The Road to War (Part I: Trade)

[LeveragedBuyout]

I am starting this thread to document the mounting anxiety, as reflected in the media, that citizens across the world are turning against free trade. Free trade has been a tie that binds the world together, and the breakdown of free trade will inevitably reveal and exacerbate other frictions. This is especially concerning because the country that has benefited the most from free trade over the last 30 years, China, is one of the most skeptical about the benefits of free trade. The United States and Europe are not far behind.

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Watch Out, Obama: Only Israelis Believe Trade Will Cut Prices for Consumers - Real Time Economics - WSJ

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• September 16, 2014, 6:00 PM ET

Watch Out, Obama: Only Israelis Believe Trade Will Cut Prices for Consumers
ByWilliam Mauldin

President Barack Obama and other world leaders are having a tough time selling the benefits of the trade agreements they’re negotiating, in part because much of the public thinks all the talk about trade’s benefits is a bunch of baloney.

Out of 44 nationalities surveyed this year, only one — Israelis — tends to believe the basic tenet of economists that increased trade will foster competition and deliver lower prices for consumers.

On a broader question of whether increasing trade and business ties with other countries is a good thing, only 68% of Americans agree, compared with 76% worldwide, according to the study released Tuesday by the Pew Research Center.

Despite the economic recovery in the last four years, Americans’ positive views toward trade have increased only slightly and remain well below 2002 levels, when 78% thought growing trade and business ties were good. Among Americans, the poor, women and seniors are less likely to see benefits of trade.

To be sure, skepticism about trade is nothing new, and many Americans have watched manufacturing jobs move overseas for a variety of reasons, including international agreements.

Part of the problem is political in the U.S. and Japan, which are leading the negotiations to form the Trans-Pacific Partnership.

Mr. Obama, who supports the TPP negotiations and similar talks underway with the European Union, leads Democratic lawmakers who have typically opposed recent trade deals, partly over concerns about lost manufacturing jobs. Japanese Prime Minister Shinzo Abe faces similar opposition in his own party over farming profits.

To counter this, the Obama administration touts the increased exports that would come from a well-negotiated trade agreement, an outcome likely to boost high-paying manufacturing jobs.

But some business leaders and other backers of trade deals say the president is presenting only half of the equation on trade, focusing on the benefits to U.S. exporters and manufacturers but not to U.S. consumers, who economists say enjoy lower prices, especially on imported goods, when tariffs fall and international competition rises.

For many critics of trade deals, the idea of lower prices through trade deals conjures up big-box retailers with low-paying service jobs and products imported from abroad. Of course, lower prices can also lead to a higher standard of living and greater profitability for businesses.

But don’t tell that to the world’s electorate. Israel is the only country surveyed by Pew where a majority–58%–says international trade leads to price cuts. In the U.S., only 35% accept that proposition (the same as in the Palestinian territories). In China, it’s only 18%.

 

[FairAndUnbiased]

As I said before, China had zero benefit from free trade during the 80's and barely broke even in terms of relative wealth in the 90's with the Cultural Revolution days. GDP per capita actually decreased during some years of the 80's, despite population growth also decreasing in the 80's. The damage that free trade had to the economy in the 90's was immense and there was a real danger of a social breakdown. Some years had 30% inflation. Only for 1/3 of the time has Chinese benefitted, but if a product only worked 1/3 the time, who the hell would buy it?

That is why there is skepticism.

 

[LeveragedBuyout]

As I said before, China had zero benefit from free trade during the 80's and barely broke even in terms of relative wealth in the 90's with the Cultural Revolution days. GDP per capita actually decreased during some years of the 80's, despite population growth also decreasing in the 80's. The damage that free trade had to the economy in the 90's was immense and there was a real danger of a social breakdown. Some years had 30% inflation. Only for 1/3 of the time has Chinese benefitted, but if a product only worked 1/3 the time, who the hell would buy it?

