility of our business operations in China. We have decided we are no longer willing to continue censoring our results on, and so over the next few weeks we will be discussing with the Chinese government the basis on which we could operate an unfiltered search engine within the law, if at all. We recognize that this may well mean having to shut down, and potentially our offices in China.

The decision to review our business operations in China has been incredibly hard, and we know that it will have potentially far-reaching consequences. We want to make clear that this move was driven by our executives in the United States, without the knowledge or involvement of our employees in China who have worked incredibly hard to make the success it is today. We are committed to working responsibly to resolve the very difficult issues raised.

Sometimes all it takes to change is history for the better is for someone, finally, to stand on principle. Rosa Parks did it when she refused to take a backseat on a bus in Montgomery Alabama. Google is doing so today.

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Peter Navarro writes commentary on China's industrial espionage
Howard Richman, 1/16/2010

In a January 15 commentary in the San Francisco Chronicle, economist Peter Navarro discussed China's industrial espionage. Here is a selection:

China's recent cyberattacks against Google and as many as 33 other U.S. corporations open up a dangerous new industrial espionage front in Beijing's war on American business....

Chinese industrial espionage, along with other illegal means to acquire American business technology, is hardly new either. For example, an American manufacturer such as GM or Intel that produces in China must surrender some of its technology. Such forced technology transfer is clearly illegal under World Trade Organization rules, but U.S. executives meekly kowtow for a piece of the action.

Navarro urges that the United States government not allow such attacks upon American industry:

At the dawn of this new cold cyberwar, President Obama and Secretary of State Hillary Rodham Clinton must be clear: Any attack on America - from Pentagon hackings and industrial espionage to forced technology transfer and mercantilist weapons like currency manipulation - represents an act of aggression and will not be tolerated.

When will we elect leaders that will defend American industry from the attacks by foreign governments?

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Policies to Get the Economy Going
Raymond Richman, 1/15/2010

The news during the week Friday, January 8 to Thursday, January 14, 2010, was dominated by two events indicating a worsening economic outlook. The first was the disappointing employment news released by the U.S. Bureau of Labor Statistics that showed that total nonfarm payroll employment declined by 85,000 workers between November and December, 2009 while economists were expecting a much smaller decline as though any decline is good. The decline was led by a loss of 57,000 construction jobs and 27,000 manufacturing jobs. The former is understandable; the latter is scandalous.

The second was the trade data released by the Department of Commerce that showed that U.S. exports rose in November to $138 billion, up 0.9 of one percent but imports rose faster, up 2.6 percent to $175 billion, the difference equivalent to a loss of about 370 thousand jobs. Manufacturing jobs have been declining precipitously since the explosion of the trade deficits since the late 90s. This is the sector whose growth is the key to ending the recession. Below we offer some suggestions that will create millions of jobs in a few years and won’t require “trillion economic stimuli” based on a disproved theory of a Keynesian multiplier.

There are a number of reasons why we are not getting much investment in American manufacturing. The major reason is that it is much cheaper to produce goods abroad and export them to the U.S. than produce them here. The Obama administration and preceding Republican and Democrat administrations let Japan and Germany since WWII and China and other Asian countries more recently to employ mercantilist policies such as import barriers and export subsidies and keep their currencies undervalued in order to keep their products less expensive and American products more expensive. American manufacturers have learned that it is foolish to invest in manufacturing facilities in the U.S. They joined the club, producing abroad and exporting to the U.S.

 There is a simple solution, balanced trade. Under the rules of international trade, countries experiencing chronic trade deficits have a right to impose tariffs and restrict imports. My recommendation is that a uniform tariff of one-third or more be levied on imports from those countries and only those countries with which we have sizable chronic deficits. Some fear China will retaliate. As Prof. Paul Krugman wrote in a recent article, we have little to fear. Besides, retaliation would hurt China more than it would hurt us. They and we will talk the talk and walk the walk.

 Should the tariff be applied to oil companies who sell to the U.S.? Yes, to those which have large chronic trade deficits with us and belong to the illegal oligopoly called OPEC.

 There are many other actions we could take. Millions of jobs could be created quickly at no cost to the US taxpayer or even increase government revenues as the tariff revenues would.

Drill, drill, drill! Permit drilling for oil on public lands and off shore in the Atlantic and Pacific and in the Arctic (as Russia is doing). This would diminish the demand for foreign fuel and lower world prices even if we continue to import crude oil. Likewise, we should be encouraging the use of natural gas, which is abundant, as an automotive fuel. Huge amounts are available and a pipeline from Alaska is being built from Prudhoe to Alberta and Saskatchewan by Alaska, Canada, and Exxon-Mobile. Under pressure from leftist environmentalists, the U.S. administration and Congress has ignored the job-creating potential of prospecting, producing, and distributing additional supplies of oil and gas. Hundreds of good-paying jobs are being forfeited on the altar of environmentalism. (I am tempted to use the word “treasonous” to describe some of the policies of environmental activists. Recent evidence suggests that the hypothesis that global warming is man-made may have been a hoax perpetrated by leftist academics. A large number of distinguished physicists believe that changes in the sun’s geomagnetic emissions are the principal cause of climate warming and cooling, not carbon emissions. Carbon emissions are unable to explain the earth’s recent cooling that lasted more than a decade and continues to this day.)

Abolish the Corporate income tax to stimulate manufacturing investment in the U.S. A distinguished American economist has shown that corporations that sell in the U.S. are able to shift the burden of the tax to consumers whereas they cannot do so in international markets. This puts the American corporation at a great disadvantage. Whereas foreign nations are permitted to rebate value-added taxes under WTO rules, income taxes may not be rebated.  We should replace the corporate income tax with a value-added tax that can be rebated to our exporters and imposed on all our imports.

