When imports and exports are in balance all trading countries benefit

by Mike Collins, Author, Saving American Manufacturing

"I am confident that if the new administration abandons the Milton Friedman policies and focuses on negotiating with the mercantilist countries we can come close to balanced trade."

Let me begin this article by describing this economic anomaly called a trade deficit.  When imports and exports of a country are in balance all trading countries benefit.

Each country specializes in what it does best; exchanging its most competitive products for products it could not produce as cheaply as the trading country. When trade is in balance all countries benefit and living standards rise in each benefitting country.

The second major point is that trade deficits must be financed. A country simply cannot have a trade deficit unless private or government investors are willing to finance it. In the case of America we have had a trade deficit for three decades. 

In 2007 we exported $1.645 billion and imported $2.346 billion imports, with a deficit of -$700 billion(1). To make this happen we print money that we loan to our trading partners. Our two biggest trading partners are Japan and China who send the excess of the money they earn back to us by buying U.S. Government bonds and other government assets so that we buy more imports.

Normally trade deficits are self correcting because as the deficit grows the country’s currency begins to decline in price in the world market. This makes exported goods less expensive and foreign goods more expensive and trade is supposed to balance itself.

In the case of America this balance is not happening because several of our trading partners have figured out how to keep the dollar high so that they can continue to increase our imports and keep the U.S. in a permanent and artificial trade deficit. How they do this is by manipulating their currency values to keep the American currency over valued so they can sell us more imports.

Is This Fair Trade And Why Does America Let This Happen?

The short answer is no this is not fair trade but some economists and government officials have rationalizations on why it is a good thing.

First, they think that we benefit by the low cost of imported goods because we can consume more and consumption is 70 percent of GDP. Milton Friedman, the Nobel Prize winning economist is a great supporter of deficits and thinks they are good for the economy.

This belief is based on the assumption that deficits will automatically be corrected by the currency rates with time, but he never seemed to anticipate what would happen if the trading country manipulated its currency.

On the other hand, Warren Buffett, the billionaire investor said. “The U.S. trade deficit is a bigger threat to the domestic economy than either the federal budget deficit or consumer debt and could lead to political turmoil.

Why Is This Bad?

The real bad part of running long term trade deficits is their affect on manufacturing. Ongoing trade deficits are de-industrializing our country. The attraction of cheap imported goods has caused many manufacturers to relocate their facilities into low cost countries.

This has caused a plethora of long term problems. For U.S. manufacturing:

1. Loss of manufacturing jobs. In 2005 three economists were asked to do a study for the Federal Reserve Bank of New York to estimate how many manufacturing jobs were lost because of the net imports coming into the country. “They estimated the loss of jobs to be at most 3.3 million jobs in 2003, which was about 20 percent of the total manufacturing workforce at that time. By 2006 this number had increased to 4.4 million jobs or 27 percent of the 2006 manufacturing workforce(2)."
2. Most of these workers who lost their jobs found jobs in the service industries but at much lower wages. This has caused wage stagnation in the U.S. and has widened the gap between rich and poor.
3. When manufacturing goes overseas the technologies and much of the R& D leave with it. Thus making us less able to compete in the future.
4. The investment in Capital equipment and plant improvements also went down from 2.6 percent of GDP in 1996 to 1.3 percent in 2004. This does not bode well for manufacturing as a competitive sector in the future as our trading partners continue to invest in machine tools and production technologies at a rapid rate.
5. The manufacturing part of the current account deficit is not a worry to many economists because “they think that our trade surplus in services will overcome it. But the surplus in services has not even come close to overcoming the deficit in goods(3).”
6. Another rationalization is that the U.S. is in a transition to a service economy in which it is natural to see manufacturing leave the country.  The assumption is that good paying manufacturing jobs will be replaced by good paying knowledge worker jobs. The fallacy of course is that many service jobs are also leaving the country and at least 75 percent of the new service jobs being created are categorized as very low or low wages by the Department of Labor.

Why isn’t this happening in other countries? Germany, Switzerland, and Japan all have wages or overall production costs, higher then those in the US. For Germany, machinery, vehicles, chemicals, metal products are the big exports.

For Switzerland it is chemicals, metal products, mechanical –engineering products (clocks and watches). For Japan it is vehicles, computers, and electronics. All 3 are viewed as high quality. All 3 nations enjoy a surplus trade of manufactured goods.