That is why there is skepticism.

Interesting, I hadn't heard that free trade nearly wrecked China in the 1980s and 1990s. Do you have any articles I could read on that?

Do you feel that China's skepticism about free trade is justified since the turn of the 21st century?

 

[Guynextdoor2]

@LeveragedBuyout are you a conservative?

 

[LeveragedBuyout]

@LeveragedBuyout are you a conservative?

Yes.

 

[Guynextdoor2]

Yes.

I think Obama has a much more positive image than you guys give him credit. (I'm DRUNK and can say this without being a democrat, imagine that

 

[FairAndUnbiased]

Interesting, I hadn't heard that free trade nearly wrecked China in the 1980s and 1990s. Do you have any articles I could read on that?

Do you feel that China's skepticism about free trade is justified since the turn of the 21st century?

Yes it is. Free trade is "free" in the sense "free speech" is free. There are conditions and restrictions - problem is, those seem to be severely restricting certain countries, while not others.

List of IMF ranked countries by past and projected GDP (nominal) - Wikipedia, the free encyclopedia

Look at the slide in the 1980's. The GDP increased vastly during the late 90's, but inflation was at 30%, making it questionable as to how much of the growth was due to inflation and how much was real.

China Inflation Rate | 1986-2014 | Data | Chart | Calendar | Forecast

Lifespan increase: vast slowdown post-1980. Life Expectancy in China, Europe, USA and India, 1950 - 2050

There are also few English articles about this, but the privatization in the late 80's, early 90's, especially of healthcare, education and state owned assets, caused immense social pressure.

 

[LeveragedBuyout]

Yes it is. Free trade is "free" in the sense "free speech" is free. There are conditions and restrictions - problem is, those seem to be severely restricting certain countries, while not others.

List of IMF ranked countries by past and projected GDP (nominal) - Wikipedia, the free encyclopedia

Look at the slide in the 1980's. The GDP increased vastly during the late 90's, but inflation was at 30%, making it questionable as to how much of the growth was due to inflation and how much was real.

China Inflation Rate | 1986-2014 | Data | Chart | Calendar | Forecast

View attachment 54733
Lifespan increase: vast slowdown post-1980. Life Expectancy in China, Europe, USA and India, 1950 - 2050

There are also few English articles about this, but the privatization in the late 80's, early 90's, especially of healthcare, education and state owned assets, caused immense social pressure.

I don't see how this was caused by free trade. On the contrary, approximately half of the inflation suffered by China seems to have been due to poor domestic policy, namely, a devaluation of the yuan and loose monetary policy. Strong inflation in a rapidly growing economy is also not unusual.

http://www.hkma.gov.hk/media/eng/publication-and-research/quarterly-bulletin/qb200309/fa3.pdf

Healthcare and education are also not generally affected by free trade, since they are largely labor-driven service sectors, and those services cannot be imported or exported.

 

[FairAndUnbiased]

I don't see how this was caused by free trade. On the contrary, approximately half of the inflation suffered by China seems to have been due to poor domestic policy, namely, a devaluation of the yuan and loose monetary policy. Strong inflation in a rapidly growing economy is also not unusual.

http://www.hkma.gov.hk/media/eng/publication-and-research/quarterly-bulletin/qb200309/fa3.pdf

Healthcare and education are also not generally affected by free trade, since they are largely labor-driven service sectors, and those services cannot be imported or exported.

The logic is this:

Free trade, internationally, is often correlated with privatization domestically. One can almost never happen without the other, since being free trading internationally means that a company must try to find its proper pricing, and for each market that is very different. Thus, there is no economy of scale.The devaluation of the yuan and loose monetary policy is also an effect of privatization, following from free trade. Without the depreciation of the yuan, Chinese labor could not have been competitive with southeast asian labor at the time, nor would the productivity be as high as Japanese labor. The only way for Chinese labor to be competitive at that time is to make it extremely cheap through artificially suppressing domestic buying power.

