Trade Deficit Debate

Trade Deficit Debate: Cerebral Striptease -- The Final Chapter
Edited by Eric J. Fry
The Rude Awakening
Wall Street, New York
Monday, January 2, 2006

Chris Mayer, Justice Litle, Dan Denning, Bill Bonner, and Byron King conclude their Trade Deficit Debate.

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[Joel's Note: Nothing Ruder than a Monday morning Rude
Awakening issue, I say. There was so much great material in
the trade debate series we started running last week that,
we didn't really have a choice. Plus, Eric and I both LOVE
working on New Year's Day...such clarity of mind!

If you missed the previous two installments of Cerebral
Striptease, you can locate them under archives on the web
page;

www.the-rude-awakening.com

Also, if you find this kind of debate interesting and you
enjoy reading what these guys have to say, you might also
enjoy HEARING their fervent brainstorming too. We got our
editors together for a special recording of their picks for
the 11 hottest trends for 2006. If you want to have a
listen you can get access to the 'webinar' right here.

11 Hottest Trend Predictions for 2006
http://www.agora-inc.com/reports/400SPRED/E400FC33

You will want to get in before the end of the day, however,
as the price jumps tomorrow...just a thought. Speaking of
which, here's our own Eric Fry with a few more of his
own...

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Eric Fry, welcoming the New Year with a smile in his heart
and an ache in his head, reports...

Is it a good thing that America inhales $2 billion of
foreign capital every day, or a bad thing? Most traditional
economists – the kinds of folks who pay off their
mortgages, drink powdered milk to save money, and wear both
a belt and suspenders – worry that our massive borrowings
from abroad will imperil our economy.

But a new generation of creative thinkers scorns such
antiquated fear-mongering. Instead, they herald America's
massive current account deficit as a sign of strength – a
sign that foreigners consider the U.S. economy to be the
very best destination for investment capital.

We are not persuaded by these new-era arguments. To
traditionalists like ourselves, these arguments reek of
rationalization and revisionism. In other words, this stuff
sounds like baloney. But we must concede, nevertheless,
that the trade-deficit-is-good crowd presents ideas worthy
of debate, which is exactly what several of our colleagues
have been doing for the last few weeks.

On December 5th, Chris Mayer, editor of Capital and Crisis,
dispatched a seemingly innocuous email musing about the
importance of the trade deficit. Almost immediately, Chris'
far-flung colleagues began lobbing in their insights and
opinions. Justice Litle replied from Reno, Nevada, Dan
Denning sounded off from Melbourne, Australia, Bill Bonner
chimed in from Jolly Old England, while a host of other
folks dispatched their viewpoints from various cities
throughout North America.

We published the first two episodes of this exchange last
Thursday and Friday. Today we bring you the final
highlights...(but just the highlights, we promise!)

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Cerebral Striptease – the Final Chapter
Edited by Eric J. Fry

"This long e-mail thread all got started with a debate
about the meaning of trade statistics - because the trade
statistics show a 'trade deficit' which seems worrisome,"
Chris Mayer reminded his colleagues half-way through their
weeks-long email exchange.
 
"The basic points are these...
 
"1. Less than 10% of the US workforce is engaged in
manufacturing, continuing a trend that has been going on
for more than 20 years.
 
"2. US profits and profit margins are better than ever, and
have enjoyed a particular revival with the steep loss of
manufacturing jobs since 2000 (GaveKal's book has the data
– i.e. 'Our Brave New World' by Charles Gave, Anatole
Kaletsky and Louis-Vincent Gave).
 
"3. The vast majority of willing Americans are employed and
family incomes are growing and are higher than ever.
(GaveKal has the data). Though, I must say, the data can be
conflicting here. I've seen some things that show
disposable income has not grown much.

"So the American economy seems to be faring quite well,
despite the growing trade deficit. Of course, there are
other things to worry about... like the financial health of
the average consumer, the poor financial condition of the
US government, etc. But, the very basic idea behind free
trade – that it creates wealth – seems to be borne out by
the successes of the US economy.

"Furthermore, it seems to me, the trade deficit does not
capture the entire effect of trade transactions. Bill wrote
that profits were irrelevant, but I think the underlying
assumption in his post is that labor costs go down and jobs
are lost. I think it misses the idea that you can lose
manufacturing jobs, yet increase profits and margins in
other businesses, so payrolls grow over time."

