Tuesday, August 14, 2018
Saturday, June 23, 2018
In a recent post I explained that China's manipulations of its own currency hurt only herself and not her trading partners and, therefore, retaliatory tariffs were not warranted and would be self-defeating anyway. China harms herself by causing her own money supply to expand, which destroys capital through malinvestment and causes prices to rise domestically. Retaliatory tariffs cause American goods to rise in price, resulting in a recession and general lower standard of living. Few economists claim otherwise.
It seems that everyone is in favor of free trade, as long as it is the other guy who must compete with foreign products. When it comes to their own products, the most typical response from American manufacturers begins with the caveat that "although free trade is beneficial most of the time, it causes harm under certain circumstances." There follows a convoluted chain of cause-and-effect purporting to prove that lower priced foreign goods would hollow out America's key manufacturing industries and turn America into a second class nation.
The purpose of this brief response is to counter these claims and explain why understanding economic theory is vital to the argument in favor of free trade.
There are two books which address the fact that we cannot experiment with an economy the way that physical scientists do. We must use logic to form irrefutable conclusions of what MUST happen, even if we cannot see it! The first is Frederic Bastiat's early nineteenth century classic That Which Is Seen, and That Which Is Not Seen. Henry Hazlitt's updated the book a hundred years later in order to appeal to modern readers. His Economics in One Lesson employs a series of short stories to illustrate that one must always consider the economic effects of an intervention on all and not just a few actors, plus, that one must look to the long term effects of an intervention and not just the short term effects.
So, let's use logic to consider the effects of China's economic interventions on itself and its trading partners who do nothing to retaliate against China in any way.
1. China uses its capital in an inefficient way. Outright subsidies to any industry must be paid by someone. The very fact that China believes that it cannot compete in certain industries to its own satisfaction without subsidies is an admission that these industries are inefficient. Therefore, Chinese internal subsidies are transfers of capital from more efficient industries to less efficient industries. Put another way, if the targeted industries already were very efficient, more capital would flow to these industries and subsidies wouldn't be necessary.
2. Monetary expansion to fund an industry causes overall higher prices and malinvestment. This is the classic Austrian Business Cycle Theory. China may very well expand its steel industry, for example, with monetary expansion, but such action will disrupt the time structure of production and result in a higher price level and a recession. Other factors of production that feed the Chinese steel industry will rise in price, necessitating another round of currency expansion, which will lead to even higher prices and another recession. It's a vicious cycle that can end only with an end to currency expansion.
3. China's overall economy will be less developed, weakening the impact of subsidies to targeted industries. Because capital is stripped from more efficient industries, China's ancillary industries will be less developed, harming the targeted steel industry indirectly. Public infrastructure may be less than it would be otherwise, for example. The many business-to-business goods and services that feed the steel industry will lack the capital to expand. The workforce may lack adequate education. The list is endless. China's economy will lack coordinated growth, as was so apparent in the moribund economies of the old Soviet bloc. The point is that something must be sacrificed to aid the targeted industry. Of course, this is a classic Bastiat "Not Seen" scenario.
4. American products get cheaper and gain market share. It may be true to some small extent that the steel industry, for example, may not be able to expand and may even contract in the face of equal quality Chinese steel that can be purchased at lower prices. But all the many American manufacturing firms that USE steel will have a lower cost of production and, therefore, will be able to expand their markets. Again, something has to give; i.e., the Chinese may be able to sell more steel to American manufacturers, but these manufacturers can sell more finished goods into the world market.
5. American industries benefit from the general expansion of all levels of production. This is a corollary to number three above but opposite. Because the companies that use cheaper Chinese steel reduce their costs, passing along the savings to customers in the form of lower prices, passing along the increased profits in the form of dividends to shareholder, increased investment in their own firms, or a combination of above. The reason for this beneficial prospect is that America becomes more capital intensive, and that capital came in the form of a gift from China.