Indeed, free international trade for a developing economy is essentially suppressing domestic buying power. Command economies also do this, but for scientific advancement and moving up the ladder value like the USSR - it quickly moved up the value ladder from agriculture in the 1920's to automotive and shipbuilding in the 1940's and then aerospace in the 1960's. That is essentially an investment based regime, where purchasing power is suppressed for science investments.

Here is why free trade correlates to privatization and the suppression of domestic buying power: the point of exporting is to make a higher profit than domestic sales due to some form of arbitrage. In the case of developing countries, it is labor and resources; for developed countries, it is intellectual property. In developing countries, if you could export, then there is no need to price your goods for the domestic market: the export market is bigger and prices are higher. Domestic prices then rise to the level of the goods in the international market. However, domestic wages CANNOT rise accordingly - if they did, then the international prices would go up OR the employers will have to reduce number of jobs, since rising wages squeeze profits. If you want wages to go up, then something has to go - namely, employer financed healthcare, interests on loans, and tax funded social security. That is the real reason for the privatization of healthcare, education, loose monetary policy, etc. It is all to support a labor intensive export based economic regime.

That is why I disagreed that the 2005 appreciation of the RMB was due to external pressures - it was actually due to extremely severe internal pressure to end the export based regime and move to an investment based regime.

 

[LeveragedBuyout]

The logic is this:

Free trade, internationally, is often correlated with privatization domestically. One can almost never happen without the other, since being free trading internationally means that a company must try to find its proper pricing, and for each market that is very different. Thus, there is no economy of scale.

No argument from me here.

The devaluation of the yuan and loose monetary policy is also an effect of privatization, following from free trade. Without the depreciation of the yuan, Chinese labor could not have been competitive with southeast asian labor at the time, nor would the productivity be as high as Japanese labor. The only way for Chinese labor to be competitive at that time is to make it extremely cheap through artificially suppressing domestic buying power.

This is where you lose me. Chinese wages were already objectively cheaper than Western wages; a devaluation wasn't necessary to fulfill that condition. Furthermore, Chinese wages were already cheaper than competitor nations in Southeast Asia (see http://vbn.aau.dk/files/33796055/DIR_wp_114.pdf pp. 33 of the pdf/marked p. 29 on the left hand side). It's true that the RMB was grossly overvalued, but that was because a strong RMB was required by the closed Chinese economy to purchase much-needed imports. Once the economy opened up and exports could start generating hard currency, the RMB could be allowed to depreciate, which in turn would increase exports through price competitiveness, etc. In effect, it was opening up the economy that allowed China the breathing room to depreciate the currency, not the other way around.

Indeed, free international trade for a developing economy is essentially suppressing domestic buying power. Command economies also do this, but for scientific advancement and moving up the ladder value like the USSR - it quickly moved up the value ladder from agriculture in the 1920's to automotive and shipbuilding in the 1940's and then aerospace in the 1960's. That is essentially an investment based regime, where purchasing power is suppressed for science investments.

Agreed.

Here is why free trade correlates to privatization and the suppression of domestic buying power: the point of exporting is to make a higher profit than domestic sales due to some form of arbitrage. In the case of developing countries, it is labor and resources; for developed countries, it is intellectual property.

Agreed.

In developing countries, if you could export, then there is no need to price your goods for the domestic market: the export market is bigger and prices are higher. Domestic prices then rise to the level of the goods in the international market. However, domestic wages CANNOT rise accordingly - if they did, then the international prices would go up OR the employers will have to reduce number of jobs, since rising wages squeeze profits. If you want wages to go up, then something has to go - namely, employer financed healthcare, interests on loans, and tax funded social security. That is the real reason for the privatization of healthcare, education, loose monetary policy, etc. It is all to support a labor intensive export based economic regime.

