In “The Emperor’s New Clothes,” a swindled King parades around in what is, supposedly, fabric so fine that only the competent can see, until an innocent boy asks, “Why isn’t the King wearing any clothes?” January 24 was Emperor’s New Clothes Day in Washington. In the morning President Bush and the Democratic leaders of congress unveiled their bipartisan stimulus plan to prevent unemployment (and get the current congressmen and senators reelected). In the afternoon, the Labor Department released new statistics which showed that unemployment peaked at 5.0% in December and declined to 4.9% in January. And in the evening, during the Presidential debate, Governor Huckabee asked the key question:
We’ll probably end up borrowing this 150 billion dollars from the Chinese and when we get those rebate checks most people are going to go out and buy stuff that has been imported from China. I have to wonder, whose economy is going to be stimulated the most by the package?The problem with the stimulus package is that it doesn't address the real problems of the American economy. It is based upon the mistaken premise that the United States is about to go into a recession. Indeed, when Federal Reserve Chairman Bernanke first endorsed it, the latest statistics were predicting unemployment and deflation. But the statistics since his endorsement show that neither is occurring. As we already noted, the latest unemployment data from January had unemployment falling, not increasing; the just-released fourth quarter statistics for the GDP deflator show that the deflationary trend of the second and third quarters ended during the fourth quarter when inflation increased from 1.0% to 2.5%, as shown in the graph below (seasonally-adjusted data fromm www.bea.gov):
Nor is the main problem in the United States economy a lack of consumer spending or a lack of government borrowing. In fact, it is just the opposite. The United States economy has too much consumer spending and borrowing, too much government spending and borrowing, and not enough business investment and borrowing. About 2/3 of the stimulus proposal would go toward giving consumption spending a boost. Much of this consumption spending would go to imports of consumer goods. This policy would perpetuate and exacerbate the imbalances of a United States economy already unsustainably dependent on debt-financed consumer purchases from abroad. Having the U.S. Government take a larger turn at borrowing to finance consumption wouldn’t fundamentally change the fact that, as a percentage of the overall economy, consumer spending is at historic and unsustainable highs.
The main problem in the United States economy is the lack of business investment. U.S. gross fixed investment, as a percentage of GDP, has been suffering a steady decline for the past two years, as shown in the graph below (seasonally-adjusted data from www.bea.gov):
About 1/3 of the stimulus plan would allow quick write-downs of U.S. investments. If these write-downs were accompanied by steps to get the trade deficits under control, they would indeed result in the needed burst of business fixed investment in American production. Unfortunately, American companies have learned through bitter experience over the past two decades, that if they invest in U.S. production, foreigners will likely drive them out of business as they have been doing to one industry after another for two decades. Moreover, the nature of the fast write-offs of depreciation is to borrow from tomorrow in order to encourage investment today. Companies will get a quick write-off of their 2008 investments, but will have less depreciation to write-off next year and in future years as a result. Any investment increase that occurs this year will likely just be a temporary blip on the declining investment graph.
The decline of fixed investment in America's productive sectors has been going on for over a decade. This is especially visible in the statistics for investment in America's manufacturing sector. Gross investment in the U.S. manufacturing sector fell from 2.4% of GDP in 1996 to just 1.4% of GDP in 2006. The decline in net investment (investment after depreciation is subtracted) in the U.S. manufacturing sector has been even more striking, falling to from 1.0% of GDP in 1996 to just 0.2% of GDP in 2006 as shown in the graph below (data from www.bea.gov):
In a 2005 lecture, Dr.Ben S. Bernanke, now Chairman of the Federal Reserve Board, explained that the inflow of dollar reserves from governments pursuing export-led growth strategies is largely responsible for the U.S. trade deficits. In other words, our economy is being manipulated by foreign governments who want to keep the trade deficits just the way they are. Bernanke said:
In practice, these countries increased reserves through the expedient of issuing debt to their citizens, there by mobilizing domestic saving, and then using the proceeds to buy U.S. Treasury securities and other assets. Effectively, governments have acted as financial intermediaries, channeling domestic saving away from local uses and into international capital markets….He noted that reliance on market forces had not and would not solve the problem. His solution – ask these countries to change their policies. The only trouble with asking nicely is that it has not worked, does not work, and will never work. In December 2006, President Bush sent all of our government’s most persuasive financial leaders (including Bernanke) to China to jawbone together, but their mission was an abject failure. China is expected to tally record trade surpluses with the United States in 2007. Instead of buying U.S. goods the Chinese are buying U.S. companies.
