When economics and politics (don’t) mix:

Many remark (check the twitter comments) that this sounds like stuff the “Supreme Leader of North Korea” (Kim Jong-un) would say. Trump also revealed additional, previously unknown, superpowers: his ability to “obliterate” entire economies of sovereign nations.

Bloomberg reports on the EU’s 42.3% low-tech “ironing board tariff.” The goal is to protect 10 EU producers who employ about 700 workers in Italy and Poland “dumped” ironing board imports. “Ironing boards are among a group of more than 50 Chinese products subject to EU anti-dumping duties, making China by far the most frequent target of such European levies. Other Chinese goods that face such import taxes include aluminum foil, ceramic tiles, ring binders, and tableware.” Also on that list: bikes and since 2019 also e-bikes.

The new Apple Mac Pro is a good example of how bilateral tariffs work – work as in “outlining the mechanics” not as in “achieve the goal of making America great again through insourced production.” Trump tweets on Sept 30, 2019: Great news! Apple announced that it is building its new Mac Pro in Texas. This means hundreds of American jobs in Austin and for suppliers across the Country. Congratulations to the Apple team and their workers!

Apple Inc was contemplating it would move the production of the Mac Pro abroad, but decided instead it decided to continue production in America – but only after it received crucial tariff exclusions. (Over 2500 firms asked the US government for such exemptions from the Trump Tariffs, but few have been granted. Lucky Apple!) Here is the process: To qualify for a tariff exclusions firms have to prove to the U.S. government that

1. The item is available only from China, and whether it (or a comparable product) is not available in the U.S. or a third country
2. The additional duties on the item would cause severe economic harm to the applicant, or other U.S. interests
3. The item is strategically important

According to Bloomberg, the Mac Pro qualified for a tariff exclusion on its metal PC case, although it seems preposterous that a “stainless steel space frame” could not be manufactured anywhere but in China. NASA is sending spacecraft to the moon but no US company can make a steel case? The power cable, on the other hand, was denied a tariff exception — will it now be made in the US? Unlikely, the most likely supplier is said to be Taipei-based Delta Electronics Inc., which already supplies to Apple from factories in China, Taiwan, and Thailand. It plans to invest $1.8 billion in Taiwan to boost production and R&D. The case of Delta Electronics highlights the problems with the tariffs-to-repatriate-employment program: When US manufacturers cannot buy from the cheapest producer (China) the do not move production home but they go to the second cheapest producer which is likely in another country. Photo by Nilay Patel / The Verge

NPR reports on a wonderful trade diversion story. Here is the edited version:

An American investigator traveled to the Philippines last year in search of the origin of the pencils, what he found was a dusty factory that was simply repackaging pencils from China. Chinese pencils have long been subject to a stiff US anti-dumping tariffs of 114.9%, which more than doubles the cost of Chinese pencils.

According to a U.S. customs report, the manufacturing equipment at the Philippine plant “appeared to have been covered in dust and cobwebs indicating that they had not been used for some time.” The inspector saw no evidence of manufacturing, though some pencils were being sharpened. And there were boxes and boxes of finished pencils, with labels saying they were made in China. The inspector “witnessed staff repacking what appeared to be Chinese origin products into boxes labeled ‘Made in Philippines,’ ” the report said.

Mislabeling the source of products to avoid tariffs is not a new scam. But it’s likely to grow more prevalent as the trade war between the U.S. and China drags on and tariffs are extended to nearly everything China exports. Each new brick in the president’s tariff wall brings new incentives for business people to tunnel under – classic trade diversion.

Here is the Mexican version of the story:

Roberto Durazo helps set up factories in Mexico. Lately, he has been getting a lot of calls from Chinese companies eager to avoid the mounting import taxes imposed by the Trump administration. “They tell us, like, ‘Hey, I build a TV,’ ” Durazo said. ” ‘And I want that TV to be made in Mexico so I [don’t have to] pay the duties.’ ” “They just want to put it in the box, add labels and claim that it’s made in Mexico,” Durazo said. “And we tell them it doesn’t work like that.”

When the U.S. imposes tariffs on China, it’s only natural that some production really does move to other countries. Customs investigators grow suspicious when they see what appear to be abrupt moves, especially those that involve complex manufacturing or heavy machinery. “If on Monday a company is sourcing all their product from China and on Tuesday all of it is suddenly now coming from Vietnam or some other country, depending on the nature of the commodity, that’s just not realistic,” the customs spokesman said. “If that abrupt shift occurs the day after Chinese tariffs are raised, that’s another indicator.” U.S. imports from Vietnam jumped 33% in the first seven months of the year, compared with the same period a year ago.

Bear markets give investors about eight months warning that a recession might be on the way. But, how do we define a “bear market” formally to take this hypothesis to the data?

The make things even more difficult, Nobel Laureate Paul Samuelson’s famously quipped “the stock market predicted nine of the past five recessions.” Meaning that

• a) that bear markets lead recessions
• b) bear markets sufficient but not necessary conditions for recessions.

If we define a bear market as any -20% decline in the stock market for at least one month, there have been 13 bear markets in the postwar era, but only 7 recessions. So In this case, bear markets have about a 50-50 chance of predicting recessions.

Here are some leading indicators of recessions which may or may not predate bear markets.

President Trump said Japan would open its markets to $7 billion of American agricultural goods, calling the trade deal a “huge victory for America’s farmers, ranchers, and growers.” The WSJ comments “the Japan deal may be the President’s biggest trade victory in his first term. But he made it much harder than it should have been.”

Understanding this trade deal is important.

1. The US gets some access to Japan agricultural markets
2. Japan gets what it already has (no increases in US tariffs on Japanese Cars).

Trump was excited to show he had given nothing but gotten something, simply by threatening Japan with new tariffs brought Japan to the table.

Not so fast…

The access that US gains to the Japanese agricultural markets is equivalent to what had been agreed upon by pacific nations in 2016 under the multilateral Trans-Pacific Partnership trade pact (TPP).  At that time, Trump stated that “The Trans-Pacific Partnership is another disaster done and pushed by special interests who want to rape our country, just a continuing rape of our country”. One of Trump’s first acts in the office was to cancel TPP. All other countries eventually signed it.

Today the “new” US Japanese trade deal delivers for the US what it would have gotten already in 2016 under TPP and it delivers what all other TPP signatories already got years ago: better access to Japans agricultural market.

Here is another juicy detail: All trade deals be approved by Congress, but Trump kept the agreement to “and initial mini trade deal” suggesting that this is just the first part of a large trade deal, to avoid that Congress gets to approve it and to avoid that the WTO will examine its provisions.

As Bloomberg states: “All of this is doubly ironic because this week’s “mini deal” is a consequence of Trump’s decision to pull out of a far larger one — the Trans-Pacific Partnership, which included Japan and 10 other U.S. trading partners. It will also borrow heavily from the agricultural concessions the Obama administration spent years negotiating with Japan for the TPP… The end result: a partial deal that will leave out whole industries, undermine the global order and look a lot like parts of an agreement that Trump walked away from less than three years ago.“

source

Many think that Trump is compensating farmers because they are especially hard hit by global retaliation to Trump’s tariff war. Or because they loom large on Trump’s electoral re-election map. Not so. Farmers are compensated because this is the only group that CAN be compensated without a broad Congressional action to overhaul the taxes and subsidies on a grand scale.

Curiously it is a quirky welfare measure, the Commodity Credit Corporation that was established by President Roosevelt in the 1930s to help farmers during the depression dustbowl which allows Trump to pay farmers directly – 28 billion to date. Here is the full explanation from an article in the Magazine “Successful Farming.” Here are the highlights:

“Agriculture is the only sector of the U.S. economy to receive a trade-war bailout and that’s because of the broad powers given to the CCC, created during the Depression to pay for New Deal farm subsidies. After revisions over the years, it can borrow up to $30 billion from the Treasury to support commodity prices and farm income. The Reagan administration tapped the CCC to finance an export subsidy program in the early 1980s. There has been uneasiness over the unprecedented scale of Trump’s trade-war spending; $10 billion for 2018 crops and livestock and promises of up to $16 billion for 2019 agricultural damage.“

Argentina is back in crisis mode, only 2 short years after selling 100 year (!!!) bonds at 7.9% to the “unsuspecting” global public. Who is at fault? El-Erian explains:

“With a presidential election approaching next month, Argentina is once again on the cusp of a crisis that could end in depression and default, owing to mistakes made by everyone involved. Should President Mauricio Macri secure another term, he must waste no time in reversing the country’s economic deterioration.

Doug Irwin has a great summary

The purpose of the WTO is to facilitate multilateral trade liberalizations. Its elementary international economics to show why it is helpful to entice large countries with substantial market power to agree on trade liberalizations. Both countries win.

Countries that violate WTO agreements are taken to WTO court and eventually, they have to pay compensation to those countries that were injured. That is why the Trump administration has been trying to stifle any further WTO judicial processes — too many complaints have been filed against the US in response to Trump tariffs.

While the WTO judicial panel is still active, it has found for the US in part I of the Airbus-Boeing dispute and the US is now allowed to collect compensation. Politico reports that the won the right to collect a total of €7.5 billion, somewhat of a disappointment to the White House, which had prepared a list of EU export tariffs worth $21 billion.”

Part II of the Airbus-Boeing case is still pending at the WTO, which has already decided against the US in part II of the dispute, but the compensation is still being worked out. Are the US and Europe better off collecting compensation in this two-part conflict?

Bloomberg has the scoop: “Here’s how the international trading system is supposed to work: If a country gets upset with another country’s trade practices, it can file a dispute at the WTO where a panel of experts offers a judgment. If the losing country doesn’t comply with that ruling, the WTO allows the winning country to retaliate. For most of his first term in office Trump has preferred to cut to the chase and levy tariffs that he says are exempt from WTO oversight because they are necessary to protect America’s “public morals” and national security. But in the instance of Airbus, Trump and his predecessors have pursued and succeeded in a landmark case against the EU that’s been a decade-and-a-half in the
making.

Last year the WTO ruled that the EU hasn’t ended its illegal subsidies, which Boeing and the U.S. claim give Airbus an unfair advantage, and the WTO will soon green-light new U.S. tariffs on billions of dollars worth of European goods.

But the other shoe has yet to drop. In a similar action that’s still winding through the Geneva-based WTO, the European Commission is readying its own tariffs on
U.S. exports in retaliation for unfair subsidies given to Boeing. EU Trade Commissioner Cecilia Malmstrom summed up the situation on Monday by saying “both we and the U.S. have sinned” and the time has come to settle the dispute rather than resort to tit-for-tat tariffs. The multi-billion dollar question now: Will Trump see an opportunity to forge a comprehensive aerospace accord with the EU or kick off a transatlantic trade war of epic proportions instead?”

Finally, while the tariff/retaliation-compensation may be “justified” under WTO rules to “keep the peace” and enforce multilateralism, there are also the usual unintended consequences. Bloomberg reports that a substantial share of Airbus parts is sourced in the US… 

Charting the Trade War

World Trade Organization authorized $7.5 billion in U.S. duties against the EU would hit export orders for U.S. manufacturers, according to Bloomberg Economics.

UPDATE 10/4/2019:

The US just released its tariff list, targeting among other things European whiskey, most likely to compensate US whiskey producer for their market loss in China, which retaliated by reducing market access for Kentucky Burbon/Whiskey produced in the Senate Majority leader’s home state… Other than that we have tariffs that help US agriculture (olive oil, cheese, meat, wool) which already received a $28 billion bailout when China stopped buying US goods. 

Kinzius et al dig through the Global Trade Alert database, which features wonderful visualizations of trade interventions (positive liberalizations and negative tariff measures).

Number of newly implemented protectionist interventions by type, 2009 – 2017

Note: Numbers in the bars represent a rise in protection by specific policies: we count the change in tariff increases (tariff changes), newly introduced anti-dumping, anti-subsidy and safeguard measures (trade defense), and newly introduced non-tariff barriers (non-tariff barriers) e.g. new national regulations.
Source: GTA.

Figure 2 illustrates that over the past years tariffs were not the major trade policy tool to protect domestic economies. Instead, NTBs have been most often applied. Since 2009, only 20% of all implemented protectionist interventions could be attributed to an increase in tariffs. In contrast, NTBs accounted for on average 55% of the implemented protectionist interventions.

Number of NTBs imposed by country, 2009-2017

The European Central Bank cut its key interest rate and launched a sweeping package of bond purchases. It is the ECB’s largest dose of monetary stimulus in 3½ years and a bold finale for departing President Mario Draghi, who looks to be committing his successor to negative interest rates and an open-ended bond-buying program, possibly for years, Tom Fairless reports. The ECB’s pre-emptive move was aimed at insulating the eurozone’s wobbling economy from a global slowdown and trade tensions. But it triggered opposition from a handful of ECB officials and an immediate response from President Trump.

A quick application of interest parity will yield some insights on the effects on the value of the US dollar.

While Trump loves what the ECB is doing, it should be noted that the Eurozone is at the brink of a recession with contracting output, while the US is at the pinnacle of its expansion.

One would not expect such a consistently dismal record of forecasting inflation (inflation!!!), which is one of the most fundamental variables in the macroeconomy, from any central bank, especially not the European Central Bank

The Wall Street Journal reports on the global effects of the local/bilateral US/Chinese trade war. A perfect application for the large open economy diagram! Can you work out the effects of a US tariff imposed on Chinese goods and then the Chinese retaliation. Who wins/looses? Then Draw the US on the vertical axis and “The Rest of The World” on the horizontal axis to show the impact of the Trade War in the US on the rest of the world. Who wins/looses?

China lodges tariff case at WTO against the U.S. reports Reuters.

Charting the Trade War

A 15% tariff that went into effect Sept. 1 on about $112 billion of goods imported from China will start pushing up prices of clothing, shoes and other consumer goods arriving at U.S. ports this week.

A return to the gold standard will not win Trump’s trade war,

says Barry Eichengreen in the Guardian. But it does highlight the confusion of Trump and Shelton as to what the Gold Standard does and how it would run counter of their ideas of low interest rates.

Treasury Secretary Mnuchin inside the US Fort Knox Gold Vault, 2017.

BEWARE FAKE TRADE NEWS: Outgoing European Trade Commissioner Cecilia Malmström made a not-so-subtle swipe at Trump’s trade worldview as she countered some of the president’s most commonly held views during a speech Wednesday.

“The biggest misconception I have seen on the rise now is about tariffs,” she said. “People who advocate tariffs seem to base their arguments on two things: Tariffs target foreign business when they in fact the consumers. And tariffs are the tool of narrow interest seeking to protect industries at the expense of broader society.” Another wrong perception is believing that producing all goods at home is cheaper and better for the economy, she said, adding that this idea goes against the idea of comparative advantage.

Here is the whole speech

Ladies and gentlemen,

Today I want to discuss truth. In the age we live in – of instant communication, simplified messages and government by Twitter – truth can be difficult to hold on to. There is a quote, attributed to Mark Twain: “A lie travels around the globe while the truth is putting on its shoes.” It is a famous quote, and very apt – especially given that there is no evidence that he said it.

Today, many in this room will agree on most things – but we will disagree on others. And in my experience, it is always good to find a mutual point to start on.

So let me suggest one: Ladies and Gentlemen – the earth is round. Or to be accurate: an oblate spheroid. Life would be easier if it were flat:

• cartographers could make maps more easily
• lunar eclipses would not ruin our view of the moon
• all of the stars in the sky would be perfectly visible every night

But unfortunately it is not flat – a fact first proved in the 3rd century BCE, when Hellenistic astronomy calculated its shape and circumference. Since then, the evidence has mounted up. From astronomical calculations to simple observation. From ground-level views to photos from aircraft and spacecraft.
So why, despite all of this evidence, does the International Flat Earth Research Society maintain a membership? Why is there a small, but active, online community? Because they follow instincts over evidence. When they look around them, they see a flat earth.
I am afraid, however, that they are wrong. We sit here and we laugh about people believing the earth is flat, based on intuitive presumptions. Yet, these days many similar presumptions are made about trade – ones that feel intuitively true but are backed up by nothing of substance.
Often you hear people say that they are entitled to their opinion – That’s of course true, but even so, your beliefs should guide you, but not all decisions can be gut decisions. If you want to disagree with something, you have a responsibility to look at and understand the evidence.

This is something that has become very clear to me in my time as Commissioner for Trade. I am a proud liberal – I believe in open borders and free trade. My ideological beliefs have guided me – but sometimes I must recognise the reality of a situation that is constantly evolving, even where I have had some initial doubts.
So today I want to talk to you about a few things in trade – specifically: the things that feel intuitively true, but are in fact not, and what lessons we can draw from this for the future.

TARIFFS TARGET FOREIGNERS

The biggest misconception I have seen on the rise is about tariffs. People who advocate for tariffs seem to base their argument on two things: The first is that tariffs target foreign businesses – when they in fact target the consumer. Tariffs are the tool of narrow interests seeking to protect industries at the expense of broader society.
The second is that if we make a product at home, we save money, strengthen the economy and create jobs. This is a tempting argument, but it is not true.

A basic principle of trade – that of comparative advantage, that specialisation is more efficient – seems to be increasingly forgotten these days. This type of thinking could lead to:

• unsustainable business models
• higher prices for ordinary citizens
• and a more fragile economy in the long run

Tariffs are not the answer to a transforming global economy – they are rarely the answer to anything – they are the equivalent of shooting yourself in the foot to hurt the shoe salesman.

EXPORTS ARE PROFITS

Another big mistake people make these days is confusing a trade balance with a bank balance. They misread “exports” to mean profits and “imports” to mean losses. This ignores a range of economic realities.

For example, the increasingly service-oriented economies in Europe, or the fact that getting hold of low priced and reliable imports is vital for our companies. Or that in a modern global economy, good will cross borders many times before they are finished – bringing prosperity and jobs wherever they go.
In fact, a surplus in trade can be a bad sign. It is a sign of weak domestic demand – this can make countries sensitive to changes in the global economy. Balancing the books on trade is not like a household budget.

TRADE IS ONLY FOR THE BIG GUYS

Another common misperception is that trade is only for big companies. But I know a few people who would disagree with that – Laura Fontan and Diego Cortizas, for example. They are the Spanish owners of Chula Fashion, a company based in Hanoi. They are a family-owned company with 68 employees. Our agreement with Vietnam will simplify rules of origin to make it easier to export to the EU.
Trade is important to companies, both big and small. However, it is true that small and medium-sized companies are underrepresented in global trade. Exporting can be hard. In a new market there are many barriers – customs, language, marketing. Throw tariffs and other trade barriers in and it becomes very difficult indeed.

Often larger companies can absorb these costs, but smaller companies might not be able to. This is why we have started to include provisions focusing on them in our trade agreements. These often include measures like:

• providing information online on market requirements
• an SME Helpdesk, where EU companies can protect themselves from unfair practices
• access to helpful contacts, like the Enterprise Europe Network

In the coming years, it is estimated that 90% of global growth will originate outside the EU. Developing and emerging markets will account for 60% of world GDP by 2030. Smaller companies are well placed to take advantage of that – taking up their role in global supply chains. Trade is not just for the big guys – it is an opportunity for all.

TRADE HARMS THE ENVIRONMENT

Another presumption is that trade is automatically bad for the environment. In fact, the picture is much more complicated than that. For example, it is better for the climate for northern Europeans to buy tomatoes from Spain, despite the transport costs involved – it cuts back on other causes of emissions, such as heated greenhouses.

Lamb from New Zealand has been similarly shown to have its transport emissions offset by other factors. Both are counter-intuitive but that doesn’t mean they aren’t true. We must aim for a lower environmental impact – but we should keep our approaches evidence-based. Trade can have other indirect, positive spill-overs on the environment too:

• encouraging innovation
• spurring investment in low-carbon production to meet standards in other countries
• lowering the costs of environmental goods and services

Indeed, a critical part of fighting climate change is improving local production processes. Trade and investment liberalisation can provide firms with incentives to adopt the high standards from elsewhere. Changes needed to meet these requirements, in turn, flow backwards along the supply chain. This stimulates the use of cleaner production processes and technologies throughout a country.
To encourage this, we have inserted environmental provisions into our agreements. Each of our comprehensive agreements has a chapter on Trade and Sustainable Development. Crucially, this helps us lock in commitments to implement international climate conventions, such as the Paris agreement. This is partly why our recent agreement with the four Mercosur states is so important.

It binds these four countries together with the EU at a time when the US has left the Paris accord and is encouraging others to do so. Nevertheless, there are times when the evidence is there right before our eyes. We all saw the reports over the last couple of weeks of the fires raging in the Amazon rainforest.

This is deeply worrying – the Amazon provides much of the world’s oxygen and must be protected. I firmly believe that the EU-Mercosur agreement can be part of the solution. But I want to make it very clear that we expect Brazil to live up to its commitments on deforestation. These are not just empty words.

Unfortunately things currently seem to be going in the wrong direction – and if it continues this could complicate the ratification process in Europe.
Looking forward, the new Commission President-elect Ursula von der Leyen has said that she would like to look at border adjustment measures on carbon. This could encourage our trading partners to reduce their CO2 emissions. Instinctively, many have voiced doubts, referring to international trade rules. Any measures must be non-discriminatory and WTO compliant, of course, but that is not to say that it cannot be done. New challenges mean looking beyond what we think we know and breaking down our preconceptions. As ever with trade, the devil will be in the details.

FREE TRADE IS OUR ONLY GOAL

Upgrading and enforcing protections for the environment is just one area where trade can make a positive difference, but sustainable development is more than that. Our Generalised System of Preferences and Everything But Arms initiatives also play an important role. Both offer privileged access to EU markets to developing countries for meeting these environmental standards and more – in labour rights, human rights and social rights too. Because at the end of the day, trade is about much more than goods and services.
This is another presumption that we should tackle – that the endgame is pure free trade. Because trade is about economic prosperity, but it is also about:

• Culture
• People
• Values

It is about lifting people out of poverty, and it is a way to promote peace and trust between countries. Indeed, looking at our busy trade agenda, you see deals closed with many important partners. Mexico, Mercosur. Canada, Vietnam. South Korea, Singapore, Japan.

Each deal closed is the basis of a deeper relationship – many of which act as strategic alliances. This is important to our trade strategy at the moment. The EU needs friends – because we are trying to overcome one last misconception. Arguably the most dangerous one facing trade at the moment. The idea that the WTO is useless.

SLOWER MEANS WORSE

Not a lot of progress has been made at the WTO in recent years. This has led to some losing faith in it – whilst others take it for granted or disregard its rules But it is the system that has underpinned trade for decades. It is like oxygen – you would not notice it until it is gone, and then you are in serious trouble.
The end of the WTO would be the end of predictability in international trade. Businesses could no longer rely on exports as they once did – trade would become chaotic, unstable. Our trade policy, our economies and global value chains at large would reconfigure – and not always in the most efficient or desirable ways.
The WTO is critical to the functioning of global trade, but it is also out of date. We must update rules to tackle issues like illegal state subsidies. This would bring fairness back to the heart of global trade. We must also resolve the Appellate Body crisis. The Appellate Body brings discussion of the rules out of capitals to neutral ground – avoiding tit-for-tat tariffs and the escalation of trade tensions.
These are some of the immediate issues the WTO faces. In parallel, we need to work to show the organisation can still deliver. For example, in digital rulemaking. We are pleased that after years of attempts, we are finally seeing some progress. The WTO negotiations on e-commerce were launched in Davos with 80 countries in January this year. Proving the organisation can tackle 21st century issues helps demonstrate its value – but as important as the content is, the style of negotiation itself is crucial. We have gathered a smaller group of interested countries to move forward.
The EU has presented proposals on these issues and more. Other countries have too – this is good, it shows appetite for change. But we need broad buy in:

• from countries,
• from business,
• from all who have an interest in international trade.

Reforming and rebuilding faith in the WTO is a big task, and we will need all the allies we can get.

CONCLUSION

So now we have touched on a few of the broad misconceptions about trade: from tariffs to surpluses, benefits to environmental impacts. And we have seen that things are not as simple as they seem.
Life would be easier if we could simply follow our gut instincts. But society and policy are more complex than that. The best that we can do is hold on to our values – what we believe to be good and right – but always be ready to challenge received ideas through rigorous research and understanding. This is how truth will prevail in the end. This is how we move forward.
Thank you.

For a long time I thought the issue with President Trump was that he has problems understanding economic concepts, or that he was unable to surround himself with advisors who have mainstream economic credentials.

As time marches on, evidence accumulated, however, that the problem is larger, now has become clear that he states facts he wishes to be true, rather than facts that are true — such as his insistence that the Fed raise interest rates under Obama’s recovery at times of high unemployment and low inflation. Now he’s demanding rate cuts at the apex of the economic boom cycle, even though the unemployment rate is much lower and inflation is higher.

