Sunday, January 29, 2012

Forget China. Will the Trade Enforcement Unit be a Currency Manipulator?

Published at Forbes. A shorter version published in The Tennessean, Sunday, January 29, 2012.

One good thing about President Barack Obama's State of the Union address this week was that he refrained from describing China as a currency manipulator. He did note the need to protect intellectual property rights, though the protection of property rights was not at all central to the theme of the president's speech.

The president's thinking on trade matters is better represented in his announcement of the “creation of a Trade Enforcement Unit that will be charged with investigating unfair trading practices in countries like China.” One task of this new unit will be to push China to increase the value of its currency.

This is not a new task, but it might be helpful that the unit is focused also on the encouragement of greater trade freedom and protection of property rights. Nevertheless, the whole effort is confused by allegations of currency manipulation.

As China emerged from decades of communist repression, its leaders knew that their currency would never be trusted at home or abroad if it maintained an independent monetary policy. Accepting this, for many years China chose to fix the exchange value of its currency to the dollar. What they did, in essence, was to adopt the US dollar as their monetary standard. As long as the exchange rate was fixed, the US dollar served as the Chinese monetary base. The Chinese currency itself was merely for daily domestic use.

Several countries and jurisdictions, such as the United Arab Emirates and Hong Kong, have long had fixed exchange rates between their currencies and the US dollar. Other countries, such as Ecuador and Panama, have been using the US dollar as their de facto currencies. We don't hear complaints about these countries' currency policies.

The currency complaints against the much larger China are purely instrumental, intended to serve protectionist political constituencies in the US. Charges of “currency manipulation” come mainly from politicians who need to please groups, such as trade unions and local manufacturers, who feel threatened by international competition.

Governments have often resorted to currency devaluation as a means to give domestic exporters a competitive advantage. Such a policy of “competitive devaluation” can, at best, give a short-term stimulus to a small subset of the economy. In general, it fails. It has always been a very poor substitute for domestic economic policies of low taxation, light regulation, a small government-sector, and a sound currency.

The Chinese currency is still not convertible, which means that there are controls on the access that Chinese residents have to foreign currencies. Historically, such controls have been applied in attempts to maintain demand for an overinflated currency. But the only goal that it really succeeds in achieving is increased control over citizens and the concentration of power in some government bureau. By standards suitable for public statement, such controls always fail.

Those who insist that the Chinese currency is undervalued should explain to us what the correct exchange rate is and how they determined it to be such. But they can't do that without revealing the subjectivity of the whole exercise. What they really want is to push competitors perpetually to do the opposite of competitive devaluation.

Meanwhile, they are quite content to pretend that the dollar, over which the US government has monopoly control, with the power to inflate the currency and to manipulate interest rates, is a “free-market currency” as long as we advocate flexible exchange rates.

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears on Sundays.

Twitter: @RichardJGrant1

Copyright © Richard J Grant 2012

Sunday, January 22, 2012

Unemployment is symptom of bigger problem

Published in The Tennessean, Sunday, January 22, 2012 and Forbes

by Richard J. Grant

Those who argue that construction of the Keystone XL pipeline should be approved by the president because it would support tens of thousands of jobs get the story backwards. The jobs should be created because the product delivered by the pipeline is highly valued by potential customers. There is no problem with demand. No one doubts that American and other customers would willingly pay enough to cover the cost of the project, which would pipe oil south from the Alberta tar sands.

Politicization of the “jobs” issue is understandable. With many people currently unemployed or underemployed, there are many potential voters looking for a sign that help is on the way. This creates a market for politicians who are too quick to put the cart before the horse. “Job creation” becomes an end in itself; the purpose of the job is secondary. The goods or services that are produced are relegated to the role of means.

This approach to economic management explains why we hear politicians, and their favorite economists, decrying the “lack of demand” in the economy. They either don't care, or have no idea, what demand is.

Demand, in any relevant sense, cannot exist other than as expressed through the choices of a real person who, to get what he desires, voluntarily offers in exchange something of value to another person. Whatever work might be involved in carrying out this transaction could be called a job. But any such job is worth doing only if the transaction that necessitated the job is worth carrying out.

When people are free in “the pursuit of happiness,” there is no limit to work opportunities. Compared to our imaginations and desires, there is always a scarcity of workers and other resources to meet those desires. Every unemployed person, regardless of their talents or handicaps, is an entrepreneurial opportunity.

When we observe involuntary unemployment, we need to ask why. In the case of the Keystone XL pipeline project, we know that many workers must now look elsewhere because a politically motivated president had the power to say “no.” This could and should have been a defense against property takings; instead it satisfied only a political constituency with meddlesome preferences.

