[A-List] Trade Deficit and GDP

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

The following appeared in the print version of the Hong Kong Standard,
which has a new editorial staff and in the process of upgraded the
paper. The new editors have invited me to write a short (750 words)
weekly column. The on-line version will not carry my column until next
month. A longer verion of this will appear in Asia Times on line soon.

What is interesting is that globally, wealth is being transferred from
those with dollar liquidity preference to dollar asset holders, through
low interst rate and a falling dollar, which pushed up an asset price
bubble denominated in dollars, which in turn provides more collateral
for more dollar debt. Wealth effect has replaced income, favoring those
who own over those who earn, or capital over labor in the dollar
economy. Debt is structurally being forgiven big time with asset
inflation but money retains it value through income stagnation.
Consumption is sustained by welath effect rather than earned income
(eages) rise. It is a massive global leverage-buy-out (LBO) not just of
corporations, but of whole economies.

Trade Deficit and GDP Growth

By Henry C.K. Liu

With the 2004 US presidential election drawing near, the trade deficit
is again a campaign issue. Proponents of globalization have long argued
that the US current account (trade) deficit is not a serious concern
since it is being financed by a capital account surplus supplied by
America’s trading partners, providing ample debt financing for the
dollar economy. Imports from low-wage countries have kept dollar
inflation rate low with attendant benefits of low interest rates and
high liquidity. For over a decade, the loss of US blue-collar
manufacturing jobs was accepted as what Fed Chairman Alan Greenspan
called “creative destruction,” a distortion of Joseph A. Schumpeter’s
concept of survival of the economically fittest through continuous
innovation. Notwithstanding 2.1 million jobs have left the US since
President Bush took office in January 2001, the dollar economy has not
lost manufacturing jobs; it merely relocated them overseas for more
productivity per unit of investment. US transnational companies are
still employing a growing global work force for the benefit of US
consumers through cross-border wage arbitrage and dollar hegemony, which
permits a fiat currency of the world’s most indebted nation to retain
the privileged status of reserve currency. Thus when US job growth
slows, the stock market, which measures the global performance of
companies, rises. US labor unions have watched helplessly drastic drops
in membership that translate into loss of political leverage in shaping
US economic policy. Greenspan told Congress that thinking jobs are
better than doing jobs. America will keep high-paying jobs in financial
services, management, design, development, sales and distribution and
let the emerging economies have the low-paying assembly line jobs in
factories owned by US companies. Even small business, a key component in
job creation, is increasingly taking advantage of low-cost
telecommunication and transportation to play the wage arbitrage game
through cross-border out-sourcing. Now that effects of cross-border wage
arbitrage are hitting the high-tech sector, laying off highly-paid US
high-tech workers and giving their jobs to cheaper workers overseas, the
political reverberation are louder. In this jobless recovery, these
better-educated workers have the political clout to turn US policy
towards protectionism.

Yet the structural characteristics of globalization make the prospect of
bringing low-paying manufacturing jobs back to high-wage locations an
impossible dream, unless US workers are prepared to work for
below-living wages and US industries are prepared to live with the
stricter US labor and environmental regulations. The dollar economy
grows at the expense of US domestic employment. The high yields on
workers’ pension fund investments are robbing the same workers of their
jobs.

This structural crisis has been masked by the unprecedented expansion of
US consumer debts, which now amount to over $9 trillion, or 90% of GDP,
collateralized by the wealth effect of high returns on worker pension
funds invested in the stock market and the inflated value of their
homes. Total credit market debt for all sectors is now 299% of GDP. In
1984, when consumer debt stood at only 50% of GDP, it drove the market
three years later, in 1987, to a severe crash, which Greenspan bailed
out with a flood of liquidity that released the biggest financial bubble
in history, which burst first in Asia in 1997 and finally in the US in
2001.

Imports from low-wage countries such as China are resold in the US at a
greater profit margin for US importers than that enjoyed by Chinese
exporters. Thus a $2 toy leaving a US-owned factory in China is a $3
shipment arriving at San Diego. By the time a US consumer buys it for
$10 at Wal-Mart, the US economy registers $10 in final sales, less $3
import cost, for a $7 addition to the US gross domestic product (GDP),
yielding a ratio of GDP gain to import value of two-and-a-third. Chinese
GDP gain to export value ratio is zero if the $2 export price becomes
part of the US capital account surplus. If half of the $2 export price
is used for paying return to foreign capital, then the ratio is in fact
negative. The numbers for other product types vary, but the pattern is
similar. The $1.439 trillion of imports to the US in 2002 were directly
responsible for some $3.35 trillion of US GDP, almost 32 percent of its
$10.45 trillion economy. That is why US policy-makers have no incentive
to reduce the trade deficit. But during a presidential campaign, blaming
it on China’s undervalued yuan gets votes.

