Текст книги "101 Things Everyone Should Know about Economics: From Securities and Derivatives to Interest Rates and Hedge Funds, the Basics of Economics and What They Mean for You"

Автор книги: Peter Sander

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CHAPTER 8

Trade and International Economics

Even on our small planet, no nation exists in a vacuum. Sure, the United States is blessed with abundant resources to grow food, build shelter, and accomplish the routine tasks of daily life. But we don’t have everything. We’ve always been dependent on foreign nations for some things like coffee or saffron spice or chromium. We had become increasingly dependent on other nations for energy, but with recent domestic production through so-called “fracking,” that’s become less true, demonstrating once again that necessity is the mother of invention. But that said, increasingly, we’ve found that many of the goods and services we need can be produced elsewhere for less—although that trend, too, is showing some signs of reversing. In general, global trade has its advantages and disadvantages, which will be further explored in this chapter in the discussion of globalization.

At the same time, foreign societies need American goods and services. In general, all countries need things that other countries produce, giving rise to a global economy consisting of many local economies and a trade system to connect them. Foreign trade has existed since the days of Marco Polo (and before), but as technology and economic development make the world more interconnected and “flatter,” foreign trade assumes an increasingly important role in our own personal “economy.” We buy things made overseas. We produce things that we hope will sell overseas. Overseas competition forces us to be more efficient, and when we can no longer compete, we must find something else to do. Globalization and its effects have touched millions of us, and it is often a difficult pill to swallow.

While globalization can cause pain, it’s here, it’s with us, and it also has important benefits to our economy. As individuals, we need to turn fear into an understanding of the forces of globalization, as well as the rules and tools of international trade. That’s the subject of this final chapter.

91. GLOBALIZATION

You can buy cars made in Asia. You can buy cars made by Asian companies in America or American companies in Mexico or—you name it. You can buy a computer, smartphone, or tablet manufactured by an American company in Asia, or by a Chinese company in China or in Vietnam or wherever, and if you need help using it, you call someone in India. For that matter, if you have a question about your employee benefits, such as how your U.S.-based 401(k) plan works, you might also end up talking to someone in India.

What’s going on here? Simply, it’s the inevitable march of globalization, the ever-increasing network of economic activity around the world.

What You Should Know

Globalization happens because it can happen; that is, the technologies exist to interconnect different economies and their productive components cheaply and easily. Your benefits phone call to India simply wouldn’t work without current phone and data technologies, and it wouldn’t work if it cost a dollar a minute to make the call. It is also made possible by free trade, where few artificial barriers are put into play by governments to keep an economic activity within their borders.

Globalization is driven by economic specialization and so-called comparative advantage. Comparative advantage is simply the idea that some economies or some productive elements within an economy can do something better, cheaper, or faster than someone else. Highly skilled labor with English-language and technology skills is available in India at a low cost. China has an enormous pool of skilled and unskilled manufacturing labor. Japan has precision engineering and manufacturing, and Taiwan has heavy industrial manufacturing like foundries and semiconductor manufacturing facilities. These companies don’t have a monopoly on these activities by any means, but they do them better than everyone else. They are leaders in the fields.

Globalization simply takes advantage of whoever can do whatever best. The natural forces of economics steer skilled software engineering and technical support to India, low-cost manufacturing to China, and precision instrument manufacturing to Germany or Japan. The networks are growing more complex, as Japanese companies now “reglobalize” some of their manufacturing to places like Thailand. It’s a naturally evolving world order, which is estimated to save us all trillions over a closed-economy scenario where trade and technology are restricted within a country’s borders.

Not everyone is behind the idea of globalization. It has obviously caused some of the painful job dislocations that have hurt American manufacturing. Many question whether saving a few pennies on a manufactured item is worth the loss of jobs and manufacturing infrastructure in the United States. Many also blame the exploitation of disadvantaged workers and physical environments, which can go so far as to even compromise their very safety, around the world on globalization. Finally, some take on globalization as a threat to unique world culture, just as the nationalization of business and marketing has voided U.S. regions of their local cultural imprint and made every freeway interchange across the country look like every other.

Globalization means change, and change can be painful. But the true benefits in terms of economic progress (yes, it helps poor economies too) and economic efficiencies cannot be ignored.

Why You Should Care

The news headlines and the stories you hear frequently center on the less positive effects of globalization—your neighbor gets laid off, a nearby factory closes. It probably doesn’t make the pain go away for those affected, but if you put it in the greater context of globalization and economic efficiency, and realize that comparative advantage is the most important economic driver, you can put it in perspective. You as an individual, and your employer as a company, must strive to maintain that competitive advantage in a free-market economy, else globalization becomes a risk, not an opportunity.

92. CURRENCY POLICY AND EXCHANGE RATES

“The dollar declined today against the euro and gained against the yen but held its ground at $1.04 against the Canadian dollar.”

Nice headline, but what does it mean? Sure, now my imaginary trip to Europe is a little more expensive, and it might help reduce the cost of my next new Lexus. But what’s really going on here? How—and why—do currencies fluctuate against one another?