There is a lot we can do, but unfortunately we have elected one government after another  that talks the talk but doesn’t act.

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Jobs, Jobs, Jobs - We were published in American Thinker this morning
Howard Richman, 1/15/2010

Here is how we begin:

The economic news for January has been dominated by disappointing employment news released on January 8 by the U.S. Bureau of Labor Statistics. Total non-farm payroll employment edged down by 85,000 in December from November, led by a loss of 57,000 construction jobs and 27,000 manufacturing jobs. Public dissatisfaction with the Obama administration's handling of the economy has been following employment levels down.Here's how we begin:

Follow the following link to read the commentary:

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Doha Round stalls over US demand that India and China open their markets
Howard Richman, 1/12/2010

Currently the WTO lets developing countries, including China and India, pick "strategic sectors" and lets them charge 25% tariffs on imports in those sectors. China and India both picked vehicles as strategic sectors. As a result, American-made vehicles have been excluded from Asia's growing markets. Reuters India reports that the Obama administration is insisting that the Doha Round of the WTO talks make progress in this area:

One sticking point is a demand from the United States for developing countries such as India and China to abolish tariffs entirely in some industrial sectors. Such cuts are voluntary in the Doha negotiations.

The U.S. has said it cannot agree to a Doha deal unless big emerging economies do more to open their markets.

Meanwhile India's chief Doha Round trade negotiator D.K. Mittal told Reuters that India is not prepared to make any concessions in this area:

"The demand for sectorals coming from the U.S., that's an issue," Mittal said. "No country is willing to accept that, including India," he said, adding, "nobody is willing to give more to any country at this stage."

So far, I cannot find any public statements by Chinese officials on this issue one way or the other. They may be leaving it up to India to be the heavy in public.

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Ambrose Pritchard: America Slides Deeper into Depression
Howard Richman, 1/11/2010

In an analysis that parallels my own, British journalist Ambrose Pritchard wrote a commentary yesterday (January 10) which concluded, based upon the housing market, that the American economy is in a depression. Here are some of the statistics that he cites:

Realtytrac says defaults and repossessions have been running at over 300,000 a month since February. One million American families lost their homes in the fourth quarter. Moody's expects another 2.4m homes to go this year....

It takes heroic naivety to think the US housing market has turned the corner (apologies to Goldman Sachs, as always). The fuse has yet to detonate on the next mortgage bomb, $134bn (£83bn) of "option ARM" contracts due to reset violently upwards this year and next.

US house prices have eked out five months of gains on the Case-Shiller index, but momentum stalled in October in half the cities even before the latest surge of 40 basis points in mortgage rates. Karl Case (of the index) says prices may sink another 15pc. "If the 2008 and 2009 loans go bad, then we're back where we were before – in a nightmare."

The US government has spent hundreds of billions of dollars in an attempt to stabilize home prices above their normal levels. But that huge bet may be about to come up bust, as I predicted at the end of a July 31 2009 commentary (Why House Prices will Resume Their Fall):

The victory of Bernanke and Obama over the forces of economic nature in April and May will be as short-lived as a sand castle built on a beach near the water line while the tide is coming in.

Historians will look back at it as an illustration of the fact that you can't fight the forces of economic nature. It will be paired in the economic textbooks with President Nixon's failed attempt to fight inflation through wage and price controls.

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Peter Morici: Free Trade is Failing America
Howard Richman, 1/10/2010

U. of Maryland economist had another excellent commentary on trade that was published January 5 by Seeking Alpha. He now estimates the amount that the Chinese RMB is overvalued at 25%:

Currency manipulation creates a 25 percent subsidy on China’s exports, and other Asian countries are impelled to follow similar policies, lest their exports lose competitiveness to Chinese products.

And he ties in our trade policy with our current economic woes and our need for stimulus after stimulus just to keep our economy growing:

Consequently, to keep the U.S. economy going, Americans must both borrow from foreigners and spend too much, as they did through 2008, or their government must amass huge budget deficits by borrowing from abroad, as it is now does thanks to stimulus spending and the TARP....

And he has harsh words for the Obama administration:

Campaigning for the Presidency, Barack Obama promised to do something about Chinese currency manipulation. Instead, like a good supplicant, he now thanks Chinese officials for buying U.S. Treasury securities....

It will be impossible for the United States to create the 9 million jobs needed to bring unemployment down to pre-recession levels without taking on China’s currency manipulation and other unfair trade practices.

For that Americans may need to wait for a better president—one with the courage to stand up to China.

The entire commentary is worth reading. You can find it at:

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Cost of treasury bailout of FNMA and Freddie MXC
Raymond Richman, 1/9/2010

The Treasury Department announced on December 24, 2009 that it removed the $400 billion financial cap on the money it will provide to keep Fannie Mae and Freddie Mac afloat. According to the Associated Press, taxpayers have shelled out $111 billion to the pair, and a senior Treasury official said losses are not expected to exceed the government's estimate this summer of $170 billion over 10 years. Nevertheless, it appears that the Treasury did not believe its own forecast that $400 billion would be enough. The date chosen to remove the financial cap -- Christmas Eve -- was no accident. Not only was it buried by the passage the same day of the Senate's health care biil but it obviated  the need for Congressional approval. "Treasury officials said they decided to lift the caps to eliminate any uncertainty among investors about the government's commitments. But the timing of the announcement on a traditionally slow news day raised eyebrows." The two Government Sponsored Enterprises (GSEs) constitute the secondary for mortgages. The financial commitment provides a limitless supply of money to the two government run entities for four to five more years. 