6. Chinese subsidies actually become subsidies to Americans' standard of living. The purpose of production is consumption. Although we may give lip service to how much we love our jobs, what we really mean is that we are satisfied with the life style that we can obtain through meaningful labor. I truly doubt that many of us would work if we were not paid. Chinese subsidies allow us the option to work less for the same standard of living or work as long yet enjoy a higher standard of living because our pay goes further. We workers have more options. For example, as we become richer through Chinese subsidies, mothers may opt for part time work instead of a full time job, or they may leave the workforce altogether. Fathers may decide to pursue lower paid but less stressful careers. Let us not forget that leisure is a valuable good in and of itself.
Finally, the idea that all subsidies can be eliminated worldwide and businesses can compete on a level playing field is a foolish idea. What is the definition of a subsidy? Is it government provided healthcare? How about a state or municipality forgiving business taxes in order to entice industries to expand or relocate? If the government builds a super highway near a plant, is this a subsidy? Likewise, industries in many developed economies decry the fact that undeveloped countries have lower environmental standards, worker safety requirements, and worker rights. Periodically one reads that the European Union is threatening a member for having taxes that are too low and, thus, provide an indirect subsidy.
Capitalists must accept all of these interventions by foreign governments as part of the unknown and uncontrollable factors of conducting business and not lobby their own governments to take self defeating economic reprisals. Unilateral free trade is the best and only real option.
Tuesday, June 19, 2018
Americans are being told that China's currency manipulations are causing harm to its trading partners, America being the main victim. Nothing could be further from the truth. China's currency manipulations certainly cause harm, but to China itself!
No country can cause harm to another by adopting any economic intervention. All economic interventions cause harm only to the country that adopts them. This applies to subsidies of home industries, quotas restricting import volumes, tariffs imposed on imports, and currency manipulations.
A nation typically manipulates its currency by giving more of its own currency in exchange for the currency of other countries. Thus foreign importers can buy more goods per unit of currency exchanged. In other words, if the free market exchange rate between the dollar and the yuan is six yuan per dollar, an importer would be able to buy goods costing six yuan by tendering one dollar. If the Bank of China arbitrarily decides to boost imports, it can give eight or ten yuan for each dollar presented. Chinese goods drop in price on the American market.
Protectionists such as President Trump view this as harm, but where exactly is the harm? A Chinese good that previously cost a dollar now may be purchased for sixty or eighty cents. Our American standard of living goes up at China's expense! The extra money in Americans' pockets may be used to consume or invest more. This is a very strange definition of harm.
The real harm occurs in China. The Bank of China sets off price inflation in its own country. It may try to mitigate this inflation by raising the interest rate on its own debt in order to withdraw the extra yuan from circulation. This is known as "sterilization". It then appears as if China has achieved greater exports with no price inflation. However, China's debt rises. Eventually holders of Chinese debt will desire to draw down their yuan-denominated debt. Demand for yuan for spending purposes will increase. At that point China will be faced with a dilemma. Either it can raise the interest rate high enough to entice enough marginal holders of debt to roll over their holdings or it can print yuan. The former causes a recession and the latter causes price inflation.
There is no such thing as a free lunch or an economic intervention that causes harm to others and not one's own country.
Sunday, May 20, 2018
Wednesday, March 21, 2018
From today's Open Europe news summary:
Removing tariffs post-Brexit could see prices fall up to 1.2%, suggests new study
Thursday, March 15, 2018
Saturday, January 20, 2018
According to Frank Decker, Honorary Associate at the University of Sydney Law School, it certainly can. Not only that, but eschewing savings in favor of "monetisation of assets" will yield better results! I refer to his article in Economic Affairs--Volume 37, Number 3, October 2017--, a publication of the Institute of Economic Affairs, London.
Mr. Decker purports to answer the question "Central Bank or Monetary Authority? Three Views on Money and Monetary Reform." The three views examined are commodity money, state money, and money as a derivative of property. All three views are explained very well, and a beginner to the study of the role of money will learn a lot in a short period of time.