What You Should Know

Currency fluctuations, like most things that happen in free markets, are driven by supply and demand. If the euro is up against the dollar, it reflects the fact that world currency traders feel the euro is worth more and the dollar is worth less, and so buy euros and sell dollars. The important question is: why do they feel that way?

Purchases and sales of a currency are determined by actual monetary needs at a given point of time, which are in turn driven by physical and financial trade. Physical trade refers to who is buying and selling goods and services of each country. If more people are buying European or Japanese goods or services at a given point in time, they need currency in those countries to complete the purchase, and so buy it on the open market. They may also be preparing to buy such currency by buying a futures contract. Financial trade refers to the transfer of capital to buy securities or other investments in a country, which also requires a purchase of local currency. So if euro-denominated bonds look attractive due to credit risk or higher interest rates or price stability or some combination of the three, investors will buy euros in order to buy those bonds. It’s not hard to see how these flows relate to balance of trade (see #95) and balance of payments (see #96).

Exchange rates don’t just fluctuate based on current supply and demand for a currency, but also expected future supply and demand. If a country’s economic indicators (or economic policies) signal declining production, higher deficits, more “printed” money, higher inflation, or declining interest rates ahead, currency traders will sell that country’s currency in anticipation of those events. Political and economic stability can also come into play. These sentiments can drive markets in one direction or another for a considerable period of time even though actual economic statistics and trade flows ultimately fail to support the sentiment.

Not every currency “floats” against every other; for various political reasons, some countries choose to intervene or even tightly control their foreign exchange rates. When a currency is allowed to “float,” free markets determine the exchange rates as just described, and the U.S., Japanese, Eurozone, and most other major European currencies do just that. “Floating” currency exchange rates are the “pure market.”

A country may also decide to “fix” its currency against another, often but not always the U.S. dollar. The goal is price stability in the country and stabilization of foreign trade, and it is accomplished either by direct control or intervention in the open currency markets to keep the exchange rate stable. China is the biggest and most influential user of the fixed exchange rate approach. Many U.S. policymakers and industrialists criticize this approach for they feel that the Chinese renminbi (their exchangeable currency) is too low against the U.S. dollar, which serves to stimulate their exports at the expense of making it hard for U.S. firms to compete.

Why You Should Care

Even if you don’t plan a trip to Europe or to buy a Japanese-manufactured automobile in the future, currency fluctuations can affect you, especially in the long term. The proliferation of U.S.-based factories for Japanese cars is driven (pardon the pun) by the long-term decline of the dollar against the yen. The abundance of cheap Chinese manufactured goods, supported by the Chinese government exchange rate “fix,” helps tame U.S. inflation, but perhaps at the expense of long-term U.S. economic strength. Currency rates can be both a result of and a cause of economic change, and you should keep your finger on the pulse of such change.

93. CURRENCY DEVALUATION AND DEPRECIATION

When thinking in an economic frame of mind, the term “devaluation” suggests bad things—less value, less worth, less productivity, less to be had or shared by all. The term “depreciation” also suggests long-term, inexorable decay. These two words, in fact, describe deliberate economic policy a nation might employ to reduce the exchange rate of its currency on the world market. While often indicating heavy medicine for a very sick economic patient, such actions aren’t always as bad as they sound.

What You Should Know

In the previous entry the role of currency exchange in the long-term economic prospects of a nation—and vice versa—were described. The distinction between floating and fixed, or controlled, exchange rates was also examined. Some countries take a more active role than others in controlling their exchange rates for clear political and economic reasons—to stimulate exports, to stimulate capital investments in their countries, and to achieve price stability within the country.

When a country fixes or closely manages its exchange rate, a central monetary authority (like a central bank) can decide to formally adopt a new fixed rate with respect to a foreign currency, usually but not always the U.S. dollar. That rate can be set by mandate or more often by government intervention in the currency markets. When a country chooses to lower its currency against the reference currency, that is known as devaluation. When a country chooses to intervene in the markets or adopt other policies that lead to a lower exchange rate, that’s depreciation.

Devaluation is overt and is carried out publicly with fixed rate control; depreciation is carried out without specific declaration or obvious action. Both actions serve to make a currency, and thus the economy behind it, more attractive on the world stage, either for foreign purchases of goods and services or for foreign capital inflows or both.

Done right, a devaluation can help an economy, but done wrong or without warning, it can be quite disruptive. Currency devaluation caused an economic crisis in Mexico in 1994. The government decided to devalue to stem the tide of imports and keep a healthy trade balance, but did it suddenly and without warning. Those who had made investments in Mexico suddenly panicked over the value of their investments, withdrew capital, and sent the economy into a short tailspin. Untimely interventions also helped cause the Asian currency crisis in 1998.