The last chapter of the saga are the news stories that accumulate that make it apparent that he does not mind to commit fraud and lie to mislead the US public to its detriment, in order to cover up a trivial mistake he may have made in reading data. 

Labor day in the US is meant to honor the American labor movement and the power of collective action by laborers,^[1] who are essential for the workings of society. President Trump marked the day with a visit to the Shell Petroleum Plant where workers were cohersed to attend or else lose a day’s pay. “At one point, the president turned to the union leaders and demanded that they support his reelection campaign. Trump told the workers that if the leaders refused to back him, they should “vote them the hell out of office because they’re not doing their job.””

The BBC reports that Argentina imposes currency controls to support its economy, again.

Argentina reportedly imposed currency controls to stabilise financial markets as the country faces a deepening financial crisis. The government restricted foreign currency purchases following a sharp drop in the value of the peso. Individuals can continue to buy US dollars, but they need permission to purchase more than $10,000 a month. Firms have to seek central bank permission to sell pesos to buy foreign currency and to make transfers abroad.

Argentina is also seeking to defer debt payments to the International Monetary Fund (IMF) to deal with the crisis.

What has the government said?

In an official bulletin issued on Sunday, the government said that it was necessary to adopt “a series of extraordinary measures to ensure the normal functioning of the economy, to sustain the level of activity and employment and protect the consumers”.

The central bank said the measures were intended to “maintain currency stability”

What triggered the current crisis?

 

The peso fell to a record low last month after the vote showed that the business-friendly government of President Mauricio Macri is likely to be ousted in elections in October.

The country is in a deep recession. It has one of the world’s highest inflation rates, running at 22% during the first half of the year. Argentina’s economy contracted by 5.8% in the first quarter of 2019, after shrinking 2.5% last year. Three million people have fallen into poverty over the past year.

How is the move likely to be received?

Ordinary Argentines have traditionally had little faith in their own currency, preferring to convert their spare pesos into dollars as soon as they can. They don’t trust financial institutions much either, so they resort to what is locally known as the “colchón bank” – that is, stuffing their dollars under the mattress. Anecdotal stories abound of people keeping money buried in the garden, hidden in the walls or even stuffed in heating systems – occasionally with disastrous consequences if there is an unexpected cold snap.

People still have bad memories of the “corralito”, imposed in 2001, which stopped all withdrawals of dollars from bank accounts for a whole year. The only serious attempt to wean Argentines off their dollar dependency dates back to the 1990s under President Carlos Menem, when the peso’s value was fixed by law at parity with the dollar.

Last week, the country said it would seek to restructure its debt with the IMF by extending its maturity. This would give the country more time to pay back the money it owes to the IMF. Rating agencies, including Standard & Poor’s and Fitch, decided that amounted to a default and downgraded the country’s credit ratings. Whatever happens in Argentina, the risk of financial contagion is low, say analysts.

On August 25, 2019, Politico reports that “Trump continued to shrug off responsibility for any economic fallout from his trade war with China on Wednesday, arguing that a face-off with Beijing was necessary due to the failures of past administrations. Trump painted himself as a reluctant warrior, shifting from his usual narrative that the trade fight is not hurting the American economy or his political prospects to asserting that it was something he had to do. The president also adopted a religious theme in describing his role in picking a trade fight with China, saying: “I am the chosen one.” “Somebody said it is Trump’s trade war,” he said. “This isn’t my trade war. This is a trade war that should have taken place a long time ago by a lot of other presidents.”

“

Can he order US companies to do anything? No. Has he considered what the world for US companies would look like if they stopped buying foreign goods and foreigners stopped buying US companies goods? 

The WSJ is the most conservative mainstream paper, and it decided to pick a bone with White House Trade Policy, after which The White House Trade Advisor “then compared the WSJ, which has long been a leading capitalist voice in the US, to the main media outlet of the Chinese Communist Party.”!

Screenshot via video.foxnews.com/

• The Wall Street Journal editorial board lambasted the economic policies of White House trade adviser Peter Navarro for the second time in one week on Thursday.
• That came a day after a key recession warning led to the stock market’s worst session of the year. 
• Investors have become increasingly unnerved by slower global growth and escalating tariff disputes.
  

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The Wall Street Journal editorial board has lambasted the economic policies of White House trade adviser Peter Navarro for the second time in one week, a day after a key recession warning sent stocks to their worst session of the year.

The Journal first took aim at the China hawk in an op-ed last week, saying the trade war could lead to a “Navarro Recession.” Navarro then compared the Journal, which has long been a leading capitalist voice in the US, to the main media outlet of the Chinese Communist Party.

“That was novel as criticisms of these columns go, but perhaps Mr. Navarro would care to comment again after Wednesday’s recession warning from the bond and equity markets? Are they Commies too?” the Journal’s editorial board wrote Wednesday in an article titled “The Navarro Recession, II.”

 “Wednesday’s market moves are an omen of the future, not destiny,” they wrote. “The key to avoiding the worst is to restore a sense of policy calm and confidence. Stop the trade threats by tweet. Call a tariff truce with China, Europe and the rest of the world while negotiations resume.”

“We’ve been warning for two years that trade wars have economic consequences, but the wizards of protectionism told Mr. Trump not to worry,” the Journal article said. “The economy was fine and the trade worrywarts were wrong.”

 

The Trump administration has argued that its trade policies would ultimately protect Americans from what it has found to be unfair business practices abroad, such as intellectual property theft in China.

“Someone should tell Mr. Trump that incumbent Presidents who preside over recessions within two years of an election rarely get a second term,” the editorial board wrote.

Since the US imports more from China than China from the US, Trump has been excited to level more and more tariffs on Chinese goods claiming that eventually, China would not be able to retaliate. It turns out that global trade has many dimensions. China can retaliate not only via tariffs on trade but restrictions on FDI or simply by depreciating its exchange rate: TB($) = X [$, Chinese tariffs] – M[E, US tariffs]. As tariffs increase China does not have to increase its tariffs on US goods, it can simply depreciate its currency, as it did today.

Boris Johnson, the new British Prime Minister promised the “beginning of a new golden age” in his inaugural speech. Sounds like Britain has a dose of Trump coming its way. As per the Oxford Dictionary, Golden Age is defined as “an idyllic, often imaginary past time of peace, prosperity, and happiness.” The one part that I can see happening is the “imaginary” part. Here is why

• Today the British currency fell to new lows against both the Dollar and the Euro on disorderly Brexit fears (BJ promised to exit with or without an agreement by October 2019).
• BJ promised to renegotiate Brexit while EU leaders immediately clarified there won’t be renegotiations especially about issues Johnson promised to renegotiate (among other things the “Irish Backstop“).
• The UK government’s own commissioned study indicates that Brexit will cost the UK hundreds of billions, up to 10% of GDP in 10 years. Other studies are more pessimistic.

All this does not sound like the coming of a golden age, actually, it sounds like the opposite. But if BJ can say it at least three times it may come true or at least people may think it becomes true according to “Trump’s Rule” which he called “truthful hyperbole” as he laid out how he enjoys “playing with people’s fantasies.”

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Brown and Irwin have a wonderful piece documenting the importance of US tariffs as a source of government revenue. The two economists parse Trump’s recently tweet:

“Billions of Dollars are pouring into the coffers of the U.S.A. because of the Tariffs being charged to China, and there is a long way to go. If companies don’t want to pay Tariffs, build in the U.S.A. Otherwise, lets just make our Country richer than ever before!”

Here is what they find

1. The United States gets 98 percent of government revenue from non-tariff sources.

2. Raising revenue through tariffs is more costly than other forms of taxation.

3. Raising revenue from tariffs generates fairness concerns.

The monthly release of the US Payroll data is always a key indicator of economic activity. Jeff Miller parses what we should and should not read into the payroll data. Here is the abstract:

A) Job creation and destruction exceeds 2 million per month, so the net effect is likely going to be relatively small – despite the fact that the economy created millions of jobs.

B) The reported payroll data is the change in the net, reducing the magnitude of the payroll data even further.

C) But most importantly, the payroll data ist is not the actual change in payroll jobs based on a surveyed sample of US businesses.

D) Given the size of the US workforce (~150 million), the sampling error implies a 90% confidence interval of 112,000 jobs!  This means that if 100 samples were taken, the mean of 90 of the 100 samples would contain the true mean, but that these 90 samples could differ up to 112,000 jobs.

This has important implications for the interpretation of payroll results:

A new Fed paper outlines the “local content” in US Imports, to highlight that trade is not “us against them” but that global supply chains are intertwined. It is well known that Apple designs in the US, builds components globally, and assembles its phones in China. That is one reason why US tariffs on Chinese goods hurt not only China, other countries that produce intermediate inputs, and also the US itself!

“When you buy a $100 pair of Nike sneakers made in Asia, only $25 of its cost goes to the Asian factory that assembles the shoes (Kish 2014). Of the remaining $75, $3.50 is spent on shipping from Asia to the United States, and $21.50 goes to Nike to cover its design, marketing, profits, and other expenses. The remaining $50 goes to the U.S. retailer that pays for the transportation of the sneakers inside the United States, worker wages in its U.S. warehouses and retail outlets, rental cost of retail space, insurance, and so on. Thus, half the cost of a pair of sneakers made abroad pays for workers and capital expenditures in the United States, not even counting the part that goes to Nike.

When you buy a MADE IN THE US of A Jeep Patriot, manufactured in Illinois, at least 17% of the cost goes to parts made in other countries (NHTSA 2017). Thus, even for a car that is manufactured in the United States, a substantial part of its cost traces to imported intermediate parts used in its production.

These examples are useful to understand how raw statistics on imports fail to fully account for the cost of imports, and how part of the cost of American goods and services reflects imports. The Fed study accounts for the US (“local”) content of US imports and finds that for some countries (including China) over half of the expenditures for imports flows back to US companies and workers.” 

In May 2019, President Trump declared a national emergency regarding potential threats posed by foreign technology companies and blacklisted the Chinese Company Huwwei to prevent it from conducting business with U.S. companies. The U.S. Department of Justice (DOJ) had charged Huawei in January 2018 with bank fraud and stealing trade secrets as well as crimes including conspiracy, money laundering, bank and wire fraud, flouting U.S. sanctions on Iran, and obstruction of justice.

Several dozen(!) countries intoduced bans on Huawei, followed the US lead on Huawei either because they were strong-armed or because they trusted the US threat assessment.

Six weeks later, Trump declared Huawei open for business again and all other countries that shut down Huawei for supposed national security reasons now sit with egg on their faces. Even Republican senators noted that no one will believe the US anymore if one day it declares a country/company a threat to national security and on the next day declares it open for business.

This raises they question why anyone would believe Trump in the first place (see also link and link). Here is the latest soap opera regarding his trade negotiations with China:

“Trump on Monday [7/1/2-19] said talks have already begun. “They’re speaking very much on the phone and also meeting,” he told reporters at the White House. A spokesperson for [US Trade Representative] Lighthizer said there no scheduling announcements at this time. “The date is not set. The city is not set,” said one person close to the talks, when asked by Morning Trade about when U.S. Trade Representative Robert Lighthizer might sit down with Chinese Vice Premier Liu He.”

We also learned some interesting new pieces if information about these negotiations. They are no longer about tariff reductions but about changes in laws. The “U.S. still wants China to change its laws to implement commitments to combat forced technology transfers and other intellectual property transgressions.” “China wants the U.S. to also amend its laws that Beijing views as hostile to Chinese companies.” You be the judge how likely any of these outcomes are…

After the G20 summit in Japan, US President Trump went to the only country where he could claim a sealed trade agreement: South Korea (Trump signed a slight update of the comprehensive 2012 Korean-US trade agreement). In Korea he toasted the deal as evidence he’s winning.

But in Washington officials were confronting a grim new reality for U.S. economic power. When Trump dialed up the heat with tariffs and threats, the rest of the world looked elsewhere for opportunities: Bloomberg reports that the European Union is taking advantage of the void created by Trump’s lack of Free Trade leadership by signing historic trade deals with Japan, Latin America, and Vietnam benefiting EU firms in these key markets over US firms.

“For two decades, Europe had been trying to nail down a pact with Brazil, Argentina and the two other members of Mercosur, a bloc traditionally known for its nationalist approach to industrial policy and protectionism. But hours before Trump and Xi met, the EU announced the deal was finally done. The message was stark. European industrial giants such as Airbus and Siemens would gain an advantage over their U.S. competitors in Latin America. Argentinian and Brazilian farmers would win an edge in Europe over U.S. competitors, adding to the decline of America as an agricultural export power… With Trump threatening the global order, officials in Brussels, Brasilia and Buenos Aires had spied an opportunity to forge the new economic alliance — just as the EU and Japan had in a deal that took effect earlier in 2019. A day after the leaders left Osaka summit, the EU signed a deal with Vietnam, a nation Trump just days earlier lambasted as ‘almost the single worst abuser of everybody.’”

And just to clarify what Trump calls “winning” as he visits Korea: The Korean trade deal (signed September 2018) has done nothing to reverse the bilateral US trade deficit (not that bilateral trade deficits matter, but it just shows its unclear what Trump was toasting in Korea as evidence he’s “winning”).

Data source: BEA

• St. Louis Fed economic database Thousands of time series on economic activity, in an easily downloadable form.
• IMF International Financial Statistics
• IMF World Economic Outlook databases.
• World Bank World Development Indicators.
• BIS
• ECB
• DBnomics (a “European FRED”)
• YCharts Macro and equity market data series.
• ino.com Futures data.
• Federal Reserve Board data Monetary, financial and output data collected by the Nation’s central bank.
• Bureau of Economic Analysis, Dept. of Commerce Data on GDP and components (the national income and product accounts) as well as other macroeconomic data.
• Bureau of the Census, Dept. of Commerce Data on the characteristics of the US population as well as of US firms.
• Bureau of Labor Statistics, Dept. of Labor Data on wages, prices, productivity, and employment and unemployment rates.
• Energy Information Agency, Dept. of Energy Data on energy (electricity, gas, petroleum) production, consumption and prices.
• Economic Report of the President, various years. The back portion of this annual publication contains about 70 tables of government economic data.
• Economic Indicators CEA and JEC Compilation of economic data in tabular form.
• Economic Time Series page A large collection of economic time series.
• NBER Data Specialized economic databases created by economists associated with the National Bureau of Economic Research.
• Penn World Tables.

US President Trump met General Secretary Xi of China at the G20 meeting in Osaka, Japan. Subsequently Trump announced not to impose additional tariffs in exchange for China’s increased purchases of US agricultural goods, [mysteriously the Chinese statement of the meeting did not mention China’s increased purchases...].

Just to be clear, the brilliantly negotiated, triumphant outcome for Trump is thus simply status quo that existed along before Trump started his bilateral trade wars (e.g: no tariffs and China buying US Ag products).  Well, no, one thing is different: The US will provide China a shopping list of what it is supposed to buy from the US. Whoever came up with this unusual idea really distinguished himself/herself. Of course the Chinese will only buy what they need so they are humoring Trumps list — but what is the purpose of Trump going around threatening countries with forced shopping lists of US products? Is that how the Trump or the US wants to “win” the trade war?

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T’was an HP that my son ordered, which was custom built and shipped straight from the factory in China to our doorstep. No notions that there may be any American manufacturing involved (like the Dells computers who first make their way to Texas to be shipped out from an American address). Fortune Magazine reports that

“Dell, HP, and Microsoft said they account for about half of the notebooks and detachable tablets sold in the U.S. Prices for laptops and tablets will increase by at least 19%—about $120 for the average retail price of a laptop [and game consoles!] — if the proposed tariffs are implemented, according to a study released this week by the Consumer Technology Association. The companies said they spent a collective $35 billion on research and development in 2018 alone, and tariff costs would divert resources from innovation while providing “a windfall” to manufacturers based outside the U.S. that are less dependent on American sales.”

So the Chinese exporters that Trump is trying to hurt are actually US companies. The profit shifting from China to the US are actually reducing US companies’ profits as the tariff reduces US companies’ profits relative to competitors who ship their computers to non US consumers (from China).

Here are the results from the study: After accounting for new tariff revenue, there is a net $8.1 billion loss for the U.S. economy, from cell phone and laptop tariffs alone, with most of the burden carried by U.S. consumers.

CELL PHONES:

• Change in Price of Chinese Imports +22.0%
• Change in Chinese Production -4.8%
• Change in U.S. Production 0.0%
• Change in Prices of U.S.-Made Cell Phones 0%
• Change in U.S. Consumer Prices (from All Sources) +14.0%
• Impact on Consumption -28.0%
• Reduction in Consumer Spending Power $8.1 bill.
  Net Impact on U.S. Economy -$4.5 bill.

Laptops and Tablets

• Change in Price of Chinese Imports +21.0%
• Change in Chinese Production -7.0%
• Change in U.S. Production +4.8%
• Change in Prices of U.S.-Made Laptops/Tablets +6.5%
• Change in Prices to U.S. Consumers +19.1%
• Impact on Consumption -35.3%
• Reduction in Consumer Spending Power $8.2 bill.
  Net Impact on U.S. Economy -$3.6 bill.

President Trump likes to fight each country individually, each with its own personalized trade war. A quick search of this blogroll highlights how quixotic it is to focus on bilateral trade balances. Aside from the fact that the aggregate trade deficit is determined by factors other than unfair trade measures in any particular country, there is also the issue of “trans-shipments.” Brad Setser documented it for “Chicken Feet” while the WSJ documents the same for computer electronics. Chinese exports to the US now simply have to traverse through a 3rd country to avoid 25% tariff. 

In May 2018 the US Department of Commerce started to investigate the car industry to determine whether imports created a national security risk. Usually, these investigations are initiated by either firms in the industry or by unions but curiously both opposed the investigation. The Motor and Equipment Manufacturers Association, which represents auto parts suppliers, warned that “tariffs will shrink investment in the United States at a time when the auto industry is already reeling from declining sales, Trump’s tariffs on steel and aluminum, and tariffs on auto parts from China… These tariffs, if applied, could move the development and implementation of new automotive technologies offshore, leaving America behind… Not a single company in the domestic auto industry requested this investigation.”

Safeguard investigations are allowed to last up to 270 days and on February 17, 2019, two (!) hours before the 270 day deadline was up, the US Department of Commerce sent its report to the White House, triggering a 90-day review period for Trump to decide whether to impose tariffs (IF the report found national security issues). These 90 days were supposed to be up on May 17, 2019, but this has not stopped the White House from a) keeping the report secret although it has a statutory legal obligation to make it public, b) threaten car tariffs.

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“While Trump shows other countries nothing but his tariff stick, China has been offering carrots.  Beijing has repeatedly cut its duties on imports from America’s commercial rivals, including Canada, Japan, and Germany.”

In an amazingly researched piece, Chad Brown at the Peterson Institute of International Economics documents that while China is raising its tariffs in retaliation to the US, it is lowering its tariffs to the rest of the world. Probably to limit the negative impact from the Trump Tariff War. So the escalation in tariffs Trump is forcing is only half the bad news for US exporters, the other half is American companies and workers now are at a considerable cost disadvantage relative to both Chinese firms and firms in third countries. The result is one more eerie parallel to the conditions US exporters faced in the 1930s.

The IMF puts next year’s cost at $455billion…

There are two approaches to addressing migration. 1) Trumps political hostage taking, hoping paramilitary and human rights violations (due to aberrant asylum laws) will solve the issue. 2) Addressing the cause of migration: income inequality.

When the Iron Curtain fell in the early 1990s, migration pressure from Eastern to Western Europe was tremendous. In PPP USD, several former Eastern Bloc countries had per capita incomes that were less than 1/6th of Germany’s. That is similar to the current disparity between the US  and Central American countries that originate most of the migrants. Instead of building new walls, dismantling asylum laws or instituting paramilitary searches, Europe went on a determined program of structural adjustment loans to help developing Europe catch up and provide jobs and reasons from former Eastern Block citizens to stay instead of migrating.  25 years later, migration from Eastern European countries is not an issue. The Peterson Institute makes the same case for Latin America:

“Low ‘k’ ” or limited capital mobility seems like a preposterous concept these days — although it was the global standard from 1044-1972. Most industrial and developing countries have since liberalized their financial accounts, but China and Vietnam still maintain strict controls on the financial account. Here is a comparison courtesy of the Vietnam Investment Review:

Comparison of China’s capital controls with Vietnam’s

Economic theory defines the ‘Impossible Trinity’, also known as ‘the Triangle of Impossibility’, as a nation’s inability to simultaneously pursue three macroeconomic goals: a stable exchange rate, free capital flows, and an independent monetary policy. This theory was named the Mundell-Fleming Model, put forward by Robert Mundell and Marcus Fleming in the 1960s.

“A little hyperbole never hurts. People want to believe something is the biggest and the greatest and the most spectacular. I call it truthful hyperbole. It’s an innocent form of exaggeration — and a very effective form of promotion.” (Donald Trump, “The Art of the Deal”)

In his great confusion (or “truthful hyperbole”) about tariff mechanics, President Trump proclaimed that China is paying US tariffs: he tweeted that “I am very happy with over $100 Billion a year in Tariffs filling U.S. coffers… great for the U.S. not good for China.”

Steil and Della Rocca from the Council of Foreign Relations point out that the $100 billion is without foundation and actual tariff revenues are less than $10 billion: “As we pointed out last December, Trump’s tariff claims have a bigger flaw. In 2018, the U.S. government committed to paying American farmers $9.6 billion to offset their losses from Chinese tariff retaliation. This is about $1 billion more than it took in all year from Trump’s China tariffs. Tariffs, therefore, ending up not just harming American companies and consumers, but costing the government money. More money left “U.S. coffers” to offset farm losses than came into them from U.S. importers.”

“Since last year, as the graphic above shows, Trump’s “tariff deficit” has only ballooned further. The Department of Agriculture just unveiled a new $16 billion bailout for farmers hit by the trade war. After just ten months of a trade war with China, subsidies to farmers are set to drain over $25 billion from “U.S. coffers” for damage done to date. China tariffs, meanwhile, have so far brought in just over $19 billion in tax payments from U.S. importers—$6 billion less than authorized farmer payments.”

Seven years ago, at the height of the Greek Euro Crisis, Robert Mundell, “father” of the Mundell Fleming model and “father” of the Euro, proclaimed that the biggest threat to the euro is a potential bailout of Italy, which might just be too expensive. 

Italy is still (again?) teetering on the brink as it risks a $4billion penalty for violating the Euro’s fiscal discipline rules. Why? Use the MF model to explain Italy’s interest in racking up debt.

One way to detract from the fact that the USMCA trade agreement may not be ratified is to kill it before it has even been discussed in Congress.

On May 20, 2019, President Trump announced a 5% tariffs on Mexican goods would go into effect on June 10, unless Mexico “curbs illegal migration” at the US Mexico Border. It is unclear what the measure of “curb” is here, but perhaps that is his point. These tariffs are supposed to grow steadily up to 25% by Oct. 1, 2019.

Deutsche Bank reminds us that two-thirds of U.S.-Mexico trade is between factories owned by the same company. Source: Deutsche Bank Research

A previous blog pointed out that bilateral trade balances are not the proper metrics to analyze a country’s trade competitiveness (see here). Now we have had enough time with Trump tariffs to see the issue unfold in the data as US importers are rapidly shifting suppliers to countries outside of China (to which the trade deficit will follow). 

The National Bank of Canada noticed that Canada, as the largest trading partner of the US would benefit from the trade diversion created by the US-Chinese tariff war. The statistical analysis seems a bit suspect (a 1% reciprocal tariff increase is supposed to result in increased Canadian exports to the US that lift Canada’s real value added by about 0.8%. But the tariff increase is going to be 10%-25%). Nevertheless, it is nice to see that someone picked up on the trade diversion concept. A windfall for the Canadians and another loss for American consumers.

It turns out, just when President Trump wrote his epic “The Art Of The Deal” fiction novel. He was losing billions of dollars to bilk the US Government/IRS and private banks out of revenues. He called this behavior a “sport.” Although the arch-conservative Washington Inquirer newspaper notes that his “sport” cost tens of thousands of honest Americans dearly. 

He may be following a similar script in his trade negotiations with China. On less than a week’s notice, increased tariffs on $200 billion in Chinese imports to 25% tariff (I wonder what that will do the iPhone…). The WSJ reports that the first round of Trump tariffs cost US consumers $69 billion, this new round will be substantially more expensive. Now Trump threatens virtually all Chinese imports with tariffs. The Chinese will retaliate.

One interest group is being taken care of, however, Trump tweeted that US government would “buy agricultural products from our Great Farmers, in larger amounts than China ever did.” That’s in addition to the $12billion handout farmers already received in January 2019 to compensate them for earlier tariff-related trade losses.

