Trade Wind Turbulence

April 8, 2018

Remember the clip of Jack Nicholson In the 1980 movie The Shining? Jack hacks his way through a door with an axe, then presses his face to the jagged hole and announces, “It’s Johnny!” Substitute “Trade Wars” and we get a dramatic portrayal of the stock market this past week. On several days, the Dow swung 700+ points, or more than 2%, in response to fears of a tariff feud between the U.S. and China.

The share of global commodities that China consumes far exceeds its share of the world’s population (1/5) or the global economy (1/6). Here’s a chart from Visual Capitalist.

On Thursday, the market opened almost 2% down in response to comments from the chief Tweety Bird in the White House. Later that morning, Larry Kudlow, Trump’s new NEC Director, did a quite effective job of easing market jitters. Kudlow has been a host of CNBC and his own radio program for many years and is savvy to shifting sentiments. No, he said, Trump is a free trader in disguise. This is just a bargaining tactic. The market started the day 500 points down and finished up 240 points.

This is a trader’s market. Much of the price action is taking place in the last hour of the trading day. Each price recovery since mid-March has failed, so the overall sentiment is negative and Friday’s trading was near the 200-day average. For an investor who has not yet made their 2017 IRA contribution, buying now is somewhat equivalent to dollar cost averaging over the past nine months. For those with shorter time horizons, cash looks good till the market finds its head.

The Labor Report for March showed job gains of just 103,000. This was below the 175,000 anticipated gains and far below ADP’s 240,000 estimate of job gains. Mid-March weather on the east coast may have had a negative effect on this month’s survey. The average of the BLS and ADP surveys is 172K, and I find that average to be a more accurate long-term estimate.

The BLS recently released a report on unemployment rates and weekly earnings classified by degree. This chart is a dramatic picture of the advantages of higher education.

VividMaps released a map showing the income needed to buy an average home in each state. Because the data uses average house prices, the map overstates the affordability problem for many families but does reveal the underlying trend. Why do I say overstates? The average home price is far above the median price because extremely expensive homes raise the average.

First quarter earnings to be released in the next two weeks are expected to show strong annual growth. Will the confirmation of rosy expectations overcome the darker fears of a global trade war? Stay tuned.

The Donald and the Washington Post

March 22, 2016

The editorial board and several other employees at the Washington Post recently sat down with Donald Trump.  Here is a transcript of the conversation .

Here are some highlights.   Donald rambles a lot but I think I got the kernel of his responses.  I think my edited version does Donald more justice than the sometimes incoherent responses he actually gave. He really is not ready for prime time. At this point in the campaign his responses to questions about foreign policy, international trade, and other issues mentioned on the campaign trail should be more practiced, not the rambling sentiments that any of us might have in a conversation with a co-worker at a lunch break.

WP = Editorial staff at Washington Post, DT = Donald Trump.  I’ve included some context where I thought it might be needed.

WP: “is there a secretary of state and a secretary of defense in the modern era who you think have done a good job?”

DT: “I think George Shultz [Reagan’s Sec’y State] was very good, I thought he was excellent.”  “I think your last secretary of state [Hillary Clinton] and your current secretary of state [John Kerry] have not done much.”  Trump uses the word “your” to indicate that media institutions are partisan and biased, and including the WP in the liberal media. It indicates that Trump’s essential sense of the world is polarized, a game of warball.  That may be the case in Washington but it mutes Trump’s appeal among independent voters who have less polarized outlooks. Trump offered an example of Kerry’s bad negotiating tactics with Iran: “We should have had our prisoners before the negotiations started.”

In response to a question about promoting values like democracy and freedom around the world,
DT: “I don’t think we should be nation building anymore,” indicating that he is not a neo-con. “We’re sitting probably on a bubble and, you know, it’s a bubble that if it breaks is going to be very nasty. And I just think we have to rebuild our country.”   Trump is not the only person who thinks that extremely low interest rates for seven years have over inflated stock, bond and housing values.  Trump immediately changes the subject and endorses infrastructure spending, aligning himself with economists Paul Krugman, Robert Frank, and others who recommend large Federal stimulus programs to repair infrastructure and employ those with low to modest educational backgrounds.  Trump recalls that we built schools in Iraq, and rebuilt them several times when they got bombed “and yet we can’t build a school in Brooklyn. We have no money for education, because we can’t build in our own country. And at what point do you say hey, we have to take care of ourselves. “

WP: “So what would you do for Baltimore [as an example of a city with troubled inner neighborhoods]”

DT: “I’d create economic zones. I’d create incentives for companies to move in. I’d work on spirit because the spirit is so low… unemployment for black youth in this country, African American youth, is 58-59 percent.”  These are called enterprise zones and have been used with mixed success in the U.S. but particularly in Britain.  See this article

WP: “in general, do you believe there are disparities in law enforcement?”

