Sunday, July 27, 2014

No. 000059 Most important Post of six months Frances Coppola's "America's Greatest Export Is It's Debt"

While the theme of this blog is Missouri state economics and attendant politics, there is a piece so important to understanding Missouri's place in the World that I must recognize it as the most important post on economics in the last six months.

America's greatest export is its debt

That piece is by Great Britain's Ms. Frances Coppola, "America's greatest export is its debt," for it explains why Missouri's economic problems are so intractable. Ms. Coppola and I frequently argue over her conclusion. She argues that the U.S. cannot eliminate its trade deficit without serious damage to the world financial system. Being a Hamiltonian Mercantilist, first, I argue the world financial system be damned, we need to eliminate the U.S. trade deficit and put people in Missouri back to work at jobs that provide for a growing and constantly improving standard of living.

What are the main points.

Trade with China costs jobs and income.

First, contrary to the free traders and the arguments for free trade you find throughout the economic literature, there is no evidence that free trade without capital restrictions improves the lives of Americans. The literature is consistent and uniform: free trade destroys jobs and incomes. More to the point, trade with China has destroyed jobs, incomes, and lives in Missouri. 

If someone is interested in the subtly of the matter start with Larry Summers here. Ask yourself whether the secular stagnation that surrounds us is real. And, ask yourself, does the ability of capital to move freely to the lowest wage country drive secular stagnation. When I listen to Mr. Summers that is what I hear him saying.

US has promoted Free Trade without the consent of its citizens.

Second, for political purposes, the United States has found it extremely advantageous to the United States dollar function as the World's Reserve Currency. Further, for political purposes, the United States has found it extremely advantageous to increase the standard of living of the Chinese people at the expense of most people living in Missouri. 

In both instances these policies have been pursued with the same level or skill and deception that assured the American public there were WMD's in Iraq. 

Ms. Coppola, as an observe across the Atlantic, is able to be very blunt on this point, writing
The trade deficit is a long-standing problem that is not easily solved: It principally arises from the world's demand for dollars. The U.S. dollar is the world's reserve currency mainly because much of the world's trade is settled in dollars, and all commodities and currencies are priced in relation to dollars. Since the world demand for dollars far exceeds the ability of the U.S. to produce enough goods and services to meet that demand, the U.S. imports far more than it exports.

It is often argued that the U.S. could cut its trade deficit by restricting imports and increasing exports. But this would seriously restrict dollar liquidity in the world. Back in the 1960s, Robert Triffin pointed out that the U.S.'s position as provider of liquidity to the world would force it to run substantial trade deficits. He was right. And the existence of such large trade deficits also forces the U.S. government to run fiscal deficits most of the time. The few times in recent years that the U.S. government has managed to run fiscal surpluses, the cost has been a significant reduction in private sector saving … Yet we want the private sector to save. We want corporations to have profits. We want households to provide for their futures. We bewail the lack of saving by U.S. households, and we call for more investment by corporations. None of these are compatible with the goal of running fiscal surpluses when there is a trade deficit — and the trade deficit cannot be eliminated without serious damage to the world financial system. Like it or not, the U.S. is stuck with its deficits.
In short, Ms. Coppola recognizes that US political goals have a cost; they appear to create a paradox. We can pursue our political  goals in the eyes of Ms. Coppola only at the cost economic ruin at home, ruin caused by the twin imbalances of higher debt and ever greater trade deficits. 

Tea Party has attacked both the quality and quantity of the safe assets we offer the World.

Ms. Coppola then makes two telling arguments about the know-nothings of the Tea Party: 
But in fact, the deficits are not nearly as serious a problem as many seem to think. The enormous trade deficit makes the U.S. a massive net importer of capital. And the world loves this. The U.S. government is the market leader in the provision of safe assets to the global financial system. And it is the number one provider of quality investment products for the world's savers. That's where the "glut of capital" that Ben Bernanke talks about comes from. The savings of the world come to America. It is the world's biggest investment fund.
Except that it doesn't behave like it. What investment fund would try to discourage people from investing in it? And what investment fund would set out to destroy its own credibility by undermining the quality of its investments? Yet the U.S. does both of these things. Deficit reduction discourages people from investing. And flirting with debt default undermines its quality. Look what happened to the yields on U.S. debt as the stalemate in Congress over the federal budget intensified through the summer and fall of 2013, finally ending after a two-week shutdown in October:

But the fact is that despite awful mismanagement by U.S. politicians, U.S. government debt remains the savings vehicle of choice for the world. It is America's greatest export.

Strength through Strength or Strength through more fiscal and trade deficits.

Ms. Coppola ends her piece by recognizing that our fiscal and trade deficits have taken an enormous toll on America. Her solution is more debt. 
Embrace your debt, America. You are already the world's central bank: Your destiny is to be the world's savings bank as well. Expand your production to meet the world's demand for quality savings products. Forget this idea that deficits must be eliminated and debt must be reduced. That is not what the world is saying to you. No, the world is saying, "More! Give us more!"