Herman Cain, Tea Party activist, former presidential hopeful, and Trump’s uniquely unqualified Fed nominee withdrew April 22, 2019, although he had adamantly stated 4 days earlier that he would “continue the fight.” That was after Senate Republicans withdrew they support for his confirmation.

Ten days later, Stephen Moore, ‘American Writer’ at the Heritage Foundation, and Trump’s other uniquely unqualified Fed nominee also withdrew only hours after his “I’m all in” pledge. Incoherent interviews showed him struggling to explain away his lunatic economics statements/forecasts, and his disqualifying misogynistic and racist statements/jokes did him in.

Let’s hope the next nominees are qualified.

The below may be a surprise to the Trump administration:Sources: 1, 2

writes Jeff Pross. It was no other than Alexander Hamilton, the first US Secretary of the Treasury, who instituted the first US tariffs in 1792 with the explicit intent of raising funds and paying off the first States’ debts and developing US industries. (Here is the full story).

In 1944, global institutions were established to assure free trade (IMF, World Bank, GATT, WTO), which impose tough rules that guarantee free movement of goods across borders. These rules prohibit public subsidies and “industrial policy” (tariffs to safeguard industries threatened by imports). Sure, China and many other nations flout those rules (here is a list of the nearly 600 WTO trade disputes since 1995), but neither the US nor Europe became rich by following these rules themselves! Quite the contrary, Pross suggests that China’s current trade strategies are basically plays from the 1800-1944 US/European development playbook. In fact, the US/Chinese trade tensions hold an “uncanny resemblance to the German/UK trade tensions in the nineteenth century… Both rivalries feature countries enmeshed in tariff threats, standard-fights, technology theft, financial power struggles, and infrastructure subsidies for advantage.”

“Between 1816 and the end of the Second World War, the U.S. had one of the highest average tariff rates on manufacturing imports in the world.” Over its history, the U.S. has never shied away from using subsidies and industrial policy to support everything from agriculture to transportation to health research. Right after independence and technologically behind Britain, America was absolutely shameless about snatching technology and intellectual property from other countries. By comparison, China’s “forced” technology transfer is pretty tame: It simply demands that any foreign investor who voluntarily decides to do business in China’s domestic market must engage in a joint venture with a Chinese partner.

European countries followed the same playbook of development. Britain built up wool manufacturing in the late 1500s through industrial policy.. lowering tariffs on imports of raw materials, but raising tariffs on imports of manufactured products — in order to keep the resources coming in but to protect its high value-added industries. In the mid-1800s, Britain pulled off the original “technology transfer” with China as its victim: Britain sent agents through China to steal tea plants/seeds and learn agricultural practices to introduce tea plants to India and marginalize China in the global tea market. And oh, to “fix” its trade deficit with China, the British government (!) resorted to overt drug trade, flooding China with Opium; and once addicted, the British sold China opium at exorbitant prices to reverse the trade deficit into a surplus.

I’d like to keep the blog academic and fact-based, and at the same time, some of the recent economic events are just so surreal and frankly (in my opinion) dangerous that I fear some of my posts start to read like partisan politics (see my posts on Turmp’s trade person, Peter Navarro here, here, here, here,  and here). But what has to be said in the name of truth, has to be said.

If you think I am harsh on the people Trump employs to lie about economics, I should note that even arch-conservative magazines like “Fortune,” (to the right of the WSJ) call the Trump’s economic policies “stupideconomics.” (here and here).

It has long been Trump’s goal to dismantle government agencies by installing critics who hate the very agencies they were supposed to lead. These critics then proceeded to dismantle with impunity key agencies such as the US Department of Agriculture, the US Department of Energy, the US Environmental Protection Agency, or the US Consumer Financial Protection Bureau (or 68 minor agencies and programs that are being eliminated directly through proposed 100% funding cuts). While it is difficult for me personally to see these agencies and programs go, I accept that the will of the people (in form of the electoral college) apparently supports Trump’s concept of “instant deregulation” through agency shut down.

But when it comes to the dismantling of the Fed we are starting to talk not just about the dismantling of an agency, but about the dismantling of the very economic foundation of our society. I have written about the two new nominees for the Fed positions before. In a recent New York Times OpEd, Paul Krugman puts it eloquently:

“The Fed’s governing board currently has two vacancies, and Donald Trump has proposed filling those vacancies with ludicrous hacks. If he succeeds, one of our few remaining havens of serious, nonpartisan policymaking will be on its way toward becoming as corrupt and dysfunctional as the rest of the Trump administration. Stephen Moore and Herman Cain are, of course, completely unqualified — I say “of course” because their lack of qualifications is, paradoxically, a key qualification… for Trump…”

As I pointed out before, both Moore and Cain were “Hard Money Men” during Obama’s presidency, meaning both demanded higher interest rates when unemployment was high (to fight inflation they predicted would appear but which never materialized). Now, strangely, both demand lower interest rates while unemployment is at an all-time low — only because it conforms with Trump’s view of the world.

Krugman characterizes Moore and Cain succinctly: Moore “is basically a classic right-wing hack who tries (incompetently) to impersonate an economic expert. Cain, on the other hand, is a spam king whose business model involves making his email list available to direct marketers… Moore has been out there predicting magical results from tax cuts, putting out fake economic numbers, and giving speeches to FreedomFest. At the same time, Cain has been offering a platform for peddlers of get-rich schemes and cures for erectile dysfunction.” This reminds me of Trump’s choice Attorney General,  whose prior job was to promote hot tubs and toilet seats for well-endowed men for a scam company that was shut down by the FTC.

Tampering with the independence and competence of the FED by nominating either a pizza exec who peddles erectile dysfunction spam or an unscrupulous economic liar is dangerously undermining the very foundation of the US.

This from the conservative WSJ

President Trump said Thursday he intends to nominate former GOP presidential candidate Herman Cain to the Federal Reserve’s board of governors… The selection of Mr. Cain, following the president’s decision to nominate his former campaign adviser Stephen Moore, marks an effort to install two Fed critics and loyal Trump supporters on the central bank’s powerful seven-seat board… Messrs. Cain and Moore both staked out positions quite critical of the Fed’s easy-money policies earlier this decade —stances that would appear to be at odds with Mr. Trump’s desire for rate cuts now. Messrs. Cain and Moore have previously advocated, for example, a return to the gold standard… 

…JPMorgan Chase & Co. Chief Executive James Dimon said he hoped senators would “do their homework” on Messrs. Moore and Cain. “I don’t think they are the right people,” he said at an event in New York. “They should put professional people on.”

What does Dimon mean by “professional people?”  Probably “economists.”

Cain’s background — other than his sexual harassment allegations and settlements is in the burger and pizza business. I am not making this up, zero economics background. No wonder he is a gold bug.

Moore’s background — other than his refusal to pay debts to child support – is an MA in economics with zero peer-reviewed output and a long, scary history of flagrant lying about economic facts. Here are some direct links from Menzie Chinn that are well worth reading to understand how scary his appointment would be — and he is the “more qualified” of the two candidates…

• Stephen Moore: … “Powell Should Resign”
• Stephen Moore Lies Again
• Stephen Moore Lies & Lies & Lies
• Stephen Moore: “When It Comes To Electric Power, Coal Is No. 1
• Further Documentation on “Stephen Moore Is a Liar”
• Stephen Moore Is a Liar, Part 2
• Stephen Moore Is a Liar
• CNN: Fire this Buffoon
• Homosocial Reproduction and Economic Policy Formulation in the White House

This picture speaks 1000 words: From 2016 to 2019, the balance sheets of central banks (in an (over)simplified way of thinking, the amount of bonds they are holding) increased from about 5 trillion to 22 trillion dollars. That is an incredible infusion of liquidity into the global financial markets, which has led to near zero (in some cases negative) interest rates – but very little inflation and certainly no roaring equipment investment. Structurally, the economies or certainly financial intermediation has changed. 

Note that this is funding of the annual deficit, NOT total US debt. 

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The UK is learning how important it is to have market power in FTA negotiations. When the entire EU (28 countries) negotiated FTAs with non-member countries, they were able to insist on basic human rights standards. No so anymore as Britain is trying to renegotiate its own agreements. The Guardian reports that “Britain has received demands to roll back its human rights standards in exchange for progress on post-Brexit trade deals…” Even countries like Japan and Korea are in no hurry to sign trade deals and demand additional economic concessions. So far, only the UK has rolled over just £16bn out of £117bn in trade deals (link).

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Depite strong income (GDP) growth in 2018 and increases government spending tax revenues were flat, thanks to the huge Trump tax cut (mostly for corporations).  Menzi Chinn highlights a real puzzle: Why are term spreads (10yr -3mo Treasury Bill Spreads) falling as the deficit is rising? ON TOP OF THAT, demand for treasuries in general seems to be falling (although it would be interesting to see the graph disaggregated by 10yr and 3mo terms). Figure 1: 10 year-3 month Treasury spread (blue), structural budget deficit as a share of potential GDP (red). Orange shading denotes Trump administration. Source: Federal Reserve, CBO, Budget and Economic Outlook, and Chinn’s calculations.Figure 2: Foreign and international holdings of US Treasurys (blue) and Federal Reserve holdings (red), both as a share of potential GDP. Source: BEA, CBO, and Chinn’s calculations.

Brad W. Setser digs into the details. 

From Wiki: In statistics, a confidence interval (CI) is a type of interval estimate, computed from the statistics of the observed data, that might contain the true value of an unknown population parameter. The CI has an associated confidence level that, loosely speaking, quantifies the level of confidence that the parameter lies in the interval.

More strictly speaking, the CI represents the frequency (i.e. the proportion) of possible confidence intervals that contain the true value of the unknown population parameter. If confidence intervals are constructed for a given confidence level from an infinite number of independent sample statistics, the proportion of those intervals that contain the true value of the parameter will be equal to the confidence level.

Menzi Chinn highlights what a Confidence Intervals is not:

The specific 95 % confidence interval presented by a study has a 95 % chance of containing the true effect size. No!

A reported confidence interval is a range between two numbers. The frequency with which an observed interval (e.g., 0.72–2.88) contains the true effect is either 100 % if the true effect is within the interval or 0 % if not; the 95 % [confidence interval] refers only to how often 95 % confidence intervals computed from very many studies would contain the true size, if all the assumptions used to compute the intervals were correct. [A polite way of saying, if your statistical model is garbage, your confidence interval is garbage, too. Garbage in Garbage Out.] It is possible to compute an interval that can be interpreted as having 95 % probability of containing the true value; nonetheless, such computations require not only the assumptions used to compute the confidence interval, but also further assumptions about the size of effects in the model. These further assumptions are summarized in what is called a prior distribution, and the resulting intervals are usually called Bayesian posterior (or credible) intervals to distinguish them from confidence intervals. Source: Greenland et al. (2016).

“Northern Economics Inc” provided an economic impact study of the Washington Shellfish Industry: Over 2500 jobs created, over $250 million in output and labor income. 

Note that these gains are largely private, that is, they accrue to private individuals such as workers or business proprietors. What the study does not mention are the costs, most of them public. Cliff Mass at the UW, summarizes the harrowing costs outlined in the must-read book “Toxic Pearl” (The Kindle version from Amazon is only $5.99))                                               

Here is the abstract from Mass’ blogpost: The book describes

• Poisoning of Washington State’s shorelines by some members of the shellfish industry.
• Spraying of herbicides and pesticides over State shorelines from Puget Sound to Willapa Bay,
• Spread of plastic pollution,
• Physical destruction of shorelines areas.
• Cooperation of WA Department of Ecology and Natural Resources officials and even the Governor’s office with the shellfish industry, and even the participation of the State’s educational institutions like WSU and the UW. Apparently The WA State Departments of Ecology and Natural Resources have supported the use of pesticides to kill the native burrowing shrimp.

For decades, this industry, sprayed the pesticide Carbaryl, a powerful neurotoxin (also known as Sevin) around Willapa Bay and other local shore areas to kill a Washington State native animal, the burrowing shrimp.  Burrowing shrimp are an important food source for many native species including fish, birds, and crabs.

Some members of the shellfish industry are also spraying herbicides such as imazamox  over the coastal zone to kill eel grasse to make it easier for the industrial clam and oyster operations.  Such grasses are important source of food for wildlife and provide habitat for a wide variety of species.  More recently, some in the shellfish industry is pushing to spray ANOTHER neurotoxin (Imidacloprid) over our coastal waters.   And, chasing the high-value Chinese market for geoducks, the industry is putting in miles of cut-off plastic tubes with plastic netting over mudflats around the region, resulting in the dispersal of plastic pollution throughout our coastal environment (see picture below).
Toxic Pearl also documents sickness and illness following the spraying, and reviews the association of spraying with a large increase of miscarriages among the Shoalwater Bay Tribe.

In 2015, Danny Westneat of the Seattle Times wrote an important article outlining the herbicide/pesticide spraying by the WA shellfish industry, but some of the clam/oyster folks are still spraying herbicides and pushing to spray Imidacloprid.

Source

Would increasing household income lead to increased voter participation?Econofact mentions a recent study that involved a natural experiment: unexpected and permanent increase in household incomes.  The Eastern Band of Cherokee Indians in North Carolina opened a Casino and households enjoyed a windfall increase in income that was unrelated to education, disabilities, income level, marital status or the presence of children (each adult received $4,700/year). The increase in income did not have an effect on parents’ voting behavior, however, it did increase their children’s voting behavior. Children benefiting (indirectly) from the cash transfers had higher levels of education, which suggests that the subsequent increase in voting. Another possible is that families who received the income windfall were less likely to move, which helped students education attainments or their families’ civic participation.

In what seems to be a curious public relations stunt, the US farmers are financing a public relations website called tariffshurt.com. It reports that the Pittsburgh based non-profit called “Cribs for Kids” had to reduce the amount of cribs it could provide to US moms in need.

Tariffhurts.com also quantifies the cost of Trump tariffs on each state’s economy (sadly no methodology was provided). Here is the impact on Washington State: 

How much of a stimulus did the economy receive from the 100’s of billions in tax cuts corporations received? Reuters/Yahoo reports that U.S. companies used the money to go on a shopping spree for their own stocks to raise their own share prices.

These stock buybacks were a major factor behind the 2018 bull market. “Companies bought back around 2.8 percent of shares outstanding in 2018. That was a substantial support to the market and bigger than dividends,” said Jack Ablin, chief investment officer at Cresset Wealth Advisors in Chicago. 2018 will go in the books as a record for buybacks. Through the first three quarters of the year companies bought $583.4 billion of their own stock, just shy of 2007’s full-year record of $589.1 billion, according to S&P Dow Jones Indices data.

Strategists say U.S. companies spend heavily on their own shares as they have plenty of cash and tend to favor buybacks over dividends and major capital investments in times of economic and policy uncertainty. Goldman Sachs has forecast a 44 percent jump in buybacks to $770 billion for 2018, with growth slowing to a 22 percent rise to $940 billion for 2019.

After rushing home some $295 billion of foreign profits in the first quarter of 2018, the pace of repatriation by U.S. multinationals has since slowed sharply, Commerce Department data shows. In the third quarter that was down to about $93 billion. About $190 billion, or about a third, of repatriated funds were used on buybacks in the first three quarters of 2018, JPMorgan strategist Nikolaos Panigirtzoglou wrote.

FEEDING THE BULL

Buybacks have been a major support to the bull market that began in March 2009. S&P 500 companies bought roughly $4.5 trillion worth of their own shares, equal to about a third of the benchmark’s $15 trillion gain in value over that time, according to Audrey Kaplan, head of global equity strategy at Wells Fargo in New York. Datatrek Research said U.S. companies tend to spend between 40 percent and 60 percent of operating income on buybacks and only breach the low end in “the direst times.”

The country might be getting tired of this kind of winning, as Menzi Chinn points out in his update of Trumps fixation of the China-US bilateral trade balance:US merchandise exports to China (blue), and seasonally adjusted using X-13 with lunar new year dummy (bold dark blue), and US merchandise imports from China (red), and seasonally adjusted (bold dark red), both in billions US$, at annual rates. NBER defined recession dates shaded gray. Trump administration shaded light orange. Source: BEA/BuCensus, NBER, and author’s calculations.

Of course, examining any bilateral trade balance is not the right metric (see here). If any trade balance matters, it is the overall, not a bilateral. Also, this is part II of the ongoing series “tired of winning the trade war”

27 Nobel Laureate economists, 3 other former Chairs of the Federal Reserve and 15 former Chairs of the Council of Economic Advisers and thousands of economists from around the country are signatories of the Economists’ Statement below. The statement was released today on the opinion page of the Wall Street Journal. It outlines what we believe is the most cost-effective, equitable and politically-viable national climate solution. Now more than ever, it is critical for economists to point the way forward and coalesce around a bipartisan climate policy.

ECONOMISTS’ STATEMENT ON CARBON DIVIDENDS

Global climate change is a serious problem calling for immediate national action. Guided by sound economic principles, we are united in the following policy recommendations. 

I.          A carbon tax offers the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary. By correcting a well-known market failure, a carbon tax will send a powerful price signal that harnesses the invisible hand of the marketplace to steer economic actors towards a low-carbon future. 

II.         A carbon tax should increase every year until emissions reductions goals are met and be revenue neutral to avoid debates over the size of government. A consistently rising carbon price will encourage technological innovation and large-scale infrastructure development. It will also accelerate the diffusion of carbon-efficient goods and services. 

III.        A sufficiently robust and gradually rising carbon tax will replace the need for various carbon regulations that are less efficient. Substituting a price signal for cumbersome regulations will promote economic growth and provide the regulatory certainty companies need for long- term investment in clean-energy alternatives. 

IV.        To prevent carbon leakage and to protect U.S. competitiveness, a border carbon adjustment system should be established. This system would enhance the competitiveness of American firms that are more energy-efficient than their global competitors. It would also create an incentive for other nations to adopt similar carbon pricing. 

V.         To maximize the fairness and political viability of a rising carbon tax, all the revenue should be returned directly to U.S. citizens through equal lump-sum rebates. The majority of American families, including the most vulnerable, will benefit financially by receiving more in “carbon dividends” than they pay in increased energy prices.

The Guardian reports how parts for the Mini Cooper Car ship back and forth across Europe, several times to and from the same country!

A Mini part’s incredible journey shows how Brexit will hit the UK car industry. Multiple cross-Channel road trips highlight how carmakers and suppliers in Britain and the EU are intertwined.

The Guardian visualizes the effect of the UK leaving the EU without a new preferential trading agreement in place.

Makes Russia Great Again (MRGA) Edition:

“Tariffs will make our country much richer than it is today,” President Trump tweeted in August. So far, there’s not much evidence of that. As the left-hand graphic above shows, U.S. exports to China have plummeted since June—while U.S. imports from China have continued to rise. Meanwhile, U.S. importers (many of whom are exporters) have seen their U.S. tariff bill more than double since May, topping $5 billion in October.

Trump’s tariff war has some clear winners, however—high among them, Russia. As shown in the left-hand graphic, Chinese imports from non-U.S. firms have continued to grow at a robust 18 percent year-over-year rate while those from U.S. firms have fallen. Among the hardest-hit U.S. sectors have been soybeans, autos, and oil. Whereas China had accounted for about 22 percent of U.S. oil exports in the two years to July 2018, it fell to zero thereafter. This has proven a boon to alternative suppliers like Russia, as shown in the right-hand figure. And so, in the ultimate irony, Americans are paying tariffs that boost the profits of Russian firms subject to U.S. sanctions.

The Wall Street Journal has an excellent review of China manages its currency in a fixed exchange rate with tightly controlled financial flows.

The Chinese currency: where it’s traded, how it’s controlled, what it all means

• The Yuan Moves—in a Controlled Way and Central Bank Tools
• The Yuan Trades in Two Markets
• China’s “war chest” to “defend” the price of the Yuan
• Why the Yuan is not truly global

Skip the “trilemma” video, its not helpful.

Eurozone inflation finally surpassed the 2% threshold in October 2018 so it was clear EU QE would come to an end sooner rather than later. The 2.5 trillion euro bond purchasing program of the European Central Bank, which was started in 2015 to stimulate economic recovery, has finally done its job. Perhaps. The ECB deposit rate on excess reserves is still negative, and the ECB lending rate is still zero. What do we expect of Eurozone interest rates and the value of the Euro in the future? (Give key determinants of the Euro’s value.) 

From the national savings identity we can derive an immediate correlation between the “Trade Deficit ” and the “Fiscal Budget Deficit.” Desmond Lachman connects the dots between “America First” Policy and the “Twin Deficits”  [edited version]:

Goldman Sachs estimates the negative impact of the US-Chinese tariff war. They consider not only the straight effects on the Goods trade balance, but also the elasticities of the goods traded and also secondary effects such as a stock market collapse as company profitability declines. Interestingly the second order effect from a stock market decline is estimated to have the largest impact.

The BBC has a nice feature visualizing hyper inflation. Below is a picture when a chicken cost 14,600,000 bolivars (equivalent to $2.22, or £1.74) in the Venezuelan capital, Caracas.or when a roll of toilet costs 2,600,000 bolivars.This explains pictures circulating on the web asking people NOT to use banknotes as toilet paper… Also, imagine the volume of money needed to buy a car! 

And yes, the Venezuelan fiscal deficit is out of control, at about 20% of GDP.

This BBC article shares a history of memorable hyperinflation events.

There were an estimated 775 million undernourished people in 2014 and that number increased to 815 million in 2016. In 2016 23% of children in the world are “stunted,” meaning they are too short for their age as a result of chronic malnutrition (link). But in the US food is rotting by the tons as farmers cannot afford the harvest or storage prices now that Trump’s trade policy has closed key global export markets. A good application of the “large open economy” effect where the lack of exports depress domestic prices.

The gap between US and Brazil (World) soybean prices is substantial: 

Source: CNBC.

The UK’s ruling government’s very own study suggests Brexit will cost the UK between $80-$300 billion (2.5-9.3% of GDP) per year (!).  A study commissioned by the “People’s Vote campaign” (which seeks a second Brexit referendum), was conducted by the independent National Institute of Economic and Social Research (NIESR), found that the most likely cost to the UK would be 3.9% of GDP or $125 billion. The House of Commons Treasury Committee requested that the Bank of England published an analysis of the effects of Brexit; the Bank of England Report published today suggested the impact could exceed $300 billion with -10% of GDP per year

Correlate “the different levels of integration” we learned bout in class with the “no deal” and “FTA” Brexit options in the figure below to explain the size and origins of the losses.

Source1, Source2, Source3

Who knew there was a market for these? China’s retaliatory soybean tariffs have created a market for huge plastic bags to store soybeans as farmers have run out of existing storage capacity. As soybean prices per bushel have fallen by about 20%, farmers have opted to increase storage rather than sell. Here is the catch: the beans in these bags are only good for about 4 months. Will there be a resolution of the trade war before March 2019? China probably knows about the storage life of these bags…

Chad Brown and coauthors examine how US steel imports changed from 6 months before the 25% Trump Tariffs to 6 months after: They find that “because of strong US economic growth, total US imports of steel actually increased by 2.2 percent in the first full six-month period after Trump imposed 25 percent tariffs on March 23.”

How could this be explained using the partial equilibrium tariff graph?

Interestingly, US importers did not pay the full 25% increase in prices. Exporters and importers shared the tariff burden just about equitably as prices paid by importers rose only 14%. Clearly the world price is not perfectly elastic and seems to have declined some in response to tariffs. Why? 

Trump exempted some countries from tariffs during April and May (Argentina, Brazil, Canada, Mexico, and the European Union) as other countries faced the 25% tariff. This produced nothing other than a redistribution of imports – towards exempt countries. Small and poor countries saw steel export volumes and export prices plummet, while exempt countries saw no change in exports and even an increase in prices and revenues.

The quote is from President Trump  as recounted by Peter Coy. Then Trump added: ““It will be a lot of money coming into the coffers of the United States of America.” That’s scary stuff for any student who has taken international economics. As Menzie Chinn points out these statements highlight that  “(1) Mr. Trump has no understanding of how tariffs work, or (2) he does understand, and he’s lying.”

As a simple application of the partial equilibrium framework, who is paying for the tariffs? China or…..

As another simple application of the partial equilibrium framework, who is generating the “money coming into [the US government’s] coffers”?

The extra credit question relates to the “large country” case that Menzie Chinn refers to. It would require a substantial decline in Chinese export prices which has (to date) not been observed. EVEN IF a dramatic decline in export prices from China could be observed (because it lost the US as its export market), basic principles of international economics highlight that it is the value added not the absolute value of exports that matter. To the degree that prices would fall, Chinese producers would only be affected to the degree that they add value added. But what do we know about the US or foreign share in value added of Chinese exports?