Involuntary unemployment, when it persists, is not natural. When people are free to set their own terms and prices, work opportunities are unlimited. When people are not free, but subject to inappropriate regulations and excessive taxation, problems arise.

In general, it is a failure to define and protect property rights that results in the unemployment or underemployment of people and their resources. How many businessmen have wasted how many hours justifying themselves and their actions to some committee of politicians or bureaucrats?

Are those politicians and bureaucrats productively employed or destructively employed? When they institute laws that protect people and their property from infringement by others, they facilitate peaceful cooperation. But when they interfere with trade and the use of private property, they are limiting employment and contributing to social strife.

The unemployment that we observe is the result of our failure to limit the size and power of our own government. It is no solution that we now call for that government to treat the symptoms by creating jobs. Nor do we need a government that becomes, like the jobs it creates, an end in itself.

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears on Sundays.

Twitter: @RichardJGrant1

Copyright © Richard J Grant 2012

Sunday, January 15, 2012

Obama compounds our short-term problems

Published in The Tennessean, Sunday, January 15, 2012

by Richard J. Grant

We know that federal budget deficits tend to rise during and immediately after recessions. This is not because they should or must according to any moral or inexorable law of nature. It is merely programmed into the current fiscal structure: unemployment rises and incomes fall along with production. This automatically increases government spending and reduces tax revenues.

These effects are usually compounded by a predictable political reaction, which most recently included the extension of unemployment benefits, increased government “stimulus” spending, and the reduction of payroll tax rates.

The political payoff from these reactions will certainly be greater than the real economic payoff. Extending unemployment benefits sounds compassionate, but it draws resources away from other uses and reduces both the incentive to work at finding a job and the likelihood that such job opportunities will be created.

So-called “stimulus” spending might be directed into beneficial infrastructure projects that reasonable people could agree to fund. But, as we have seen, it could just as easily be blown on speculative, too-clever-by-half attempts to create new industries ahead of their time. “Green energy” is one such area where government has demonstrated its incompetence and has probably retarded innovation in the energy sector.

Payroll taxes affect many people. They are low, flat taxes on a relatively stable tax base. Payroll tax revenues fall as employment falls, but they are not as sensitive to downturns as are other taxes on income and capital gains. Also, the reduction in revenues earmarked for Social Security will hasten the day when the trust fund reaches zero and Congress must make new appropriations to keep the checks coming to retirees.

We can forgive a newly elected politician for the automatic increases in the budget deficit that occur in his first year of office. What we can, and should, judge him on is the economic value added or destroyed by his own actions.

In a recent Wall Street Journal article, Austan Goolsbee, a University of Chicago economist and former chairman of President Obama's Council of Economic Advisers, criticizes the Republican presidential candidates for under-appreciating the automatic nature of deficit increases during a downturn. He notes that, “As the economy grows back to health, the government share of the economy will fall.”

But by making this point, he seems to miss the point. Although economic growth is positive, it is about half the long-term average rate. Twenty-eight years ago, after a similar recession, the economic growth rate was double the long-term average. That was during the equivalent period in President Ronald Reagan's first term. This difference is not an accident.

President Reagan knew the difference between reduced tax revenues and reduced tax rates. But Professor Goolsbee points to the recent low tax revenues and wonders why the GOP candidates are not “trumpeting the last three years as one of the greatest tax cutting periods of the century.” If President Obama understood this, he would have copied Reagan rather than attempting the opposite.

President Reagan knew that he was, and would be, plagued by short-term deficits. He focused, not on quick fixes, but on improvements that would be effective and would last. By his presidency’s end, top marginal income-tax rates were less than half what they had been. Economic activities were much freer from government interference and the economy grew accordingly.

After that, what president could complain about his “inheritance”?

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears on Sundays.

Twitter: @RichardJGrant1

Copyright © Richard J Grant 2012

Sunday, January 08, 2012

Government debt matters, because everyone's different

Published in The Tennessean, Sunday, January 8, 2012 and at Forbes.

by Richard J. Grant

When Nobel laureate Paul Krugman began a recent New York Times column by showing concern about “disastrously high unemployment,” we could sympathize with his assertion that too much attention is focused on “the allegedly urgent issue of reducing the budget deficit.” After all, there are many other factors that prevent us from employing our resources in the most productive uses. We are overregulated, overtaxed, overinflated, and the government spends wastefully and too much.

If we were to prioritize any of those policies, such as cutting tax rates, then we could justify tolerating high deficits a little longer. The brighter prospects for higher growth and improved resource employment would increase our future debt-service capacity.

But this is not what Professor Krugman is talking about. He believes that we need more government spending, not less. Drawing inspiration from John Maynard Keynes, he remarks that Keynes wrote about the need to spend our way out of the depression when “Britain was deeper in debt than any advanced nation today, with the exception of Japan.”

