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Richard Duncan, The Corruption of Capitalism: A strategy to rebalance the global economy and restore sustainable growth (Hong Kong: CLSA Books, 2009)
Raymond Richman, 2/8/2010

Richard Duncan is currently chief economist at Blackhorse Asset Management. He has worked or served as a consultant for ABN\AMRO in London, the World Bank in Washington, Capel Securities and Salomon Brothers in Bangkok, and for the IMF in Thailand during the Asian Crisis of the late 1990s. His previous book, The Dollar Crisis: Causes, Consequences, Cures, published by John Wiley (Asia) in 2003, dealt with the instabilities that the “dollar standard” that Pres. Nixon inaugurated by going off the gold-exchange standard in 1971 caused in the world economy. Capital flows to the Asian Tigers led to hyperinflation of financial assets and real estate, bubbles that could not be sustained, and caused the Asian Crisis. The capital flows from China, Germany, and Japan by their reinvestment of their trade surpluses in the U.S. produced the American stock market and real estate bubbles which he confidently predicted were unsustainable and that the disequilibrium must eventually result in plunging the world into the “most severe downturn since the Great Depression.”  Events proved him right.

The current book goes into great detail of the forces at work. Duncan’s description of the causes of the current crisis, the New Depression as he calls it, makes this almost a great book. But, as a Keynesian, his prescription for emerging from the depression is misguided economically and politically.

He writes, “There should be no confusion as to the origins of the global economic crisis that began in 2008. The crisis was set in motion in the 1960s, when policymakers in the United States abandoned the core principles of economic orthodoxy: balanced government budgets and sound money backed by gold.” (The author cannot make up his mind when we went off the gold standard. At  one point, he states that it was 1914 under Pres.WoodrowWilson; at another it was the late 1960s, under Pres. Lyndon Johnson; and finally our exit from the gold exchange standard in 1971under Pres. Nixon.  But the Great Depression, 1929 to 1940, occurred while the U.S. and all leading countries were on the gold standard. The evidence is that financial crises could occur under a gold standard, a gold-exchange standard, or a system of freely fluctuating exchange rates.

The current problems that the European Union is experiencing in Greece, Spain, Portugal, and Ireland are proof of this. All the countries had a single currency the Euro; thus the same standard. Some countries had a surplus of Euros; others a deficit. Those with a trade surplus prospered; those with a trade deficit were in trouble.

Without doubt, the author is right that U.S. economic policies played a key role in the world’s disequilibrium, both our active policies and our refusal to take action to bring trade into better balance. Under WTO rules, countries experiencing chronic trade deficits are entitled to impose tariffs and other barriers to trade. As we showed in our book, Trading Away Our Future (2008), the major culprit was the ideology of  “free trade” to which Richard Duncan also subscribes. As we pointed out, there is nothing in economic theory that justifies a policy of free trade when our trading partners practice mercantilism.

The book has no index and we are disappointed that, apparently, he has not read our book, which deals with the urgent need to balance our trade, suggests different causes, and proposes a different solution than the author does.

He correctly attributes the cause of market bubbles to capital flows that bid up the prices of financial assets and real estate. What sets the limit to the flows is the willingness of countries to continue lending, just as the willingness of China, Japan, and Germany to lend to the U.S. depends on their belief that the U.S. will continue to be credit-worthy and besides, the U.S. is their best customer. They could convert their dollars into their own currencies and this would cause a fall in the dollar and move trade toward a balance. That is not a policy for a country practicing mercantilism that wants to maintain and increase its trade surplus to accelerate its growth vis-à-vis the U.S. The enormous trade deficits of the U.S. before the collapse of the housing bubble could not be sustained forever but they did last for three decades and reached a record high in 2008 when the housing bubble burst. The trade deficits did not cause the bursting of the bubble.

The severity of our New Depression was not the result of the bursting of the housing bubble either. The cause was the fall in real estate prices that followed the bursting of the bubble. This in turn caused millions of  mortgage defaults and the collapse of the derivatives based on real estate mortgages that endangered the world’s financial system. The New Depression is really two recessions (so far!), the end of the housing bubble recession and the mortgage defaults recession.