Source

Reposting an excellent blog from Jeff Frankel [edited down]:

September 23, 2018 — The US Treasury is due in October to submit its biannual report to Congress on what countries, if any, are manipulating their currencies to gain unfair trade advantage.  President Trump has recently resumed the accusation against China  that he made during the election campaign.  “I think China’s manipulating their currency, absolutely. And I think the euro is being manipulated also,” he told Reuters.  He is apparently pressuring the Treasury directly in its deliberations.

What has changed since April?

What has changed since the last Treasury foreign exchange report in April?  That document did not find China else guilty of manipulation.  Nor did its predecessors in the previous two administrations.  The last time the Treasury report pronounced China or anyone else a manipulator was in 1994.

China does not qualify for the accusation any more now than last April.  It still does not meet the three criteria that Congress specified in a 2015 modification of the legislation that requires the bi-annual Treasury reports.  First, it hasn’t been persistently intervening in the foreign exchange markets (at least not in the direction to push down its currency).   Second, it isn’t running an overall current account surplus greater than or equal to 3 per cent of GDP.  Its surplus was 1.3 % in 2017.

It does meet the third criterion specified by Congress, a bilateral trade surplus with the US in excess of $20 billion.  But Congress was wrong to use the bilateral balance as a criterion and the bilateral balance is not one of the criteria for manipulation in the internationally agreed rules under the IMF Articles of Agreement. The reason the US runs a bilateral trade balance with China is, first and foremost, because it runs a huge trade deficit worldwide:  currently about $600 billion.  (That includes trade in services, while the Trump Administration unaccountably counts only trade in goods.)  China is 15% of the world economy, so even just its proportionate share of the US deficit would be $90 billion, well over the $20 billion threshold.  True, the bilateral deficit is in fact a lot higher than that.  But that is for a variety of reasons, including that many of China’s exports to the US contain as much inputs that it imports from other countries as domestic value added.

In any case, a country has to meet all three of the congressional criteria to warrant the designation.  The April 2018 report did find five other countries — Germany, India, Japan, Korea, and Switzerland — that met two out of the three criteria and so were said to merit monitoring, along with China, but none that met all three.  That hasn’t changed.

What has changed since April is that the renminbi has depreciated 6% against the dollar.  The euro too has depreciated 6% against the dollar since April.  But most currencies have depreciated against the dollar since April.  There is a phrase for that: the dollar has appreciated.  Indeed on a broad average basis across trading partners (trade-weighted), the dollar has appreciated by 7%.  Perhaps the reasons for the exchange rate movement originate primarily in the United States instead of among all of its nefarious trading partners.

Sometimes exchange rate theory works

Why has the dollar been so strong?  Exchange rates don’t always act in ways that can be predicted by economists’ models.  But in this case the appreciation of the dollar can be readily explained by either or both of President Trump’s biggest economic policy moves, in the areas of fiscal policy and trade policy, respectively.

First, he has undertaken a big fiscal expansion — producing budget deficits virtually unprecedented outside of war-time or severe recession — in the form of the tax cut bill passed in December, the rapid increase in government spending this year, and proposals over the summer for further tax cuts.  Macroeconomic theory says that such fiscal expansion should drive up interest rates, attract a capital inflow from abroad, and appreciate the dollar.  That is what happened when the US had a similar fiscal-monetary mix under Ronald Reagan in 1981-84.  And it seems to be happening again now.

Second, Trump launched a trade war against America’s major trading partners in the spring and summer.  Most recently, he announced tariffs on another $200 billion of Chinese exports, to take effect September 24.  He thinks this will improve the US trade balance.  Economists explain, to little avail, that if we cut off foreigners’ exports to us, they won’t have the dollars to buy US goods.  This works through a number of channels.  Foreign retaliation in the form of tariffs against US agriculture   and other products is the first and most tangible channel.  Second, if foreign trading partners go into recession as a result of lost exports, they will not be able to import as much from us.  Finally, to return to the exchange rate, theory says that since the dollar floats, if we curtail foreigners’ ability to earn dollars by exporting to us the dollar scarcity will automatically cause the dollar to increase in value in the foreign exchange market.  Trump’s escalation of the trade war appears to have had the predicted effect on the dollar.

China’s Exchange Rate Policy

In 2014, for whatever reason – probably the slowdown in the Chinese economy, strong growth in the US, and a corresponding shift in relative monetary policies – capital started to flow out of China and the currency started to depreciate, reversing a ten-year pattern.  Just as the People’s Bank of China had intervened to dampen the appreciation of the RMB from 2004-2014, so it began intervening to dampen its depreciation after 2014.  This pattern of intervention is called leaning against the wind.  Indeed the PBoC spent a world-record $1 trillion trying to defend the currency against its slide.  If the authorities had followed the demands from American politicians, to let the market determine the exchange rate, the renminbi would have depreciated further and US producers would have had a harder time competing.

Eventually American politicians began to figure it out.  The last one to get the message was Donald Trump.  He campaigned for president on the issue and, even as late as April 2, 2017, called the Chinese the “world champions” of currency manipulation.

Then suddenly ten days later, on April 12, 2017, he switched positions, telling the Wall Street Journal “They’re not currency manipulators.”  (Apparently one of his business advisory councils managed the feat of explaining the issue to him, before they disbanded.)  Trump said relatively little about the subject for the rest of the year until returning to the attack recently. Ironically, the year during which he suspended the charge that China was pushing down the currency was also the year – 2017 – during which it in fact suspended its efforts to push up the currency.  Its foreign exchange reserves were roughly flat for the year.

More recently the Chinese have resumed their efforts to defend the currency, just in time for Trump to resume his accusation that they are doing the opposite.  Its central bank has signaled application of a so-called “counter-cyclical factor” (in its daily “fixing” in the foreign exchange market), to slow depreciation.

Why has Trump consistently gotten it backwards, accusing the Chinese of currency manipulation during periods when they are working hard to keep the RMB higher than it would otherwise be (2016 and now) and dropping the charge when they are not (2017)?  No, it’s not simple perversity. He makes the charge when the renminbi depreciates, which is also when the Chinese central bank intervenes to support it.  But what is fundamentally driving the depreciation?  Market forces, which in turn respond to Trump’s own fiscal and trade policies.

Food for Thought:

Argentina has been in crisis mode for much of 2018 (see here, here, here, and here). Today the WSJ reports that Argentina received the largest IMF program loan ever. While the IMF recommended a currency board in 1989 (which failed in 2001), it now requires Argentina “to maintaining a floating exchange-rate regime without intervention” and to reduce its fiscal deficit to zero, indeed to a surplus (!) by 2021 (WSJ).

This is a nice application of the TB/Y or the Mundell Fleming Model (as the capital account opened up again recently) to figure out how a huge reduction in government spending (~6.5% of GDP) and a flexible exchange rate will affect Argentina and its reserves vs the currency board medicine which had previously been prescribed by the IMF.Source:

The Peterson Institute for International Economics summaries all tariffs actions by the Trump administration and the ensuing retaliation and legal actions at the WTO with timeline and charts although I find the version without graphics a bit easier to read. Politico has a running tab on actual imposed tariffs and Politicopro has its own infographic: 

By now economists are reasonably confident that Trump Tariffs were never designed to moving manufacturing jobs to the US. If that was the policy target, one would/could have gone about it in an effective fashion. Indeed there are many reasons why Trump Tariffs wont have the promised economic effect.

1. Trump is obsessed with bilateral trade balances. Even the right wing Cato Institute tried to explain the futility of the concept and elementary trade theory clarifies the point. But that confuses Trumps intentions; his point is not the US trade balance. His point is to blame specific countries for unskilled workers plights in the US. US Commerce Secretary “We are using “trade deficit” as a shorthand way of saying job creation.”
2. Reducing the trade deficit will not return the US to the manufacturing employment of the 1970s. US wages have increased since then and no one in the US is willing to work for Chinese or Vietnamese wages. So, even if Trump chose prohibitive tariffs (forcing the US to produce certain products in the US), firms would not use the same number of workers as in the 1970s — they would substitute ample capital to increase labor productivity to the point where they would be able to pay the going US wages. Whats next? Prohibiting artificial intelligence in the production processes?
3. Nicholas Kristof laid out nicely decades ago that tariffs wont reduce the trade deficit. He provides some wonderful examples.
4. The recent articles about companies moving production from China to (Chinese subsidiaries in) Vietnam show that the jobs won’t return to the US but instead move to lower wage countries. 

The ratio of CEO pay to the median salary for all other employees in the company provides a reference of how high CEO pay is. It’s often used to compare CEO pay across countries. For CEOs in the U.K., the ratio is 22; in France, it’s 15; and in Germany it’s 12. Here is the ratio for the US (over time)

President Trump is said to have imposed the additional $200 billion in tariffs on China (beyond the initial $50 billion) “because China cannot retaliate” — China only imports $130 billion in US goods. Not so fast, the trade balance is not TB = X – M, but we measure its value (in dollar) as

TB = P[US] * X – E*{P[China]*(1+tariff)}*M, so a devaluation of the Yuan, or an appreciation of the dollar (E decreases) implies that Chinese goods appear cheaper to US consumers (even if prices in the US and China remain constant).  Sufficiently cheaper perhaps to offset a tariff…

Menzie Chinn [you can skip the tariff analysis, if you have not taken econ 471] lays out nicely what that means for Exchange Rate Management: China has a managed exchange rate; so it could unload its Treasury Bills but the capital losses would be large. (Recent estimates of impacts on Treasury yields are here [this link is fyi only, not required).

Source: Torsten Slok, April Chartbook, DeutscheBank.

However, China could do the opposite, and buy more Treasury Bills, strengthening the dollar, i.e., weakening the yuan. There is substantial scope for depreciation, as shown in Figure 2. A 25% depreciation (log terms) would restore the CNY to 2011 levels.Figure 2: Log real trade weighted Yuan (blue), nominal (red), 2010=0. March 2018 observation for March 26. Source: BIS.

So, in order to restore competitiveness after Trump tariffs, all China needs to do is to engineer a depreciation/rebuild forex reserves. Of course a managed depreciation of the yuan would be declared “currency manipulation” by the Trump administration, who would then be calling the kettle black, since the white house first initiated the “trade manipulation” but imposing tariffs.

Update; 9/7/18 President Trump just announced he is ready to slap tariffs onto another $260 billion in Chinese goods (that’s $50bil + $200bil + $260bil = $510bil) which actually exceeds the current US trade deficit with China ($505billion). Perhaps the White House will come to its senses when it reads the Menzie Chinn post?

China is a unique case study about technology transfer. While most developing countries have had trouble attracting sophisticated foreign direct investment in the past 200 years, China’s market size is large enough that it can impose rules on firms that seek to enter the Chinese market.

Some of these rules related to the sharing of technology/ownership structure. For example, when foreign firms can enter China only when they establish a joint venture with a Chinese company. The Chinese provide capital/land, the foreigners bring technology. This can be seen as “forced technology transfer.” At this point there are no international rules that guide which conditions countries can impose on foreign investors (in fact there are many such conditions in first world countries, too).

The problem arises, however, if the joint venture leads to misappropriation of foreign technology. For example, if one year after the joint venture has been established, the foreign company finds an exact copy of its product on the market produced by a rogue Chinese firm. Note that this is an intellectual property rights issue, not a “forced technology transfer issue;” the two are is often confused. Technology sharing in a joint venture is voluntary — foreign companies can choose not to enter. Stealing technology is a crime.

Econofact has a great discussion of the issue (based on the 2018 PIIE Brief by Lee Branstetter: “China’s Forced Technology Transfer Problem — And What to Do About It.” which I summarize in edited form:

• The problem of protection and enforcement of intellectual property rights in China is a longstanding one — and a concern for current and previous U.S. administrations. Weak intellectual property enforcement. Studies by the current and previous U.S. administrations have tried to quantify the financial losses that these practices impose on owners of U.S. intellectual property. The wide-ranging estimates have indicated that losses could be measured in the ten of billions — perhaps even hundreds of billions — of dollars (see for instance U.S. Trade Representative 2018, U.S. International Trade Commission 2011, and Commission on the Theft of American Intellectual Property 2017). These estimates mostly reflect the value of intellectual property believed to be infringed by Chinese entities, due to weak enforcement of intellectual property rights (see here).
• There are plenty of cases when multinationals based in the U.S. or Japan or Europe will voluntarily choose to transfer technology to other firms — even other firms that they do not control. For instance, if a firm has a supplier providing a critical input, it is in the firm’s interest to make sure that that input is of high quality. If it has technology that can help the supplier be more reliable, to produce a higher quality product, or a higher-performing product, it has a strong incentive to provide that technology.
• First World countries (and their corporations) prefer to let transacting parties work out the degree of technology transfer, without (Chinese) government interference).  That would be a key tenant of economic imperialism: let the advanced country/firm decide how to enter developing markets, vs letting the developing market decide how best to manage entry for its market benefit. The issues is even more preposterous since the first world countries, especially the US, have government rules to its own benefit that prohibit the transfer of certain technologies. The “forced technology transfer” issue in reverse, so to say.

Incredibly frustrating data, shocking annecdotes. Corroborated by

Chen, Kim, and Liuy (AER Conference Paper 2016), who find that, relative to males in the same cohort, female economists are less likely (by 9.6%) to have received tenure and promotion during the first eight years since graduation.

Antecol, Bedard, Stearns (AER 2018), who find that, using data on all(!) assistant professor hires at US top-50 economics departments from 1985-2004, the adoption of gender-neutral tenure clock stopping policies substantially reduced female tenure rates while substantially increasing male tenure rates.

Of course there is also the long legal history between Columbia and Graciela Chichilnisky, that started while I was in NY. At the time the rumor at Columbia was that the University had problems establishing the absence of wage discrimination because there were no other female professors (to establish wage comparisons) at any other Ivy League econ department.

In our department, I very much hope Judy Thornton, an absolute trailblazer of (tenured) women in economics, will write her memoirs to report on the situation starting in the 1950s. She shared with me that at Harvard she had to sit outside the door of Schumpeter’s lecture hall to hear his class (as women were not admitted to sit in class) and upon arriving at the UW in the early 1960s she reports that “one of the full professors patted me on the head and said ‘we needed a cute little instructor’.”

Excess Reserves are the amount of money that banks deposit at the Central Bank for safe keeping above and beyond what is necessary under the Reserve Requirement.

I have been fascinated by excess reserves since 2008, given that they reached $2.5 trillion – that is money banks decided not to lend to investors but instead stash away for safe keeping at the FED. Apparently Banks were less interested in the return ON their investment than in the return OF their investment.

Here is a good explanation of some of the reasons for excess reserves, unclear how relevant the explanation it is still today (since excess reserves are still seemingly inexplicably large).

The newest Argentinean Crisis required another trip to the IMF. The BBC details the long sorted history of Argentina and the IMF (here) and (here):The Expenditure Reducing measures announced (exceeded the IMF requirements) include “taxes on exports of some grains and other products” and “about half of the nation’s government ministries will be abolished” and “half of ministry jobs being axed.” This after January’s cuts that froze government employees’ pay and cut “one out of every four ‘political positions’ appointed by ministers.”

The measures are designed to stabilize the value of Argentina’s currency, which has lost about half its value this year against the US dollar, despite the central bank raising interest rates to 60%(!).

While these measures go beyond the IMF’s conditionality (FMI abbreviated in Spanish), Argentinians learn one thing: call the IMF and the country goes into a real crisis. Why?

As background info, the BBC provides key statistics

Why do you think the BBC chose these graphs?

The WSJ reports that U.S. companies are buying back record amounts of stock this year. S&P 500 companies are on track to repurchase as much as $800 billion in stock this year, a record that would eclipse 2007’s buyback bonanza. The Real Problem With Stock Buybacks is that they transfer wealth from investors to company executives.. Billions of dollars spent to buy back shares could have gone toward investment in new factories or technology that could lead to stronger profit and wage growth in the future.

Good stuff by behavioral economist Dan Ariely:

The gusto with which President Trump imposes tariffs on other countries makes me wonder if the notion of “retaliation” has been fully discussed in the White House. If so, one wonders why the President still raises tariffs expecting other countries to roll over. (As Einstein said, “insanity is to conduct the same experiment over and over again and expect different outcomes”)

Most recently, President Trump imposed tariffs on the shaky economy of Turkey. Not because it steals intellectual property of US firms (as was Trumps rational for Chinese tariffs), and not because it was in the interest of national security (as Trumps rational for Mexico, Canada, EU tariffs). This time it was to punish the shaky Turkish government (featuring a coup attempt two years ago) for having imprisoned a US citizen. In the past, governments used diplomacy in these cases, but President Trump seems to prefer tariffs.

So here we have a developing country, not even a EU member, not even a country with a timeline for EU accession, and President Trump imposes a tariff. Did Turkey retaliate? You bet.

UW launched a new webpage to provide information on “teaching international and multilingual students at UW” covering

• Who are international and multilingual students at UW?
• Research report: faculty survey on teaching international and multilingual students
• Center for Teaching & Learning support for instructors regarding teaching international and multilingual students?
• Where can UW instructors refer their students?

Econfact  reviews the case of US steel tariffs, after the Department of Commerce concluded that under Section 232 of the Trade Expansion Act of 1962 (19 U.S.C. 1862(b)(1)(A)) steel and aluminum imports constitute a “national security threat.”

But wait there is more, on May 23rd 2018, the administration initiated a new investigation to determine whether imports of automobiles also threaten US national security.

Prior to the two Trump cases, the Department found national security threats in only two cases in the past 56 years (both involving oil). How could this be true? Well because the Department of Commerce recently adopted a new “definition” of “national security.” Commerce Secretary Wilbur Ross stated that

“National security is broadly defined to include the economy, ….to include employment, to include a very big variety of things… 

So national security = economy = a very big variety of things.

This raises an interesting question, what is the effect of a steel tariff on the economy. Since steel is an important intermediate input, the tariff implies higher prices not only for consumers but also producers (e.g., of cars). Here is a summary of the economic effects from Econfact:

• “Imposition of these tariffs under the guise of national defense could have large negative economic effects even in the absence of retaliation. For instance, one estimate indicates a 40,000-job loss in the automobile industry (a heavy steel user) from the steel tariffs alone. With the expiration of exemptions on the EU, Canada and Mexico, some $50 billion of steel and aluminum imports are now covered by tariffs. One can expect the employment impact to be even more substantial. Adding in retaliation (but incorporating the now defunct exemption for Canada and Mexico), the consulting firm Trade Partnership estimated a net loss to the economy of 470,000 jobs. The Peterson Institute for International Economics estimates a 25 percent tariff on imported automobiles (currently at 2.5 percent for non-Nafta members, and 25 percent for trucks) would reduce employment by 195,000 over the course of three years. With retaliation, that number would rise to 624,000.”

Under the above definition of national security, maybe we should subsidize steel?

Paul Krugman (Economics Nobel for his work in international trade) discusses trade wars (here) and (here)

Menzie Chinn is getting exasperated, here is his post ad verbum:  Things I Never Thought I’d Have to Explain on Econbrowser: Trade Creation/Trade Diversion:

The recent political crisis in Italy has given rise to expectations that President Matarella has in effect launched a referendum on the EU/euro. This makes for a wonderful application to study interest parity. The Wall Street Journal’s Daily Shot Blog as (as usual) all the relevant graphics: Italian 2 year bond yields experienced the greatest one-day increase in years (NB: yields were negative just a few days ago!): Source: Bloomberg

And, to complete the interest parity case study, here is the 10 year Bond Spread to Germany, which has the identical currency!

And then there is contagion with immediate spillovers into Spain and Portugal, as their CDS Spreads* and Bond Spreads widen:

–

[*CDS or a Credit Default Swap is referred to as its “spread,” and is denominated in basis points (bp), or one-hundredths of a percentage point. For example, right now a Citigroup CDS has a spread of 255.5 bp, or 2.555%. That means that, to insure $100 of Citigroup debt, you have to pay $2.555 per year]

Politico reports about TRUMP’S AUTO TARIFF SURPRISE: What started Wednesday as a cryptic tweet from President Donald Trump ended in the evening with the Commerce Department launching a Section 232 [effect of imports on national security] investigation into whether to restrict imports of cars, trucks and auto parts. Trump requested the probe into whether auto imports could justify a 25 percent tariff to protect U.S. national security, a senior administration official confirmed to POLITICO.

The response from the US auto industry was unsurprisingly negative. “To our knowledge, no one is asking for this protection,” said John Bozzella, the CEO of Global Automakers.

The investigation could take several months to complete, but few think it will take that long. Indeed that same night, Commerce Secretary Wilbur Ross night laid out the facts justifying the trade probe: “There is evidence suggesting that, for decades, imports from abroad have eroded our domestic auto industry.” That sure looks like a threat to national security; looks like the Commerce Department has their facts at the ready.

All roads lead to NAFTA: The news was viewed by some observers through the lens of the NAFTA talks that have focused almost obsessively on auto issues. A final deal is hung up on the willingness of Mexico and Canada, the two largest exporters of cars to the U.S., to accept new content rules that could potentially alter existing supply chains to the benefit of U.S. production.

Trump appeared to link the two issues on Wednesday, when he told reporters that he felt the auto industry would “be very happy with what’s going to happen. You’ll be seeing very soon what I’m talking about. NAFTA is very difficult. Mexico has been very difficult to deal with. Canada has been very difficult to deal with. They have been taking advantage of the United States for a long time. I am not happy with their requests. But I will tell you, in the end, we win. We will win, and we’ll win big.”

Trade and the Environment Theories stress three key effects of trade on the environment: Scale, Technique and Composition effects. Here is a good example of the composition effects — as an added bonus it plays out with a trade barrier!

Trade allowed for recycling waste to find its way to China, or HOW THE CHINESE COULD DISRUPT GLOBAL RECYCLING MARKETS

The recent Trump trade war has given China a great opportunity to “clean up its” composition effect as U.S. scrap exports to China just came to a screeching halt…

The WSJ reports that US-Chinese Spoiled Relations lead to U.S. Goods Stuck at China’s Ports as Trade Tensions Heat Up. Not only nvel oranges, lemons and cherries and Washington apples, have been sitting at Chinese docks longer than normal. China’s customs agency said Monday it would start strengthening quarantine inspections on U.S. apples and timber after claiming to have found pests in some recent shipments. Before last week, U.S. cherries could pass through such quarantine inspections in a matter of hours, and oranges and lemons would typically take a couple of days to clear the reviews. Now the process is, in some cases, taking five to seven days.

Even Ford cars may now need to be disassembled for Chinese customs officials as US cars are now subjected to unusually rigorous checks at the port. Chinese customs officials want to inspect individual components inside the vehicles’ emissions system, which basically requires the car to be disassembled…

The Chinese have a playbook for Non Tariff Barriers, the WSJ reports: “Last year, amid tensions about South Korea’s deployment of a U.S.-built missile-defense system, China stopped sending tour groups to the country and sales of Hyundai Motor Co. cars in China plummeted. China at one time imposed curbs on imports of Philippine bananas over rival territorial claims in the South China Sea.

In April, Beijing increased tariffs on fruit, including lemons and limes to 26% from 11% and 25% on cherries from 10%, along with a number of other U.S. imports. It was in retaliation against the Trump administration’s penalties that have hit Chinese steel and aluminum. Now we pile on NTBs.

Would the real Republican please stand up? This Wall Street Journal editorial says it all.

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Section 301 of the U.S. Trade Act of 1974 authorizes the President to take all appropriate action, including retaliation, to obtain the removal of any act, policy, or practice of a foreign government that violates an international trade agreement or is unjustified, unreasonable, or discriminatory, and that burdens or restricts U.S. commerce. If the US Trade Representative initiates a Section 301 investigation, it must seek to negotiate a settlement with the foreign country in the form of compensation or elimination of the trade barrier.

For cases involving trade agreements, the USTR is required to request formal dispute proceedings as provided by the trade agreements under Section 301. The law does not require that the U.S. government wait until it receives authorization from the WTO to take enforcement actions.

In the 1990s, Section 301 ws challenged by a number of Members of the WTO as contrary to the WTO Agreement.^[8] The WTO ruled that that “taking any such actions against other WTO member countries without first securing approval under the WTO Understanding on Rules and Procedures Governing the Settlement of Disputes is, itself, a violation of the WTO Agreement.”

The most recent Section 301 investigation involved Chinese intellectual property rights theft. Here is the report. It was the basis for President Trumps $60 billion tariff. Chad Brown does the analysis and characterizes the retaliation.