DT: “I’ve read where there are and I’ve read where there aren’t…I have no opinion on that.  We have to create incentives for people to go back and to reinvigorate the areas and to put people to work…we have lost million and millions of jobs to China and other countries.”   When Trump doesn’t like the topic, law enforcement, he switches subjects to an old refrain, jobs lost to China, and now Mexico. “Mexico is really becoming the new China.”

WP, returning to the topic:  “There is disproportionate incarceration of African Americans vs. whites. Is that something that concerns you?”

DT: “It would concern me. But at the same time it can be solved to a large extent with jobs.”  Some economists and social scientists have championed this idea that people in poor neighborhoods will choose  legal employment if presented with better job prospects.  Over time, residents in the area will become more committed to the neighborhood, to the protection of their property, to law and order.

WP: “Baltimore received a lot of federal aid over the years. What’s different specifically about your approach to these issues from what’s been tried in the past, because a lot of effort has been put in just the direction you just described.”

DT: “I think what’s different is we have a very divided country.”  He goes on about how divided the country is, as if we didn’t already know that.  How does that answer the question about Baltimore? “I thought that President Obama would be a great cheerleader for the country. And it just hasn’t happened. You have to start by giving them hope and giving them spirit and that has not taken place. I actually think I’d be a great cheerleader for the country.”

WP: “What presidential powers and executive actions would you take to open up the libel laws?”

DT: “I’ve had stories written about me … that are so false, that are written with such hatred.  I think libel laws almost don’t exist in this country.  I think that [the media] can do a retraction if they’re wrong. They should at least try to get it right. And if they don’t do a retraction, they should, they should you know have a form of a trial. I don’t want to impede free press, by the way.”

WP: “So in a better world would you be able to sue [the Post]?”

DT: “In a better world I would be able to get a retraction or a correction. Not even a retraction, a correction.”

WP: “Would you require less than [actual] malice for news organizations?”  “Actual malice” is a legal standard, a criteria for liability for libel set up the Supreme Court in 1964.  See below.

DT: “I would make it so that when someone writes incorrectly, yeah, I think I would get a little bit away from malice without having to get too totally away.”  What does that mean?

WP: “How are you defining ‘incorrect?’ It seems like you’re defining it as fairness or your view of fairness rather than accuracy.”

DT: “Fairness is… part of the word. I’ve had stories that are written that are absolutely incorrect. I’ll tell you now and the word ‘intent’, as you know, is an important word, as you know, in libel.”  Trump then gives an example of a news account of a protester at a Trump rally.  The video tape is edited to make Trump supporters look guilty of unprovoked violence.  Trump says these are professional protesters with trained voices that can be heard throughout a large hall in order to disrupt Trump’s speech or a question from the crowd.  Trump says that news media accounts do not potray these incidents accurately.

Through several questions various people from the Post try to get Trump to acknowledge that Trump condones violence.  Trump insists that he supports law and order, not violence.  Trump’s campaign manager notes that there are repeated public service messages before every rally that the audience should not confront protestors and to let security personnel do that.  Trump repeats that some protesters, when interviewed, say they don’t know why they are there, implying that the protesters are paid agitators by those who want to make Trump rallies look violent.  Some protesters simply interrupt his speeches with shouted obscenities.  Out of 20,000 attending a rally, Trump claims that there are just a few protesters and that they are strategically placed at the rally venue.

WP:  “given the Supreme Court rulings on libel — Sullivan v. New York Times — how would you change the law?”  New York Times v. Sullivan is a 1964 decision by the Supreme Court that there must be a malice standard applied before reporting about a public official can be considered libel.  “Actual malice” is a legal concept that the media outlet knew the information was incorrect or should have known, i.e. that they exercised little or no effort to find the correct information.  After this decision, a person claiming libel in the U.S. must prove the untruth of something published.  This departed from centuries of common law precedent.  In Britain, for example, the defendant of a libel claim must prove the truth of the information they published.

DT: “I’d have to get my lawyers in to tell you, but I would loosen them up.”  Although Trump is not specific on this, I’m guessing that he would like some balance between the strict U.S. system and the Briitish system.  U.S. precedent was based on a problem that existed in the southern states during the early 20th century.

WP: “Would that be the standard then? If there is an article that you feel has hatred, or is bad, would that be the basis for libel?”

