By David Stockman as originally published on Contra Corner and reprinted here with permission
In Part 1 we made it clear that the Donald is right about the horrific results of US trade since the 1970s, and that the Keynesian “free traders” of both the saltwater (Harvard) and freshwater (Chicago) schools of monetary central planning have their heads buried far deeper in the sand than does even the orange comb-over with his bombastic affection for 17th century mercantilism.
The fact is, you do not get an $810 billion trade deficit and a 66% ratio of exports ($1.55 trillion) to imports ($2.36 trillion), as the US did in 2017, on a level playing field. And most especially, an honest free market would never generate an unbroken and deepening string of trade deficits over the last 43 years running, which cumulate to the staggering sum of $15 trillion.
Better than anything else, those baleful trade numbers explain why industrial America has been hollowed-out and off-shored, and why vast stretches of Flyover America have been left to flounder in economic malaise and decline.
But two things are absolutely clear about the “why” of this $15 trillion calamity. To wit, it was not caused by some mysterious loss of capitalist enterprise and energy on America’s main street economy since 1975. Nor was it caused—contrary to the Donald’s simple-minded blather—by bad trade deals and stupid people at the USTR and Commerce Department.
After all, American capitalism produced modest trade surpluses every year between 1895 and 1975. Yet it has not lost its mojo during the 43 years of massive trade deficits since then. In fact, the explosion of technological advance in Silicon Valley and on-line business enterprise from coast-to-coast suggests more nearly the opposite.
Likewise, the basic framework of global commerce and trade deals under the WTO and other multi-lateral arrangements was established in the immediate post-war years and was well embedded when the US ran trade surpluses in the 1950s and 1960s.
Those healthy post-war US trade surpluses, in fact, were consistent with the historical scheme of things during the golden era of industrial growth between 1870 and 1914. During that era of gold standard-based global commerce, Great Britain, France and the US (after the mid-1890s) tended to run trade surpluses owing to their advanced technology, industry and productivity, while exporting capital to less developed economies around the world. That’s also what the US did during the halcyon economic times of the 1950s and 1960s.
What changed dramatically after 1975, however, is the monetary regime, and with it the regulator of both central bank policy and the resulting expansion rate of global credit.
In a word, Tricky Dick’s ash-canning of the Bretton Woods gold exchange standard removed the essential flywheel that kept global trade balanced and sustainable. Thus, without a disciplinary mechanism independent of and external to the central banks, trade and current account imbalances among countries never needed to be “settled” via gains and losses in the reserve asset (gold or gold-linked dollars).
Stated differently, the destruction of Bretton Woods allowed domestic monetary policies to escape the financial discipline that automatically resulted from reserve asset movements. That is, trade deficits caused the loss of gold, domestic deflation and an eventual rebalancing of trade. At the same time, the prolonged accumulation of reserve assets owing to persistent current account surpluses generated the opposite—- domestic credit expansion, price and wage inflation and an eventual reduction in those surpluses.
Needless to say, as the issuer of the gold-linked “reserve currency” under Bretton Woods, the Fed was the first to break jail when it was deep-sixed in 1971-1973. At the time, the freshwater Keynesians led by Milton Friedman and his errand boy in the Nixon/Ford White House, labor economics professor George Schultz, said there was nothing to sweat over.
That’s because the free market would purportedly generate the “correct” exchange rate between the dollar and D-mark, franc, yen etc; and then these market-determined FX rates, in turn, would regulate the flow of trade and capital. Very simple. Adam Smith’s unseen hand all over again.
In fact, not in a million years!
The giant skunk in the woodpile actually smelled of state monetary emissions or what was called the “Dirty Float”. The latter threw everything into a cocked hat because unlike under Bretton Woods or the classic pre-1914 gold standard, the new regime of unanchored money allowed governments to hijack their central banks and to use them as instruments of mercantilist trade promotion and Keynesian domestic macro-economic management.
To be sure, it took some time for traditional central bankers to realize that they had been unshackled. For example, during the final years of his tenure (1970-1978) Arthur Burns caused a pretty nasty recession in 1975 trying to reclaim his reputation for monetary probity after meekly capitulating to Nixon in fueling the 1972 election year boom that finally destroyed the remnants of Bretton Woods entirely.
At length, however, Alan Greenspan inaugurated the era of Bubble Finance in 1987, and the die was cast. During his 19-years at the helm of the Fed, Greenspan massively inflated the Fed’s balance sheet (from $200 billion to $700 billion) and the cost structure of the US economy at a time when the mobilization of cheap labor from the rice paddies of China and east Asia demanded exactly the opposite policy. That is, a policy of Fed balance sheet shrinkage and domestic deflation.
Accordingly, a destructive pattern of reciprocating monetary inflation within the global convoy of central banks was set in motion: The Fed inflated and they inflated in a continuous loop. So doing, the central banks of the world locked-in a permanent condition of unbalanced trade.
The latter originated in the Fed’s flood of excess dollars into the international financial system in the 1990s and thereafter. This, in turn, caused central banks in Asia, much of the EM, the petro-states and sometimes Europe, too, to buy dollars and sequester them in US treasury paper (and GSE securities).
This Dirty Float was undertaken, of course, to stop exchange rate appreciation and to further mercantilist trade and export-based domestic economic policies in China, South Korea, Japan and elsewhere.
But what is also did was enable a sustained debt-based consumption boom in the US that was not earned by current production. The excess of US consumption over production, which showed up in the continuous US current account deficits, was effectively borrowed from central banks (and often their domestic investors).
That happened because these central banks, in effect, were willing to swap the labor of their people and the endowments of their natural resources for US debt paper rather than face rising exchange rates and temporary headwinds to their mercantilist growth policies.
