Kudlow on the Trade Deficit

Today, with the release of January's $58.3 billion dollar trade deficit (the second worst monthly result on record), the enormity of the imbalance was once again overshadowed by the rhetoric immediately following its release. As he has in the past CNBC's Larry Kudlow extolled the virtues of the trade deficit as reflecting America's superior economic growth, while chastising Europe and Japan for not doing their fair share in moving the world's economy forward.

In essence, Mr. Kudlow criticized Europeans and Japanese as being economic slackers (because all they do is save money and manufacture products), while praising Americans, who borrow those savings and consume those products, for doing all the hard work. Give me a break.

When asked if he though the fact that Americans were "living beyond their means was a problem" Kudlow's reply was to deny that they were. Apparently, he believes that one's means are merely a function of how much one can borrow. It reminds me of the old joke about the housewife who was amazed to discover that her checking account was overdrawn as there were still unused checks remaining in her book. Further, when asked if he believed that the debt Americans were accumulating was problematic, he assured the television audience that it was not, because "Americans were putting the money to good use." I'm not exactly sure to what good use he is referring, as American's borrow mainly to consume. Imagine trying to convince a banker to loan you money on the grounds that you would put it to good use by buying a big screen T.V. and taking a vacation.

Mr. Kudlow's rhetoric typifies an ongoing Wall Street, government, and media propaganda effort that would even amaze George Orwell. I have addressed these ridiculous arguments many times in the past, but rather than rehashing them, I offer some of my past commentaries in response to similar statements on this issue made by John Snow and Arthur Laffer.

January 13, 2005

John's Snow Job on the Record Trade Deficit

In reaction to yesterday's release of a record trade deficit, Treasury Secretary John Snow continued with his Rumpelstiltskin routine of characterizing disastrous economic news as if it were just the opposite. Here's a quick look at yesterday's zingers:

Snow attributed the unexpected import surge to wealthy foreigners refusing to buy American products. However, the problem is not that foreigners shun American products, but simply that America is not producing any that are worth buying. After all, if Americans themselves aren't buying American products, how can we expect foreigners to do so? And if wealthy Europeans decided to consumer more, as the Secretary alleges they should, they would most likely do their shopping in China, just like Americans. How would that improve America's trade imbalance?

Furthermore, Snow claims that the growing deficit results in part from the American economy growing faster than that of its trading partners. To anyone even remotely familiar with economic statistics, this assertion is absurd on its face. America's largest and fastest growing trade deficit is with China, a nation experiencing economic growth at a rate nearly three times than that of the U.S.!

Further, Snow confuses consumption with growth. It is not that the American economy is growing faster than many others; it's just that its citizens are accumulating more consumer debt then are their less irresponsible foreign counterparts. Those "slow growth" economies are simply living within their means. Snow also stated that the faster growing U.S. economy creates greater disposable income, enabling Americans to buy imports. However, this misses the point that it is debt, not income that is growing. What really allows Americans to buy imports is foreign lending, not domestic income.

White House spokesman Scott McClellan said President George W. Bush sees the record trade deficit as evidence that "the United States economy is the economic engine for world growth" and that "American prosperity enables us to shop in the global marketplace, buying more goods than citizens of slower growing economies." Talk about putting the cart before the horse. Rather than being the engine for world growth, the U.S. economy is the caboose. American consumption doesn't drive global production, it's the reverse. It's not American prosperity that allows them to shop, but foreign generosity.

Many other Wall Street economists have also weighed in on this subject, with few exhibiting any real understand of the problem, or the ramifications surrounding its ultimate resolution. One economist remarked "U.S. consumers have a huge demand for imported goods and the means to pay for them." The reality is they lack the means to pay for them, (the means being exports) which is why there is a trade deficit in the first place. Foreigners are supplying the means… by lending the money.

Another popular explanation of the record deficit is that it is evidence of the "J-curve," an economic model that holds that currency led trade adjustments initially produce larger deficits before the situation ultimately improves. The problem with this explanation is that the dollar has been falling for three years, and the trade deficit just made a new record high. Just how elongated is the "J" supposed to be before it swerves up? If a 30% decline over three years hasn't made a difference, why should we expect anything different in the future?

January 4, 2005

Laffer on the Trade Deficit

In the 1980's Arthur Laffer gained fame by sketching his controversial "Laffer Curve" on a cocktail napkin. In an interview today on CNBC Mr. Laffer lead me to believe that the same napkin could probably provide enough surface area to hold the sum total of his economic wisdom. In a stunning display of economic ignorance and media propaganda, Laffer not only explained why the gargantuan U.S. trade deficit was not a problem, but argued that an even bigger one would be even better. Come again?

In an attempt to explain why such deficits can exist indefinitely, Laffer compared today's current account deficits to those seen during America's first two hundred as a developing nation. This flawed comparison over looks the fact that as a developing nation, America borrowed to invest, resulting in current account deficits that funded the construction of vast infrastructure, such as roads, bridges, ports, and rail roads, as well the formation of capital equipment, farms, and factories, all of which fueled American productivity. Such investments enabled the production of vast quantities of consumer goods, which America sold back to its creditors, to both pay interest and retire principle. In the end, America's creditors got consumer goods, and America became the wealthiest industrial nation the world had ever seen, in the process turning its current account deficits into enormous surpluses.

In a "night and day" contrast, today's current account deficit has the much more limited role of solely financing consumer spending. By squandering borrowed money on consumption, America has no way to repay the principal of its debts, let alone the interest. Borrowing to build a factory is not the economic equivalent of borrowing to buy a television set, and it's amazing that Laffer can't see the difference.

Second, Laffer defends the trade deficits as resulting from the vastly superior investment returns available in America. His argument is that a capital account surplus necessitated a current account deficit. Talk about putting the cart before the horse. According to Lafferese, foreigners sell products to Americans to earn dollars, so that they can "invest" in America to achieve superior returns. This ridiculous logic overlooks the fact that much of these earrings are simply invested in low yielding government and corporate bonds, with a significant portion being purchased by foreign governments. If as Laffer maintains, investment returns in the U.S. really are far superior to those available else where, why are foreign central banks doing so much of the "investing?" Where is all the private capital seeking those alleged superior returns?

Lastly, when asked if a six hundred billion dollar trade deficit was a good thing, wouldn't a one trillion dollar deficit be even better, Laffer's round about response was basically, yes, the bigger the better.

11 March 2005

Peter Schiff

C.E.O. and Chief Global Strategist

Euro Pacific Capital, Inc.

[email protected]

www.europac.net