Housing Predictor forecasts that this bail-out will cost trillions and take a number of years to unwind the real estate crisis as more homeowners lose homes to foreclosure. The surge of foreclosures in the New Year is forecast to top previous records. The Treasury and the Fed are on a mortgage buying binge of securities, and the Federal Reserve Board of New York made an emergency loan to the companies.

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Manufacturing employment continued to decline in December
Howard Richman, 1/8/2010


According to preliminary statistics released by the Bureau of Labor Statistics this morning, manufacturing employment declined from 11,657,000 workers in November to 11,630,000 workers in December, as shown in the above graph. Overall, non-farm employment declined by 85,000, but unemployment remained unchanged at 10%.

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Calla Wiemer misunderstands Chinese mercantilism in Wall Street Journal
Howard Richman, 1/8/2010

In tthe January 7 Wall Street Journal (Don't Revalue the Yuan Yet) Calla Wiemer argues that China should continue to peg the yuan to the dollar. Weimer is an associate professor of economics at Claremont McKenna College and a visiting scholar at UCLA's Center for Chinese Studies. She wrote:

Yet the exchange rate isn't a relevant factor in achieving a sustainable rebalancing in China's foreign trade. A surplus of exports over imports is simply the external manifestation of an excess of saving over domestic investment. Export revenues not spent on imports are used to acquire foreign assets, which represent Chinese saving invested abroad.

Ms. Wiemer may be an associate professor of economics and an expert on China, but she fails to understand Chinese economic policy. The high savings rate in China is the result of dollar mercantilism, not the cause. She could get an overview of dollar mercantilism in our book, Trading Away Our Future, or she could read Peking U. economics professor Heng-Fu Zou's 1997 paper "Dynamic Analysis of the Viner Model of Mercantilism" (discussed in Chapter 1 of our book). 

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NY Times now explaining Chinese mercantilism
Howard Richman, 1/7/2010

Paul Krugman's December 31 New York Times op ed about Chinese mercantilism has had a major effect: the Times is now explaining "dollar mercantilism" to its readers. For example, in a January 7 article about the People's Bank of China starting to raise short term interest rates, Times business writer Keith Bradsher explains the mechanics of "sterilization", the mercantilist government practice of buying foreign currencies.

Bradsher's explanation could have come right out of our book Trading Away Our Future.  He not only explains how the People's Bank of China "sterilizes" foreign currencies, but he also explains the effect of those currency manipulations on the United States:

The goal of sterilization is to keep inflation under control in China while keeping the renminbi weak. That helps make China’s exports competitive overseas and preserves jobs in China, while contributing to unemployment in countries producing rival goods.

Bradsher is being very generous with China when he claims that they are only trying to "keep inflation under control" and preserve "jobs in China".  Their actual goal is to steal market share from their trading partners, and they prevent inflation by suppressing domestic consumption, partly by making credit largely unavailable to Chinese consumers. Bradsher comes closer to the true goal of sterilization at the end of the same article:

The central bank is already buying more than $300 billion a year of foreign currencies, mainly dollars, to keep the renminbi weak and preserve the competitiveness of Chinese exports in foreign markets....

Still, he is not completely correct. The Chinese policy is not only to "preserve the competitiveness of Chinese exports," it is also to prevent the competitiveness of products of its victim countries. Chinese currency manipulations not only weaken the renminbi, subsidizing Chinese products, but they also strengthen the dollar, placing a hidden tarriff on all U.S. products, wherever they are sold.

The New York Times has made a lot of progress this week. But they still have a long way to go. Mercantilism is the successful beggar-thy-neighbor strategy of maximizing exports and minimizing imports. It can only be stopped when the victim countries insist upon balanced trade.

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Obama raises stakes on his house price gamble
Howard Richman, 1/6/2010

There is a foolish gambling strategy. When your bet starts going bad, you raise the stakes and throw everything you have into the pot. Then if you lose, you go bankrupt.

Over the past year, President Obama's economic advisors have been trying out that gambling strategy using US Treasury money. Through the first three quarters of 2009, according to a Treasury spokesman, they had already bet $111 billion on Fannie Mae and Freddie Mac in hopes of stopping house prices from falling to their normal inflation-adjusted levels.

On Christmas eve, according to, they raised the limit that they are willing throw into the pot from the previously announced $400 billion. They are gambling our country's future with no limit on how much they are willing to bet.

Meanwhile the latest statistics suggest that the gamble is failing. On January 4, the New York Times reported that house prices may have already started falling:

The figures released Tuesday showed that the Standard & Poor’s/Case-Shiller home price index, a widely watched measure of housing markets in 20 metropolitan areas, rose 0.4 percent in October from the previous month on a seasonally adjusted basis. 

[Some analysts] noted that the Case-Shiller index showed an increase only because each report is an average of the preceding three months, meaning the strong August market was still being counted in the October report....

The strong August market was inflated by first time home buyers trying to buy houses before tax breaks were supposed to expire. House prices have been declining since then.

Obama's advisors are gambling that if they can stabilize house prices, they can stabilize banks, and that if banks have more money to lend, businesses will borrow it. But manufacturing companies won't invest unless there are investment opportunities, and investment opportunities won't occur until we require balanced trade.

Instead of tackling the root cause of our economic problems, our lack of manufacturing investment due to our toleration of foreign-government produced trade deficits, the Obama administration's strategy has been to grow our economy on gambling winnings.