In short, the $15 trillion plague of US trade deficits since 1975 is the bastard step-child of the Dirty Float maintained in Asia and elsewhere as a defense against the Fed’s profligate money printing. Over time, it morphed into a back-door form of de facto export subsidies that would otherwise be illegal under the current WTO rules of global trade.
So when the Donald declaims that pointy-head bureaucrats are the culprits behind the US trade disaster, the part he gets wrong is the names. To wit, the real malefactors of trade stupidity are named Alan (Greenspan), Ben (Bernanke) and the Two Janets (Yellen and Powell). America is losing it shirt in trade owing to their bad money, not bad deals cut at the Commerce Department or Foggy Bottom (State).
As we indicated in Part 1, Keynesian monetary central planning has it upside down. It seeks to inflatedomestic prices, wages and costs at 2% per year (or more if correctly measured) in a world teeming with cheap labor—when a regime of honest money would have generated deflationary adjustments designed to keep American industry competitive.
So doing, it would have denied much of the incentive for and rationalization of the Dirty Float. Indeed, had the US maintained a regime of high interest rates, low consumption and enhanced levels of savings and investments in order to maintain sustainable equilibrium with the rest of the world after 1990, it is doubtful that the Dirty Float would have become massive, near-universal and quasi-permanent.
That’s because in a world of hard dollars, money-printing, low-interest rate central banks would have caused soaring domestic inflation and destructive capital flight. The People’s Printing Press of China, for example, would have been caught short decades ago. Indeed, in a world of hard money, the egregious 9X expansion of its balance sheet, which fueled the Red Ponzi’s runaway capital spending mania, could never have happened.
Needless to say, China was not the only Dirty Float malefactor. The Japanese have been far worse. Since 1990 the balance sheet of the BOJ has expanded by 20X, thereby insuring that the yen exchange rate versus the dollar remained uneconomically low, and that Japan’s egregiously mercantilist trade policy would remain undisturbed by honest yen selling prices for its goods sold on the international markets.
The story is much the same throughout the lands of cheap labor and/or Dirty Floats. As we pointed out in Part 1, Mexico’s exchange rate has fallen from 4:1 at the time of NAFTA’s inception to 19:1 at present. Therefore, it wasn’t a bad trade deal that caused the current $71 billion US trade deficit with Mexico; it was bad money.
After all, about the only thing more profligate than the Fed’s 20X balance sheet growth since 1990, is the 40X expansion by the Mexican central bank.
Not surprisingly, it turns out that the land of Dirty Floats accounts for the 90% of the $810 billiontrade deficit incurred by the US last year.
That’s right. The overall trade problem is that the US exported only $1.55 trillion of goods, materials and energy last year, or just 66% of the $2.36 trillion of merchandise that it imported. Yet just 10 countries account for nearly all of that huge imbalance.
These countries are China, Vietnam, Mexico, Japan, Germany, South Korea, Taiwan, Malaysia, Thailand and India. As a group, these countries bought just $627 billion of US exports, while sending $1.35 trillion of imports to the US.
Accordingly, the combined deficit was $725 billion, representing 90% of the total US trade deficit.
Moreover, the US export-to-import ratio was just 46% for the 10 countries as a whole, and far worse among the most egregious Dirty Floaters. Thus, China’s $130 billion of exports from the US represented just 26% of its $506 billion of imports to the US. In the case of Vietnam, the export ratio was only 17% ($8 billion of US exports versus $46 billion of imports to the US).
In Part 3 we will explain why the massive trade deficit with these 10 countries is largely a product of the Eccles Building and the Dirty Floats it has fostered among these mercantilist countries.
And that’s true even in the case of Germany, which sent $118 billion of goods to the US last year compared to US exports to Germany of just $53 billion. The latter amounted to only 45% of imports from Germany, and resulted in a staggering $65 billion trade deficit with the US.
Were Germany not a part of the EU, the exchange rate for the D-mark would be far higher than the euro’s, and Germany’s trade surplus with the US (and the rest of the world) would be far smaller. In effect, the mad money printer, Mario Draghi, has actually effected a hidden Dirty Float that has been a tremendous windfall to German industry.
By contrast, the US trade accounts are functionally in balance with the entire rest of the world. As we showed in Part 1, for instance, US exports to Canada are 95% of imports from our giant trading partner to the north.
Indeed, for the rest-of-the-world as a whole, the trade numbers are quite striking and sustainable. Overall US exports to these destinations amounted to $924 billion during 2017 compared to $1.0 trillion of imports from these suppliers.
Accordingly, exports amounted to 92% of imports, and the total $85 billion deficit at just 4% of two-way trade (nearly $2 trillion) was close enough to zero for big picture purposes.
Needless to say, dumb trade negotiators did not produce a healthy balance within half of the $3.9trillion of total US two-way trade, and a massive, disastrous deficit within the other half among the top ten Dirty Float countries itemized above.
As we said, we are dealing here with bad money, but, alas, neither the protectionist inside the White House nor the free traders shouting at the front gate have explained that to the Donald.
Ironically, the only way out of the Donald’s crude protectionism is a return to sound money. Yet that’s the last thing the Wall Street and Fortune 500 “free-traders” are about to embrace, as we will elaborate in Part 3.
In effect, they wish to perpetuate a regime that swaps American labor and living standard in Flyover America for massively inflated financial asset prices on Wall Street. That is, for unspeakable windfalls to the top 1% and 10% which own 45% and 85% of financial assets, respectively.
No wonder the people out there in Rust Belt America are mad!
And it’s also no wonder they put a mad man in the Oval Office to attack a system that truly is “rigged” against them.