From hereon out I will refer to intentionally made up numbers that are used to either confuse the public (because until now we believed numbers were real) or to support wishful thinking on the part of the policy makers as “mickey mouse economics.”  Here is an example, from Time Magazine (via Menzie Chinn’s Blog)

Mr. Trump holds forth on how he interacts with other heads-of-state (from TIME):

And by the way, Canada? They negotiate tougher than Mexico. Trudeau came to see me, he’s a good man, he said we have no trade deficit with you, we have none. Donald, please. Nice guy, good looking guy. Comes in. Donald we have no trade deficit. He’s very tough. Everyone else, getting killed or whatever. But he’s tough. I said, well Justin, you do. I didn’t even know. Josh, I had no idea. I just said you’re wrong. You’re wrong. It was so stupid. [LAUGHTER]. I thought it was fine. I said, you’re wrong Justin. He said, nope we have no trade deficit. I said, well in that case I feel differently. I said but I don’t believe it. I sent one of our guys out. His guy, my guy. They said check because I can’t believe it. Well, sir you’re actually right, we have no deficit but that doesn’t include energy and timber. [LAUGHTER]. Well you don’t have timber, and when you do we’ll lost $17 billion. It’s incredible.

USTR notes that the 2016 bilateral trade balance between the US and Canada is +12.9 billion.

As the Britains voted to exist the European Unions common market (which led to a spike in Google.uk searches for “What is the EU?”) and as the US trade policy is run by wishful thinkers, Asia is taking the lead today. The BBC reports [edited]:

Asia-Pacific trade deal signed by 11 nations

• tariffs reductions between member countries.
• reductions in non-tariff measures and harmonized, transparent and fair regulations
• commitments to enforce minimum labor
• commitments to enforce and environmental standards
• an Investor-State Dispute Settlement mechanism, which allows companies to sue governments when they believe a change in law has affected their profits.

President Donald Trump in his efforts to work for american workers and against special interests groups labeled the agreement “a rape of our country.”

Teaching trade used to be fun. We used to talk about valid positions held on both sides of an issue and weighted pros and cons. All this has gone by the wayside. It is such a sad state of affairs when the country is run by wishful thinking with vacuous content, which leaves no room for pros and cons discussions.

March, 2, 2018. Twitter. The President:

“When a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win,” Trump said on Twitter on Friday March 2, 2018. And later that day, “We must protect our country and our workers. Our steel industry is in bad shape. IF YOU DON’T HAVE STEEL, YOU DON’T HAVE A COUNTRY!”  

“The United States has the lowest tariffs in the world — the lowest non-tariff barriers — and what do we get for that? We get a half-a-trillion-dollar a year trade deficit, which is draining us dry, taking our jobs, putting them offshore, harming the workers of America, and driving down wages.”
— Peter Navarro, director of White House National Trade Council, interview on Fox News, March 2, 2018

Aside from the fact that anyone with remedial economics knows that the trade deficit has its origins elsewhere, it is interesting to follow up on this statement. The Washington Post does some digging. There is an interesting issue related to the measurement of “non-tariff barriers” but Credit Swiss apparently did a tally:

Here are my favorite non-trade barriers. The Japanese used to be the quite creative until they were outdone by the French:

• Japan’s used to refuse to import American skis because Japanese snow is different. So, Japan argued, US skis cannot not meet Japanese safety standards.
•  When Japan refused to lower its quota on American Beef imports in the 1980s, the Japanese argued that they were physically incapable of eating more beef. Mr. Hata, the Japanese agriculture minister, explained that that Japanese people have longer intestines than other people.
• Foreign pharmaceutical manufacturers often cannot sell their drugs in japan because their exhaustive tests for new drugs are judged inadequate. These tests were conducted on other humans and not Japanese.
• France then got back at the Japanese and required that all Japanese VCRs be inspected in the city of Poitiers before they could be sold in France. Poitiers is a tiny town in the middle of France far from ports and highway connections to ports.

It is true that average tariffs (which can actually be measured) are low in the US, but certainly not the lowest in the world according to the WTO which spends a fortune monitoring tariff data.

Who is Trump trying to stick it to? The US International Trade Administration reports. Would you have guessed? 

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Trade Remedies in the Steel Sector include Antidumping duties (AD), countervailing duties (CVD), and safeguards. These are internationally agreed upon mechanisms to address the market-distorting effects of unfair trade, or serious injury or threat of serious injury caused by a surge in imports. The nice thing about safeguard tariffs is that they do not require to be motivated by “unfair” practice, it is sufficient to assert injury caused to a domestic industry. The table below provides statistics on the current number of trade remedies the United States has against imports of steel mill products from various countries.

So much for the country without the lowest trade barriers…

I come across a lot of graphs and figures, but Piketty’s education/income graph easily takes the prize as the most impressive in a long time: 

The data is from Chetty et al and I paraphrase Piketty’s penetrating commentary: All societies need a grand narrative to justify their inequalities. In contemporary societies, the focus is on meritocratic narratives, such as: `Modern inequality exists as the outcome of free choice; all individuals have the same opportunities.’ The problem with such narratives is the yawning gap between meritocracy and reality. The graph shows that, in the United States, chances of obtaining higher education are almost entirely determined by the income of one’s parents! Barely 30% for the poorest 10% attend college, while over 90% of kids of the richest 10% attend. (What is worse, we are not even talking about the same educational quality that the richest and poorest receive in college…).

Guess what: Educational experiences of poor and rich families translate directly into inequality: 

It turns out that tit-for-tat is a surprisingly effective strategy in some games; trade being one of them, especially among large industrialized countries. Already in 1956, Harry Johnson pointed out that trade wars a la Trump wont yield good outcomes (for consumers and national welfare), given that partner countries are likely to retaliate.

After recent attacks by the White House to upset Canadian trade relations, Canada is playing tit-for-tat-trade with the US. Let’s not forget where most US exports go:

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priceless

It is difficult to make sense of politics at times, especially when it comes to economics. The 2017 Republican Tax Cut is supposed to cut taxes, but increase revenues. Many focus on distributional concerns, This post is about the feasibility of cutting taxes and without increasing the deficit, implying that revenues must stay at least neutral. How is it possible? Only if income goes up sharply, so that a lower tax on a larger tax base (income) does not affect revenues.

Economic Growth theory, suggests this is actually possible. Think about it this way: If there were no taxes there would be no funds to provide public goods (education, roads) crucially needed for prosperity. so we know that taxes must be positive even for low levels of income. On the other hand, the tax rate also cannot be linear (increasing with income) because prohibitive taxes (100%) would provide no incentives to work as income rises. So, the optimal tax is rising to a certain level and then declines again, inverted U curve. The question is what determines the maximum and is an economy to the left of the right or the maximum where taxes should either increase or decrease to foster growth.

In a sense this is an empirical question and is easily answered. The Kennedy/Johnson  Reduction Act cut income tax rates across the board and reduced the corporate tax rate. Revenues increased. The Reagan and Bush tax cuts had opposite effects Economic Recovery Tax Act of 1981 cut the top marginal tax rates from 70% to 50% and the bottom rate from 14% to 11% in addition to cutting capital gains, estate and corporate taxes.  Under the Tax Reform Act of 1986, the top marginal tax rates were reduced further (from 50% to 28%) and increased the bottom rates from 11% to 15% (in other words, taxes on the lowest earners were raised to 1% higher than when Reagan stepped into office.

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Recently Kansas tried the same experiment by lowering taxes dramatically in 2012. NPR has a summary of the effects that is well worth listening to.

So You Want to Fix the Trade Deficit?

Figure 1: Net exports (blue), net exports ex.-petroleum products (red), and current account (light green), as a share of nominal GDP. NBER defined recession dates shaded gray. Source: BEA, 2017Q1 3rd release and author’s calculations.Notice that net exports have improved since the onset of the Great Recession, in part because of

a) slower growth

b) a depreciated dollar

c) an increases in petroleum product exports (as highlighted by the fact that the ex-petroleum net export series moving closer to balance than the overall).

The dollar’s value is one key factor in these movements. Below in Figure 2, the trade weighted dollar is graphed (the dollar exchange rate against a broad basket of currencies, in Chinn’s definition, a downward movement is a appreciation), lagged two years, against net exports, ex-petroleum.Figure 2: Log US dollar exchange rate against a broad basket of currencies, lagged two years (dark blue), net exports ex.-petroleum products as a share of nominal GDP (red). Exchange rate defined as downward movement is a dollar appreciation. NBER defined recession dates shaded gray. Source: BEA, 2017Q1 3rd release and author’s calculations.

So, the question is whether trade measures will have a noticeable impact on the trade balance (this is a separate question from whether it’s welfare improving to impose such barriers). The answer depends in large part whether you think the impacts of US income and the dollar’s value (the two key variables) are going swamp any changes in relative prices coming from tariffs and quotas imposed at the sectoral level.

I tend to think that level of US national saving (the sum of government budget surplus and private saving) and desired investment tend to drive the trade balance (approximately the current account, as shown in Figure 1) more than the trade balance drives the US budget balance, private saving and investment. In that framework, trade protection measures have second order effects, unless they were to drastically change these macro aggregates. Tariff revenues are too small to affect the budget balance. It is hard to see how they increase private savings; maybe they could affect investment in protected sectors — but that works in the wrong direction. (More on the national saving identity here).

So, the Trump project of reducing trade deficits through protection, while maintaining growth (protection which triggers retaliation and a global slowdown could “work” to reduce the US trade deficit) is doomed to fail.

 

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The best trade podcast. How to deal with playground bullies (on the global trade scale)…

Krugman classified economics into three kinds of writing in economics: Greek-letter, up-and-down, and airport.

Greek-letter writing formal, theoretical, mathematical is how professors communicate… using the specialized language of the discipline [Greek Letters] as an efficient way to express deep insights….

Up-and-down economics is what one encounters on the business pages of newspapers, or for that matter on TV. It is preoccupied with the latest news and the latest numbers, hence its name. […]

Airport economics is the language of economics bestsellers. These books are most prominently displayed at airport bookstores, where the delayed business traveler is likely to buy them. Most of these books predict disaster: a new great depression, the evisceration of our economy by Japanese multinationals, the collapse of our money. A minority have the opposite view, a boundless optimism. Whether pessimistic or optimistic, airport economics is usually fun, rarely well informed, and never serious.”

Never serious? Well, that was the 1990s… These days Airport economics is the stuff that White House economics is made of.

Here is the White House Director of the National Trade Council, Peter Navarro’s most recent book: Death by China” 

Navarro’s theories have not been received kindly by Greek Letter Economists: A New Yorker reporter described Navarro’s views on trade and China as so radical “that, even with his assistance, I was unable to find another economist who fully agrees with them.“^[34] University of Michigan economist Justin Wolfers described Navarro’s views as “far outside the mainstream,” noting that “he endorses few of the key tenets of” the economics profession.^[36] According to Lee Branstetter, economics professor at Carnegie Mellon, Navarro “was never a part of the group of economists who ever studied the global free-trade system … He doesn’t publish in journals. What he’s writing and saying right now has nothing to do with what he got his Harvard Ph.D. in … he doesn’t do research that would meet the scientific standards of that community.”^[37] Marcus Noland, an economist at the Peterson Institute for International Economics, described a tax and trade paper written by Navarro and Wilbur Ross for Trump as “a complete misunderstanding of international trade, on their part.”^[22]

Next up, billionaire Commerce Secretary Wilbur Ross. Without economics background, his specialty is leverage buyouts (buying distressed companies, chopping them up and selling them at a premium a few years later). Wilbur Ross is unencumbered by the facts or data as top Greek Letter Trade Economist Jeff Frankel at Harvard points out. Frankel described Wilbur Ross’ Financial Times column “not economically literate or coherent.  This judgement is not based on economic theories, but rather definitions and facts.  For example, he says three or four times that American productivity has fallen. It has not; it continues to rise. Okay, what he means is the rate of productivity growth, which has indeed fallen since the turn of the century, and is indeed a problem.  But what numbers does he choose to cite to measure the productivity slowdown?  “During the 1970s growth in US unit labour costs was 6.8 per cent a year but it dropped…to 1.2 per cent so far this century.”  What a bizarre thing to say!   Growth in unit labor costs (ULC) equals the rate of wage increase minus the rate of productivity growth.  Other things equal, the productivity slowdown would show up as a higher rate of increase in ULC, not lower.  Does he know that higher ULC is usually considered a bad thing (by hurting competitiveness)?   Is he trying to say something about wages, and if so, what?  Is he agreeing with Trump’s statement about wages being too high or not?  It is impossible to tell. There are other mistakes as well.  For example, the continent of Europe does not “run massive and chronic trade deficits.”  To the contrary.  He seems to imply  manufacturing employment shares in Germany and Japan have not declined.  They have.   And so on. It appears that definitions, logic and facts are no more important to Trump’s adviser than to the candidate himself.”

The most recent nominee to the Trump “Team Econ” is Kevin Hassett as the Head of the President”s Council of Economic Advisors. His claim to fame is THE epitome of Airport Economics: a 1999 book entitled “the Dow at 36000” (at that time the Dow Jones Industrial Index index was at 10,000…)

Nobel laureate Paul Krugman pointed out basic arithmetic errors in the book and statistician and blogger Nate Silver described the book as “charlatanic..”[9]^[10]

An then there is the president himself. He recently gave his first in depth economics interview to the Economist Magazine. Public Radio International summarizes the article

This week, The Economist published an in-depth interview with Donald Trump about his economic policy. The piece, which described Trump’s economic strategy as “unimaginative and incoherent,” picked up a lot of attention. The president’s speech was riddled with falsehoods and confusion, drawing critics and social media commentators out of the woodwork. The Economist’s own analysis was even more scalding…

“Contrary to the Trump team’s assertions, there is little evidence that either the global trading system or individual trade deals have been systematically biased against America (see article). Instead, America’s trade deficit—Mr Trump’s main gauge of the unfairness of trade deals—is better understood as the gap between how much Americans save and how much they invest (see article)… A deeper problem is that Trumponomics draws on a blinkered view of America’s economy. Mr Trump and his advisers are obsessed with the effect of trade on manufacturing jobs, even though manufacturing employs only 8.5% of America’s workers and accounts for only 12% of GDP. Service industries barely seem to register. This blinds Trumponomics to today’s biggest economic worry: the turbulence being created by new technologies. Yet technology, not trade, is ravaging American retailing, an industry that employs more people than manufacturing (see article). And economic nationalism will speed automation: firms unable to outsource jobs to Mexico will stay competitive by investing in machines at home. Productivity and profits may rise, but this may not help the less-skilled factory workers who Mr Trump claims are his priority.”

And finally the Economist Magazine clarifies how the capriciousness with which policy is being made at the White House:

We asked him about the whole saga of how he was on the very point of withdrawing from NAFTA. He told us the back story, that he’d been ready to do it, but then he’d had a nice phone call from the prime minister of Canada and the president of Mexico. And they asked him “could you think again? Maybe we should renegotiate instead of withdraw completely?” And so out of respect for them, he agreed to do that. 

Now that’s actually slightly different from the story that we heard from people in the inner circle who said it was a lot more chaotic as a process. We heard some fairly startling stories that the reason the Canadians and the Mexicans called the president was that people in the inner circle of team Trump were very anxious about what was about to go down. They called [Canada and Mexico] and said, “You need to call [the president]. Right now.” People inside the White House also called the new Agriculture Secretary Sonny Perdue. Perdue who had only been confirmed a day or two earlier. And they called him in, [saying], “You need to come over here now! You need to! He’s about to withdraw from NAFTA.” So Sonny Perdue literally asked his staff to draw up a map of the bits of America that had voted for Donald Trump and the bits of America that do well from exporting grain and corn through NAFTA. [The map] showed how these two areas often overlap. So he went in, said to Donald Trump, “Actually, Trump America, your voters, they do pretty well out of NAFTA.” And the president said, “Oh. Then maybe I won’t withdraw from NAFTA.”

The solution to Pollution havens and Summers-Memo-Style model implications is to internalize (aka globally pay for) the externalities (aka the global environment).

Nobel Laureate Joe Stiglitz lays it out clearly, Costa Rica does it alone with an “ecotax” since the international community did not come through, and Ecuador tried it…

Trump Tweet: “The U.S. recorded its slowest economic growth in five years (2016). GDP up only 1.6%. Trade deficits hurt the economy very badly,” [April 26, 2017]

Martin Feldstein [Head of Ronald Reagan’s Council of Economic Advisers]:

The real reason for the trade deficit? Our spending habits  Published: Apr 26, 2017 1:14 p.m. ET CAMBRIDGE (Project Syndicate)

The United States has a trade deficit of about $450 billion, or 2.5% of gross domestic product. That means that Americans import $450 billion of goods and services more than they export to the rest of the world. What explains the enormous U.S. deficit year after year, and what would happen to Americans’ standard of living if it were to decline?

It is easy to blame the large trade deficit on foreign governments that block the sale of U.S. products in their markets, which hurts American businesses and lowers their employees’ standard of living. It’s also easy to blame foreign governments that subsidize their exports to the U.S., which hurts the businesses and employees that lose sales to foreign suppliers (though U.S. households as a whole benefit when foreign governments subsidize what American consumers buy).

But foreign import barriers and exports subsidies aren’t the reason for the U.S. trade deficit. The real reason is that Americans are spending more than they produce. The overall trade deficit is the result of the saving and investment decisions of U.S. households and businesses. The policies of foreign governments affect only how that deficit is divided among America’s trading partners.

The reason why Americans’ saving and investment decisions drive the overall trade deficit is straightforward: If a country saves more of total output than it invests in business equipment and structures, it has extra output to sell to the rest of the world. In other words, saving minus investment equals exports minus imports — a fundamental accounting identity that is true for every country in every year.

So reducing the U.S. trade deficit requires Americans to save more or invest less. On their own, policies that open other countries’ markets to U.S. products, or close U.S. markets to foreign products, won’t change the overall trade balance.

The U.S. has been able to sustain a trade deficit every year for more than three decades because foreigners are willing to lend it the money to finance its net purchases, by purchasing U.S. bonds and stocks or investing in U.S. real estate and other businesses. There is no guarantee that this will continue in the decades ahead; but there is also no reason why it should come to an end. While foreign entities that lend to U.S. borrowers will want to be repaid some day, others can take their place as the next generation of lenders.

But if foreigners as a whole reduced their demand for U.S. financial assets, the prices of those assets would decline, and the resulting interest rates would rise. Higher U.S. interest rates would discourage domestic investment and increase domestic saving, causing the trade deficit to shrink.

Bloomberg summarizes how Germany be the worlds third largest exporter (largest per capita exporter), running a huge trade surplus, if its manufacturing sector has been shrinking just liked Trump laments in the US? Summarize the arguments of the Bloomberg article and be able to criticize them. Krugman, on the other hand argues that the decline in manufacturing could not have been caused by the trade deficit, which would have to be much larger to the culprit. Which means of course, that reducing the trade deficit is also not going to cause a huge reversal in manufacturing employment.

When company X in Ballard or Seattle goes out of business because company Y in Fremont or Portland, or Alabama has found a cheaper way to produce the same (or better) product, we take it as evidence that the good ole capitalist system is working just fine. We revel in all signs of “successful entrepreneurism” that is what capitalism is all about! No complaints, quite the contrary.

But now this:

If company X in Ballard or Seattle goes out of business because company Y in Toronto or China has found a cheaper way to produce the same (or better) product, we almost invariably observe incensed reactions. There are often feelings of grave injustices – the basic, underlying driver of “fear of international trade.”

Curiously, while intra-national gains from trade are the very foundation of “The American Dream,” inter-national trade is are considered to be undermining the American dream – requiring “protection,” “assistance,” and “compensation.”

How about some examples:

1. The real long-term threat to American jobs…
2. Amazon and the changing the nature of retail

http://si.wsj.net/public/resources/images/BN-SP677_Dshot_NS_20170323002543.jpg

http://si.wsj.net/public/resources/images/BN-SP674_Dshot_NS_20170323002541.jpg

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Source

The Peterson Institute – widely acknowledged to be the highest quality international economics policy think tank in the US, estimates that WTO sanctioned global retaliation to the border tax could add up to $385 billion “almost immediately upon implementing the tax, through the imposition of countervailing duties by trading partners.

Oliver Blanchard, former chief economist at the IMF and top econ professor at MIT, analyzed the long run impact of the tax. His assessment in a paper with Jason Furman: THE CATCH: BORDER ADJUSTMENT ACTUALLY RAISES NO REVENUE IN THE LONG RUN. IT ONLY BORROWS FROM THE FUTURE.” In other words, the great border tax revenues that the US will surely trump around early on ($1.2 trillion over 10 years) the price Americans have to pay in the future. This reveals the sad truth about the border adjustment tax: “Who Pays for Border Adjustment? Sooner or Later, Americans Do”

Here is the Blanchard’s intuition:

Net revenues from border adjustment taxes and subsidies will be positive so long as the United States runs a trade deficit. But if foreign debt is not to explode, trade deficits must eventually be offset by trade surpluses in the future. Net revenues that are positive today will eventually have to turn negative. Indeed, any positive net revenues today must be offset by an equal discounted value of negative net revenues in the future. As trade deficits eventually turn into trade surpluses, and thus border adjustment net revenues turn from positive to negative. Sooner or later, taxes will have to increase to make up for the lost border tax revenue.

Econ students should be fundamentally familiar with this line of reasoning. It is akin to a decrease in taxes today financed by new debt issues today (perhaps to win an election). When the government issues debt, taxpayers get a break now, but they will have to repay the cost of the debt eventually in the future.

While the border tax may be “intertemporally zero sum”, that is it wont generate more revnues in the long run, Robert Reich highlights the distributional issues with the border adjustment tax. Ok, Reich was labor secretary under Clinton, so he has a slant. If that makes his analysis suspect to you, simply check out what happened to the stock price index for major US retailers since the border tax was first mentioned in December:

Source

Markets are preparing for the Czech National Bank (CNB) to remove the cap on the Czech currency, the koruna. Here is the koruna (CZK) vs. the euro (EUR).Maintaining a fixed exchange rates implies a cap on the price of foreign currency which has forced the central bank to keep buying euros (and selling koruna) to make sure the koruna doesn’t appreciate above the target level. This policy has resulted in the CNB holding huge amounts of euros.Source: Goldman Sachs, @joshdigga

Foreigners who bought the koruna (and sold euros to the Czech central bank) have invested in Czech bonds. They are hoping to see a pop [aka a spike in return] when the CNB abandons its currency cap driven by the increase in the value of the investment as the koruna appreciates (although much of this cap removal is already priced into these bonds).

Staggering portions of the investment community choose to PAY to park their money, rather than generate a return on their investment. That is after all what negative interest rates imply. Shockingly, even in 2017 over 10 trillion(!!) dollars are investment in assets that guarantee the “return of the investment, but not a return on the investment.”Source: @fastFT

Looks like the sequel to Navarro’s “Death by China” is “Death by Germany” (spoiler alert, there are many more sequels to come to line Navarro’s pocket book with his creative writings). President Trump’s trade adviser suggested on Monday March 7 2017 that the US should “negotiate with Germany on a bilateral(!) basis.” Neither magic tricks nor bilateral trade negotiations will “fix” the US-German trade deficit. Surely once Trump hires a real economist, s/he can explain to Navarro what “EU” means. Forbes Magazine, even more conservative than the WSJ, calls this “stupideconomics.” (here and here).

He’d like to make trade great again. So, on March 3, 2017, President Trump rolled out his trade strategy. No one summarizes it better than Menzie Chinn, and I am reproducing the analysis in his blog (spoiler alert: the Trump trade strategy may likely end up being contractionary):

The Administration rolled out a new trade strategy yesterday (The President’s 2017 Trade Policy Agenda, part of this document)… If the Administration pursues a trade agenda that invites trade retaliation, while implementation of stimulative macro policies (e.g., infrastructure investment, tax cuts) are delayed, then we may very well get an economic slowdown before a boom. From the document: “It is time for a more aggressive approach. The Trump Administration will use all possible leverage to encourage other countries to give U.S. producers fair, reciprocal access to their markets…”

From WaPo: The new trade approach, which was sent to Congress Wednesday, could affect businesses and consumers worldwide, with the White House suggesting the United States could unilaterally impose tariffs against countries it thinks have unfair trade practices — paving the way for a more adversarial relationship with China and other trading partners — and punish companies that relocate overseas and then attempt to sell products on the U.S. market… Trump’s threatened tariffs and other trade barriers could violate WTO rules and bring blowback from other countries in the trade organization. But the agenda signals the Trump administration could simply ignore those complaints… Chad Bown, a senior fellow at the Peterson Institute for International Economics, said he fears the administration’s criticism of WTO rules could end up creating a more lawless global system. “The difficulty is, once we step away from that and say the WTO rules imply a lot more flexibility in what we’re allowed to do, we can be 100 percent certain other countries will start to do the same. That’s what will ultimately undermine the U.S. system, and there will be big repercussions for U.S. exporters.”