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5.4% tax surcharge on rich in House Health Care Bill would apply to capital gains & dividends
Howard Richman, 1/6/2010

On November 12, the Wall Street Journal reported that the version of the Health Care bill that passed the House would result in a 69% hike in the capital gains tax rate because it would apply to adjusted gross income (which includes dividend and capital gains income) and would coincide with the capital gains rate automatically going up from 15% to 20% with the expiration of the Bush tax cuts in January 2011.

Comments: 0 "House Prices Will Roar Back in 2009"
Howard Richman, 1/6/2010

If you are about to buy a house because of this forecast, then you are a sucker. Here's a quote from the story:

SACRAMENTO, Calif., Dec 09, 2008 (BUSINESS WIRE) -- The nation's foreclosure hemorrhage has finally slowed and 2009 should see a significant decline in foreclosures as buyers return, pushing home prices up and fueling a real estate recovery, according to the 2009 Outlook from, the leading real estate and property information and education specialists.

"Recovery is underway. Affordable is back in the housing market," says Alexis McGee, real estate expert, educator, and president of "In 2009, housing will not only recover, but we'll see buyers leap into this market in droves, depleting our housing oversupply, and actually put higher price pressures on the market."

"With 4.5% fixed mortgage rates, housing prices lower than they were 'pre-housing bubble', commodity prices lower, tax credits available for homebuyers, and the government eager to stimulate our economy, for the first time in years I can see prices rising again in 2009," adds McGee. "This is a great time to buy properties for investors -- to buy properties at wholesale prices below today's already low prices -- rent them out for positive cash flow and then sell them for big profits in late 2009 once price appreciation kicks in."

But, here's the graph of the housing bubble so far:


As you can see, house prices are nowhere close to their normal levels. (.) A little review of how we got here could help.

From 1951 through 1997, whenever a homeowner sold his or her primary residence to buy another residence, the capital gains tax was deferred (i.e., rolled-over) until the new home was sold. Homeowners would typically build up their equity in one home, sell that home, and then use their savings to make a downpayment on a larger home. During that period, there were large changes in interest rates, yet home prices were quite stable as shown in the graph below:


This is non-seasonally adjusted data through September 2008

Interest rates probably caused some of the price appreciation after 1997. Governments around the world have been building up their dollar reserves since 1996, sending their countries’ savings to the United States. The increase of foreign savings flowing into the United States caused real-long term interest rates to fall precipitously from 4.5% in 1996 to 1.3% in 2005 (see Chapter 2 of our book). The fall in interest rates tends to push up house prices, both because it reduces mortgage interest rates and also because it reduces the returns to competing investments.

But it took Congress to get the house price bubble started. In 1997, at the urging of President Clinton, they eliminated the capital gain tax paid by most homeowners. This action told speculators that the capital gain that they would earn if they bought a house with plans to sell it would probably be higher, since it would be tax free.

Under the new provision, almost anyone who had lived in a house for 2 years of the past 5 years could sell the house free from capital gains tax. The new policy encouraged people to gamble on real estate. If they saw that houses were going up in price, they would buy in hopes of getting a tax-free capital gain.

Here is how Kenneth Harney (2008) described how the 1997 tax treatment encouraged speculation in a Washington Post article about Congress’s 2008 attempt to tighten its provisions:

[Property owners] can claim the exclusion [from capital gains taxation] even if they convert an investment property or vacation house into their principal residence and live there for at least two years. This flexibility has been a boon to many tax-wise owners of multiple houses – particularly during the bubble years when values doubled in some parts of the country.

Property owners in markets with high appreciation rates could sell their principal residences for hefty profits – pocketing the first $250,000 or $500,000 tax-free – and then move into their rental condo or vacation property for a couple of years and repeat the process.

In effect, it was a form of financial alchemy where taxable profits could be magically transmuted into tax-free gains – at least up to the $250,000 and $500,000 limits.

The Housing Bubble that began in 1998 had other contributing factors, but Vernon L. Smith, a Nobel Prize winning economist largely due to his laboratory study of economic bubbles, held that it was primarily caused by the 1997 legislation. He pointed out that, at the time it was enacted, the 1997 legislation was quite popular among the industries that were most severely hurt when the bubble burst. He wrote, sarcastically:

Thank you President Bill Clinton for your 1997 action, applauded by the banks, the realtors and all citizens in search of half-millionaire status from an investment they could understand and self deceptively believe to be low risk; thank you for fueling the mother of all housing bubbles; thank you for enabling so many of us who bought second or third homes, and homes before construction began, which we then sold to someone else who dreamed of riches from owning homes long enough to sell to another fool.

Smith argued that, instead, Congress should have done exactly what we recommend in our book. Specifically:

More daring than the action to exempt real estate from the capital gains tax -- and in lasting service to the poor -- would have been actions allowing capital gains on all assets to go tax free, provided that the capital was reinvested -- i.e., not consumed, and yes, good citizens, housing counts as consumption.

During the asset bubble, homeowners depleted their savings, leaving them with less money for a future downpayment. Tyler Cowen (2008) described this psychology in a New York Times commentary:

The fundamental problem in the American economy is that, for years, people treated rising asset prices as a substitute for personal savings. The thinking went something like this: As long as your home’s value rose every year, you didn’t have to set aside so much from your paycheck….

In fact, people did more than stop adding to their personal savings. They began subtracting from their personal savings. As documented by Louise Story in the New York Times, bank advertising campaigns encouraged people to consider the rising value of their homes to be income, to be consumed in the present. They urged homeowners to take out second mortgages on their homes so that they could increase their current consumption and coined the new term “equity access” to replace “second mortgage.” Borrowing on home equity increased steadily.