Krugman supports his argument by noting that Britain “has had debt exceeding 100 percent of GDP for 81 of the last 170 years.” We could be forgiven for rather doubting that this supports his argument.

The root of Krugman's confusion on debt lies in adherence to what my old professor James Buchanan (also a Nobel laureate) once called the New Orthodoxy. Krugman believes that governments differ from families in that they don't have to pay back their debt. From this, he can deny that debt burden is shifted on to future generations. Krugman also believes that when Americans lend to the U.S. government there is very little burden because “we owe it to ourselves.”

Acceptance of the New Orthodoxy was a boon to big-spending politicians and their special-interest groups. If government debt was less burdensome than once believed, then they could justify the greater use of debt to fund government spending.

Professor Buchanan's great contribution (54 years ago) was to show that the New Orthodoxy was wrong. Government debt really does resemble private debt. Government debt really does shift the burden onto future generations. Also, the distinction between internal and external debt is largely false.

Krugman's debt theory fails for the same reason that his government-spending stimulus theory fails. He sees us in the aggregate, not as individuals. This is why he can claim that “every dollar's worth of foreign claims on America is matched by 89 cents' worth of U.S. claims on foreigners” as if it all just nets out. What he does not mention is that each of us is affected differently.

When someone buys a government bond, it is a voluntary market transaction. The buyer voluntarily gives up current resources for use by the government. There is no symmetry for taxpayers, especially those in future generations. For those who bear the burden of current and future taxation, the transaction is not voluntary.

It makes no sense to say that “we owe it to ourselves.” Even when Americans lend to the U.S. government, those who lend are not necessarily the same as those who bear the burden. Understood this way, Krugman would be correct to downplay the extent to which we are “in hock to the Chinese.” But he is wrong to downplay the extent to which we are in hock.

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears on Sundays.

Twitter: @RichardJGrant1

Copyright © Richard J Grant 2012

Sunday, January 01, 2012

Government stimulus myth continues to disappoint

Published in The Tennessean, Sunday, January 1, 2012

by Richard J. Grant

Where there’s a front, there’s a back; and so it is with demand and supply. For over three years, we have been told repeatedly that our sluggish economic recovery is due to an insufficiency of demand. We were urged to get out and spend — to stimulate the economy, we were told.

First, the Bush administration sent us all $600 checks; then the Obama administration pushed a $700 billion “stimulus” package. When we got our $600 checks, in a time of recession, many of us thought it prudent to save as much cash as possible. In our eyes it was prudent, but not in the eyes of government planners. They wanted us to spend — spend on anything.

If we preferred to save and provide for the future, then the government would do an end run around us. The stimulus package did not give us a choice: the government would spend for us — or despite us.

In times of recession or economic uncertainty, it makes sense for individuals to reduce or delay spending. When we do so, we reduce our demand for the products of many businesses. This affects the plans of the owners and employees of these businesses. But clearly, the mere fact that we are facing recession implies that we must all change our plans to some extent. Our plans have already become incompatible, so we need to get back in tune with the realities around us.

This reality is hard if your business is stuck with unsold inventory. It might seem obvious to you that your problem is insufficient demand. You might even be tempted to support increased government spending in the hope that it might help stimulate sales of your products. That might help your business, or someone else’s, but it cannot help everyone at once.

Even if we could separate government stimulus spending from political favoritism, which we cannot, such spending would still not create something from nothing. The stimulus myth implies that government somehow knows better than each of us what is best for us. But this was not true in the 1930s, and it is not true now.

The “demand-side” argument fails from two perspectives. First, need is not currency. Needing or wanting something is not equivalent to making something. Demand, in the economic sense, implies having something to offer in return for that which you desire. Having something to offer is what we call “supply.” In economics, the word “demand” is not an imperative; it is an offer to trade.

Second, demand is not generic. It matters to each of us what we purchase, how much, and at what price. Government policymakers might imagine some magical “aggregate demand” that they can augment through spending programs. But if such programs make us better off, it is only by accident. Policymakers can never have the detailed knowledge necessary either to know what we need or to coordinate the production and trade needed to achieve it. They just get in our way.

The Obama administration likes to tell us that their actions saved us from “another Great Depression.” As luck would have it, they are not as bad as the Franklin D. Roosevelt administration. But they try: taking over industries, controlling prices, imposing mandates and spending money that we have not yet earned.

Here is what they should try this year: Get out of our way.

Richard J. Grant is a Professor of Finance and Economics at Lipscomb University and a Senior Fellow at the Beacon Center of Tennessee. His column appears on Sundays.

E-mail: --------- Twitter: @RichardJGrant1

Copyright © Richard J Grant 2011