So retaliation is a distinct possibility. The amount of the potentially authorized retaliation against the U.S. is not trivial. From Mericle and Phillips, “US Daily: Trade Disputes: What Happens When You Break the Rules?” Goldman Sachs, February 17, 2017 (not online): 

Exhibit 3 A WTO Case against Recent US Trade Policy Proposals Would Likely Be Unprecedented in Size. Source:Mericle and Phillips, “US Daily: Trade Disputes: What Happens When You Break the Rules?” Goldman Sachs, February 17, 2017 (not online), based on data from World Trade Organization, Goldman Sachs Global Investment Research.

Frankly, I didn’t even contemplate the fact that the amounts could be so large… From the GS Note: How such a scenario would play out is extremely uncertain. But in light of the magnitude of the potential violation, the likelihood that a WTO case would be lengthy, the fact that authorized penalties would not be retroactive, and the domestic political pressures that would quickly mount, press reports suggesting that the EU, Mexico, and China would likely respond quickly are unsurprising. It is difficult to know how President Trump might react to an adverse ruling from the WTO, an organization he has called a “disaster,” or to foreign retaliation. But reversing a large tariff, let alone a fundamental corporate tax reform, would be difficult politically, raising a risk of escalation that could undermine current multilateral trade agreements.

By the way, I have not discussed the macroeconomic impact of a full-fledged trade war (see here). Here’s a depiction of the impact on employment, state-by-state.

Predicted Job Losses Due To Trade War, state-by-state.

Source: Marcus Noland, Gary Clyde Hufbauer, Sherman Robinson, and Tyler Moran, “Assessing Trade Agendas in the US Presidential Campaign,” PIIE Briefing 16-6 (September 2016).

And, for all those people who bemoaned policy uncertainty as slowing down economic growth, over the past eight years, something to consider — again from WaPo: Stan Veuger, a resident scholar at the American Enterprise Institute, said the administration’s plan to continually reevaluate existing trade relationships could end up disrupting American business. “All those things together create a system where the U.S. government may intervene in arbitrary and unpredictable ways in trade relationships, and I don’t think that kind of framework is very helpful for the creation of lasting, worthwhile relationships between firms in the U.S. and firms abroad,” he said. “It just makes the business environment more uncertain.”

Here is the Baker, Bloom and Davis measure of global economic policy uncertainty through January 2017.

Figure 1: Global Economic Policy Uncertainty Index, Market GDP weights (blue). Orange denotes post-election period.

Source: Policyuncertainty.com, accessed 3/2/2017.

Trump and his Trade person, Peter Navarro, (I just cannot get myself to write ‘economist”) want to redefine the US trade balance to scare Americans. Neither the OECD, UN, World Bank or IMF trade statistics use Trump’s definition — this should give us pause and raise suspicions that Trump/Navarro are in the process of creating “alternative economics.” The Wall Street Journal calls it a “fuzzy math” “trade trick.” Here is the issue in a nutshell, the trade balance is defined as

TB = X – M

Trump/Navarro want to define the trade balance as

TB = X – M – Re-Exports

to “exaggerate the overall U.S. trade deficits with countries such as Mexico, and create the illusion of deficits where none exist” (WSJ). Re-Exports are goods that are exported in the same state that they were previously imported. Re-exports equal the difference between total exports and domestic exports. At first it may seem reasonable to focus on domestic exports only.

Issue #1. If we are deflating our trade balance by Re-Exports, why wouldn’t we also deflate imports by Re-Imports? Reliable statistics for this do not exist. Caroline Freund provides a detailed explanation.

Issue #2. The focus on bilateral trade balances is a scare tactic, but reveals little about the US economy or economics. As Nicholas Kristof outlined so eloquently, it is the overall US trade deficit that matters, which is given by National Savings – Investment.

Issue #3) The issue had originally invented by trade alarmist Senator Bernie Sanders. It was misguided then then and it wrong now.

Economists usually like data and studies. Navarro’s approach is new: Thoughtful commentary usually does not commence with “these garbage studies.” The corollary to fake news is, I guess, fake econ. How do you like them apples?

P.S. The origin of “how do you like them apples“: In World War I, some of the mortars resembled apples with a stick in them. In the 1959 movie Rio Bravo a guy tosses a hand grenade and says “How do ya like them apples?”

Chad Bown,Senior Fellow, Peterson Institute for International Economics (Washington, DC), discusses retaliation WTO style (not to be confused with all options for retaliations that other countries might have).

He predicts potential retaliation for the new “border tax” proposal that is making its way through Congress, if the WTO rules against the US.

True Story:

WASHINGTON – President Donald Trump was confused about the dollar: Was it a strong one that’s good for the economy? Or a weak one?

Brad Setser has the thorough analysis. In true NS-I=TB manner he states: A national savings rate that still approaches 50 percent of output increasingly implies either bubbles in credit domestically or large capital surpluses that have to be exported.

Trade Policy gone awry is now being expressed in chicken parts – America’s great exports to the world.

First Bush Legs, now Trump Feet.  When the US imposed countervailing duties on Chinese tires, the Chinese “counter-sanctioned” the US with their own tariff on, you guessed, chicken feet.

Of course, the tire tariff reduces only Chinese tire imports but not total US tire imports, as Brad Setser documents. And while Chinese imports of US chicken feet have declined dramatically, the US saw a mysterious, huge, increase of chicken feet to Hong Kong… How surprising, the Chinese+Hong Kong chicken feet exports are essentially constant.

In the most recent installment of this short course in trade policy, the original trucks-for-chicken-tax is coming home to roost. This time around, American manufacturers are hurt by the tariff, as they want to produce in Mexico and import their Rams to the US.

[pls read all associated articles in the links].

President Trump promised Mexico would. Since the proposed border tax is not location dependent, actually all foreign imports are subject to higher prices. In fact, Bloomberg estimates that Mexico is not even on the top 10 list. 

Here the rhetoric is important. Pay here means that these countries may see a decline in their exports to the US because US import prices rise. This implies of course that the people who really pay for the wall via this tax are Americans who consume imports that have risen in price to reflect the border tax. Most of these imports are not from Mexico. On top of that, Forbes outlines why the border tax wont affect the trade balance.

President Trumps executive orders reveal one pillar of his “Make America Great Again” campaign promise. “Trump signed a third [executive] order mandating that the pipes used for the [Keystone Pipeline] project be manufactured in the United States — “like we used to in the old days.” Trump has been meeting with a lot of business executives during his first days in office — JMC Industries probably was not included to provide an alternative reality.

President Trump pulled the plug the ratification of the Trans Pacific Partnership (TPP). The TPP is an odd animal whose framework agreement was signed February 2016 in New Zealand by Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the United States and Vietnam, but these signatures only started the process of each country’s TPP ratification. The ratification process allowed for further changes to the TPP, so it was widely expected that countries such as the US would determine the final standards ranging from workers’ rights to intellectual property protection.

Trump’s act was only symbolic; Congress and the Obama administration had already signaled in November that there would be no path to TPP ratification in the US.  The 12-Nation Pacific Trade Agreement is about a lot more than trade, future posts will outline the embattled pros and cons of TPP.

Correlated County-level pesticide use with county level health data from CDC, healthypeople.gov, etc. What a treasure trove.

source

Congress is discussing a new Bill that stipulates ‘Buy America’ Provisions.” Speaker Paul Ryan and other Republican lawmakers raise objections over requiring U.S. iron and steel in water infrastructure projects. Mr. Ryan and other Republicans have begun raising objections, saying “the requirement would pick winners and losers among U.S. companies and shouldn’t be included in the final legislation.” Are there other reasons to scrap “buy American” provisions, generally?

source

Brad Setser highlights the difficulties statistical agencies encounter in their efforts to track all international transactions When The Trade Data Does Not Add Up: The bulk of the UK’s surplus in services come from trade with non-EU countries (services exports to the EU are large, but so are imports—Tuscan and French vacations?). See this chart (h/t Toby Nangle).

A big part of the non-EU surplus in services comes from the United States. In 2015, the UK reported a 27 billion GBP (just over $40 billion) surplus in services trade with the U.S. and an overall surplus in goods and services with the United States. The funny thing? The U.S. also thinks it runs a surplus in services trade with the UK. A $14 billion surplus in 2015, for exampleIt is pretty hard to square those two data points. UK data is from the Office of National Statistics’ Pink Book, U.S. data is from the Bureau of Economic Analysis (BEA), table 1.3 of the “International Transactions” data set. It turns out that the U.S. thinks it sells more services to the UK than the UK thinks it buys:And the UK thinks it sells more services to the U.S. than the U.S. thinks it buys.My guess is that such discrepancies are actually common in the services trade numbers. Goods trade is calculated by customs bureaus. Lots of the numbers on services trade come from surveys, estimates, and the like.

Substantial attention has been devoted to the disasterous effects of implementing a Trump and Sanders Trade agenda of imposing 45% tariffs on imports of goods from China. To gain some perspective, consider the implications for prices of goods imported from China if such a tariff were imposed (and a large country assumption used, so that only half of the tariff increase manifested in increased prices). Menzi Chinn has the scoop (be sure to read the cited WA PO and WSJ articles, too!):

The Wall Street Journal states today that "The fact that investors are willing to buy the 10-year note without enough compensation for an uptick in consumer prices has been confounding many analysts"

Why do investors pay to park their money? The return OF their investment is more important to them than the return ON their investment.

Here is a nice primer on negative interst rates

Having finally gotten over the juicy term "currency war" the popular press is starting to understand the implications of competitive devaluation, beggar-thy-neighor policies and currency wars. Use the Large Open Economy Mundell Fleming Model to explain the apparent impotence of Central Banks around the globle.

Ken Rogoff has a great piece on the Chinese FX dilemma: How can a country with a fixed exchange rate, very very little capital mobility, and a huge Current Account surplus be running down its reserves? Try it in the MF model – but think about how Risk affects the Financial Account! 

Source 

The idea was that the US would "Inflict Pain on Chinese Solar Manufacturers" (who gains who looses?)

Turns out things aren't all that easy in the world of trade and retaliation: a few month later not only the Chinese but also WA manufacturers felt the pain as WA Solar Plants have to shut down because of the trade war with China over solar panels. Even the WA governor is intervening, WA is providing massive subsidies to the Solar energy, just like the Chinese. 

But wait there is more. New fronts on the trade war have been opened with India as Europe also enters the fray (Europe's case has since been resolved "amicably"). Here is the background that outlines the case 

Moses Lake Silicon Plant 

Summarize Blanchard’s arguments why recent changes in the oil price should be good news in the US, and why events in China should not have a large effect on the US

What does Blanchard identify as the most likely cause of the recent stock market decline in the US?

A new Peg! This video explains it all!

The Chinese currency stays firm against the basked, and soft against the dollar. A wonderful way to hide the depreciation against the major trading partner.  Here is the new basket:

 But the the Financial Times cleverly tracks the dollar against the $ and against other currencies (by their definition, a decline in the indes is a weakening of the currency)

From the WSJ MarketWatch:

China cuts banks' reserve ratio

Published: Apr 19, 2015 9:45 a.m. ET By
LINGLING WEI, Mark Magnier contributed to this article.

BEIJING–China's
central bank reduced the amount of reserves commercial banks are required to
hold, freeing up about $200 billion for lending in the latest easing measure to
shore up the world's second-largest economy.

The People's Bank
of China's one percentage point cut in the reserve requirement, announced
Sunday, is a larger-than-usual reduction. It is the second cut in banks'
reserve requirement in less than three months and comes after the economy
decelerated to 7% year-over-year growth in the first quarter, the slowest pace
in six years.

China has been struggling with economic ills, ranging from a
slumping property market and persistent industrial overcapacity to high debt
levels among companies and local governments. Many Chinese officials and
economists say the central bank will have to step on the easing pedal harder
for Beijing to
reach its 7% annual growth target for this year–already the lowest level in 24
years.

The government has
been trying to guide the economy to a soft landing. But the latest step
highlights concerns growth continues to flag and that two interest-rate cuts
since November and other easing measures helped heavily indebted industries and
fueled a run-up in the stock markets, but failed to lift areas that nurture
demand and consumption, such as small businesses. Borrowing costs for business
remain high, made worse by weak prices that border on disinflation.

Still, China's central
bank officials remain wary of too much easing, for fear that relaxing credit
too aggressively would add to the country's debt problems and put the economy
at greater risk. In a statement at the International Monetary Fund's meetings
in Washington this weekend, the People's Bank
governor, Zhou Xiaochuan, said that while China's economic growth is slowing,
it's still within a "reasonable range" and employment growth remains
stable. Mr. Zhou reiterated that China will maintain a
"prudent" monetary policy stance.

Sunday's announced
cut, which lowers the reserve-requirement ratio, or RRR, to 18.5%, takes effect
Monday. The move frees up about 1.2 trillion Chinese yuan (US$194 billion) in
additional funds that banks can now lend. The central bank also announced additional
reserve reductions aimed at banks catering to agriculture and small businesses,
which some analysts say will free up an additional 300 billion yuan in funds.

A question now is
whether Chinese banks and companies will take advantage of these new efforts or
hold fast amid further signs of slowing growth.

Despite prodding
from policy makers, Chinese banks have become increasingly cautious about
making loans, especially to small and private businesses, which are generally
seen as higher credit risks than big state-owned companies–the state banking
sector's mainstay customers. On Friday, China's Premier Li Keqiang urged banks
to step up their support to the economy, saying that the government would give
commercial banks "preferential policies" if they lend to small
borrowers.

The latest
reserve-requirement cut was unusually large in scale. The central bank last cut
the required reserves in early Feb.–the first such move since May 2012–by the
typical half a percentage point.

In the past, the
central bank used the reserve requirement to counteract cross-border capital
inflows, hiking the ratio banks were required to hold to sop up money investors
were pouring into China
to capitalize on the red-hot economy. Now, with the Chinese economy cooling,
there are increased signs of money leaving China's shores. Yuan positions on
the central bank's balance sheet, a gauge of capital flows, declined a record
251.1 billion yuan in the first quarter. With the outflows come higher
expectations for more reserve cuts.

"China should cut the RRR 20 times in the next
five years as the pattern of capital flows has changed significantly,"
said China
economist Larry Hu at Macquarie Group Ltd

Fan Gang, professor of economics at Beijing University, explains the need for Chinese sterilization. Here is the abstract: 

While the Fed is pumping more money into the US economy, the
People’s Bank of China (PBC) is trying to reduce the amount of money in
circulation. Money used by commercial banks to satisfy the required reserve
requirement (RRR), which is held in accounts at the PBC, can no longer be
extended as loans. As a result, more money than ever is now frozen or inactive
in China. 

It is understandable that the Fed wants to boost demand as long as the US economy
remains depressed. But why has the PBC tightened monetary policy so much? Inflation
is a concern – having risen to 4.4% year on year in October, from 3.6% in
September. But really, the PBC’s policy is preemptive: sterilize over-liquidity
and get the money supply under control in order to prevent inflation or
over-heating.

At the beginning of the year, the RRR increases could be regarded
as part of efforts to correct the over-supply of money that arose from the
anti-crisis stimulus package. But the most recent RRR increases serve mainly to
sterilize the increase in the money supply caused by the increase in
foreign-exchange reserves.

Indeed, in September 2014 alone, China’s foreign-currency reserves
increased by almost $100 billion compared to August. With the global economy
recovering, China’s
trade surplus began to grow. The rapid growth in foreign-exchange reserves, means
an increase in the domestic money supply, because the PBC issues RMB6.64 (down
3% since June) for every dollar it receives. That means that money supply
increase by nearly RMB700 billion in September. The two 50-basis-point RRR
increases just locked up the same amount of liquidity. The PBC now holds more
than $2.6 trillion in foreign reserves.

The RRR is only one example of a textbook sterilization
instrument. Another is to sell off government bonds held by the central bank in
order to take money out of circulation – again, just the opposite of what the
Fed is now doing. But the PBC sold out its holdings of Chinese government bonds
in 2005. So it had to create something else to sell. It created so-called
“Central Bank Bills,” which commercial banks are supposed to buy voluntarily.
When they do, the money they pay is also locked up in the PBC’s accounts. To
date, up to 5-6% of total liquidity has been returned to the central bank in
this way.

Roughly one-quarter of China’s total monetary base is
illiquid [tied up in RRR]. Thus, although China’s total money supply seems
excessive, with the M2-to-GDP ratio now at about 190%, the real monetary base
is actually much smaller than it appears. As a result, China’s
inflation, as well as asset prices, remain under control. With the Fed’s QE2 on
the table, conditions may worsen before they improve. The PBC may have to
continue its sterilization for some time in the foreseeable future. 

The Romer and Romer corollary to This Time It Different 

Austan D. Goolsbee and Alan B. Krueger both had front row seats at the time… 

Can long-term global growth be saved?

neglects the aggregate vs per capita growth destinction. But gets to the point of Chad Jones' "Upcoming Slowdown in U.S. Economic Growth" just with the exact opposite answer (Jones' update of sorts of the earlier paper is here and here). Robert Gordon made a similar point recently. 

Where to look for global growth?

is sobering

The BBC reports that ratings giant Standard & Poor's (S&P) agreed to pay a $1.38bn to settle with US regulators for knowingly inflating ratings of risky mortgage bonds from 2004-2007.

S&P is only the first credit agency to be fined over financial crisis-era violations. The falsely rated bonds that sub-prime mortgages, have been blamed for the collapse of the US property market and subsequent global financial crisis. By certifying bonds as AAA, the bonds were not as safe as the rating suggested. 

The US government said that S&P's ratings encouraged financial institutions around the world to buy and sell what proved to be "toxic" financial products in their trillions.

It also accused S&P of failing to warn investors that the housing market was collapsing in 2006 because doing so would have hurt its business.

S&P admits under this settlement, that company executives complained that the company declined to downgrade underperforming assets, because it was worried that doing so would hurt the company's business. While this strategy may have helped S&P avoid disappointing its clients, it did major harm to the larger economy, contributing to the worst financial crisis since the Great Depression.

Metaphors, Metaphors, Metaphors… The number of metaphors in econ articles is usually inversely related to the value of its content. This one is entertaining:

Draghi’s ‘QE battleship’ sinks the Euro

January
22 2015

Investors will welcome with caution the
ECB’s “shock and awe” announcement and will look to buy eurozone equities –
particularly exporters – and to a lesser degree the Danish Krona and gold.

Tom Elliott, International Investment Strategist at deVere Group, observes:
“The ECB has added its newest €60 billion a month battleship to the currency
wars, which only the U.S.
and Swiss stay aloof from. It is a larger-than-expected quantitative easing
(QE) program, designed to inflict shock and awe on markets.

“Its goal is to severely weaken the euro and so spur exports and
boost imported inflation. Let’s not pretend it will boost eurozone lending,
while the bank sector remains so weak.

“But while this will boost eurozone stocks, by weakening the euro,
investors should regard QE with mixed feelings.  Capital markets are in a
curious and unstable mode thanks to QE from other central banks that has pushed
up all asset prices in recent years with little discrimination over quality.”

Mr Elliott adds: “Many investors will pile into eurozone
export-based stocks. But a broader stock market recovery may happen if, and
when, stronger exports feed through into a broad-based recovery, which is the
intention.

“In addition, investors may look to buy the Danish Krona on the
chance that the Danes break their peg with the Euro, preferring a revalued DKR
and a recession to the risks caused by ultra-loose ECB monetary policy. The
current peg has resulted in a large and destabilising current account surplus.
This would echo the Swiss franc move last week, though in the case of Denmark the
significance would be greater given the duration of the peg with the
deutschmark and then the euro.

“If the idea of the Danish National Bank breaking the euro peg is
a step too far for investors, a small position in gold to hedge against the
whole global QE experiment ending in inflationary tears must be a reasonable
step for a long-term investor. If not, we can throw all monetary economics text
books away.”

Here is the full story (link 1) (link2) (link 3), (link4 and link4a), and then the result: (link 5)

Switzerland, like China, used to peg its currency to its major trading partner to avoid an appreciation. Today a Swiss stunner sends euro to 11-year low against buck. Of course it also (primarily) caused a crash of the euro. The end of the Swiss Central Bank Policy to peg the currency to the Euro, has consequences for the value of the euro against the dollar (the "Buck"). Why? 

 More Background material can be found here and here and the videos here and here 

In June the European Central Bank decided to induce negative interest rates as version I of quantitative easing in Euroland. 

By October 2014, the central bank began buying "covered bonds" which are bonds secured by a pool of loans, such as mortgages. November 2014 it started purchasing "asset-backed securities" injecting a total of about 7 billion Euro into the market (ECB Balance Sheet link). 

Why not buy government bonds outright to create a full fledged QE? It turns out that the treaties that founded the modern EU prohibit the ECB from financing governments (aka buying their bonds)! Germany’s Bundesbank, which is always paranoid about inflation (given the sore memories of German Hyperinflation a century ago) is outspoken against expanding the supply of money through government bond purchases. The Bundesbank argument is that aside from risking inflation, the moves reduce the incentives for governments to stop overspending and make their economies more competitive. But ECB president Draghi (who is Italian) suggested that the ECB could add as much as 1 trillion euros ($1.3 trillion) to its balance sheet!  A great review can be found here.

source 

Probably one of the most deep seated erronious  views is that if "I have to balance my checkbook, so does the country." Paul Krugman highlights that a country is not a company. 

The first few sentences are ominous:

College students who plan to go into business often major in economics, but few believe that they will end up using what they hear in the lecture hall. Those students understand a fundamental truth: What they learn in economics courses won’t help them run a business. The converse is also true: What people learn from running a business won’t help them formulate economic policy. A country is not a big corporation. The habits of mind that make a great business leader are not, in general, those that make a great economic analyst; an executive who has made $1 billion is rarely the right person to turn to for advice about a $6 trillion economy. 

Then there is a 2014 addendum that you can read in (here) 

A great visual by Infographics detailing Greeks Debt and The lenders to struggling European countries

Recessions, Deflations, and now the wheels are coming off the wagon in Greece:

The View From Greece: Debt Write Off or Euro Exit 

The German View  and it will be interesting to see how credible the German bluff is, since Euroland holds 85% of the Greek Debt…

First in Sept (WSJ) 2014, leading the WSJ to declare that King Dollar was about to reign, and interest rates reach lows not seen since the "Black Death" during King Edward III reign in 1346. The Zerohedge Blog chronicles what fraction of bonds is not "paying" negative returns

Not so says Tim Duy

Meanwhile, the international fallout from the oil price drop continues. Russia is a classic emerging market crisis story. The decline in energy prices reveals a currency mismatch between assets and liabilities. The decline in oil dries up the dollars needed to support those liabilities, so the value of the ruble is bid down as market participants scramble for dollars. One suspects that capital flight from Russia only aggravates the problem; those oligarchs are seeing their fortunes whither. Currency plummets, aggravating the cycle. The sanctions were the beginning of this crisis, the oil price shock the culmination.

The Central Bank of Russia is forced into defending its currency via either depleting reserves or hiking interest rates. Both are losing games in a full blown crisis. The Central Bank of Russia has tried both, upping the ante by jacking up rates to 17% this afternoon, a hike of 650bp. That, however, is no guarantee of stability. Tight policy will crush the financial sector and the economy with it, triggering further net capital outflows that my guess will swamp the net inflows the rate hike was intended to create. Everything heads into free-fall until a new, lower equilibrium is established.

It is all appears really quite textbook. At this point, an IMF program would be on the horizon. But that's where the textbook changes. Hard to see the IMF just handing out a lifeline to an economy probably viewed by most as currently invading its neighbor (that's the point of the sanctions after all). And I am guessing that Russian Premier Vladimir Putin is not going to easily acquiesce to an IMF program in any event. At the moment, looks like Russia is toast. (Update: Arguably I am being a little pessimistic here. Joseph Cotterill points out that the rate hike falls well short of 1998.)

Venezuela is heading down the tubes as well, but that was always a given. Just a matter of time on that one. 

Contagion

Capital Controls (1), (2), (analysis). The last time Russia saw capital controls was before its 1998 default.

Volatile exchange rate hurts business 

As the Central Bank is selling reserves 

BRICS is the acronym for an association of five major emerging national economies: Brazil, Russia, India, China, and South Africa. Their curriencies have been sliding since the US fed started to taper. Why? Use the Large Open Economy MF Model to explain.

After spending $70 billion this year to stabilize the rouble, the Russian central bank reverts to more desperate tactics…

As of Monday afternoon, it takes more than 60 roubles to buy a single dollar. The 60 mark is considered a "psychological barrier" for Russia's national currency, says the BBC's Moscow correspondent, Steve Rosenberg. The "psychology" might have been influenced by this…

\

Willem Buiter is always super provocative and insightful. Enjoy

!

