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Balanced Trade Monetarism
Howard Richman, 11/9/2011

Economic depressions, like the present one which began in the first quarter of 2008, are long periods of economic stagnation, characterized by high unemployment. They result from insufficient Aggregate Demand (AD) for the goods that an economy can produce. Aggregate Demand can be divided into its components:

AD = C+ I + G + (X-M)

where C = Consumption, I = Investment by businesses in tools and structures, G = Government consumption, and (X-M) is net exports (eXports minus iMports).

John Maynard Keynes was the first to point out that if a country had a trade deficit (i.e., negative net exports), then the trade deficit would act as a drag on Aggregate Demand. He more or less predicted the current depressions in the United States, Greece, Spain, Portugal and Italy in 1936 in his chapter about mercantilism and its victims from his magnum opus (The General Theory of Employment Interest and Money) when he wrote:  

(A) favorable [trade] balance, provided it is not too large, will prove extremely stimulating; whilst an unfavorable balance may soon produce a state of persistent depression. (p. 338)

Modern mercantilism is based upon the twin goals of mercantilism as explained by University of Chicago economist Jacob Viner: (1) maximizing a country's power through accumulation of foreign assets while (2) maximizing long-term consumption by delaying present consumption in favor of future consumption. In order to accomplish these ends it places tariffs (and other barriers) upon foreign products while at the same time buying foreign assets (mainly interest-bearing bonds today; gold in the past) in order to produce trade surpluses. In other words, mercantilist governments maximize their power and their people's future consumption, and bring down their trading partners' power and future consumption, through the combination of import barriers and foreign loans.

But American economists never paid attention to Keynes' and Viner's writings about mercantilism. They thought that an economy beset by mercantilist trading partners could increase AD simply by increasing Consumption or Investment or Government purchases. The methods that they have been recommending have all been failing:  

  1. Monetary Growth. Federal Reserve Chairman Bernanke thought he could increase Consumption and Investment by expanding the money supply in order to fund QE2 (his second massive purchase of US government bonds). These purchases reduced nominal U.S. interests rates and may have caused the jump in the inflation rate from 1.1% in November 2010 to 3.6% in May 2011 shown in the graph below:



    The combination of low interest rates and high inflation, in turn, made private savings unprofitable, which indeed increased consumption, just as he hoped, but he was unable to improve the US trade deficit, even though he successfully sent lots of private savings abroad. Foreign mercantilist governments simply tightened up on their own money supplies so that they could send even more of their countries' savings to the United States. Bernanke's action reduced American private savings and wealth without much improving Aggregate Demand.

  2. Government Budgets. President Obama tried to increase Government Purchases and Consumption by running unbalanced budgets. But foreign mercantilist governments simply increased their loans to the United States in order to grow their trade deficits with the United States. Although he increased Government Purchases and Consumption, the mercantilist governments caused the US trade deficit to worsten at the same time. The result was that Obama reduced American public savings and wealth, but without much improving Aggregate Demand.

Meanwhile, businesses in the United States have been reluctant to spend money on Investment, even though interest rates have been extremely low. They know that so long as the American government doesn't insist on balanced trade, the mercantilist governments will likely make such new investments unprofitable. The graph below shows that net investment in U.S. manufacturing has declined to near zero in conjunction with the steady worsening of the trade deficits.

 

Milton Friedman and his colleagues at the University of Chicago invented the economic school called monetarism which holds that economic growth and stability can be maintained simply through balanced monetary growth and balanced government budgets. But Friedman missed an important elemenent. When an economy is beset by mercantilist trading partners, the only way to end economic stagnation is to balance trade, perhaps using a WTO-legal scaled tariff which is only applied to countries with whom a country has a trade deficit and is proportional to that deficit. Such a measure would simultaneously increase business Investment and net exports. The correct recipe for economic growth is Balanced Trade Monetarism:

Economic Growth = Balanced Monetary Growth + Balanced Budgets + Balanced Trade

 

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    Wikipedia:

  • [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]