You'd think that economists would understand what was happening at the time, but as recently as September 2005, Charles Himmelburg, a senior economist at the New York Federal Reserve, co-authored a NY Fed staff report and an NBER working paper which claimed that there was no housing bubble. You really have to read this one to believe it.

Just 9 months later, in June 2006, house prices peaked and the house price bubble began to burst. Now house prices will probably keep falling for awhile unless overall inflation forces prices upwards.


p.s. Follow the following link to see the original Shiller index starting with 1890 as it appeared in his 2005 book Irrational Exhuberance:

[This piece was initially published on our old blog on December 9, 2008]

Comments: 0

Levy Economics Institute's analysis of Import Certificates to balance trade
Howard Richman, 1/6/2010

In a July 2008 working paper, three economists from the Levy Economics Institute of Bard College (Papadimitriou, Hannsgen, and Zezza) analyzed the costs and benefits of Warren Buffett’s Import Certificate (IC) plan, making quantitative estimates of the effects.

As far as benefits go, they pointed out that Buffett’s plan would cause an immediate macroeconomic boost to the economy, increase government tax collections (because of increased American income) and reduce the trade deficits to a sustainable level. On the costs side, they pointed out that the ICs could result in increased uncertainty and could produce trade retaliations.

Their discussion, throughout, was thoughtful and balanced. They made three important contributions to the Import Certificates discussion:

  • 1. They pointed out that the ICs would be less expensive if not applied to fuel products, as during the first years of Senators Dorgan and Feingold’s Balanced Trade Restoration Act. The reason being that demand for fuel imports does not much respond to price.

  • 2. They pointed out that if ICs were earned by service exports, not just goods exports, then there would likely be many faked exports in order to fraudulently obtain ICs.

  • 3. They came up with a new version of the IC plan: Having the government auction the ICs and then use the funds generated to reduce payroll taxes.

Their cost argument about the unstable and uncertain future value of the ICs may have exaggerated the disruptiveness of this uncertainty. They did not seem to be aware that Buffett had suggested that expiration dates be placed upon the ICs in order to insure that the futures market for ICs would be liquid. Importers and exporters already deal with future uncertainty in foreign trade due to changing exchange rates and could deal with changing IC prices the same ways.

Their cost argument that other countries would retaliate to the ICs ignored our two major contributions to the Import Certificates debate in our 2008 book, Trading Away Our Future, which was published just a few months before their working paper:

  • 1. We developed a targeted IC plan. Under our WTO-compliant alternative to Buffett's plan, the ICs would be auctioned by the U.S. government and be targeted to the mercantilist countries so that they would be country specific (i.e., an IC obtained by exporting to China would allow importing from China). If a mercantilist country were to respond by further restricting their imports from us, they would be further restricting our imports from them. Instead, they would be forced to take down their many tariff and non-tariff barriers to our imports so that they could export more to us. Buffett's plan could make use of country-specific ICs when needed by the U.S. Treasury to respond to retaliation. The trade deficit country wins any trade war if it has country-specific ICs in its arsenal.

  • 2. We anticipated the world's response to Buffett's Plan. We foresaw that if the United States were to adopt Buffett's plan, most other trade deficit countries would soon follow suit, creating a new international system to replace the WTO that did not require any international supervision. Any trade surplus country that tried to restrict its imports would necessarily be restricting its own exports.

The Levy Economics Institute economists are in agreement with us that if the trade surplus countries do not respond by restricting their imports from the United States, then U.S. producers would reap a tremendous benefit. They wrote:

In the absence of retaliation, we estimate that exporting firms would cut their prices on foreign markets only moderately, as the demand they face is price inelastic. They would therefore reap a windfall in profits almost equal to the full value of the certificates they sold, minus any increase in the costs of the imported intermediate goods they use to produce exports. (p. 24)

They also noted that additional profits made from the new trade situation would be invested, resulting in increased employment and increased disposable income for American workers.

Thus, ICs increase profits for American producers and fixed investment in American production. Not only could this increased fixed investment jumpstart the American economy out of the current recession, but it would also create better tools and products for American workers, and thus increase long-term American growth and productivity.

The ICs would be temporary. Gradually the increased investment caused by the ICs would make American products more competitive, which would, in turn, eventually make the ICs less and less expensive. Eventually, the ICs would not be necessary to keep trade in balance. They could be discontinued, while kept available should mercantilism again raise its ugly head. The era of modern mercantilism would be over.

[Originally published on our old blog on March 29, 2009]

Comments: 0

Wall Street Journal's take on Bush economic mistakes
Howard Richman, 1/5/2010

On Friday [Jan. 16, 2009], the Wall Street Journal editorial staff analyzed President Bush's economic mistakes (The Bush Economy) while completely ignoring two of them: (1) tolerating the foreign savings inflows that caused the trade deficits and (2) causing the stock buybacks that slowed economic growth.

Tolerating Foreign Savings Inflows

The Wall Street Journal begins by correctly pointing out that Bush inherited a recession when he took office in 2000:

Mr. Bush inherited a recession. The dot-com bubble had burst in 2000, and the economy was sinking even before the shock of 9/11, the corporate scandals and Sarbanes-Oxley....