Again, you lose me here. Why do domestic prices have to rise to the level of goods in the international market? The international market does not have unlimited demand, so some output will be provided for the domestic market. Since, as you have correctly argued, Chinese labor costs were advantageous compared to international competitors, this additional output could be sold domestically and still produce a profit. Free trade isn't an all-export or no-export proposition, it can accommodate both markets.

Furthermore, the reason to privatize industries is to make them more productive. Privatized industries don't need taxpayer subsidies, and they produce more profit (and thus tax revenue), which both helps the fiscal position of the government and also increases the GDP growth rate. Productivity growth allows wages to rise without inflationary pressures, and as long as the productivity growth is faster than competitors, it doesn't impact the price advantage, either.

That is why I disagreed that the 2005 appreciation of the RMB was due to external pressures - it was actually due to extremely severe internal pressure to end the export based regime and move to an investment based regime.

But we never established in the other thread what those "severe internal pressures" were. It wasn't inflation, which was tame since the late 1990s. The Chinese current account surplus continued to grow even after the RMB appreciation started in 2005, so it wasn't the growing forex reserves or treasury holdings. What were those internal pressures, and can you please quantify them? And how did allowing the RMB to appreciate address those internal pressures?

 

[FairAndUnbiased]

Again, you lose me here. Why do domestic prices have to rise to the level of goods in the international market? The international market does not have unlimited demand, so some output will be provided for the domestic market. Since, as you have correctly argued, Chinese labor costs were advantageous compared to international competitors, this additional output could be sold domestically and still produce a profit. Free trade isn't an all-export or no-export proposition, it can accommodate both markets.

But the domestic prices did rise to the export level, and that is why people are skeptical. iPhones, Nikes, Coach, Samsung, etc. are all sold for the same prices in both domestic and export markets despite them being made in China. Even Lenovo, etc are sold for the same price in export and domestic markets because they gain the majority of their income from export markets. I didn't know about that myself until I purchased a Lenovo laptop. The only companies that sold for "domestic prices" were those who did not export at all due to a saturated export market, and they suffered from much lower profit margins. Many survived only because of neglect by competitors (Li Ning) or because of their own intellectual property (Huawei, Inspur).

I will address these points later one by one. They are good points.

 

[LeveragedBuyout]

But the domestic prices did rise to the export level, and that is why people are skeptical. iPhones, Nikes, Coach, Samsung, etc. are all sold for the same prices in both domestic and export markets despite them being made in China. Even Lenovo, etc are sold for the same price in export and domestic markets because they gain the majority of their income from export markets. I didn't know about that myself until I purchased a Lenovo laptop. The only companies that sold for "domestic prices" were those who did not export at all due to a saturated export market, and they suffered from much lower profit margins. Many survived only because of neglect by competitors (Li Ning) or because of their own intellectual property (Huawei, Inspur).

I will address these points later one by one. They are good points.

For electronics, the labor cost component is a very small part of the cost, and therefore the price is not as flexible; in fact, many of the components in those electronics must be imported from international sources (either tangible hardware or IP licensing), so it's natural that they would reflect the international price. But not all products are like that. The whole idea of PPP is that prices will adjust to accommodate local purchasing power, and are not consistent on an absolute price level basis across the world. The most famous example is The Economist's Big Mac Index. It has a nice interactive graph, but in the text portion, it explains the following:

THE Big Mac index was invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of an identical basket of goods and services (in this case, a burger) in any two countries. For example, the average price of a Big Mac in America in July 2014 was $4.80; in China it was only $2.73 at market exchange rates. So the "raw" Big Mac index says that the yuan was undervalued by 43% at that time.

So the local price of a Big Mac in China is indeed cheaper, as it is for a whole range of products that can be produced locally.

 

[LeveragedBuyout]

The TPP’s Biggest Obstacles | The Diplomat

The TPP’s Biggest Obstacles
Americans and Japanese are far less supportive of trade than the public in other TPP countries.

