Friday, March 31, 2017

Two Unfounded Objections to Unilateral Free Trade


Recently I forwarded to my circle of friends what I considered to be a concise and accurate argument in favor of unilateral free trade. The author was Professor Don Boudreaux of George Mason University, writing in his daily blog He responded to Mr. Daniel Dimiccio, former CEO of Nucor Steel, who was defending tariffs on foreign steel. Professor Boudreaux explained that arguments in favor of tariffs place all of economics on its head; i.e., that consumers were required to support producers rather than the other way around.


After sending Professor Boudreaux's article, I have been hearing two common objections to his article from friends who consider themselves generally to be in favor of free trade, even unilateral free trade. The first objection I will call the Donald Trump objection; i.e., that imports have cost Americans good paying jobs, from which the nation has never recovered and cannot recover as long as we allow imports to replace American made products. The second I will call the essential industries objection; i.e., that there are some products that America must produce itself, no matter what the cost or inefficiency, in sufficient quantities to ensure access to these products in time of war.


Objection number one: Free trade causes unemployment


The first objection is easiest to dismiss, for it attempts to refute the "Law of Comparative Advantage", postulated exactly two hundred years ago by the great English economist David Ricardo. Peaceful cooperation among peoples of the earth has no limit. Just as we Pennsylvanians find it advantageous to import pineapples from Hawaii rather than attempt to grow them ourselves, Americans find it advantageous to import many goods from people who just happen to live in foreign countries. Absent government intervention to restricts one's own citizens from entering into peaceful cooperation to produce any legal product or service, all will find employment and all will be wealthier. A simple example will suffice. Let's assume that Michael Jordan, the greatest basketball player of his generation (and perhaps of any generation) desired a new home. Let's also assume that Mr. Jordan was a skilled carpenter, electrician, plumber, etc. Would Mr. Jordan become wealthier by quitting basketball for a year or two at the height of his career in order to build his own home? Of course not. Even if we assume that Mr. Jordan not only was a skilled craftsman but just happened to be the best craftsman in the world, he still would be wealthier paying less skilled workmen to build his new home while he earned much higher wages playing basketball. The corollary is that even those who are less skilled in ALL things can find useful employment in an unhampered market.  This is the "Law of Absolute Advantage", a corollary to the "Law of Comparative Advantage".


The Law of Comparative Advantage is also revealed once producers create a surplus. Savings produces capital, which produces more wealth when individuals are allowed to engage in the productivity enhancing division of labor via trade. The resulting products and services cost less than previously, yet employment is not destroyed. It is transferred to better uses, which enrich all. Both sides expect that trade is beneficial and must be allowed to freely trade their surplus product. The political location of individuals engaged in such trade is completely irrelevant to the wealth enhancing benefits of trade.


The logical conclusion of restricting international trade for just one or two so-called threatened industries is the demand that all products be protected. Advocating an autarkic society is to argue in favor of the fallacy of composition; i.e., that what might be good for one industry--for example, allowing domestic steel producers to extort higher prices from customers--cannot be extended to all industries.


This is akin to standing in a giant circle with everyone picking the pocket of the person in front while having his pocket picked in return.


The source of our societal problems, even those correctly identified, such as persistent unemployment, must be found elsewhere. As Ludwig von Mises would advise, one must find the proper means to arrive at the ends desired. If the US really does suffer from collapsing industries, restricting trade is not the solution but will exacerbate the problem. In other words, trade restrictions to cure unemployment are the wrong cure and will cause even more harm to society.


Unfortunately in modern day America there are many suspects to which one can assign economic decline. American industry is hampered by a panoply of regulatory red tape and outright restrictions at federal, state, and local levels. One needs only to consider the effects of the Environmental Protection Agency, the Occupational Health and Safety Administration, the Federal Food and Drug Administration, not to mention similar agencies at the state level, plus the disaster that is public education (regulated mostly by the states) and ever increasing regulations on economic life at the local level. (My tiny township government in southeast Pennsylvania recently informed us homeowners that we needed to obtain a township issued permit in order to resurface our driveways. So, now I need government permission to maintain my home in good repair!)


Objection number two: Essential industries must be protected


This is the national security objection; i.e., that the US must maintain a minimum production level of essential war related products.  This is not an argument in favor of economic efficiency. Quite the opposite. Furthermore, little or no evidence is offered that nations have lost wars due to running out of essential products, although it undoubtedly is true that denying the enemy all kinds of goods and services does reduce a nation's war-making capability. Nevertheless, one can make a good case that this concern is unlikely to be a factor by taking a closer look below the surface of this argument.


Stating the "essential industries" case:

Let's assume that China wants to drive US steel manufacturers out of business. It succeeds by offering US steel users--manufacturers of buildings, bridges, autos, etc-- high quality products at low prices for an extended period of time. After US steel production has been reduced to zero, China suddenly refuses to sell steel to us and, as a consequence we cannot build essential war material that requires steel components. We surrender to China, withdraw our military protection to allies, and/or accede to China's demands, whatever those may be.