The mortgage defaults had multiple causes but they had their origin in foolish government policies that encouraged lending with inadequate collateral, illustrated by the  Community Reinvestment Act of 1977 and amendments thereto. Democrats supported easy mortgages so that poor people could own their own homes and Republicans supported them because home-owners tend to be conservative. The terms of the CRA enabled radical (Marxist) neighborhood groups to blackmail the banks. Until the recent ACORN scandal, ACORN  and other leftist groups were receiving money from the Bank of America and almost all of the large banks. ACORN  became so rich that the brother of its founder was able to embezzle an estimated million dollars or two from it. I could find no mention in the book of the role mortgages played in worsening the New Depression.

Duncan is on sound ground when he writes, “The forces of globalization are hollowing out US industry and leaving the country incapable of producing as much as it consumes” and he is right when he writes: “It will require only a few more years of double-digit unemployment before a grassroots protectionist backlash sets in and Americans vote for high trade barriers . .”

Duncan believes in “free trade” and abhors protectionism but apparently not when practiced by China, Japan, and Germany. Mercantilism is protectionism. Nor does he blame OPEC or our restrictive environmental policies even though he writes at one point that $10 oil would reduce the disequilibrium.

Duncan’s book, despite our belief that the trade deficits are principally caused by the mercantilist practices of some of our trading partners and that his solution is no solution at all, is an excellent history of recent decades of U.S. economic policy.  We disagree totally with his Keynesian solution which is to run enormous deficits to develop new advanced technology industries like solar energy. To give some flavor to his solution, he writes that the private sector in the United States did not win World War II. It was government that won it. Who produced the tanks and airplanes and ships that we and our allies used? Private companies produced the military equipment that enabled our allies and us to gain victory. And the solution to the disequilibrium, he writes, will also require government-financed production of new products and new technologies. That is not socialism, he says. His model is Japan.

He approves of the continuous deficits Japan has run for two decades to support the Japanese economy. He fails to note that Japan during those decades continued to enjoy a favorable balance of trade with the United States. Indeed, Japan has enjoyed a trade surplus with the U.S. for more than five decades. We do not believe that his solution will close the trade gaps. Is he assuming our mercantilist trading partners will stand idly by while we subsidize exports?  They have maintained their deficits by pursuing simultaneously an import-substitution and an export-based growth strategy. Buy as little as possible from the U.S. and sell as much as possible.

Only protectionism will force trade into balance. The only issue is the form that that protectionism will take. In our book, we suggested a version of Warren Buffett’s import certificates. An alternative would be a uniform tariff on goods coming from each country enjoying a chronic trade surplus with us. The import certificates plan would require a new bureaucracy, but the bureaucracy required to administer the tariffs is already in place. Indeed, it might be accomplished by a simple presidential directive and not even require a Congressional debate before implementation.  The revenues from those tariffs would be considerable. Under World Trade Organization rules, countries experiencing chronic trade deficits may employ tariffs and impose other barriers on imports from the trade surplus countries.

Recovery from an ordinary bubble need not require  more than 2 or 3 quarters. The depth of the New Depression is caused by the millions of  “under-water”  mortgages, mortgages that exceed the value of the underlying real estate that still overhang the financial community. The huge number of mortgages that appeared to be government guaranteed were underwritten by Fanny Mae and Freddie Mac and were easily marketed world-wide by Wall St. firms in the form of derivatives that created the financial crisis.

We agree with Duncan that the $3 trillion the U.S. is throwing at the recession are a palliative at best. The government hoped everything would go back to normal once the TARP program got credit flowing again. The trouble is that the causes of the crisis have not been corrected. We’ve been making slow progress on the overhanging mortgages.

American business is reluctant to invest in manufacturing in the U.S. They can produce goods more cheaply abroad and import the products free of tariffs. How would Duncan prevent new American products from likewise being produced abroad in China and India? Why produce them here? Most of the goods we import were invented or designed here but there is no incentive to produce them here.

Duncan believes that the U.S. is largely to blame for the trade imbalances that developed in the years “following the breakdown of the Bretton Woods system.” The U.S. accounts for 23% of world GDP. Between 1996 and 2008, US imports tripled as two bubbles inflated American purchasing power. When the second bubble popped, imports fell by a third and the global economy was plunged into a crisis of excess capacity and insufficient demand. In 1990, China’s economy was only twice the size of Belgium’s. In 2008, it was the third largest in the world. This was due almost entirely to China’s trade surplus with the US. In our view China has enjoyed a Keynesian multiplier! The manufacturing jobs created in China as a result of her mercantilist practices were real and sustainable whereas our current spending creates temporary jobs (or none at all!) which have no multiplier effects as we have written several times on our blog.