By Zachary Keck
September 17, 2014

People in the United States and Japan are overwhelming opposed to the Trans-Pacific Trade Partnership (TPP), according to a new survey.

On Wednesday the Pew Research Center released a major report on public opinion regarding international trade in numerous countries across the world. While support for trade is widespread globally, it was far more robust in emerging and developing countries than in developed ones. Even among the latter group, Japan and the United States were among the most downcast in their views of the benefits of global trade.

For example, just 19 percent of the world believes trade is destructive to employment in their country. However, no less than half of the American populace and 38 percent of Japanese respondents say that trade hurts jobs in their countries. Similarly, while only 21 percent of the world believes that trade lowers wages, this number rises to 47 percent in the United States and 37 percent in Japan. Just 10 percent of Japanese believe trade increases wages compared with 17 percent of Americans. Globally, those believing that trade increases wages outnumber those who believe the opposite by a two-to-one ratio.

These views put Japan and the United States starkly at odds with the other TPP countries surveyed by Pew, including Vietnam, Malaysia, Chile, Peru and Mexico.

Vietnamese are the most favorable towards trade among TPP countries; 95 percent of respondents in that country say trade is good. Similarly, 78 percent of Vietnamese say trade creates jobs, 72 percent say it increases wages and 31 percent say it decreases prices. In all but the last category, Vietnam led other TPP countries surveyed.

Malaysia was close behind with 87 percent of respondents in that country saying that trade is good, 57 percent saying it increases jobs, 47 percent saying it increases wages while only 9 percent believes it reduces prices.

Besides Japan and the United States, Mexico was the least favorable towards trade among the TPP countries surveyed. Just 43 percent of Mexicans say that trade increases employment, 31 percent say it increases wages, and 24 percent say it reduces prices. Still, Mexico compares favorably to Japan where only 15 percent believe trade increases jobs and just 10 percent say it increases wages.

Americans were only slightly more favorable than their Japanese counterparts in this regard, with 20 percent of them saying that trade creates jobs and 17 percent saying it increases wages. Notably, 35 percent of Americans say trade reduces prices, which was the highest among the TPP countries surveyed (it’s worth noting that trade likely decreases prices more in advanced economies like the United States and Japan than it does in developing countries).

Still, Americans are the least supportive of trade generally, with only 68 percent of them saying that trade is a good thing. Japanese were a close second with only 69 percent of respondents in that country saying trade is good. Over 80 percent of people globally say that trade is good.

The survey underscores that Japan and the United States are likely to face the strongest opposition domestically in ratifying the TPP. Interestingly, opposition to the TPP is likely to be strongest among the political parties of Prime Minister Shinzo Abe and President Barack Obama. In Japan, Abe’s Liberal Democratic Party has close ties to influential interest groups who oppose the TPP, especially the agricultural lobby.

Despite the treaty of the text still being negotiated — and few details are known about any of it — Democratic members of Congress have repeatedly spoken out about the treaty in large numbers. President Obama has alsofailed to gain the fast track authority that many believe is essential to getting the TPP approved in a form that is acceptable to America’s negotiating partners. Likely Democratic presidential candidate Hillary Clinton has also said that she doesn’t believe the treaty could pass the U.S. Congress in today’s political climate.

 

[tonyget]

@LeveragedBuyout

Here is my interpretation regarding China's inflation issue:

Chinese Yuan is not freely convertible currency, that means money flow into the country is easy, the other way around is hard. The dollar earned from export is converted into RMB. As China export volume increase, gov has to print more and more RMB to buy all those dollars from exporter, and this larget amount RMB will flow into China's domestic market, thus create inflation.

 

[LeveragedBuyout]

@LeveragedBuyout

Here is my interpretation regarding China's inflation issue:

Chinese Yuan is not freely convertible currency, that means money flow into the country is easy, the other way around is hard. The dollar earned from export is converted into RMB. As China export volume increase, gov has to print more and more RMB to buy all those dollars from exporter, and this larget amount RMB will flow into China's domestic market, thus create inflation.