The response:

Note that for a long period of time, perhaps years or even decades, China must subsidize steel production, which drains its public coffers and actually reduces its own war making capacity. (China can't build its own battleships, for example, if it is subsidizing construction of ours.)  In the meantime, the US enjoys an increase in its standard of living. We build up our country in many ways, from new and improved bridges to a revitalized domestic auto industry (remember, cheap, high quality Chinese steel is subsidizing US car makers). Now China embargoes steel shipments to the US and makes threats of some kind. Our modern battle fleet, the product of cheap Chinese steel, is at our immediate disposal.


Meanwhile, our modern infrastructure, built with cheap Chinese steel, allows us to rush stockpiled war material, also built with subsidized Chinese steel, to our fleet and onward to our overseas bases and the battle area. We then gear up for the possibility of a protracted war by placing orders for steel with the other thirty-odd nations of the world who are eager to sell us high quality steel but who have been shut out of the American market by subsidized Chinese steel.


Now, I ask this not the more likely scenario?


Importing subsidized products--perhaps especially products essential for war--increase a nation's war making capacity rather than diminish it. We build up all aspects of our nation's economy, including the defense sector, by using products with the best combination of quality and price, whether imported or not. Doing so allows us either to spend less for the same level of defense or increase our defense by spending the same amount of money but getting more war material in return. Our theoretical potential enemy has actually helped us defend ourselves and our vital interests abroad.




In conclusion, these two common objections to unilateral free trade do not stand up to closer scrutiny. For two hundred years David Ricardo's Law of Comparative Advantage has informed us that in an unhampered market economy all will be employed to the limit of their capabilities. Furthermore, rather than reduce a nation's security, imports of what we might consider to be "essential materials" actually enhance our security. We need to tax our own citizens less for the same level of security while building up our nation at the expense of potential enemies.


Let us end such nonsensical worries and trade freely with the world, especially with those whom we might currently fear, such as China. It wasn't that long ago our nation feared Germany, Japan, and even Great Britain. It's good to remember that peaceful cooperation provides its own momentum for everyone.


Thursday, March 23, 2017

The true goal for the EU's call to beef up financial regulation

From today's Open Europe news summary:

European Commission considers beefing-up powers of pan-EU financial supervisors

The Financial Times reports that the European Commission is considering plans to beef-up the powers of the three pan-EU financial supervisors, in a bid to address potential supervisory loopholes ahead of Brexit. Valdis Dombrovskis, a vice-president of the Commission, is quoted as saying, “Already you hear there are some disagreements among [EU] member states whether or not some kind of regulatory arbitrage is taking place, so indeed it strengthens the need of the case for regulatory convergence.” The article notes that one of the options under consideration would see the European Securities and Markets Authority (ESMA) been given powers to directly supervise clearing houses, as well as greater oversight over cross-border investment funds.
Let's all consider the true meaning of the Commission's goals by examining these phrases:

"potential supervisory loopholes"
"regulatory arbitrage"
"the need for regulatory convergence"
The EU is terrified that Brexit will mean that it is losing its stranglehold on ever increasing financial regulation.


Tuesday, March 21, 2017

End Banks' Exemption from Normal Commercial Law

Mr. Burke asked me to respond to the article below about how banks engage in money creation. Like many such articles, the one by Mr. Werner seems almost designed to be confusing and obtuse. My short explanation attempts to inform the layman of what is actually happening; i.e., that banks are exempt from normal commercial law and we all suffer.

Pat Barron

From: Patrick Barron
Sent: Tuesday, March 21, 2017 10:33 AM
To: Dan Burke
Subject: Re: Richard Werner
Banks are exempt from normal commercial law; i.e., they are allowed to engage in fractional reserve banking. In other words, a new dollar of reserves can be pyramided into approximately ten dollars of new bank deposits. Austrian economists call such money created out of thin air as fiduciary media in order to differentiate it from deposits backed by actual reserves. A loss of confidence in a bank can cause a bank run in which there are more claims for deposit withdrawals in the form of actual reserves (Federal Reserve Notes) than the bank actually owns. The bank's bankruptcy is exposed. Bank runs are rare today, because the Federal Reserve promises, via Federal Deposit Insurance, to lend the bank as many reserves as necessary. Nevertheless, this does not fix the fundamental error, which is legal tolerance for fractional reserve banking, and merely causes an expansion of base money (cash and bank reserve balances at local Federal Reserve offices) and sets the stage for another round of money expansion via banks' fractional reserve lending capability. Furthermore, the expansion of base money leads to malinvestment of capital and a rising price level, commonly and mistakenly called inflation. (The real inflation is inflation of the money supply via fractional reserve banking.)

The solution is to withdraw the banks' exemption from normal commercial law and prosecute fractional reserve banking as the fraud that it is. Banking would divide itself naturally into deposit banking, with one hundred percent reserve backing, and loan banking, in which the depositor gives up access to his money for a certain period of time so that the loan banker can find credit worthy customers.

Such a system would lead to the immediate end of federal deposit insurance and government bank examiners. Deposits would become bailments. Loans would be subject to full loss, just as today there is full risk of loss of one's investment in corporate bonds, corporate stock, real estate, etc.

Patrick Barron

From: Dan Burke
Sent: Tuesday, March 21, 2017 9:08 AM
Subject: Richard Werner
Would you please react to Mr. Werner's article?
How do banks create money, and why can other firms not do the same? An explanation for the coexistence of lending and deposit-taking ☆ Richard A. Werner