DT: “The Washington Post never calls me. I never had a call, ‘Why – why did you do this?’ or ‘Why did you do that?’ It’s just, you know, like I’m this horrible human being. And I’m not.”  If a news organization makes no effort to validate information, is that cause for libel?  “I want to make it more fair from the side where I am, because things are said that are libelous, things are said about me that are so egregious and so wrong, and right now according to the libel laws I can do almost nothing about it because I’m a well-known person.”

WP: “can you talk a little bit about what you see as the future of NATO? Should it expand in any way?”

DT: “Ukraine is a country that affects us far less than it affects other countries in NATO, and yet we are doing all of the lifting, [European members of NATO are] not doing anything.”

WP: “Could I ask you about ISIS, speaking of making commitments, because you talked recently about possibly sending 20 or 30,000 troops”

DT: “I said the generals, the military is saying you would need 20- to 30,000 troops, but I didn’t say that I would send them. I would put tremendous pressure on other countries that are over there to use their troops and I’d give them tremendous air … support because we have to get rid of ISIS. I would get other countries to become very much involved.”

WP: “What about China and the South China Sea?”

DT: “We have trade power over China. I don’t think we are going to start World War III over what they did, it affects other countries certainly a lot more than it affects us. I always say we have to be unpredictable. We’re totally predictable.  And predictable is bad. Sitting at a meeting like this and explaining my views and if I do become president, I have these views that are down for the other side to look at, you know. I hate being so open.”

WP:  Asks about Iraq and ISIS

DT: “We then got out [of Iraq] badly, then after we got out, I said, “Keep the oil. If we don’t keep it Iran’s going to get it.” And it turns out Iran and ISIS basically—”  Trump is interrupted but I wonder if he was going to say that Iran and ISIS were conspiring to get Iraq’s oil?  Iran and ISIS are blood enemies.  Iran embodies the Shia sect of Islam, ISIS is Sunni.

WP: “How do you keep it without troops, how do you defend the oil?”

DT: “I would defend the areas with the oil [with U.S. troops].”  Asserting that Iran is out for Iraq’s oil, Trump says, “Iran is taking over Iraq as sure as you’re sitting there. And I’ve been very good on this stuff. My prognostications, my predictions have become, have been very accurate, if you look.”

WP:  Asks Trump about his claim that he could use trade as a diplomatic cudgel against China’s territorial ambitions in the South China sea.  These disputes involve Vietnam, the Phillipines, and Malaysia.

DT: “You start making it tougher [for Chinese exporters]. They’re selling their products to us for… you know, with no tax, no nothing. If you’re a manufacturer, you want to go into China? It’s very hard to get your product in, and if you get it in you have to pay a very big tax.” “I don’t like to tell you what I’d do, because I don’t want to…”

WP: “This theory of unpredictability …there are many people who think that North Korea invaded South Korea precisely because [Secretary of State Dean] Acheson wasn’t clear that we would defend South Korea. So I’m curious, does ambiguity sometimes have dangers?”  Acheson served under Truman from 1949 to 1953.  In 1950, the N. Korean People’s Army crossed the 38th parallel to invade South Korea.

DT: “President Obama, when he left Iraq, gave a specific date – we’re going to be out. I thought that was a terrible thing to do. [The enemy] pulled back, and after we left, all hell broke out, right?”

WP: “What you’re saying [about European NATO members] is very similar to what President Obama said to Jeffrey Goldberg (Atlantic article) in that we have allies that become free riders. Do you have a percent of GDP that they should be spending on defense? Because it’s not that you want to pull the U.S. out [of NATO].”

DT:  “No, I don’t want to pull it out. NATO is costing us a fortune and yes, we’re protecting Europe but we’re spending a lot of money.”  Again, nothing specific in answer to the question.

WP:  “does the United States gain anything by having bases [in Japan and S. Korea]?”  The Post cites an unnamed public source that the U.S. pays 50% of non-personnel costs to maintain the bases.

DT: “I think we were a very powerful, very wealthy country. And we’re a poor country now. We’re a debtor nation.  We’re spending that [money] to protect other countries. We’re not spending it on ourselves. We have armor-plated vehicles that are obsolete. The best ones are given to the enemy.”  Donald relates that the son of one of his friends has served three tours in Iraq and Afghanistan.  “He said the enemy has our equipment – the new version — and we have all the old version, and the enemy has our equipment.  “We send 2,300 Humvees over, all armor-plated. we have wounded warriors, with no legs, with no arms, because they were driving in stuff without the armor. And the enemy has most of the new ones we sent over that they captured. And he said, it’s so discouraging when they see that the enemy has better equipment than we have – and it’s our equipment.”

There was more, including someone at the Post asking about the size of Donald’s hands.

Free Trade

March 20, 2016

This week’s blog will be about free trade.  Donald Trump first made it one of two signature Presidential campaign issues, then Bernie Sanders joined the chorus and now Hillary Clinton has made it part of her campaign speech. Have trade agreements with other countries put Americans at a disadvantage?