He also inherited a growing trade deficit. During the late 1990s, when the bubble was occurring, foreigners were selling their currencies to buy dollars so that they could buy US stocks. As a result, they bid up the dollar and caused the US trade deficits to worsen, as shown in the graph below:


After 2002, the trade deficit would have fallen, but foreign central banks greatly increased their dollar reserve purchases so that they could keep the dollar high compared to their currencies. In the graph below, the US trade deficit (i.e., the current account deficit) is shown in red and the portion caused by foreign central banks is shown in green:


Bush and Greenspan did nothing to stop these increased foreign central bank dollar purchases. Greenspan could have easily counteracted them by buying the same amount of foreign currency reserves. Because he didn't do anything, net fixed investment in US manufacturing collapsed, as shown in the graph below, making American products less and less competitive in world markets:


The other effect of the foreign government reserve purchases was that they caused US long-term interest rates to fall, which contributed to the house price bubble. The Wall Street Journal blames these low interest rates on Greenspan's monetary policy. But Greenspan wasn't causing inflation.

His real mistake was that he, like the Wall Street Journal editorial staff, believed in the "free flow of capital ideology" which holds that the inflow of foreign capital is good for a country, even when it causes trade deficits. That's why neither he nor Bernanke nor the Bush administration did anything to counteract the inflow, even when it was deliberately being produced by foreign central banks, at the behest of their governments, in order to steal manufacturing market share from American producers.

The main central bank to follow this strategy was the People's Bank of China. The Bush administration never counteracted their successful attempts to manipulate their currency and ours in order to steal market share from American manufacturers.

Causing Stock Buybacks with a Capital Gains Tax Cut

The Bush administration's record is not entirely negative. They did do a good job with a tax cut in 2003 that helped the economy recover from a recession. The Wall Street Journal editorial notes:

This time the tax rate reductions were immediate, and they included cuts in capital gains and dividends designed to spur business incentives. As the tax cuts became law in late May 2003, the recovery began in earnest. Growth averaged nearly 4% over the next three years, the jobless rate fell from 6.3% in June 2003 to 4.4% in October 2006, and real wages began to grow despite rising food and energy prices. The 2003 tax cut was the high point of Bush economic policy.

Indeed, Bush's tax cuts provided the short-term stimulus which got the economy out of the recession. Unfortunately, the capital gains tax cut part of the stimulus severely hurt the economy in the long-term. Capital gains tax cuts increase tax revenue because investors take advantage of them to cash in and consume their capital.

Investors always face the choice of whether or not to keep their capital invested in order to earn the future income. When capital gains tax rates fall, as they did in 2003, investors are more likely to choose present consumption over future income. When they cash-in their wealth, aggregate demand temporarily increases while future income permanently decreases.

After 2003, Corporate managers, especially, cashed in their companies' wealth through stock buybacks. They would have their companies borrow at the cheap interest rates produced by the foreign savings inflow and use the borrowed money to buyback their own stock. They gave themselves stock options and then bid up their own companies stock price through stock buybacks. In this way they took advantage of Bush's 15% capital gains tax rate, as compared to the 35% tax rate they would have had to pay if they had received salary bonuses.

In all, from 2004 through 2007, America’s 500 largest corporations earned $2,505 billion while spending $1,578 billion on buybacks and $853 billion on dividends, leaving only $84 billion of their profits for reinvestment and corporate income taxes. The increase in stock buybacks began immediately after the 2003 capital gains tax cut, as shown below:


When the financial crisis hit in 2008, the very same corporations that were coming to the government for help had been depleting their corporate reserves through buybacks.

[Note: We recommend the rollover tax treatment for capital gains: High tax rate when capital consumed, but taxation deferred when capital rolled-over from one asset to another.]

Bush Administration's Failures in 2008

At the end of their editorial, the Wall Street Journal blames the Bush administration for the fact that their February 2008 stimulus package and October 2008 TARP bill did not turn around the economy. They argue that if these stimulus packages had been different in their composition or if they had been timed differently, they would have worked.

But these stimulus packages completely failed to address the real cause of the current recession: The American consumer could not continue borrowing more and more money to pay for the trade deficits. As the economics analysis of the Levy Economics Institute of Bard College makes clear, no stimulus package will end this recession unless the trade deficits are also addressed.

In an May 15 commentary, we summarized Bush's economic mistakes with the following words:

There are four major Republican economic ideas. Two of them work and two of them don't. Unfortunately, President Bush chose the two that don't work, and that is the reason for the current U.S. economic stagnation. These two Republican economic ideas work:

1. Reduce the size of U.S. government.

2. Cut business taxes.

These two Republican economic ideas don't work:

1. Cut capital gains taxes.

2. Welcome foreign investment that costs jobs.

The Republican Party has lost the Presidency, the House, and the Senate because of President Bush's economic mistakes. It is ill-served when the Wall Street Journal ignores those mistakes.

[This was originally posted on Jan. 19, 2009 on our old blog.]

Comments: 0

Requiem to an Improvident Generation
Jesse Richman, 1/5/2010

In his most recent column, Cal Thomas provides a sweeping summary of the financial difficulties faced by the American Republic. He argues that the projected 9.1 trillion next-decade budget deficit is actually overly optimistic, and that a more realistic figure would be 13 trillion. Thomas concludes with the warning that

If we don't [ask government to let us take care for ourselves and vote accordingly], the future belongs not to us but to China, Japan, Qatar, Venezuela and Saudi Arabia, among others -- all holders of our national debt.

Thomas' warnings concerning the improvidence of American government are well placed, but they are likely to go unheard. The last four decades have been decades of improvidence, a period in which government has heeded the calls of a narciscistic generation unwilling to plan and cooperate effectively for the future, whether personal or collective.