 Source

Negative Interest Rates

…

What do negative interest rates mean (other than that you pay the bank to hold your money)

or read about a very specific example… 

From  

The Nikkei closed up 4.83%, hitting a seven-year high after the Bank of Japan (BoJ) unexpectedly announced it was expanding its monetary easing policy Friday morning.

In a tight vote, the BoJ backed an 80 trillion yen ($720 billion) target for expanding the monetary base (a measure of the amount of money held by the central bank and in the economy). That's up from a previous target of 60 trillion to 70 trillion yen.

Analysts were basically not expecting anything Friday: this one was a genuine surprise. Just as the Fed this week announced the final tapering of QE3 (in which the monthly bond purchases the Fed had been making were stopped), the Bank of Japan is hitting the gas. 

REUTERS/Toru HanaiBank of Japan Governor Haruhiko Kuroda caught the markets by surprise Friday.

 Quantitative Easing, Rest In Peace…

Bankrate.com

St Louis Fed 

BBC 

ECB 

WASHINGTON (MarketWatch) — Federal Reserve revealed in the
minutes of its June meeting released Wednesday that it has decided to end its
asset-purchase program in October if the economy stays on track. Market Watch, July 9, 2014, 3:37 p.m. EDT. By Greg Robb

The minutes
also reveal that Fed officials had a lengthy discussion of its exit strategy. The central
bankers generally agreed to keep reinvesting the proceeds of securities that
mature on its balance sheet until after it had hiked interest rates. Fed
officials also agreed that the rate of interest on excess reserves would play a
“central role” in moving rates higher when the time comes. It will have an
overnight reverse-repo facility with an interest rate set below the IOER rate [the interest rate the FED pays on commercial banks' excess reserves is often called the IOER rate]. The spread would be “near or above the current level of 20 basis points and
give the Fed adequate control over interest rates.” A reverse repo is when the
Fed accepts cash from counterparties such as banks and money-market funds on an
overnight basis in return for a security. Responding to some criticism that the
Fed’s overnight repo facility might become too large and drown out private
market participants, the central bankers discussed some design features that
might limit its size. Several Fed officials said that they don’t think the
facility will become a permanent policy tool. Fed officials “signal a good deal
of comfort in managing policy with a high balance sheet,” said Eric Green, head
of U.S.
rates and economic research at TD Securities. There is “no appetite whatsoever
to sell assets,” he noted. The Fed holds a record $4.38 trillion of securities.

The Wall Street Journal Reports that "Central Banks in Asia Battle a Flood of Cash" (link) and that "Foreign-Exchange Reserves Rise as Central Banks Buy Dollars; Fed Easing Called 'Distorting Factor" Using the large open economy Mundell Fleming model, can you explain why the Fed is being implicated?  

The sequel continues (link). The Wall Street Journal (link) discusses Argentina's impending default. As a side show, two international hedge funds are now at each others throats in a game of "collection agency" (link).

This is a great application to use the Mundell Fleming model to show how the increase in default risk affects the exchange rate. Think carefully what you assume about the Argentinean exchange rate regime. Hint: 

The US is winding down its third round of quantitative easing (QE3), having been joined by QEs in the UK and Japan (Abenomics) in recent years.  The purpose of these programs is always to provide effective monetary policy when interest rates hit the zero lower bound. At zero the central bank cannot simply lower discount rates further. Existing versions of QE all rely on central bank purchases of (mostly) treasury bills which increase the demand for these assets, raise their price and thus lower their interest rate. By depressing interest rates on secure assets the central bank hopes to entice investors to loan out their money to riskier but higher yielding investments – such as business investment. 

The European version of QE started June 5, 2014 but it took a different form than outright goverment bond purchases. In the EU its a bit tricky to purchase goverment bonds, since there are so many goverments with different levels of debt! So the Europeans started with a new version of QE: paying negative interest rates on the deposits that banks have at the central bank. Just like citizens deposit funds at commercial banks, commercial banks at times deposit extra funds with the central bank. Now the European Central Bank will be charging commercial banks to do so. In effect the hope is that commercial banks move their money from the ECB and provide it to business men and women to stimulate the economy. We will see how effective this measure will be. 

Clearly the US, UK, and Japan could have gone similar routes. Instead especially in the US the central bank decided to pay interest on commercial bank deposits (albeit only 0.25%). Some suggest that the FED's reluctance to charge negative interest rates is related to the worry how it would affect commercial banks' balance sheets.

When and how will the Fed and other central banks wind down
their mammoth asset purchases, also known as quantitative easing (QE)? Since the
start of the financial crisis, the Fed, the European Central Bank, the Bank of
England, and the Bank of Japan have used QE to inject more than $4 trillion of
additional liquidity into their economies. When these programs end, governments,
some emerging markets, and some corporations could be vulnerable. They need to
prepare.

• Research by the McKinsey Global Institute suggests that
  lower interest rates saved the US
  and European governments nearly $1.6 trillion from 2007 to 2012. This windfall
  allowed higher government spending and less austerity. If interest rates were
  to return to 2007 levels, interest payments on government debt could rise by 20%,
  other things being equal. Governments in the US and the eurozone are
  particularly vulnerable as interest rates
  rise, governments will need to determine whether higher tax revenue or stricter
  austerity measures will be required to offset the increase in debt-service
  costs.
• Likewise, QE saved firms $710
  billion from lower debt-service payments, thus ultra-low interest rates boosted profits by about 5% in the US
  and the UK,
  and by 3% in the eurozone. This source of profit growth will disappear as
  interest rates rise, and some firms will need to reconsider business models –
  for example, private equity – that rely on cheap capital.
• Emerging economies have also benefited from access to cheap
  capital. Foreign investors’ purchases of emerging-market sovereign and
  corporate bonds almost tripled from 2009 to 2012, reaching $264 billion. As QE programs end, emerging-market countries could see an outflow
  of capital.
• By contrast, households in the US
  and Europe lost $630 billion in net interest
  income as a result of QE. This hurt older households that have significant
  interest-bearing assets, while benefiting younger households that are net
  borrowers. 
• QE may have also generated NEW asset-price bubbles in
  some sectors, especially real estate. The International
  Monetary Fund noted in 2013 that there were already “signs of overheating in
  real-estate markets” in Europe, Canada,
  and some emerging-market economies. 

Of course, QE and ultra-low interest rates served a purpose.
If central banks had not acted decisively to inject liquidity into their
economies, the world could have faced a much worse outcome. Economic activity
and business profits would have been lower, and government deficits would have
been higher. When monetary support is finally withdrawn, this will be an
indicator of the economic recovery’s ability to withstand higher interest rates.

Nevertheless, all players need to understand how the end of QE
will affect them. After more than five years, QE has arguably entrenched
expectations for continued low or even negative real interest rates – acting
more like addictive painkillers than powerful antibiotics, as one commentator
has put it. Governments, companies, investors, and individuals all need to
shake off complacency and take a more disciplined approach to borrowing and
lending to prepare for the end – or continuation – of QE.

The recent years have been a frustration for anyone trying to make sense of China’s capital control policies. Capital controls have been an important part the Chinese economic policies since the communist revolution in 1949. At present, the dominant view both among Chinese policy makers and analysts is that at some point the restrictions have to go. They are incompatible with the pursuit of a
free market economy especially for a country with a leadership role in international commerce.

However, as with many other reforms, the chosen model of capital account liberalization has been baby steps. So far, capital account liberalization measures have opened up only new channel for Chinese firms to transfer funds abroad or new channels for foreigners to invest in China. Hong Kong has emerged as a renminbi (RMB) hub, where off-shore Euro-RMB can be deposited and freely traded. After all these developments, are the controls still effective?

Yin-Wong Cheung and Risto Heralla study the covered interest differential (CID) between onshore and offshore RMB (interest rates on RMB assets in China and outside China). The CID is a much used measure of the effectiveness of capital account restrictions because it vanishes by arbitrage under free capital mobility. So, if the CID is still large (in absolute value), we can be confident that capital account restrictions are still important (“binding”), and the arbitrageurs have not yet been able to arbitrage away the interest differential. Cheung and Heralla find that Chinese Capital Controls are still binding (see graph below) in fact the CID seems to be getting larger over time..

Apparently, China still considers capital control policy to be an indispensable tool to manage and stabilize the economy. However, the use of capital controls to restrict capital inflows and thereby undervalue the RMB comes at high cost: it is at variance with the goal to develop the domestic economy, since it depresses credit
availability within China. 

Source:

In  the Past 7 Days Yuan Devalues Most In 20 Years
By Tyler Durden 2/25/2014 [edited]
 
The last 7 days have seen the end of the unstoppable 'sure-thing', the one-way bet-of-the-decade, – yes Durden is referring to the end of the appreciation of the Chinese Yuan. ince the currency has gained nearly 1%, the largest gain since 1994, suggests the Chinese Central Bank is intervening. 

As for the causes, there is clear evidence of intervention from the People's Bank of China. We think that the recent yuan move is intended to discourage arbitrage inflows. If short-term capital inflows abate, the depreciation will probably halt. 

The yuan appreciated by nearly 3% against the greenback and 7% against in nominal effective exchange rate terms in 2013. Over the same period, China's FX reserves added another $500bn, despite the repeated talk from officials that China has had enough reserves. These seemingly contradictory messages and signs, in our view, suggest that the PBoC never really wants too much yuan appreciation, especially if it is driven by short-term speculative capital inflows.

The recent divergence of Chinese RMB interest rates and off-shore RMB interest rates raise suspicion that the Chinese Central Bank is behind the move. As the Chinese Central Bank buys more USD, it creates natural liquidity in the CNY, leading to much lower interest rates. For the Chinese authorities, this intentional weakening seems to be aimed at trade – specifically exports (and maintained export growth).

But this certainly will not please the Japanese (trying to devalue and manufacture their own recovery) or any other beggar thy neighbor nation. Welcome to the Currency Wars China… Potential asset deflation is a risk, as the carry trades diminish/unwind.  

Here are entirely unexpected obstacles to the Law of one Price:

The BBC tracks the Sterilization of Chinese Foreign Currency Interventions: 

 China removes $8bn from money markets to control lending

China's central bank has removed nearly $8bn (£4.7bn) from the money markets in a bid to control the amount of credit in the country's financial system.

According to reports, the People's Bank of China (PBOC) did so by issuing 14-day forward bond repurchase agreements, also known as forward repos.

It is the first time since June the PBOC has used forward repos, and comes after China released unusually strong economic data earlier this year.

Chinese stocks fell in Shanghai.

A trader at a Chinese commercial bank in Shanghai told the Reuters news agency that the move "sent a strong signal to the markets that the central bank is not letting liquidity ease".

"If money market conditions remain sloppy, the central bank could even step up efforts to mop up excess," he said.

China has been looking to suck excess cash from its open-market operations to reduce the risks of shadow banking, or informal lending to businesses.

Shadow banking has been identified as a major risk to China's future growth, because of the possibility of large debts turning sour.

Chinese banks traditionally see a spurt in lending at the beginning of the year, as businesses and consumers borrow money to fund spending in the new year.

In January, new local currency loans nearly tripled from the month before to $218bn.

By reducing the amount of money available, the government makes it harder for banks to borrow and move the money into risky investments.

However, in its attempt to rein in credit, China's money conditions have been volatile over the past six months.

China's seven-day bond repurchase rate – a measure of short-term liquidity – surged to double digit territory last year on concerns there was not enough money in the system.

This caused a sell-off in global markets last year, spurring China's central bank to make a series of short-term capital injections to soothe investors.

In a monetary policy report released in February, the PBOC said volatility in money-market rates is set to persist.

"When the valve of liquidity starts to tame and curb excessive credit expansion, money-market rates, or the cost of liquidity, will reflect that," it said.

"The market needs to tolerate reasonable rate changes so that rates can be effective in allocating resources and modifying the behaviour of market players." 

To address issues with its Big Mac Index, the Economist Magazin now has a revised index displayed interactively (here)

This is an update to my depressing Spanish recession blog entry from 4 years ago: The WSJ finally announced the

"End of Recession in Spain Fuels Hopes for the  for Euro Zone"

The article neglects to mention that Spanish unemployment is still exceeding 26%. Yes, this is no typo. Youth unemployment (16-24 year olds) has dropped below 55%. But these are good numbers compared to the Spanish economic situation in the past (see the Guardian's analysis)! 

Bloomberg has a great application to practice how the external balance line behaves in times of risk and crisis. 

1. Describe the major thesis,
the central idea, or set of ideas in
the reading. 

2. Citing specific lines in the article, quote verbatim a statement
or brief passage that is interesting to you or elicits in you some type of
emotional response.  Then identify your emotional response or why you
found it interesting, describe the meaning(s) that the statement or
passage has for you, and provide actual or possible reasons for your
response.

3. Show how the External Balance line behaves after the first riots, and explain why.   

International Economics usually covers the concept of sterilization in the context of central banks' intention. That is,  Central Banks "sterilize the effects of foreign currency interventions" when Central Banks buy or sell foreign currency, so minimize the effect on the domestic money supply. 

In Europe the GIPS countries have encountered serious economic crises, that resulted in huge goverment deficits and massive public debt. To allow these countries to remain in the EU, the European Central Bank (ECB) decided to buy their debt and thus keep the interest on the debt managable. Of course every time the ECB purchases government debt, it increases the money supply – much the chegrin of other EU countries who fear inflation. In response the ECB is "sterliziing" these bond purchases. Here is the article: 

Questions:

1. Why does the WSJ say the the ECB sterilizing its money supply?

2. If Eurozone countries start to struggle with a trade deficit that continues for a long period of time, what will eventually happen to their foreign reserves? Draw a graph to illustrate your point.

3. What are some policy options countries can take if they want to correct their trade deficits or their fiscal deficits?   

Back to Housing Bubbles

An uncomfortable topic. Nouriel Roubini sees housing bubbles in Switzerland, Sweden, Norway, Finland, France, Germany, Canada, Australia, New Zealand, and, back for an encore, the UK (well, London). In emerging markets, bubbles are appearing in Hong Kong, Singapore, China, and Israel, and in major urban centers in Turkey, India, Indonesia, and Brazil. Given global interest rates, the analysis is not surprising…

The Washington Post has a great article on the history of the debt ceiling (thanks Jun Ong for pointing me to it!)

Here is the upshot: Since Congress had to approve all debt issues, it thought it might be easier not to micromanage the Treasury during WWI, but simply provide a debt ceiling. The ceiling was not used as a bargaining chip until the mid 1950s, and the current president admits to having voted against the debt ceiling (during his time as a senator) for political reasons – which he now regrets 🙂 

Source 

Jeff Frankel
wrote an interesting blog about
trade policy: Solar Panel Dumping.  So called "Infant industry arguments" have been justifying anti-dumping tariffs dating back to Alexander Hamilton's Report on Manufactures", which he
drafted in 1790 to stimulate the US
economic independence from Great
Britain. 

At the core of the infant industry argument is the belief that nascent
industries may not have achieved the
necessary scale, yet, to compete with
established industries abroad, or, that sufficient production volume is required
to generate learning-by-doing to sufficiently lower production costs.

Below is
an edited version from Frankel's blog – it focuses on Chinese subsidies, but neglects to discuss in detail the huge subsidies that the US provides to
its own solar industry. The US federal government spent Over $100 billion dollars (more than is entire spending on education!) on solar and wind subsidies, to generate a list of subsidy recipients that is a mile long. On top of that, US states have their
own subsidies.

The huge difference is that China
subsidizes production (and hence the low cost of solar panels) while the US largely subsidizes consumption (rebating the cost of expensive panel installations to households, and
guaranteeing huge solar electricity subsidies
of up to 54 cent per KWH). 

Protectionist Clouds Darken Sunny Forecast for Solar Power

On
July 27 negotiators reached a compromise settlement in the world’s largest
anti-dumping dispute, regarding Chinese exports of solar panels to the European
Union.   China
agreed to constrain its exports to a minimum price and a maximum
quantity.   The solution is restrictive relative to the six-year
trend of rapidly Chinese market share (which had reached 80% in Europe), and plummeting prices.  But it is less
severe than what had been the imminent alternative:
 EU tariffs on Chinese solar panels had been set to rise sharply on August
6, to 47.6%, as the result of a “finding” by the EU Trade Commissioner that China had been
“dumping.”   The threat of likely retaliation by China helped
persuade the Europeans to back off from their determination to impose such high
protective walls around their own solar panel industry. 

The
China-EU dispute parallels a similar one running between China and the United States.  Last fall,
tariffs went into effect against US imports of Chinese solar panels, at
24%-36%, after the Commerce Department “found dumping” into the American
market.  China has
already retaliated in a targeted way: imposing tariffs, which could reach
prohibitive levels in excess of 50%, on imports from the US of
polysilicon.  (It had not yet done the same on imports from the EU.) 
China
cited its own finding of US dumping of polysilicon into its market.  The
material is a key input into the production of solar panels, which gives poetic
justice to its choice as target of retaliation.

Trade could be the savior of solar power

The
solar power industry is a perfect example of how trade can have beneficial
effects on air quality.  Most Europeans, and many Americans, would in
principle like to be able to get more of their energy from renewable sources
like solar power — but not so much if the cost is exorbitant.  Skeptics of
solar power have long argued that its share in electricity generation cannot
rise above a few percentage points without massive subsidies, because it is too
costly unaided to compete with alternatives such as coal.  Proponents, for
their part, have long made sunnier forecasts, arguing that if moderate
subsidies were used temporarily to expand the solar industry, economies of
scale and learning-by-doing would then bring down costs sharply. 

But
proponents have focused too much on subsidies by their own governments and paid
insufficient attention to the contribution of international trade.  Trade
has been a very positive development in the industry of solar power generation
in recent years, as the bonanza of cheap solar panels from China had
helped keep down costs.  Conversely, the new protectionism in solar panels
is a negative development.  Remarkably, European imports of products that
facilitate renewable energy are apparently now the target of almost ¾ of the
Trade Defense Instruments currently in force in the EU (by import value; Kasteng, 2013).

High
subsidies had also helped drive the European industry until recently.  But
the subsidies were unsustainably expensive and have now been cut back for
budget reasons.  With the loss of subsidies and the loss of cheap solar
panels from China, the share of solar power in Europe will far short of environmentalists’
goals.  (Of course the loss of subsidies also helps explain why hard-hit
European solar panel makers lobbied for protection against imports from China.)

Solar-loving
Westerners should send Chinese producers of panels a note of thanks for their
contribution to keeping solar power viable, rather than letting the US and EU governments impose barriers or
blackmail China
to restrain the exports “voluntarily.”   Apparently western producers
of polysilicon, for their parts, are more efficient than Chinese producers, and
so they too should be sent a note of thanks by anyone favoring solar power,
rather than being penalized in anti-dumping battles.   Efficient
production in our globalized world economy means different countries
specializing in different stages of the process (Deutch and
Steinfield, 2013).

What
is “dumping”?

But
surely “findings of dumping” warrant some response, even if the ensuing damage
goes beyond the cause of international trade and growth and falls on a
specially valued activity like solar power?  Actually, no. 

“Dumping”
into a foreign market in such cases is defined as selling at a price below
cost. (It used to be defined only as selling in the foreign market at a price
below the home market price.  But the United States wasn’t finding enough
cases of dumping under the old definition and so changed it.) 

Why
would any producing country sell below cost, a recipe for losing
money?   How does one measure cost, anyway?  And why do I keep
putting those quotation marks around “finding,” “dumping,” and “cost”? 
The answers to these questions are closely related.

First,
the motive for “selling below cost.”  Even those who are generally
sympathetic to trade and markets are often given the impression that
anti-dumping laws are laws against “predatory pricing:”  a large producer
is selling below cost in order to drive its competitors into bankruptcy, under
a plan subsequently to exploit the absence of competition to raise the price and
reap monopoly profits.  But in fact, that is not even the way anti-dumping
laws are usually written, let alone applied.  To put it simply,
anti-dumping proceedings, such as the US and EU tariffs against Chinese
solar panels, are a means of reducing competition, not of
fostering it.  

If
predatory pricing is not the producers’ motive for selling below cost in these
cases, then what is?   This leads us to the second question, the
definition of cost.  The world solar panel industry has a glut of
productive capacity on all three continents: in China,
in Europe, and in the US. 
As a consequence, the competitive market intersection of supply and demand
occurs at a global price that is below long run average cost per unit, which is
defined to include a share of the cost that has already been incurred in
building the factories.  But that global market price is not below the
short run cost of keeping the factories running once they are built.  In
other words, it is at what economists call Marginal Cost, though
below Average Cost.   Producers sell at prices where they lose money
because, having already built the factories they will lose even more money
if they charge above the competitive market price or if they shut down
production altogether.   That low price is the appropriate
competitive outcome.  When the US or EU government finds that China is
“dumping” solar panels below cost, or when China finds that the US is “dumping”
polysilicon below cost, they are using the irrelevantly high measure of average
cost instead of marginal cost.   By this criterion, dumping occurs
every time a store has a clearance sale.

A
precedent

Some
have compared the accusations of dumping in the solar panel case, and the
subsequent avoidance of anti-dumping tariffs by means of negotiated agreements
to limit exports, to past “Voluntary Export Restraints” (VERs) or “Orderly
Marketing Arrangements” (OMAs) in the steel and consumer electronic industries,
especially those that Japan agreed to apply to its exports to the United States
in the 1980s.  But an even more illuminating precedent is Japan’s VERs on
exports of autos around that same time.  American automakers had found it
harder and harder to compete against imports of Japanese autos that were not
only better value for the money, but were also smaller and more
fuel-efficient.  Antidumping cases and VERs under the Reagan
Administration gave temporary protection.  When free trade was eventually
restored, the increasing imports of fuel-efficient Japanese autos benefited
both American pocketbooks and air quality.  The healthy competition even
forced a slimmed down American auto industry to become more efficient.

Trade
was good for the environment in the case of automobiles thirty years
ago.   The same is true of trade in solar equipment today.  Westerners
should celebrate the contribution of trade to reducing the cost of solar power,
not block it with protectionist anti-dumping measures.

The WSJ soap channel helps James Rickards sell some of his books that predict "the next global economic crisis." Here is someone not afraid of predicting gold at $7000, but the video does have some entertainment value.

From The European Crisis in the Context of the History of Previous Financial Crises (by Bordo, and James, NBER 19112)

There are some striking similarities between the pre 1914 gold standard and EMU today. Both arrangements are based on fixed exchange rates, monetary and fiscal orthodoxy. Each regime gave easy access by financially underdeveloped peripheral countries to capital from the core countries. But the gold standard was a contingent rule—in the case of an emergency like a major war or a serious financial crisis –a country could temporarily devalue its currency. The EMU has no such safety valve. Capital flows in both regimes fueled asset price booms via the banking system ending in major crises in the peripheral countries. But not having the escape clause has meant that present day Greece and other peripheral European countries have suffered much greater economic harm than did Argentina in the Baring Crisis of 1890. 

Econbrowser has a great post on interest-forward rates, and monetary tightening

The Federal Reserve has been trying hard to communicate that it intends to keep short-term interest rates low for quite some time. The market seems to have embraced the message.

One way to summarize the yields on securities with different maturities is with the forward curve. Suppose that today I sold $1000 worth of a bond that I’ll have to pay back with interest 365 days from now and simultaneously bought $1000 worth of a bond that will pay me back with interest 366 days from now. That would leave me on net owing nothing and receiving nothing for the next year, paying out some money 365 days from now, and getting my money back with interest 366 days from now. In effect, I’ve used today’s interest rates to lock in the return on a one-day security I plan to purchase 365 days from today. The return I could get from that transaction is known as today’s 365-day forward rate.

You can’t usually buy a 366-day bond, but you can fit a smooth function to the yields on whatever bonds you can buy to get an estimate of the 365-day and 366-day interest rate, from which you can calculate the 365-day forward rate, and indeed could calculate the n-day forward rate for any value of n you might be interested in. A paper by Gurkaynak, Sack, and Wright developed a simple way to do that. You can download their summary of the yield curve for any historical date going back to 1961.

I’ve used their data (along with equation (21) in their paper) to calculate what forward rates looked like as of November 18. Their approximation is designed for the longer end of the yield curve, and the very near forward rates you’d calculate from their formula have trouble coping with the zero lower bound. For this reason, I start the graph below with the 6-month forward rate. The date in the future at which I would earn my one-day yield is plotted on the horizontal axis, and the yield at an annual rate is on the vertical axis. The forward curve implies overnight rates that remain below 25 basis points through the end of 2014, and only rise very slowly after that, with the rate still below 2.5% until the end of 2017.

 

Current instantaneous forward rates as function of horizon as calculated from Gurkaynak, Sack and Wright data and formulas.

