Free trade, USA's freekenomics

Free trade, USA's freekenomics

No economic policy could better serve Americans than genuine free trade, but open trade policies are failing Americans.

Free trade is a compelling idea. Let each nation do more of what it does best, and specialization will raise productivity and incomes. Americans are not sharing in those benefits because President Barack Obama, like president George W Bush, permits China and others to cheat on the rules, unchallenged, to the detriment of the US interests he was elected to champion.

The World Trade Organization has greatly reduced tariffs, prohibits virtually all export subsidies, and regulates other national policies that could subvert trade, such as health and product safety standards arbitrarily slanted to favor domestic suppliers.

For these rules to optimize trade, raise productivity and boost incomes, exchange rates must adjust to reasonably reflect production costs. To buy Chinese televisions, Americans must be able to purchase yuan with dollars; however, an artificially strong dollar that overprices US tractors and software in China will unravel the benefits of trade by denying Americans opportunities to export to pay for those televisions

Exchange rates are established in currency markets, created by businesses trading through major financial institutions. Unfortunately, China and several other Asian governments blatantly manipulate those markets without a credible US response and with ruinous consequences for American workers.

The United States annually exports US$1.6 trillion in goods and services, and these finance a like amount of imports. This raises US gross domestic product by about $170 billion because workers are about 10% more productive in export industries, such as software, than in import-competing industries, such as apparel.
Unfortunately, US imports exceed exports by another $400 billion, and workers released from making those products go into non-trade-competing industries, such as retailing, where productivity is at least 50% lower. This slashes gross domestic product by about $200 billion, overwhelming the gains from trade, and requires workers displaced by imports to accept lower wages.

The trade deficit creates an excess supply of dollars in international currency markets, as Americans offer more dollars to purchase foreign products than foreigners demand to purchase US products.

Simple supply and demand should drive down the value of the dollar against the yuan and other currencies, make US imports more expensive and exports cheaper, and reduce or eliminate the trade deficit. But the Chinese government subverts this process by habitually printing and selling yuan for dollars in currency markets, keeping its currency and exports artificially cheap.

Currency manipulation creates a 25% subsidy on China's exports, and other Asian countries are impelled to follow similar policies, lest their exports lose competitiveness to Chinese products.

Also, huge trade imbalances between Asia and the West, perpetuated by currency mercantilism, create an imbalance in demand - a shortage of demand for the goods and services produced in the United States and Europe, and artificially robust demand for products made in China and elsewhere in Asia.

Consequently, to keep the US economy going, Americans must both borrow from foreigners and spend too much, as they did through 2008, or their government must amass huge budget deficits by borrowing from abroad, as it is now does thanks to stimulus spending and the Troubled Asset Relief Program.

In the bargain, the United States sends manufacturing jobs to Asia in industries that would be competitive, but for rigged exchange rates. The trade deficit slices $400 billion to $600 billion off GDP, and Americans suffer unemployment above 10%.

China grows at nearly 10% a year and makes American diplomats look like fools for advocating free markets as a growth policy.

Campaigning for the presidency, Barack Obama promised to do something about Chinese currency manipulation. Instead, like a good supplicant, he now thanks Chinese officials for buying US Treasury securities.

China's development policies make its leaders look smart, but nothing makes them look like geniuses better than an American president who appeases their beggar-thy-neighbor policies.

It will be impossible for the United States to create the 9 million jobs needed to bring unemployment down to pre-recession levels without taking on China's currency manipulation and other unfair trade practices.

For that, Americans may need to wait for a better president - one with the courage to stand up to China.

Through dollar hegemony, the United States is the only country that can defy the Mundell-Fleming thesis. For more than a decade since the end of the Cold War, the US has kept the fiat dollar significantly above its real economic value, attracted capital account surpluses and exercised unilateral policy autonomy within a globalized financial system dictated by dollar hegemony. The reasons for this are complex but the single most important reason is that all major commodities, most notably oil, are denominated in dollars, mostly as an extension of superpower geopolitics. This fact is the anchor for dollar hegemony which makes possible US finance hegemony, which makes possible US exceptionism and unilateralism.

When China exports real wealth to the US for fiat dollars, it is receiving US sovereign credit in exchange of material wealth in the form of goods. Thus the US trade deficit denominated in dollars is in fact US lending to China through buying Chinese goods on credit. China now is a holder of US fiat money and as such is acting as a state agent of the US, with the full faith and credit of the US behind the US sovereign credit instrument (dollar), which is good for paying US taxes and is legal tender for all debt public and private in the US.

Fiat money, like a passport, entitles the holder to the protection of the state in enforcing sovereign credit. It is a certificate of state financial power inherent in sovereignty. Since China does not pay US taxes, the dollars that China receives can only be used to buy US sovereign debt (Treasuries) through extinguishing the US sovereign credit instruments (dollars). Through this transaction, China changes its position from that of an agent of US sovereign credit to that of a creditor to the US. This is why China must buy Treasuries with its surplus dollar - to change its position from that of a US agent to that of a US creditor.