Trade Deficit Debate: The Ability to Raise Capital

To which Dan Denning, editor of Strategic Investments,
replied:
 
"It's not my intention to say that trade deficits, willy-
nilly, are bad or that they threaten the American way of
life (although such as it is, they probably do). What I'm
interested in, like you, is what it means, if anything, to
evaluating the quality of stocks we might recommend to our
subscribers. It's far more interesting and profitable to
focus on specific firms that ARE competitive and making
good use of their capital.

"But I would gently submit that the ability of a firm to
raise capital, and then deploy it in the creation of a good
or service at a profit (surplus value)—i.e. the ability of
an American firm to be competitive-- is directly related to
some very macroeconomic conditions. Those conditions
include tax policy, regulation, labor laws, and of course,
credit, currency, and the money supply...and capital
formation.

"What I'm interested in is capital formation and value. And
the reason I'm interested in them is that I believe the
size of the trade deficit is an indication that America is
importing capital faster than it is forming it. To call
this a 'capital surplus' might be clever. But to me it
suggests that in the aggregate the economy is, in fact,
less competitive and getting more so day by day, although
individual firms may prove the exception."

To which Justice Litle, editor of Outstanding Investments,
responded:
 
"For discussion purposes, perhaps there is a better
question than, 'Do trade deficits matter or not?' How
about, 'Is America in financial trouble or not?'

"Reframing the question allows for a broader scope of
discussion. For example, consider the proportion of US
Treasuries in the hands of foreign creditors -- something
like $2 trillion, or 50% of the total outstanding, if I'm
not mistaken. When foreign creditors are lending $2
trillion to the US government, something is seriously
amiss, no? Those funds aren't going to cutting-edge private
companies or efficient asset-allocators. Instead, this big
chunk of change is going to an inefficient government
entity, inevitably allocated to pork and guns and butter. 
That worries me.

"And when you consider how that $2 trillion indirectly
props up the housing market and the economy -- by filling
in budget holes created by mortgage tax deductions,
enabling the hubris of big-bank mortgage lenders with a
too-big-to-fail attitude, and keeping long-term interest
rates artificially low in the first place -- what you get
is a chain of bankers helping bankers that has artificially
pumped up the asset-bubble boom. 

"When the links in the chain are added up, there is a valid
and sobering argument that America is living well, thanks
to the largesse of the world's central bankers, independent
of whether the trade stats can be trusted or not."

Then, Dan Denning re-entered the fray: 

"Chris makes the excellent point that you can lose
manufacturing jobs but still increase profits and margins
and thus payrolls. You can. But I think that's where the
debate is. Have we? Payrolls have grown nominally as the
economy has chugged along. But who has benefited most from
the increase in profits and margins? Well, any of the CEOs
who aren't in jail have done well. And shareholders. But
not everyone is a shareholder. So it seems to me the wealth
that's been created from the one-off of realizing our
competitive advantage has accrued to a smaller number of
people than the wealth created early last century. Maybe
that's just inevitable (and doesn't include harder-to-
measure improvements in the overall standard of living). Or
maybe it is late-degenerate capitalism, where the new
wealth created is not once, but twice removed from
production, derivative wealth if you will (which is
admittedly what investing is). We benefit as shareholders,
but not as producers.
 
"One last point regarding the trade deficit. I've only said
that it matters in the sense that it measures how much and
what we're producing. But consumption in excess of
production (a trade deficit) does not lead to the formation
of productive new capital. The trade deficit measures--
albeit in a flawed way--the prevailing type of behavior in
an economy. Ours is consumptive, not productive. Our
corporate and social culture is bent on maximizing current
gratification. There is not much willingness to delay
consumption and save or invest."

Trade Deficit Debate: Credit Upswing

To which, Bill Bonner offered his concluding thoughts:

"It's a good discussion. But it's complicated by several
issues mixed up together. No question, a company can
flourish as a 'platform' business. No question, investors
can make money. But has the US economy really become
generally richer and more profitable because it has taken
advantage of global markets?

"Or...has there been a huge credit upswing in the last few
years which has several effects: it increases company's
sales without an offsetting labor cost (making them more
profitable)...and it puts people to work helping each other
spend their money. 

"On the surface, it sure looks like the society is
richer...more profits...more spending...more sales...more
people working. But whence the source of this wealth? Is it
real?

"Incomes per hour are not going up -- they're going down.
And the average man...as I remember the data...has no more
real spending power per hour worked than he did 30 years
ago. Is he richer? Hmmm...His house went up in price. His
wife went to work. Interest rates went down...finance
companies had a few drinks and loosened up...he spends more
money.  But what is it that brings him the extra spending
power? It is higher debt, not higher earnings.