Most economists will not even entertain the idea.  The benefits of free trade are ultimately based on the benefits of specialization, the idea that everyone benefits when the most efficient producers supply a good or service.  Each producer achieves a comparative advantage (CA) in that specialization.   First formalized by economist David Ricardo in the 19th century, CA has long been a bedrock of micro-economic theory and introductory economics textbooks.

Greg Mankiw’s Prinicples of Economics cites the example of a rancher and farmer, who both benefit when they specialize.  The rancher concentrates on raising beef, the farmer raises potatoes and they produce more beef and potatoes at a lower cost than if the rancher and farmer did both. (Chapter 3)

A key concept to understanding CA is another bedrock economic principle:  opportunity cost, or what someone has to give up (the cost) to get some good or service (opportunity).  Each person, each country wants to minimize the cost to take advantage of the opportunity.

The same principle can be extended to international trade.  If a Mexican company can produce a good at a more efficient cost than an American company, then Americans will benefit if they buy the good from Mexico and sell something to Mexico which an American company can produce at a cheaper cost.  The ill effects in a particular part of the country are balanced by the good effects in another part of the country or economy, and lower prices benefit all Americans.

When countries impose tariffs on imports, those goods become more expensive for consumers. Economists talk about the “deadweight loss” from tariffs. Here is a graph of the negative effects of tariffs and more discussion on the topic.

The matter would seem settled then, as economist Paul Krugman noted in a 1987 paper : “the underlying commonality among conventional trade models is such that until a few years ago international trade theory was one of the most unified fields in economics.”

As early as the 1960s, economists questioned some aspects of conventional trade models, leading to the development of new models. Krugman notes, “The new view of international trade holds that trade is to an important degree driven by economies of scale rather than comparative advantage, and that international markets are typically imperfectly competitive.” [my emphasis]

Economies of scale. What’s that? This idea, also called increasing return, is when a producer gets a greater growth in outputs than the growth in inputs.  Increasing returns become a force separate from comparative advantage that leads to a “geographical concentration of production of each good,” or regional oligopolies.  We see this phenomenon in southeast Asia, Indonesia and Australia, where a complex web of materials and components production dominates the global electronics market.

“The view that free trade is the best of all possible policies is part of the general case for laissez-faire in a market economy, and rests on the proposition that markets are efficient. If increasing returns and imperfect competition are necessary parts of the explanation of international trade, however, we are living in a second-best world where government intervention can in principle improve on market outcomes.” [my emphasis]  The new idea in trade models is that strategic trade policy by a government “can tilt the terms of oligopolistic competition to shift excess returns from foreign to domestic firms.”  On the campaign stump, Trump makes the same case, although a bit less elegantly; that the U.S. government should make trade deals that shift the benefits of trade back to American workers and producers.  Is Trump channeling Paul Krugman?

Not quite.  Krugman notes three sometimes vociferous criticisms of government intervention. 1) The difficulty in measuring, understanding and modeling imperfect markets makes it impossible to formulate just the right policy.  2) If the government is going to intervene, companies will devote some resources to compete for favors from government, a process called “rent-seeking.” 3) Markets will make adjustments to offset intervention.  Other governments will initiate policies to counter the effects of a government’s intervention.

Krugman concludes “This is not the old argument that free trade is optimal because markets are efficient. Instead, it is a sadder but wiser argument for free trade as a rule of thumb in a world whose politics are as imperfect as its markets.”  This is the argument that Adam Smith made for laissez-faire capitalism, finding it undesireable but better than the alternatives.  Smith spent considerable effort in his book The Wealth of Nations to recount the degree of political corruption that distorted economies and society, that poisoned the human character.

That Krugman disregards those cautions when he favors government intervention within domestic markets confirms the fact that economists are human.

Economist Ian Fletcher presents far more arguments against free trade than Krugman. I would add an additional consideration.  When economists compute the costs of free trade policies, they use a model which does not include the economic benefits provided to workers displaced by free trade policies.  The costs are presumed to be offset by higher taxes from those areas of the country which benefit from free trade.  Admittably, these costs and additional tax revenues attributable to free trade policies are difficult to measure.  However, I do think that the effort should be made.  I suspect that the benefits paid to dislocated workers and the total negative effect, the multiplier, of the lost economic activity have not been fully accounted for and that free trade is much more costly than conventional models portray.

Even if we can measure and agree on the facts, we can not agree on what those facts mean.  Whatever the facts, we prefer our familiar and favorite idea.  They not only reassure us but are also well integrated into our values, and our philosophical sense of life.