At the personal level many Americans have abandoned thrift and saving for improvident waste. Personal savings rates have recovered slightly over the last year, but this probably reflects the inability of the irresponsible to get additional credit more than a true change in national culture.

At the collective level the Federal government has run budget deficits through most of the last four decades. The current levels of deficit spending would be far more modest were it not for the massive interest payments that are already due, currently running about 400 billion per year. Democrats favor spending increases and Republicans favor tax cuts. Unless balanced by painful tax increases or spending decreases the result is quite the same in the end.

The Federal government under both Democratic and Republican administrations has also done little or nothing to stop three decades of massive trade deficits that have transformed the United States from a creditor to the worlds largest debtor. In the process, trade deficits (and the government policies that sustain them) have eviscerated American comparative advantage across a wide range of fields, diminishing the prospects that the U.S. will be able to successfully pay back decades of borrowing without suffering broad declines in living standards.

The illusion persists among those in the improvident generations that have wrought the current and coming crises that somehow they will escape. That this will all be passed on "to the kids."

Thomas remains in delusion. He writes "(the kids will be paying for this)." It is unquestionably the case that the kids will (and are) paying for this. But the assumption that only the kids will pay for this is an illusion of the first order. Perhaps Thomas plans to die soon. But it is us, and our parents as well as our children who will be and are paying for the improvidence of ourselves and our forebears. We have met the improvident and it is us.

It is also a delusion of the first order to claim that either the Republican or Democratic parties stand for fiscal responsibility or serious efforts to right our international balance of payments. Such efforts would smack too much of the self control, care for the future, and discipline that the improvident have ever lacked.

Thomas calls for mobilization:

It's our money, not theirs. They are now stealing it before we make it. Let's hear some outrage about this. Let's sustain it through the next three election cycles, beginning next month with the governors' races in New Jersey and Virginia.

Vote for a Democrat who supports substantial and specific spending cuts or a Republican who takes a stand for real and sizable tax increases if you can find one. They are rare in this improvident land.
[This is a re-post of an entry originally dated from October 2009 on our old trade and taxes blog.  I'm reposting it because the old blog is currently not accessable, and I like this piece.]

Comments: 0

US wins WTO appeal on China's non-tariff barriers against US movies, music, and games
Howard Richman, 1/5/2010

The Chinese government keeps out almost all American consumer products through one barrier or another. For example, as I noted in a September 2009 Seeking Alpha commentary (China's Non-Tariff Barriers to US Games), they freely permit the piracy of American movies, music, and games, while delaying the issuance of permits to import the legitimate products. The U.S. has been disputing this barrier through a WTO complaint since April 2007. In a December 21 press release, US Trade Ambassador Ron Kirk announced that the WTO Appellate Body has agreed with the U.S. position. Here is a selection:

WASHINGTON - U.S. Trade Representative Ron Kirk announced today that the WTO Appellate Body has confirmed that China's restrictions on the importation and distribution of certain copyright-intensive products are inconsistent with China's WTO obligations. The products at issue include films for theatrical release, DVDs, music, books and journals.

"Today America got a big win. We are very pleased that the WTO has found against China's import and distribution restrictions on U.S. movies, music, DVDs and publications," Ambassador Kirk said. "The Appellate Body's findings are key to ensuring full market access in China for legitimate, high-quality entertainment products and the exporters and distributors of those products. U.S. companies and workers are at the cutting edge of these industries, and they deserve a full chance to compete under agreed WTO rules. We expect China to respond promptly to these findings and bring its measures into compliance."...

So what's next. The bottom of the press release notes:

The WTO Dispute Settlement Body is expected to adopt the Appellate Body report and the panel report within the next 30 days. Within 30 days following adoption, China must announce its intentions with respect to implementation of the WTO's rulings.

The Obama administration is doing its best to chip away at China's trade barriers. They are trying to show that free trade and the WTO can work.

Comments: 0

Prof. Krugman and Chinese Mercantilism
Raymond Richman, 1/4/2010

In his op-ed in the NY Times (12-31-09) entitled Macroeconomic Effects of Chinese Mercantilism, Nobel economics prize-winner Paul Krugman charges China with practicing mercantilism Prof. Krugman is rather late in condemning China’s mercantilism. We called attention to it in our book Trading Away Our Future (January, 2008). Indeed, in the book, we quoted from a column of his that appeared in Slate Magazine in 1997.

Professional trade alarmist Alan Tonelson’(s) … claim is that as emerging economies grow – that is, produce and sell greatly increased quantities of goods and services – their spending will not grow by a comparable amount; equivalently, he is claiming that they will run massive trade surpluses. But when a country grows, its total income must, by definition, rise ... Maybe you don’t think that income will get paid out in higher wages, but it has to show up somewhere. And why should we imagine that people in emerging countries, unlike people in advanced nations, cannot find things to spend their money on?" (p. 70)

 The Chinese people can find plenty of things to buy from us but their government as Japan’s government before it chooses not to permit it. Well, Tonelson was clearly right and Krugman wrong. Prof. Krugman, an international trade specialist, ought to have been aware that Japan had been pursuing the same mercantilist policy of expanding exports and restricting imports for five decades when he wrote those words.

 Now he writes: “China has become a major financial and trade power. But it doesn’t act like other big economies. Instead, it follows a mercantilist policy, keeping its trade surplus artificially high. And in today’s depressed world, that policy is, to put it bluntly, predatory.”  

