OK, pose the following question to anyone: “why has the US lost over 3 million manufacturing jobs in last 15 years?” I’d bet good money that the answer will be free trade or maybe NAFTA. It’s just common knowledge. Duh. As paleoconservative Pat Buchanan puts it “Between January 2002 and January 2007, the gargantuan U.S. trade deficit set five straight world records…If this is the fruit of a successful trade policy, what would a failed trade policy look like?” (1) Or Barack Obama who agrees with Pat on approximately nothing is actually in perfect harmony here “It's a game where trade deals like NAFTA ship jobs overseas and force parents to compete with their teenagers to work for minimum wage at Wal-Mart.” I’ve even heard Lou Dobbs isn’t a fan. I guess John McCain still supports free trade, but never really gives a rationale for it. That seems pretty standard these days, I mean, look at the embarrassing attempts the guy defending free trade makes in this debate. Countries like China have much lower wages, fewer labor protections and environmental standards so of course every company that can would up and leave the United States if there were no trade barriers. It’s that simple.
Well, that’s a pretty good argument with only one small flaw… it’s complete, utter bullshit. It’s actually not very hard to prove this too, which I just happen to be in the mood to do. Actually, scratch that, I’ll let renowned economist Henry Hazlitt do it for me, suppose
An American exporter sells his goods to a British importer and is paid in British pounds sterling. But he cannot use British pounds to pay the wages of his workers, to buy his wife’s clothes or to buy theater tickets. For all these purposes he needs American dollars. Therefore his British pounds are of no use to him unless he either uses them himself to buy British goods or sells them to some American importer…” (2)
For all intensive purposes the United States is the only country that uses the dollar.* Every dollar that leaves our country must eventually come back. Foreigners could buy up some manufacturing plants here, but if they move them out of the country, any profits they got from the United States would still have to be spent in the United States.
So there really shouldn’t ever be a trade deficit of any major significance. Oh, but you’re saying there are. Well two points need to be made, first in general and then specifically with regards to the United States.
In general, obviously currencies don’t leave and come back instantaneously. There will be up and down cycles. It’s also hard to account for every economic transaction-taking place between individuals in one country and another. This is especially true given there are often large black markets in even the freest economies. And lastly, well governments just lie sometimes. This all becomes obvious when you look at the CIA factbook for 2007, which says the world as a whole is running a $178 billion dollar trade surplus.** This of course is impossible.
Accounting issues only explain small discrepancies though. The United States is a very peculiar case. We just happen to hold the reserve currency of the world. To explain what this is and how it came about we have to go back to the end of World War II. After the war, the Allied governments wanted to set up a system that would facilitate international trade and prevent the hyper nationalistic protectionism of the 1930’s that helped spur the Second World War. John Maynard Keynes and Harry Dexter White designed a system known as Bretton Woods, in which every country in the American sphere of influence tied their currency to the US dollar at a fixed exchange rate and the dollar was in turn tied to gold at $35 and ounce.
Unfortunately, this system was doomed from the beginning; the problem was well, it relied on a wise fiscal policy by US politicians. In 1971, after a decade of paying for guns and butter (the Vietnam war and the Great Society) by inflating the dollar, the US government could no longer justify the $35/ounce exchange rate. Foreign investors started asking for their gold and Nixon responded by closing the gold window (effectively declaring bankruptcy).
The fixed exchange rate system was eventually replaced with floating exchange rates with no gold backing. This allowed investors to set currencies values by bidding on them in relation to each other. Now this system works in principal, but unfortunately it opens up countries to currency attacks. If a government enacts poor policies, investors can leave that currency en masse. Or powerful countries can simply defund a weaker country if they don’t like its policies. Regardless, it leaves countries vunerable as illustrated by the most famous example of such currency implosions, the Asian Financial Crisis of 1997.
To avoid these crises (and store a "risk free" currency in case of other problems), governments started stockpiling dollars in reserve to act as a bulwark in case their own currency is attacked. While the dollar was the reserve currency under Bretton Woods, as well as the 70’s and 80’s, governments stockpiles really accelerated 1990’s and 2000's when China started taking off and the fall of communism brought with it a whole host of new countries who, lacking Soviet support, needed to start stockpiling dollars.
Hopefully you can see where this is going. The dollars are no longer coming back to the United States. We buy toys from China and oil from Saudi Arabia and cars from Japan and electronics from Taiwan and cocaine from Mexico and they turn around and stuff those dollars in their central banks. This does two things; first companies no longer have to buy anything from the United States, they can simply outsource their factories and then sell the dollars they collect to the host countries central bank and thus our manufacturing sector is hollowed out. Second, it gives the US government a license to print just about infinite money with out producing inflation.
So now we can have guns and butter part deux but with out the inflation. How wonderful! Unfortunately, as Herb Stein once said, “things that can’t go on forever don’t.” The dollar currently makes up 63.8% of foreign reserves with the euro in a distance second at 26.4%. Unfortunately, as you’ve probably noticed the dollar is sinking in value like a rock. We are printing so much money that central banks are becoming nervous and diversifying into the euro and other currencies. Eventually, if our dollar continues to sink they will pull the plug and all those dollars will come rushing back to the United States. If this happens, the dollar will hyperinflate overnight.
While we may very well be starring a crisis in the face, free trade has nothing to do with it. And free trade certainly has nothing to do with our dwindling manufactuing sector. Anyways, we really don’t even have free trade, as NAFTA and the WTO are managed trade agreements that have plenty of tariffs and subsidies snuck into them. As Milton Friedman said when Charlie Rose asked him about the proposed Central American version of NAFTA “I discovered it was a thousand pages long and every page has exceptions to free trade. It’s not a free trade agreement.” (3) Still, what we have isn’t rampant protectionism either. However, if we just throw up a bunch of tariffs right now other countries would simply retaliate (or possibly sell off their dollars) and prices would rise with out our manufacturing sector returning. It would be Smoot-Hawley all over again. It’s that simple.
*There are technically 10 small countries that also use the dollar (usually secondarily to another currency). However, since the dollar is usually secondary and the countries are small this has a relatively small effect on trade balances. In addition, the fact these countries use the dollar is simply more evidence of the whole dollar hegemony problem.
**The CIA doesn’t have data on seven small countries and a few have old data. However, every country with old data has a deficit/surplus fewer than 100 million dollars and similar estimations can be made for the seven exclusions which include the likes of North Korea. These discrepancies certainly wouldn't even get close to adding up to 178 billion dollars.
(1) Patrick Buchanan, Day of Reckoning: How Hubris, Ideology, and Greed are Tearing America Apart, Pg. 203, Thomas Dunne Books, Copyright 2007
(2) Henry Hazlitt, Economics in One Lesson, Pg. 70, Laissez Faire Books, Copyright 1979
(3) Milton Friedman, An Hour with Nobel Prize-winning economist Milton Friedman, Charlie Rose, PBS, 12/26/2005
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