It's not just a capital account problem, it's also a current account problem. The dollar peg is increasingly costly to maintain, and I've been hammering this point home almost since I joined the forum half a year ago: the gigantic size of China's forex reserves is not a strength for China, but rather a burden. This is why the "reform and rebalance" is necessary, even though every time I write about this it seems to bring the ultra-nationalists out of the woodwork. Here was an article about it from back in 2011:

http://online.wsj.com/articles/SB10001424052748703796504576167593708301706

External Surpluses Root Cause of China's Inflation Problem

Updated Feb. 26, 2011 8:11 a.m. ET
BEIJING—China's large external imbalances, combined with its interventions in the foreign -exchange market, are the "root cause" of the country's current inflation problem, Yi Gang, vice governor of the People's Bank of China, said Saturday.

China should increase the flexibility of the yuan exchange rate and undertake a number of internal structural changes to reduce its trade surplus, Mr. Yi said, adding that China's focus should be on boosting imports rather than suppressing exports.

In a wide-ranging lecture at a university in Beijing, Mr. Yi also rejected many criticisms often heard in China of the central bank and its investment of foreign exchange reserves, saying it would be difficult to diversify the reserves into commodities or other alternative assets.

China's large "twin surpluses" in the current account and capital account have created massive inflows of foreign currency. The PBOC buys up those inflows by issuing newly minted yuan, thus swelling the money supply and adding to inflation pressures, Mr. Yi said.

"Why do we have so much base money? Why is the money supply relatively loose? A major reason is that our surpluses are too large," Mr. Yi said. "To maintain the basic stability of the yuan exchange rate, the central bank buys up foreign exchange inflows. If it didn't, the yuan wouldn't be so stable."

In addition to boosting the flexibility of the yuan exchange rate, China also should adjust resource prices to address imbalances, he said, as many resources are still traded in China at below their natural prices. China also should boost wages and social benefits to lift consumption, step up its enforcement of environment regulations and undertake other structural reforms to address imbalances.

After the PBOC buys up foreign exchange inflows, it attempts to "sterilize" or offset the newly created money supply by ordering banks to hold more funds in reserve and by issuing central bank bills. But Mr. Yi said such sterilization operations have costs to the central bank, as it must pay interest to banks on the bills and the reserve funds that they park with the central bank.

"We have been undertaking sterilization efforts to lock up excessive liquidity and maintain price stability," Mr. Yi said. "But all these actions have costs. We have to take into account the marginal costs and benefits if this state of affairs persists."

Many in China argue that inflows of "hot money," short-term capital that seeks to benefit from yuan appreciation and interest-rate arbitrage, are also a main factor behind China's foreign reserve accumulation and a source of imported inflation pressures.

However, estimates released last week by the State Administration of Foreign Exchange--a unit of the central bank that Mr. Yi also heads--showed such hot money inflows to be relatively limited, with just $35.5 billion of net inflows last year. Mr. Yi said the figures demonstrate that hot money inflows account for a small part of total reserve accumulation and that China's current and capital account surpluses are the main factor.

Some analysts inside and outside of China said SAFE's figures likely underestimate the true level of hot money inflows, as many such inflows are deliberately disguised as ordinary current account transactions. Mr. Yi acknowledged that this takes place to a certain degree but defended the overall accuracy of SAFE's estimates. Estimates by foreign countries such as the U.S. of their deficits with China are even greater than China's estimates, he said, indicating that China's estimates can't be significantly understated.

Many Chinese critics of the central bank argue that China should diversify its foreign exchange reserves away from sovereign debt--U.S. Treasury bonds in particular--and toward other assets such as commodities or even land. Mr. Yi said it is difficult for China to diversity into such assets without having a large impact on their market price.