 But we disagree with much of the rest of his recent op-ed. He writes that China’s “accumulation of foreign reserves, many of which were invested in American bonds, was arguably doing us a favor by keeping interest rates low — although what we did with those low interest rates was mainly to inflate a housing bubble.” We disagree that his statement China’s investment in American bonds, like the Japanese investment before, was “arguably” of any benefit at all to the U.S. economy. U.S. money supply should be determined by the Fed, not by any foreign power that is unarguably attempting by that policy to cause us to import more from them. It did contribute to the housing bubble but employment gains in construction were offset by the displacement every year of hundreds of thousands of industrial workers and caused  wage stagnation as those workers competed for lower-paying service jobs.

He writes: “Unlike the dollar, the euro or the yen, whose values fluctuate freely, China’s currency is pegged by official policy at about 6.8 yuan to the dollar. At this exchange rate, Chinese manufacturing has a large cost advantage over its rivals, leading to huge trade surpluses.” For example, as the dollar fell against the Euro and other countries’ currencies, the yuan, pegged to the dollar, fell against those currencies. As he sees it, China should let the yuan float. We agree, but it is doubtful that it would do much to reduce the trade deficit with China. Germany still has a sizable trade surplus with us even thought the dollar has fallen fifty percent against the Euro.

He argues that “right now the world is awash in cheap money. So if China were to start selling dollars, there’s no reason to think it would significantly raise U.S. interest rates. It would probably weaken the dollar against other currencies — but that would be good, not bad, for U.S. competitiveness and employment. So if the Chinese do dump dollars, we should send them a thank-you note.” The notion that a weakening dollar would stimulate U.S. exports and discourage U.S. imports is widely accepted by economists who ignore its political consequences.

Most of the world’s trade in commodities is conducted in U.S. dollars. It is appropriate that the currency of the world’s leading economic power be accepted as the world’s currency. But already as a result of the falling dollar, there are calls – especially by the BRIC countries and some UN agencies – for replacement of the dollar by another currency, the currency suggested most often being some version of IMF drawing rights. The way, in our opinion, to sustain the value of the dollar is to balance trade. There is no reason for the US dollar to fall against the Euro and other currencies when the U.S. trade deficit is the result of trade with China and the oil exporting countries.

In our book, we suggested that we restrict imports from China by the use of import licenses, a suggestion made by Warren Buffett. Personally, I favor a device that would change the relation between the yuan and the dollar without creating a costly new government bureaucracy. We can do this under World Trade Organization rules by levying a tariff on all imports from China. It has been suggested that the yuan is undervalued by 25 percent or more. The President currently may have the authority to impose such a tariff. In any case, it is easy to implement such a tariff and we already have in place the structure to collect tariffs. It’s real virtue is that it has the same effect as a fall in the value of the dollar because it makes all imports from China more expensive while keeping American goods as attractive as before. Another benefit is that it would add to federal tariff revenues which we could surely use.

Prof. Krugman deals with the claim that Chinese retaliation, such as dumping their hoard of American assets, would “wreak havoc” with the U.S. economy. We agree with him that we have little to lose while the Chinese have much more to lose. All countries gain from balanced trade as Ricardo showed two centuries ago. None benefit from an absence of trade. The current trade deficit with China is beneficial to China and has had disastrous consequences for American workers. In an addendum posted on his web site, Prof. Krugman estimates that our trade deficit with China has cost American industrial workers 1.4 million jobs. Our estimate is double that, 2.8 million,  and our trade deficit with the rest of world an additional 3.0 million or more.

Prof. Krugman concludes: “The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation. So I’d urge China’s government to reconsider its stubbornness. Otherwise, the very mild protectionism it’s currently complaining about will be the start of something much bigger.”  We disagree only to the extent that the decision is not China’s but ours.


Comments: 3

China agrees to modify export subsidies
Howard Richman, 1/4/2010

According to United States Trade Ambassador, Ron Kirk, China has agreed to eliminate or modify its export subsidy program. His office reports:

"I am very pleased that today we have signed an agreement with China confirming full elimination of the numerous subsidies we identified as prohibited under WTO rules. This agreement demonstrates President Obama's commitment to ensuring that American workers, farmers, ranchers, manufacturers, and producers get a fair chance to compete for business around the world, to sell more goods to global consumers, and to bring jobs and other benefits of our trade agreements back home," said Ambassador Kirk. "This outcome represents a victory for the full spectrum of U.S. manufacturers and their workers, given the reach of these Chinese industrial policy initiatives. We are pleased that the WTO dispute settlement mechanism has worked as intended, enabling the parties to reach an appropriate resolution," Ambassador Kirk added.

China's actual actions, however, may not be so sweeping. The same article also reports:

Under the agreement, China confirms that it has taken steps either to eliminate the measures of concern or to modify them to remove any provisions related to export-contingent brand designations and financial benefits.

Comments: 2

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  • [An] extensive argument for balanced trade, and a program to achieve balanced trade is presented in Trading Away Our Future, by Raymond Richman, Howard Richman and Jesse Richman. “A minimum standard for ensuring that trade does benefit all is that trade should be relatively in balance.” [Balanced Trade entry]

    Journal of Economic Literature:

  • [Trading Away Our Future] Examines the costs and benefits of U.S. trade and tax policies. Discusses why trade deficits matter; root of the trade deficit; the “ostrich” and “eagles” attitudes; how to balance trade; taxation of capital gains; the real estate tax; the corporate income tax; solving the low savings problem; how to protect one’s assets; and a program for a strong America....

    Atlantic Economic Journal:

  • In Trading Away Our Future   Richman ... advocates the immediate adoption of a set of public policy proposal designed to reduce the trade deficit and increase domestic savings.... the set of public policy proposals is a wake-up call... [February 17, 2009 review by T.H. Cate]