In 2004 Germany was first in the world with $893 billion in exports mostly manufactured goods from a country with a population of 83 million. The US was second with exports of $795 billion and population of 296 million -but $1.3 trillion of imports. Japan was third with $538 billion in exports and a population of 127 million people.

All 3 countries are net creditor nations, enjoy strong current account balances, and have citizens who achieve relatively high savings rates. Even Britain has avoided the reckless de-industrialization allowed in the US. All of these countries have continued to actively manage their economies so that they would not have trade deficits, which show it can be done.

So What Can We Do?

The first thing we need to do is have the government announce that manufacturing is not only important, it is the key to economic growth for everyone and all industries.

We then need to admit that prolonged trade deficits are a big problem that must be solved and that depending on a “Post Industrial” economy to provide the jobs for the future is foolish and irresponsible.

Once the free trade people realize that America is not going to bet the farm on ongoing deficits as an economic policy to fuel consumption, the government will have to slowly put the pressure on China and Japan to quit manipulating their currencies, subsidizing selected industries, protecting certain products with tariffs, and implementing unfair taxes. 

America does have bargaining power because our economy is all intertwined with the European countries, Japan, China, and India. If they won’t cooperate and help us back to some kind of balance, then our alternative is to allow the dollar to fall, which will make imports 3 to 4 times higher, cost, and will cut our consumption of foreign goods overnight.

This could lead to worldwide recession or worse. Not playing on a level playing field will lead to the destruction of the biggest market in the world (America) and is not in any country’s best interests.

If countries like Japan, India, and China don’t or can’t help us get back in balance then we will have to play hardball. The authors of Trading Away Our Future suggest the following steps:

• Step 1: Restore the withholding tax –Prior to 1984 there was a 30 percent withholding tax on all private foreign savers who were earning interest on their investments in the U.S.  This withholding tax could be reinstated by Congress.
• Step 2: Impose import certificates on mercantilists –This is a plan that would tie the imports coming from any country to the exports they receive from the U.S. This would guarantee there would be no deficit with any country.
• Step 3: Tax foreign dollar reserves –The U.S. tax system exempts foreign countries from paying taxes on dividends, or interest on their US. investments.  It is a gentleman’s agreement that if you don’t tax us we won’t tax you. America has very little investment in foreign countries and the mercantilist countries have huge investments in the U.S.  The choice would be to make the mercantilist countries quit manipulating their currencies or pay taxes on their investments.

A Hard Landing

If nothing is done and we continue with the policies of the Free Marketers, America is in for a hard landing. Other countries have been through the hard landing so we have good examples.

It would begin with a run on the dollar and result in a currency crash. In one month the cost of imported goods could double, triple, or quadruple and many retail stores would go out of business.

Interest rates will skyrocket affecting mortgages and business loans, and the money borrowed for deficits and bailouts. Bankruptcies would begin and the banks would be in jeopardy again. The dollar crash would send stock markets crashing around the world

The Argentine Experience in 2002 is a good example. “the Argentine peso collapsed on the world markets to about a quarter of the former value, giving Argentina a 10 percent inflation rate in a single month and a decline in GDP of about 11 percent in a single year. Then, from 2003 to 2005 the Argentine economy recovered rapidly growing by 9 percent per year(4).”  This is one method of allowing the economy to correct itself so it has a good side to it as a solution.

The point of this article was to show how the trade deficit has been a disastrous policy for our Manufacturing sector. Investment in the manufacturing sector has been declining, we have lost 4.4 million good paying jobs, and living standards for the entire middle class are declining.

The good news is that if we can get back to some kind of balanced trade we can grow manufacturing again, create millions of good jobs in the economy. In 2008 the trade deficit actually declined because the dollar is falling in value.

I am confident that if the new administration abandons the Milton Friedman policies and focuses on negotiating with the mercantilist countries we can come close to balanced trade. This could be the shot in the arm that the manufacturing sector needs and reverse the tide of off shoring.

1. U.S. CENSUS BUREAU, FOREIGN TRADE STATISTICS, Annual 2007 Trade Highlights.
2. Trading Away Our Future, Raymond, Howard, and Jesse Richman, United Graphics, 2008, page 2.
3. Trading Away Our Future, Raymond, Howard, and Jesse Richman, United Graphics, 2008, page 2.
4. Trading Away Our Future, Raymond, Howard, and Jesse Richman, United Graphics, 2008, page 2.