"But then, why should he earn more? Why should he be
richer? Whence cometh the extra loot? In the past, the
answer was simple. The factories -- representing huge,
fixed capital outlays -- were in his backyard, not in
China's. He had a huge advantage...the factory could not
escape. He and other workers could unionize and exploit the
capitalists. No more. Where is his advantage? 

"Not that we're getting misty eyed over the fate of the
poor lumpen. He's had it good for a very long time. If it
ain't so good in the future it is only the way things work.
But he really has no way to increase his purchasing power -
- faced with billions of competitors in the East -- how
will the U.S. domestic market grow? How will he pay back
all the money he borrowed? How will he keep up with
payments...with spending...with life's little
setbacks...when the credit flows less fluidly?

"We don't know. But we wouldn't want to hold his mortgage. 
And we suspect that the marvelous performance of the U.S.
economy over the last few years is less a feature of a
Brave New World a la GaveKal and more a feature of an old
fashioned credit binge." 

Trade Deficit Debate: Elastic Currency

At the conclusion of the trade deficit debate, Byron King,
contributing editor of Whiskey and Gunpowder, offered an
entertaining footnote:

"Amigos, none of the aspects of our virtuous trade deficit
could have been maintained without the U.S. having the
luxury of an 'elastic currency,' courtesy of the Greenspan
Fed. In a hard-money, gold-standard world, or even in an
elastic monetary world in which the Fed resisted the
temptation to accommodate the fiscal fads and fixations of
the elected parties of our government, the con would have
been called long ago. Are the continuing 'profits' really
meaningful in an economy in which deficit-spending
continues to increase the nominal money supply far in
excess of any accompanying growth in underlying economic
activity? Sure, people have more cash in their pockets, but
it buys less every year. Of course, the U.S. can afford to
'de-capitalize' itself overseas, every year to the tune of
$600 billion or $700 billion. Just increase the money
supply, lower interest rates, and watch the nominal
increase in 'value' (ahem....) of the U.S. housing base and
total capital stock. Son-of-a-gun, we be rich!

"It is like a perpetually-winning lottery ticket. Whence
comes this national blessing? How is it that the U.S. can
get something for nothing, year after year? Manmade money,
perhaps? We have discussed the epic year of revolution,
1913. (That's the year the Federal Reserve emerged from the
legislative womb). And we have discussed the other epic
year of gold confiscation, 1933. But then, there is the
year of the 'dollar-as-world-reserve,' 1944, and the events
at Bretton Woods. And there is the year-of-take-it-or-
leave-it-or-shove-it, 1971.

"As WWII was beginning its final chapters in 1944, the
moneybags got together at Bretton Woods, New Hampshire to
figure it all out. The U.S. guy said, 'Hey, we have an
aircraft industry that can produce 50,000 planes per year. 
We are building fleets of B-29s that can flatten cities. Do
any of you guys have an aircraft industry that can produce
50,000 planes per year? Are any of you guys building fleets
of B-29s that can flatten cities? No? OK, then. We agree.
The dollar will be the world's reserve currency.' Oh wait a
minute. The minutes of the meetings don't say anything
about 50,000 planes, and fleets of B-29s flattening cities.
Oh well, somebody must have said something to somebody
else, and they all agreed to use the U.S. dollar as the
world's reserve currency. Sweet. Works well if you are the
U.S.

"And then there was August 15, 1971. Nixon went on TV and
said, 'Hey, we have 25,000 nuclear weapons, and the
missiles and airplanes to deliver them. Do any of you guys
have 25,000 nuclear weapons, and the missiles and airplanes
to deliver them? No? OK, then. We agree. The U.S. is
closing the gold window. We will no longer redeem our US
dollars in gold.' Oh wait a minute. The transcript of
Nixon's speech does not say anything about 25,000 nuclear
weapons, or the missiles and airplanes to deliver them. Oh
well. Nixon said something about the 'monetary' situation.
And he said something else about some sort of thing that
had to do with the U.S. dollar and gold. It sure sounded
good. And everybody in the world agreed that it was O.K.
for the U.S. to go off the gold standard. And everybody
still agreed to use the U.S. dollar as the world's reserve
currency. Sweet. Works well if you are the U.S.

"Eventually, though, the future is now. If not today, then
tomorrow. If not tomorrow, then the day after. Eventually,
everyone and everything sees its last sunset."

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And the Markets...