It’s interesting to compare that gradual slope with the actual historical path of short-term interest rates, as summarized by the graph below of the fed funds target.

 

Fed funds target rate. Source: FRED

The table below summarizes what happened during the previous 4 episodes of Fed tightening. These lasted for one or two years and resulted in an increase of the overnight rate of between 175 and 425 basis points. During an average tightening episode, the short-term rate went up by 22 basis points per month. That compares with an average increase of 6 basis points per month implied by the forward curve for a monetary tightening beginning in 2015.

 

Historical fed tightening cycles

START	END	CHANGE IN TARGET	CHANGE PER MONTH
Mar 29, 1988	Feb 24, 1989	3.25	0.30
Feb 3, 1994	Feb 1, 1995	3.0	0.25
Jun 29, 1999	May 16, 2000	1.75	0.17
Jun 29, 2004	Jun 29, 2006	4.25	0.18

I was curious to go back and see what the forward curve was signaling prior to each of these four episodes. The blue line in the graph below plots the 3-month Tbill rate, while the orange segments show the forward curve looking ahead up to 2 years from the date before the episode began. The forward curve was much more steeply sloped as those episodes began than it is today, and anticipated the Fed tightening fairly well.

 

3-month T-bill rates (blue) and forward curves as of the date of start of 4 historical Fed tightening episodes (orange).

A good deal of economic research has established that there is a risk premium built into these forward rates, particularly as you use them to describe a transaction farther into the future. There are a number of different models people have developed to try to estimate this risk premium. However, the direction of this risk premium suggests that a rational forecast of the short rate would be even lower than the path implied by the forward curve in the first figure above. This for example is the implication of the calculation of the risk premium that comes out of a model of interest rates developed by Wu and Xia (2013) that I described a couple of weeks ago. The Wu-Xia forecast of the shadow rate– a theoretical construct on the basis of which all other interest rates get determined– doesn’t begin to turn positive until September of 2016.

 

Blue: historical values for the shadow rate. Orange: forecast formed as of November 2013 of value the shadow rate will take on at indicated future date. Calculated using the procedure described in 
Wu and Xia (2013).

Based on current interest rates, the market thus appears quite convinced that the Fed is indeed not going to begin raising short rates for some time, and that, when it does finally begin to raise rates, it will do so much more slowly than was the case in any of the 4 previous tightenings. Partly this might be judged a success of the Fed’s forward guidance communication efforts, and partly a conclusion that conditions just aren’t going to be strong enough to lead the Fed to want to raise short-term rates for some time. The table below summarizes what the data for unemployment and inflation (as measured by the year-over-year change in the PCE deflator) were like at the start of each of the four historical tightening episodes.

 

Historical fed tightening cycles

EPISODE	BEGINNING UNEMPLOYMENT	BEGINNING INFLATION
1988-89	5.7	3.7
1994-95	6.6	2.1
1999-2000	4.3	1.6
2004-2006	5.6	2.5
AVERAGE	5.6	2.5
Nov 2013 values	7.3	0.9

The lowest inflation rate at which the Fed began any of these cycles was 1.6% while the highest unemployment rate was 6.6%. For comparison, the inflation rate currently stands at 0.9% and the unemployment rate at 7.3%. In its most recent policy statement, the FOMC said that it “currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.” The Survey of Professional Forecasters is anticipating that the unemployment rate won’t be down to 6.6% until 2015, at which time PCE inflation will still only be 2.0%.

It is possible that the Fed will announce a slowdown in the rate of large-scale asset purchases sometime soon, which could affect the long end of the yield curve. But the market is pricing in little risk of a significant move in short rates any time soon. Some might count this as a success of the Fed’s communication strategies. But it could also be interpreted as a market consensus that robust growth for the U.S. economy is not coming any time soon.

Through humor, you can soften some of the worst blows that life delivers. And once you find laughter, no matter how painful your situation might be, you can survive it. (Bill Cosby)
 

Enjoy:  Here you go

The crisis has arrived in Italy. Anyone surprised by the S&P Downgrade? Even the IMF is speaking now using the "D" word.

As expected (but long virgerously denied by the Portuguese government), Portugal needs a bailout from the EU to maintain its fixed exchange ratet.  As usual, the past estimates were low: currently the current package has risen to $113 billion… The WSJ reports a few hours later that its closer to $126 billion…Things are starting to get interesting. Some has noticed that Spain will be next – recall that most of Portuguese debt is held by Spain…)

As expected, the BBC reports that Portugal is next, its just a matter of time – or should I say: its just a matter of election time…

Portugal bail-out looms as government nears collapse

Portugal's austerity measures have sparked widespread opposition

Portugal's opposition parties have withdrawn their support for austerity policies that may lead to the Lisbon government's collapse on Wednesday.

The government's expected defeat in a parliamentary vote is likely to trigger an international financial rescue.

The vote comes on the eve of a European Union summit where leaders hope to finalise a eurozone debt crisis plan.

Kevin Dunning, analyst at the Economist Intelligence Unit, told the BBC that this is "crunch time" for Portugal.

"This could be the week when they have to activate the bail-out fund," he said.

Last year Greece and the Republic of Ireland had to accept massive rescue packages after markets lost faith in their governments' efforts to deal with their debt burdens.

Portugal's financial collapse would likely spark another round of nervousness in financial markets and may revive concerns about the larger Spanish economy.

Opposition parties say the austerity plan – cuts in welfare, tax rises, and increases in public transport costs – go too far.

Prime Minister Jose Socrates has said he will no longer be able to run the country if the package is rejected.

Major international lenders have been wary of Portugal's attempts to avoid tapping eurozone bail-out funds by raising money in the debt markets.

The yield on Portugal's 10-year bond was at 7.4% Tuesday, close to recent records, an indication of investors' concerns about the country's ability to pay back its debts.

On Thursday eurozone leaders begin a two-day summit at which they hope to finalise details of a "grand bargain" to deal with the 17-nation group's debt burden. 

Willem Buiter is provocative, but he may be correct. Any country other than the US or Japan would have seen capital flight in response to their economic crises. But in a world of risk, both countries experienced capital inflows because they were seen as the sovereign of last resort, or, the least risky of all risky assets. If Buiter is right, what will be the new save asset?

Sovereign Debt Unsafe, Default Concern Spreads to U.S., Japan, Buiter Says

Bloomberg, By Simon
Kennedy – Jan 7, 2011

Fears of a sovereign default are “manifest” in Europe and will soon spread
to Japan and the U.S.
as governments struggle to control deficits, according to Citigroup Inc.
economists led by former Bank of England policy maker Willem Buiter.

“Despite the recent drama, we believe we have only seen the opening and
second act, with the rest of the plot still evolving,” London-based Buiter and
colleagues wrote in a research note published today. “There is absolutely no
safe” sovereign.

The warning comes after the threat of default forced Greece and Ireland to
seek bailouts and as borrowing costs for Portugal this week surged at a
six-month bill sale as investors speculate it will be next to seek aid.
Elsewhere, U.S. lawmakers
last month extended tax cuts and are now wrangling over whether to raise the
nation’s debt limit, while Japan’s
public debt is set to exceed twice the size of the economy this year.

“The U.S. and Japan likely cannot continue to ignore the
issues of fiscal sustainability,” said the Citigroup economists, who added that
it’s “only a matter of time” before the U.S. government can only fund
itself through debt issuance at “significantly higher interest rates.”

Concern of default will spread especially if the definition is extended
beyond violating legal contracts to include the infliction of losses on
bondholders by deliberately engineering inflation or currency depreciation, the
economists said.

Several debt restructurings will occur in the euro area in the next few
years and the current system of providing liquidity won’t be enough to prevent
them, the economists said. Greece’s
government is “manifestly insolvent,” they said.

European Debts

Western European government bonds are now riskier than emerging-market debt
for the first time as investors brace for $1.1 trillion of borrowing from
euro-region nations this year.

For a lasting solution, the sovereign-debt crisis must be addressed at the
same time as weaknesses in the region’s banking system, the report said. In Ireland, for
example, the recent aid package will “buy time,” yet fails to address fault
lines in the country’s banking system and highlights the need for a
continent-wide regime to deal with them, it said.

Portugal is likely to be
the next country to access the regional rescue fund soon, yet the almost $1
trillion system of support “looks insufficient” to prevent a speculative attack
on Spain
or to fund it completely for three years, the economists said.

Spain
Contingency

In a separate report also published today, JPMorgan Chase & Co.
economist David Mackie said there is concern that if Spain
seeks help “the current arrangements will not be able to contain the crisis”
and that doubts about whether debt sustainability can be achieved without
restructuring would linger and contagion could spread to Italy and Belgium.

“If that were to happen, euro-area policy makers would need to enlarge the
current facilities,” said Mackie, noting that could involve moving to a system
of debt guarantees and reducing the borrowing costs on the emergency cash.

The chance of the 17-nation euro area breaking up is nevertheless “extremely
unlikely and would be an economic disaster,” said Buiter’s team, adding that
exiting the region would be “irrational” for fiscally weak countries such as Greece.

WTO Rules U.S.Tariffs on Chinese Tire Imports Legal (Businessweek)

Dec. 13 (Bloomberg) — World Trade Organization judgesrejected China’s complaintthat U.S.tariffs on Chinese car and light-truck tires violate global trade rules, sayingthe Obama administration “did not fail to comply with its obligations.”

President Barack Obama announced the three-year dutieson $1.8 billion of tires from Chinain September 2009, acting on a complaint by the United Steelworkers union,which represents 15,000 employees at 13 tire plants in the U.S. The unionsaid Chinese tire exports to the U.S. tripled from 2001 to 2004 to41 million and called for a cap on annual imports of 21 million.

The case was the largest so-called safeguard petitionfiled to protect U.S.producers from growing imports from China. Union leaders and Democraticlawmakers said at the time the decision was proof of Obama’s commitment tosafeguarding domestic workers and jobs.

The Chinese government said the tariffs broke WTOrules and were a “serious case of trade protectionism, which Chinaresolutely opposes.” It lodged a complaint at the Geneva-based WTO against theduties just three days after Obama announced them.

‘Major Victory’

“This is a major victory for the United States and particularly for Americanworkers and businesses,” U.S. Trade Representative Ron Kirk said in a statementfrom Washingtontoday. “This outcome demonstrates that the Obama administration is stronglycommitted to using and defending our trade remedy laws to address harm to ourworkers and industries.”

Trade complaints against China have surged since Obamabecame president — as have retaliatory steps by the Chinese government. China calls U.S.complaints against its exporters signs of protectionism while the U.S. says it’senforcing trade rules.

The two countries, the world’s largest andsecond-largest economies with $366 billion in annual two-way goods trade in2009, have clashed over access to each others’ markets for products includingsteel pipes, auto parts, poultry, movies and music. Chinaran up a $201 billion trade surplus with the U.S.in the first nine months of this year, more than the U.S. deficit with the nextseven-largest trading partners combined, according to Commerce Department data.

That gap, together with the drop in Americanmanufacturing employment and the U.S.contention that the yuan — which has gained 2.4 percent since a two-year pegto the dollar ended on June 19 — is undervalued, has made China a targetfor Congress and voter anger.

Opposition

The Tire Industry Association opposed the tariffs,saying they would create shortages and hardships for tire retailers withouthelping domestic manufacturers. Findlay, Ohio-based Cooper Tire & RubberCo., the second-biggest U.S.tiremaker, and the U.S. unitof Osaka, Japan-based Toyo Tire & Rubber Co., which has a plant in Atlanta, were alsoagainst the tariffs.

One year after the duties kicked in, they have“reversed a massive decline in domestic production and provided much-neededrelief to workers, their employers and communities from a flood of Chinesetires,” according to Leo Gerard, president of the Pittsburgh-based UnitedSteelworkers.

The tariffs are calculated as a percentage of tires’value. Obama imposed a levy of 35 percent in the first year, 30 percent in thesecond year and 25 percent in the third year, on top of the 4 percent dutyapplied to all passenger-vehicle and light-truck tires imported into the U.S. market.

 Samuelson provides a dissenting opinion. 

"We [Ireland[ are no longer a sovereign nation in any meaningful sense of that term" says Morgan Kelly, professor of economics at University College Dublin "From here on, for better or worse, we can only rely on the kindness of strangers." Kelly is known as Ireland's "Doctor Doom." He's got a long (depressing) piece on Irelands (mis)fortune entitled If you thought the bank bailout was bad, wait until the mortgage defaults hit home. 

The only way you can get behind the massive government stimulus is if you believe that a one-time defibrillation is needed to resuscitate the economy from its liquidity trap. If you do not believe that we are in a liquidity trap, there is no need for stimulus and all the money spent is simply wasted without effect (other than increasing the public debt). 

There is now ample evidence that the stimulus was large enough to stop the economy from going over the cliff – economic growth has recovered. However, at the same time, the stimulus was not large enough to result in large scale hiring or investment. That's a major problem. The defibrillation returned a heart beat, but the patient is still in a coma. 

Many had argued that the stimulus was too small at the time. I didn't do the math at the time whether the size was right, but was astonished how unproductive much of the spending actually was. Unproductive in actually putting people to work. Of course,  in his General Theory, Keynes wrote, “To dig holes in the ground, paid for out of savings, will increase, not only employment, but the real national dividend of useful goods and services.” So the take-away was "it does not really matter what the stimulus is being spent on, as long as its spent. But it turns out that out insufficient size or productivity in terms of the # of people put to work matter for a stimulus. Here is how the unusually creative and brilliant Robert Schiller puts it in the NYT (via Mark Thoma). 

What Would Roosevelt Do?, by Robert J. Shiller, Commentary, NY Times: Across the United States, thousands of federally financed stimulus projects are under way, aimed at bolstering the economy and putting people to work. The results so far have not been spectacular.

Why not? There’s nothing wrong with the idea of fiscal stimulus itself. We need more stimulus, not less — but we need to focus much more on actually putting people to work.

Two friends of mine, both economists, came upon a stimulus project … highway … sign that read “Putting America to Work: Project Funded by the American Recovery and Reinvestment Act” and prominently featured a picture of a worker digging with a shovel. Out on the road, there was plenty of equipment, including a gigantic asphalt paver, dump trucks, rollers and service vehicles. But there wasn’t a single laborer with a shovel. That project employed capital, certainly, but not many human beings.

Like many such stimulus projects, it could be justified if you accept the idea that gross domestic product, not jobs, is central — a misconception…

So here’s a proposal: Why not use government policy to directly create jobs — labor-intensive service jobs in fields like education, public health and safety, urban infrastructure maintenance, youth programs, elder care, conservation, arts and letters, and scientific research?

Would this be an effective use of resources? From the standpoint of economic theory, government expenditures in such areas often provide benefits that are not being produced by the market economy. …

President Franklin D. Roosevelt's New Deal, though no more than partly successful, was much more focused on job creation than our current economic stimulus has been. It seems that the New Deal was also more successful at inspiring the American public.

Consider one of the most applauded of Roosevelt’s programs, the Civilian Conservation Corps, from 1933 to 1942. … The C.C.C. emphasized labor-intensive projects… Congress has recently set plans for tripling the size of AmeriCorps, the modern counterpart of the C.C.C…. At its peak, the C.C.C. employed 500,000 young men. Under current plans, AmeriCorps would top out at 250,000 people in 2017, even though the nation now is two and a half times larger. We ought to be bolder.

Big new programs to create jobs need not be expensive. Suppose the cost of hiring a single employee were as high as $30,000 a year, several times typical AmeriCorps living allowances. Hiring a million people would cost $30 billion a year. That’s only 4 percent of the entire federal stimulus program… Why don’t we just do it? 

This would take care of the necessary income effect to exit the liquidity trap. Appropriately targeted tax cuts could stimulate investment. But a basic result in economic theory is that temporary tax cuts have very limited effects, and the debate about the semi-permanent Bush tax cuts is still raging (see here and here and here)…

Ominous signs of weakening Eurozone foundations via Eurointelligence:

The report alleges that French banks, the largest holders of Greek debt, have been dumping their Greek bonds at the ECB, while the German banks have agreed with the finance ministry to hang on to their bonds until 2013.  The article, whose sources are anonymous central bankers in Germany, says the Bundesbank wonders why the ECB was still buying Greek paper at a time when the financial shield is already in place.

The answer is that they [the German Bankers] suspect a French conspiracy, according to the article, a presumption that French banks are using the ECB purchase programme to clean their balance sheet. The article then takes to the thought to its logical conclusion, and calls the ECB a “bad bank” [a term used for a financial institution whose purpose it is to buy toxic assets]. The article goes on to ask, whether and how the ECB can get out of this, because stopping the purchase programme would lead to a collapse in prices – as the ESCB is the only buyer. And if Greece were to restructure (which is what everybody who has looked into the numbers in some detail) knows, then the ECB itself would need to be bailed by the German taxpayer.

We assume that this article is unlikely to win a Franco-German friendship prize. French newspapers have picked up on it, including Le Monde, which said yesterday that “a perfume of divorce floats between the Germans and the ECB” (i.e. Trichet). Please also note that the source of Der Spiegel’s information do not hail from France. They are German central bankers, who voice their suspicions. So do not treat it as fact that French banks are selling, and German banks are not selling. But the article raises an interesting question: how to prevent moral hazard arising in this situation? And if the ECB were to reveal what it bought in its open market operation, we would know a lot more. At present, the only information ordinary Germans have is the Spiegel report.

That is the question. Here are two views from the opposite ends of the spectrum. Avinash Persaud thinks its good policy to bail out banks and bond holders. In the other corner of the ring is John Cochrane, free market gladiator extraordinaire, who tells us of the virtues of inflicting severe pain upon those who speculated. The interesting detail here is that Greece lied about its deficit, so one cannot really talk about fair play, or rational expectations on the part of investors… So punishing those who believed the Greek government seems to be counterproductive to me. 

Here is the bottom line on the Eurozone crisis. Is it massive government deficits, debt,  political economy of austerity, default risk, or the absence of the promised $ trillion rescue package?

The answer is neither. The scariest prospect of all is that even if none of these issues existed, the crisis countries would have to work their way out of their crisis of competitiveness. Essentially they spent more than they produced, and to align their spending with their income, not only spending has to drop, but income has to rise. This can only happen if goods in crisis countries become more competitive. Here "competitive is simply an euphemism for "lower prices and lower wages." Krugman calls it the Elephant in the Euro and puts concrete numbers to it: wages in crisis countries need to fall 20 to 30 percent relative to Germany.

What does that really mean? Well, no none can really conjure up images of such a wage decline. But we do know that the country with the most draconian austerity adjustments, Latvia, saw its unemployment rise from 6 to 22 percent, causing a decline a meager decline in labor costs of 5.4 percent. One can only hope that European labor markets are more flexible and prices and wages adjust faster than in Latvia – but this is obviously wishful thinking.  

Note to self: one stop shopping for key state and local finance indicators

European leaders learned their poker lessons. For weeks we have been listening to policy maker agonizing about the size and conditions of a bailout package. This weekend the tide turns. No more hand wringing about the size of the package, as the Eurozone moved from squeezing out 30 billion for Greece in protracted negotiations to providing a whopping $ trillion to countries in need (no details who qualifies and how). The money is to be raised by a "special purpose vehicle to be set up in the coming week." Sounds a bit like a European IMF, and much like the creation of a Eurobond to provides for the missing link in this monetary union: a centralized means to bail out member countries in need. Here are the details (via Calculated Risk):

1) The EU created a €60 billion fund based on article 122 (special circumstances). The IMF will add €30 billion. Press conference archive here (40 minutes)

2) The EU will create a Special Purpose Vehicle (SPV) for 3 years based on inter government agreements. These are potential loan guarantees backed by all Euro Zone countries. This is in addition to €60 billion and will be up to €440 billion – plus a contribution from the IMF up to half of European Union contribution (up to €220 billion). The total of the two is €750 billion.

3) There are apparently agreements from Portugal and Spain to take steps to reduce their deficits.

4) The European Central Bank (ECB) announced "interventions in the euro area public and private debt securities markets (Securities Markets Programme) to ensure depth and liquidity in those market segments which are dysfunctional."

5) The Federal Reserve reopened swap lines to provide dollar liquidity.

Story Links: rom the NY Times: E.U. Details $957 Billion Rescue Package, the WSJ: World Races to Avert Crisis in Europe, Bloomberg: EU Crafts $962 Billion Show of Force to Halt Euro Crisis

Sad news from Greece (via the economist):

Three people died on Wednesday in a blaze triggered by a fire-bomb tossed into an Athens bank during a march by tens of thousands of striking Greek workers, police said.

Earlier, police fired teargas and stun grenades at demonstrators who tried to force their way into parliament on Wednesday ahead of an emergency debate on a harsh three-year austerity package agreed with the European Union and International Monetary Fund.

Angry protesters outside the parliament building raised clenched fists and shouted “thieves, thieves” – a traditional Greek expression for corrupt politicians. 

And Eurointelligence confirms the expected:

Some really bad news from Greece – Opposition decides to vote against the deal

The EU/IMF deal will find a majority in the Greek parliament, but last night’s decision by Antonis Samaras, leader of the opposition New Democracy, to vote against the IMF/EU package destroys any hopes of a lasting consensus for reform. It signals a return to the politics as usual at a rather early stage in the adjustment process, and destroys any hope of a national consensus, which is so critical when it comes to the implementation of long-term adjustment programmes. (Remember the IMF said the whole adjustment would take 10 years!) The decision makes it very likely that Greece will not be able to maintain the commitments it made in its negotiations, except in the very short term. 

Seems like the markets decided the program is not implementable, Greece must default, and the question is only the size of contagion. The Euro is in free fall at 1.28… 

…For Europe's common currency.

Greece's financial difficulties have exposed numerous weaknesses which threaten Europe's common currency. Now, policy makers and economic experts are trying to find ways to stabilize the euro. SPIEGEL ONLINE takes a look at the proposals. 

Here is what growth theorists must explain:

The graph is from The Growth Report Strategies for Sustained Growth and Inclusive Development.

Here is a quick primer how to augment the Mundell Fleming model to tell the tale of Greek deficit deception. There is really no intertemporal dimension to the Mundell Fleming Model, which is a problem if one wants to analyse the effects of successive fiscal deficits and the ensuing debt accumulation of a country. However, there is a simple, ad hoc way to extend the model and analyze the Greek crisis.  

Chapter 17 (specifically equation 17.8 of International Economics), introduces risk as an explicit determinant of capital flows. Eaton and Gersovitz (1981, wonkish)  suggested that a country's debt to GDP ratio may influence capital flows. As a country's debt to GDP ratio rises, investors perceive that country default risk increases. That is, investors start to get worried that the country will not be able to actually repay all the money it borrowed. In response the country is forced to pay a risk premium to maintain its financial account and avoid large capital outflows. To model this, lets say that risk, R, can be proxied by R = R[Debt/Y].

Greece better brace for a nasty recession. Either because the government undertakes the austerity measures to prevent a full out speculative attack, or because in the absence of such austerity measures, financial markets will simply stop lending to Greece and the government is forced to live within its means. That is not going to be easy, after Greeks have just gotten used to the the good life of living above their means.

Of course there is a third option, the other Eurozone countries might find it in their hearts to help Greece. But that would imply that Greece looses much of its economic sovereignty. The European Central Bank already controls Greece's money supply, and if Eurozone countries do decide to undertake a Greek bailout, it will occur only if these countries have strong supervision over the Greek fiscal budget. And, oh, the Greek statistical office has already been split off from the greek treasury's control so it can no longer cook the numbers. Eurostat will now be responsible for Greece's official statistics from now on…

*Eicher and Turnovsky (1999) show that the reduction in output actually aggravates risk even more since it is likely to increase the Debt/GDP ratio further! The increase interest rates (driving up the value of the debt) also do not help…

Cliff Mass, a professor of atmospheric sciences at the University of Washington, has long been worrying about the declining math skills of UW freshmen. He recently drove his point home quite visually with a math assessment of his UW atmospheric sciences 101 class. It turns out his results were largely confirmed by a similar assessment in James Prager's UW earth and space sciences class.

I have had two epiphanies this year.

1) I have come to suspect that Seattle's K12 Every Day Math curriculum is deeply flawed — and I was surprised to find that there are actually ample reviews of the approach out there (Professor Klein's assessment might be the most damning) that could have provided the Seattle school board a heads-up (I guess there are already some regrets…). 

2) The math skills I encounter in my economics classes at the University of Washington seem to have become weaker over the past 16 years. Watching Cliff Mass's video, I started to understand why. So I gave my students Cliff's math assessment test.  

Here is the good news: The results show some positive impact of going to school at the UW. My UW students are mostly upperclassmen (87% are juniors and seniors), while Cliff Mass's class had only 39% upperclassmen. The overall score was significantly higher for my students: 78% vs. 58%. So much for the good news.