But, of course, you need to take steps to ensure that the savings products you create remain the best in the world. You don't want to compromise your market leading position by cutting corners. Unfortunately, too many people seem to think that cutting corners is the best way of preserving the quality of your products. The Bank for International Settlements, for example, argues that you should always run a fiscal surplus to ensure that you can pay the interest on your savings products. And the IMF talks about achieving "fiscal sustainability" through medium-term fiscal consolidation. This is crazy. You are a bank. Do banks cut back lending in order to pay the interest on savings accounts? Hardly. They invest the money they have borrowed in productive enterprises. The money they make on their investment enables them to pay the interest on their debt, and pay their workforce handsomely, and have large expensive offices in prime locations, and STILL make a profit. You do not need "debt reduction measures." You need to invest what you borrow in productive enterprises.

America, you should spend the money you borrow on things that create real value. Invest in both physical and human capital. Build bridges and roads. Create the best education system in the world. Create the best healthcare system in the world. Develop new ways of capturing and storing the free abundant energy that is available to us from the sun, the wind, and the sea. Invest in technologies that will bring people long life, health, and prosperity.

And above all, think big. Large, long-term projects, the more grandiose the better. This is what we know and love you for — taking on the seemingly impossible and making it happen. Let's have a new space program. Or a deep-sea exploration program — since we know even less about the depths of the ocean than we do about Mars. Create a new Atlantis. Colonize the Moon. Build the Death Star. And establish trade links with Alpha Centauri. For even if none of these things in themselves generate value, the research and development done in the course of them may in the end create greater value than we could possibly imagine.

Now why does Ms. Coppola urge this view?

Ms. Coppola is not an American; she is British, interested in promoting the vital interests of Great Britain. Those interests do not align with the US interests.  London, and for 17 years she was a London Banker, has an enormous interest in maintaining the current World Financial System.

What do Warren Buffet and Charlie Munger say in response to Ms Coppola?

We’re like an incredibly rich family. We sit on the porch of our huge farm – so big that we can’t even see the end of it – and each year, we consume 6% more than the farm produces. To pay for this, each year we sell or mortgage a little bit of the farm that we can’t see, so we don’t even notice. We’re very, very rich and the rest of the world is happy to buy from us or lend to us, so each year they take a piece of our valuable assets – and they work very hard. But we will have to service this. If it goes on for a long time, our children will pay. 

My answer: Strength through Strength 

I do not believe, in light of current events in Iraq, Syria, Israel, and Libya, the Ukraine, and Afghanistan that Ms. Coppola would write her piece today. 

World events have accelerated the moment of truth of which Messers. Buffett and Munger so simply speak. Within the past month we have learned that our deficit financed military cannot provide the World with peace and stability. 

The bitter lesson for the former Christians of Mosul is that a debt financed U.S. military permits no policy mistakes. 

More narrowly, Great Britain and Europe have learned that their inability to finance a meaningful military presence has opened the door to renewed Russian dominance of European and Mediterranean  and Middle Eastern affairs. 

Like Ms. Coppola, I believe we in the US should be spending government funds that create real value. We are a rich big country, one that could easily tax itself and pay for the investments of which Ms. Coppola speaks if, as Mr. Minsky demanded, we put everyone to work

Moreover, my point of view is supported by Keynes. As Ms. Coppola knows, the country in the World that should be running trade and fiscal deficits now is China, not the US. Contrary to common myth, Keynes did not argue for deficit spending in Great Britain to solve the Great Depression. He argued for deficit spending in the United States, because it had a trade surplus with Great Britain

As a Keynesian, that is the policy I support today: deficit spending in China, where they should be because it has a trade surplus with the US.

Contrary to the views of Ms. Coppola, countries are not banks. When a country borrows money it is not acting as a bank; it is acting as a debtor. Every dollar you borrow cedes more power to your creditors. 

The flaw in Ms. Coppola's analogy is that countries do not lend the funds they borrow at a premium over their cost of borrowing. Countries are merely agents of their principals--spending on their behalf. The US fiscal and trade deficit is nothing but consumption spending for which the US is unwilling to pay in taxes. The US writes checks to US transfer payment recipients. These recipients use the checks to buy goods from China. China takes the $$$ and buys US government debt. There is no US investment in the cycle. It is mere consumption financing, nothing more.

More particularly, it is time to stop the World from taking a piece of our valuable assets each year through trade deficits. We are now energy self sufficient, able for the first time in 40 years to export oil. 

Ms. Coppola knows what we should do. It is exactly what Hamilton and Franklin and Morris planned and executed 225 years ago and would do today. Their ideas are as relevant today as Smith's (who after all was tutored by Franklin).