Commodity money is the name Decker aptly gives to money backed by gold or some other widely accepted medium of indirect exchange. Commodity money's proponents see two major advantages--that it ends inflation and the business cycle. He quotes Mises and Rothbard to good effect.
State money, or money as a state liability, is fiat money that all the world knows today. Its two most famous proponents are Keynes and Friedman. State money's main advantages, as seen by Decker, are that the state can engage in countercyclical spending and the state can fund itself by printing all the money that it needs for current expenditures.
Decker's third type of money--money as a derivative of property--sounds no different than fractional reserve banking, except that the fraction of reserves required to be held by the lending banks is so low that it is not a factor of lending restraint. Decker gives the example of a business that uses its assets as loan collateral. According to Decker, the money that the bank creates is NOT created out of thin air, because it is backed by private property; i.e., the loan collateral. According to this theory, money can be created ad infinitum, because each round of loans creates new property with which to engage in another round of property-backed money creation. If this isn't money "out of thin air", I don't know what is!
Decker desires to find the best monetary regime to promote economic development. Of the three money systems, he settles upon a property based system with a central bank as benign overseer. His choice of this system, such as it is, shows his lack of knowledge of economic theory. In fact, he is a thorough empiricist, with all the limitations that are emblematic of trying to gather billions of facts with which to determine cause and effect. Austrian economists know that economics is a deductive science in which reliable conclusions can be drawn by using proper logic based upon irrefutable maxims.
Decker's two reasons for passing over commodity money are rather astounding. He believes that commodity money would "impose limitations on civil liberties and property rights", because "Countless episodes of monetary history show that economic actors will always find ways to monetise their assets.". He is certain that banks will continue to engage in creating money substitutes out of thin air--i.e., paper money and/or book deposits--even though it is against normal commercial law or, under a free banking system, that money creation would be limited by normal banking presentment practices. But most damaging, according to Decker, is that commodity money would restrict a nation's development. Astonishingly he states that "Commodity money would also retard economic development, as the monetisation of assets allows investment without the prior accumulation of savings,..."! In other words, why save when capital can be created ex nihilo at the stroke of a computer key? Counterfeiters must be wondering why they are persecuted when their actions are actually beneficial!
Decker equates capital with book entry capital accounts. It is as if an Iowa farmer believed that he could acquire seed corn by making an entry on his books. He would not have to save some corn from last year's crop; he could consume it all and perhaps plant pieces of paper. Of course, this capital that Decker believes appears magically actually comes from real people giving up real assets. Frederic Bastiat's That Which Is Seen, and That Which Is Not Seen and Richard Cantillon's insight that money enters the economy at specific places, unduly rewarding specific individuals (the Cantillon Effect), could not be more appropriate.
In order for Decker to be correct he must see new factories, houses, etc. arising and believe that nothing was sacrificed to build them. But clearly that is not how the world works. The sacrifice is there, even if NOT seen. Inflating the money supply robs current holders of assets, those who sacrificed and saved, for the benefit of the earlier receivers of the new money. It is a transfer of wealth, not an increase in wealth.
Decker sounds like a gambling addict who counts only his winnings and not his losses. The winners are the earliest receivers of the new money, who can buy at existing prices. Later receivers see increasingly higher prices and/or lower returns on investment.
Today's interest rate suppressions that favor borrowers come at the considerable expense of savers, many of whom are retired. Their standard of living deteriorates, but, since Decker cannot find statistics to record this fact, he believes that it is not happening. He fails to go that next and necessary step to consider that which is both seen and unseen, per Bastiat's timeless insight.
No individual or group of supposedly wise men should ever be given the power to create money out of thin air or to manipulate the interest rate. Only commodity money, which is controlled by no one, can protect private property and perform the market's time coordination function, AKA the interest rate. Spending requires prior savings, and savings cannot be spent twice.
The old saving that "there is no such thing as a free lunch" needs an addendum--Somebody always pays.