It’s Not Bad Trade Deals–It’s Bad Money, Part 2

By David Stockman

In Part 1 we made it clear that the Donald is right about the horrific results of US trade since the 1970s, and that the Keynesian “free traders” of both the saltwater (Harvard) and freshwater (Chicago) schools of monetary central planning have their heads buried far deeper in the sand than does even the orange comb-over with his bombastic affection for 17th century mercantilism.

The fact is, you do not get an $810 billion trade deficit and a 66% ratio of exports ($1.55 trillion) to imports ($2.36 trillion), as the US did in 2017, on a level playing field. And most especially, an honest free market would never generate an unbroken and deepening string of trade deficits over the last 43 years running, which cumulate to the staggering sum of $15 trillion.

Better than anything else, those baleful trade numbers explain why industrial America has been hollowed-out and off-shored, and why vast stretches of Flyover America have been left to flounder in economic malaise and decline.

But two things are absolutely clear about the “why” of this $15 trillion calamity. To wit, it was not caused by some mysterious loss of capitalist enterprise and energy on America’s main street economy since 1975. Nor was it caused—c0ntrary to the Donald’s simple-minded blather—by bad trade deals and stupid people at the USTR and Commerce Department.

After all, American capitalism produced modest trade surpluses every year between 1895 and 1975. Yet it has not lost its mojo during the 43 years of massive trade deficits since then. In fact, the explosion of technological advance in Silicon Valley and on-line business enterprise from coast-to-coast suggests more nearly the opposite.

Likewise, the basic framework of global commerce and trade deals under the WTO and other multi-lateral arrangements was established in the immediate post-war years and was well embedded when the US ran trade surpluses in the 1950s and 1960s.

Those healthy post-war US trade surpluses, in fact, were consistent with the historical scheme of things during the golden era of industrial growth between 1870 and 1914. During that era of gold standard-based global commerce, Great Britain, France and the US (after the mid-1890s) tended to run trade surpluses owing to their advanced technology, industry and productivity, while exporting capital to less developed economies around the world. That’s also what the US did during the halcyon economic times of the 1950s and 1960s.

What changed dramatically after 1975, however, is the monetary regime, and with it the regulator of both central bank policy and the resulting expansion rate of global credit.

In a word, Tricky Dick’s ash-canning of the Bretton Woods gold exchange standard removed the essential flywheel that kept global trade balanced and sustainable. Thus, without a disciplinary mechanism independent of and external to the central banks, trade and current account imbalances among countries never needed to be “settled” via gains and losses in the reserve asset (gold or gold-linked dollars).

Stated differently, the destruction of Bretton Woods allowed domestic monetary policies to escape the financial discipline that automatically resulted from reserve asset movements. That is, trade deficits caused the loss of gold, domestic deflation and an eventual rebalancing of trade. At the same time, the prolonged accumulation of reserve assets owing to persistent current account surpluses generated the opposite—- domestic credit expansion, price and wage inflation and an eventual reduction in those surpluses.

Needless to say, as the issuer of the gold-linked “reserve currency” under Bretton Woods, the Fed was the first to break jail when it was deep-sixed in 1971-1973. At the time, the freshwater Keynesians led by Milton Friedman and his errand boy in the Nixon/Ford White House, labor economics professor George Schultz, said there was nothing to sweat over.

That’s because the free market would purportedly generate the “correct” exchange rate between the dollar and D-mark, franc, yen etc; and then these market-determined FX rates, in turn, would regulate the flow of trade and capital. Very simple. Adam Smith’s unseen hand all over again.

In fact, not in a million years!

The giant skunk in the woodpile actually smelled of state monetary emissions or what was called the “Dirty Float”. The latter threw everything into a cocked hat because unlike under Bretton Woods or the classic pre-1914 gold standard, the new regime of unanchored money allowed governments to hijack their central banks and to use them as instruments of mercantilist trade promotion and Keynesian domestic macro-economic management.

To be sure, it took some time for traditional central bankers to realize that they had been unshackled. For example, during the final years of his tenure (1970-1978) Arthur Burns caused a pretty nasty recession in 1975 trying to reclaim his reputation for monetary probity after meekly capitulating to Nixon in fueling the 1972 election year boom that finally destroyed the remnants of Bretton Woods entirely.

At length, however, Alan Greenspan inaugurated the era of Bubble Finance in 1987, and the die was cast. During his 19-years at the helm of the Fed, Greenspan massively inflated the Fed’s balance sheet (from $200 billion to $700 billion) and the cost structure of the US economy at a time when the mobilization of cheap labor from the rice paddies of China and east Asia demanded exactly the opposite policy. That is, a policy of Fed balance sheet shrinkage and domestic deflation.

Accordingly, a destructive pattern of reciprocating monetary inflation within the global convoy of central banks was set in motion: The Fed inflated and they inflated in a continuous loop. So doing, the central banks of the world locked-in a permanent condition of unbalanced trade.

The latter originated in the Fed’s flood of excess dollars into the international financial system in the 1990s and thereafter. This, in turn, caused central banks in Asia, much of the EM, the petro-states and sometimes Europe, too, to buy dollars and sequester them in US treasury paper (and GSE securities).

This Dirty Float was undertaken, of course, to stop exchange rate appreciation and to further mercantilist trade and export-based domestic economic policies in China, South Korea, Japan and elsewhere.

But what is also did was enable a sustained debt-based consumption boom in the US that was not earned by current production. The excess of US consumption over production, which showed up in the continuous US current account deficits, was effectively borrowed from central banks (and often their domestic investors).

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