As Duncan notes, Japan’s economy is on life support since its bubble burst in 1990. Germany in 2007 was the fourth largest economy and had the second largest current account surplus. But GDP growth was limited (1.2%). Germany wisely invested its trade surplus abroad thus avoiding a bubble. But its foreign investments helped create bubbles abroad in East Europe, Ireland, Iceland, and the US. The current recession created a liquidity crisis in Korea. In 2008, she had a $51 billion financial account deficit. Fed arranged a swap to help Korea. A sharp depreciation of the won improved Korea’s trade balance. He fails to note that our depreciation of the dollar relative to the Euro by 50 percent has not brought our trade with Germany into balance.

In a kind of aside, Duncan notes that Saudi Arabia had the fourth largest current-account surplus followed by Russia in 2007 and that ten dollar oil would do a great deal to restore global equilibrium. He writes, “A $283 billion investment in solar energy just might end the world’s dependence on fossil fuels, and by bringing down energy cost could do more to alleviate poverty than all previous aid efforts combined.” Duncan could not be more wrong! Solar panels and wind turbines produce electricity at a greater cost than electricity produced by fossil fuels or nuclear plants. As a Spanish economist has calculated, the Spanish experiment with solar and wind energy cost two jobs for every job it created.

Duncan states that spokesmen for the Republican Party keep repeating, since losing office, that government is getting too big. Under Pres. George W. Bush, the national debt grew 70%. True. That is why we have so many independent voters. The Democrats inherited an economic crisis that “only massive government spending can prevent from turning into a new Great Depression.”  That is a non sequitur. That conclusion comes from his following a Keynesian line of thinking.

We believe that all economics is micro. Firms and individuals have to make the productive decisions. Balancing trade would provide production opportunities for thousands of firms, would require no increase in government spending but it would provide billions in revenues.

Duncan continues, “Massive government deficit spending has prevented the bottom from completely dropping out from under the economy as it did during the 1930s. This result strongly supports Keynes’s analysis.” In our view, the New Deal prolonged the depression. When the government reduced its spending in 1937, the stimulus proved temporary and economic activity declined. Depressions are conquered by restoring business investment and addressing its causes.

After the Japanese bubble burst in 1990, the government increased the budget deficit  which fluctuated between 4.6% to 6.3 percent for twenty years. Duncan writes, “It did prevent a depression.” How do we know? What if the same amount ofexpenditure were left in corporate hands. How did Japan deal with the causes of the downturn? In our opinion, not at all.

Duncan suggests an alternative solution: to become a technological superpower by investing  $3 trillion over 10 years in research and development. These innovative products  should eliminate the trade deficit. We would say impossible as long as we practice “free trade.”  Second, balance the budget. How? By raising taxes? Yes, he argues, by taxes on the more efficient solar and wind energy sources. Why do these sources require subsidies if they are more efficient? What kind of products does he believe would be likely candidates. He suggests covering Nevada with solar panels. It would result, he argues, in cheap energy and reduce the need for oil imports which would enable reducing military expenditures now required to ensure a continuous supply of oil. Invest in genetic engineering and biotech. Invest in education to increase the global dominance of our universities. Increase agricultural productivity. Discover new drugs. All would bring in new taxes. And what would our trading partners be doing during the ten years required to make a significant contribution?

Over the long-run, trade must balance. Duncan writes, “Protectionism would be one of the worst ways of restoring balanced trade.” We don’t see any alternative. Balanced trade would encourage private investment in manufacturing in the U.S. Import certificates or across the board tariffs on all imports from countries with which we have a chronic deficit meets WTO rules. Nothing revolutionary would be required. Self-imposed barriers to drilling for oil should be suspended. Abolishing the corporate income tax and substituting a value-added tax that could be rebated to exporters would do wonders. Many of these proposals are part of the Program for a Strong America that we laid out in our book.

This is almost a great book. The only thing wrong with it are the author’s suggestions as to how to get out of the New Depression and get trade into balance. We like the suggestions we made in our book a lot better.

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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]