Henry C.K. Liu

Loss of Manufacturing and GDP Growth

By Henry C.K. Liu

In 2003, Chinese exports reached US$430 billion with imports of US$410
billion, yielding only a US$20 billion surplus. Since Chinese export
value constitutes only 20% of its final market price, economies that buy
from China enjoy a greater GDP growth from trade (US$2.15 trillion) than
China does. Since China imports at full market price with little
mark-up, China does not enjoy any GDP add-on from its imports. Fair
trade between two economies with disparity in wages and living standards
then requires a trade surplus for the less-advanced economy.

If the US$430 of Chinese exports were consumed domestically at their
final market price, US$2.15 trillion would be added to China’s 2003 GDP
of $1 trillion, tripling it. The higher the trade surplus in China's
favor, meaning more goods and services leaving China than entering, the
more serious is its adverse impact on China's GDP. Chinese consumers
cannot afford the products they produce for export not because Chinese
workers are not productive, but because their wages are too low, which
ironically does not make Chinese products as competitive overseas as can
be because of high mark-up by foreign importers.

Greater profit margins enjoyed by the importing economy raise apparent
productivity because sales per employee increase from the factory floor
towards delivery to the consumer. Also, the closer final assembly is to
retail outlets, the higher its apparent productivity. Through proximity
to customers, sellers can gain advantage in the assembly of imported
parts to respond to changing customer orders. Thus US assemblers who
out-source their parts can win final sales away from offshore integrated
manufacturers who make the same parts and assemble them abroad. Japanese
car-makers have learned this lesson and are now assembling parts made
offshore in the US for the US market.

In the high-tech arena, time to market of design innovation is critical.
By deferring cost through the use of employee stock options, a local in
the importing country can use its high stock valuation driven by
creative accounting, and low production costs and low currency valuation
and interest rates in the exporter economy to raise low-cost funds
globally to further subsidize production costs of the final product. The
content of the products will increasingly come from low-wage, low-margin
exporting economies, and the out-sourcing assembler's manufacturing
involvement may be little beyond snapping out-sourced parts in place,
advertised ad nausea as a US brand. Dell is a classic example, as is
Disney's licensing empire of made-in-China toys.

Highly-indebted emerging market economies, through the under-valuation
of their currencies to subsidize exports, ironically make dollar debts
more expensive to repay in local currency terms. The moderating impact
on US price inflation also amplifies the upward trend of the
trade-weighted dollar index despite persistent US expansion of dollar
monetary aggregates, also known as money printing. Adjusting for this
debt-driven increase in the value of the dollar, import volume into the
US grew with the expansion of dollar monetary aggregates, around 15
percent annually for most of the 1990s. The US enjoyed a booming economy
when the exchange value of the dollar was rising, at a time when
interest rates in the US were higher than those in its creditor nations.
This led to the odd effect that rising US interest rates actually
prolonged the boom in the US rather than restrained it, because it
caused massive inflows of liquidity into the US financial system,
lowered import price inflation, increased apparent productivity and
prompted further spending by US consumers enriched by the wealth effect
of rising equity and real estate markets despite a slowing of wage
increases.

This was precisely what Federal Reserve Board chairman Alan Greenspan
did in the 1990s in the name of pre-emptive measures against inflation.
Dollar hegemony enabled the US to print money to fight inflation,
causing a huge debt bubble.

The transition to offshore production is the source of the productivity
boom in the US. While published government figures of the productivity
index show a rise of nearly 70 percent since 1974, the actual rise is
between zero and 10 percent in many sectors if the effect of imports is
removed from the calculation. The lower values are consistent with the
real-life experience of members of the blue-collar working class and the
white collar middle class who have to work longer hours to service their
debts. Neither the recovery nor the recent correction of the exchange
rate of the dollar will restore manufacturing jobs in the US, unless the
US is prepared to see its GDP drop by 25%.

Henry C.K. Liu