Another solution would be to allow the dollar to fall in value as it has already done vis-à-vis the euro. But China is pursuing a deliberate mercantilist policy to keep the dollar from falling much against its currency. It keeps its currency weak in order to encourage its exports and discourage its imports. In 2007, alone, China’s foreign currency reserves, predominantly dollars, went up by $462 billion. China has been practicing the strategy developed by Japan about three decades ago which allows a country to export without importing in order to steal market share from foreign businesses. And many countries, especially on the Pacific rim, are following China's and Japan’s lead.
Even though the U.S. trade deficit has improved over the last two years with the European and Latin American countries, our trade deficit has worsened with China, as shown in the chart below which uses projected final numbers, based upon the first 11 months of the year, for China's 2007 trade surplus with the United States:
In 2007 China began to accumulate large amounts of euros as well as dollars, apparently in order to build their trade deficit with the European nations just as they have been building their trade deficit with the United States. For a while Europe, too, will live beyond its means, in effect paying for goods with a Chinese credit card. The eventual outcome of this policy would be the collapse of European investment, just as U.S. investment is currently in collapse. However, unlike U.S. leaders, European leaders are unlikely to stand idly by while their trade deficits increase, manufacturing declines, and wages stagnate. But if they, too, fail to take action, we will all bear witness to the decline of the west, a hundred years later than Oswald Spengler anticipated.
The American trade deficit has been growing for more than two decades, but its most dramatic growth occurred between 1996 and 2006. Why did Congress and the Clinton and Bush administrations do nothing about a problem that has cost us millions of good paying jobs? Because, as Lee Iacocca writes (in his recently published book, Where have all the leaders Gone?), “We worship at the altar of free trade, and it’s killing us.”
Moreover, there ain't no free trade! China and other Pacific Rim countries have successfully manipulated trade and kept their wages artificially low by violating Article IV of the International Monetary Fund agreement which states:
(E)ach member shall … avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.Under the World Trade Organization's rules of international trade, a country experiencing chronic deficits with another nation may impose tariffs and restrict their imports to balance trade. We recommend import restrictions over tariffs, because import restrictions can bring trade into balance gradually and assuredly over a period of five years or so and are much less likely to provoke a destructive trade war.
In our forthcoming book, Trading Away Our Future, we lay out a way for the United States to answer these currency manipulations. We would begin by announcing to China and the other countries which have been accumulating dollar reserves that, beginning in 2008, their trade surplus in goods and services with the United States will have to be reduced by twenty percent per year.
These countries can respond to this challenge by increasing their imports from us. All China would need to do would be to eliminate existing barriers on imports of consumer goods, abandon protection of the host of "infant industries" ranging from automobiles and automobile parts to computers, cell phones, and machinery. Instead of buying American companies, China could start buying American goods.
Failure to voluntarily reduce their trade surplus would result in our imposition of auctioned Import Certificates which would forcibly reduce their trade surpluses to zero over a period of five years.
Our productive sectors will not invest in the United States until the U.S. government shows that it can and will bring the trade deficits under control. China will not stimulate its consumption of American products until it knows that it has to do so. Restricting imports through import certificates would cause a resurgence in U.S. investment which would solve both our short- and long-term economic problems.
The American economy is addicted to imports and financial investment from abroad. At best, the Bush stimulus package will supply it with a quick high. Instead, we must detox with a serious plan to bring the trade deficit under control and stimulate real investment.
Dr. Raymond Richman is the president of Ideal Taxes Association. He is professor emeritus of public and international affairs at the University of Pittsburgh with a PhD in economics from the University of Chicago. Dr. Howard Richman is executive director of a non-profit (Pennsylvania Homeschoolers Accreditation Agency) and an Internet economics teacher. Dr. Jesse Richman is an assistant professor at Old Dominion University with a PhD in political economy from Carnegie-Mellon University. Molly Inspektor is Secretary of the Ideal Taxes Association. Raymond, Howard, and Jesse are co-authors of Ideal Tax Association's forthcoming book, due out March 1: Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it's Too Late.