Many economists are concerned by the U.S. Federal Reserve’s apparent attempt to depreciate the dollar against other currencies. This is being accomplished by lowering interest rates and printing money in the interest of economic stimulus, and many regard it as a last-ditch effort to restore a healthy trade balance for American goods and services. But it could backfire if inflation takes root and causes America to lose its “safe haven” status for foreign investment. Similarly, and more recently, Japanese policies to reduce the value of the yen to stimulate trade and the internal economy have been met with skepticism—will they really work (especially in a “currency wars” environment where other major economies are depreciating their currencies too), and will it lead to excessive inflation later? Economists and world leaders thus watch any moves toward devaluation or depreciation very carefully.

Why You Should Care

Devaluation and the more covert depreciation can be used as short-term tools to stimulate an economy and balance it properly on the world stage. But they can also be used to stimulate an economy for short-term political gain. Such actions can be disruptive in the short term, and more importantly, can signal longer-term economic woes and unintended consequences to come. The economic forces and realities that caused these actions are often more important than the actions themselves.

94. FOREIGN DIRECT INVESTMENT

What do Pebble Beach Golf Links, Rockefeller Center, and the new Honda assembly plant in Greensburg, Indiana, have in common? They are owned, or have been owned, by foreign companies. When foreigners own U.S. property or business interests, it is known as foreign direct investment (FDI). It is the flip side of U.S. individuals or businesses owning foreign assets. The amount of—and flow of—such investment holdings can be important indicators of economic health and prosperity.

What You Should Know

Foreigners can and do buy investment interest in U.S. businesses and properties. Technically, it happens when a foreign enterprise, or its affiliate, buys at least a 10 percent interest in a U.S. corporation or asset. Foreign direct investments do not include purchases of U.S. government securities or other similar investments—another huge inflow of investment funds.

The amount and balance of FDI has changed dramatically over the years. The relatively weak U.S. dollar and the continued status of the United States as a “safe haven” against world politics and economic events have caused a steady growth in FDI. The proximity of U.S. production resources to markets, as exemplified by automotive assembly, is another factor.

According to the U.S. Bureau of Economic Analysis, FDI flows into the United States ranged from $231 million to $58 billion annually during the years 1960–1995. These flows moved sharply upward to reach $321 billion in 2000, declined to $63 billion in 2003, ramped into the mid-$200 billions in 2006–07, and peaked at $325 billion in 2008. Then they dropped to $194 billion in 2010 and $146 billion in 2012 due to global economic conditions, low rates of return on U.S. investments, and the stronger dollar.

This sounds bad, and it’s easy to think that Americans are selling themselves to foreigners one floor or golf hole at a time to pay off our debts. But the reality is a bit different; in fact, during much of this period, U.S. FDI in other nations was at similar or even higher levels. As a result, the growth in cross-border direct investment signals greater globalization (see #91), and indirectly, shifts of capital flows to the locations of greatest return.

Why You Should Care

Rather than taking umbrage when you find out that the Japanese or Chinese own your favorite golf course or restaurant or car company, consider cross-border investments to be natural. After all, we own those Starbucks outlets in China and Europe, right? The need for foreigners to finance U.S. debt is the bigger problem.

95. BALANCE OF TRADE

The balance of trade, much like the balance of your own household budget, measures the difference between goods and services purchased from foreigners and the goods and services purchased by foreigners from the United States. More concisely, the balance of trade is what we export minus what we import.

What You Should Know

The trade balance, or trade deficit, has been in the news a lot during the past thirty years, mainly because it has grown substantially as we buy more goods from overseas (especially China), more raw materials (oil from the Middle East and other nations), and other goods. On the services side, as we’ll see in a minute, the United States runs a net surplus.

The balance of trade is part of a bigger picture known as the current account, or balance of payments. Those figures, covered in the next entry, include not only the trade balance in physical goods and services but investments and other financial flows. When there is a trade deficit, it is often made up by financial flows—that is, how we pay our bills, although under current practice it leaves us in debt.

The trade deficit has grown substantially since 1997. Before that time, it ranged between $50 billion and $100 billion each year. It grew to almost $400 billion in 2000 and then to nearly $800 billion in 2006, as the prosperous American economy led to more imports of finished goods and raw materials. The Great Recession, combined with lower oil prices, an increase in domestic oil production, and expanding “export” of services, have all combined to attenuate the total trade deficit somewhat. The following table shows how the deficit has fluctuated over time:

Table 8.1 U.S. Balance of Trade 2000–2012 ($ Billion)

Source: U.S. Census Bureau

View a text version of this table

Long term, the balance of trade is affected by the strength of the U.S. and global economy. While a strong global economy would seem to help reduce the deficit by increasing exports, in practice it has tended to increase the deficit as Americans import more. That trend may change as America becomes more energy self-sufficient, but as you can see in Figure 8.1, the recovery has brought a return to higher deficits again—though not as high as prior to the Great Recession.

Figure 8.1 Balance of Trade, 1992–2012

Source: St. Louis Federal Reserve

Whether the U.S. trade deficit is good, bad, or ugly is still a matter of debate. The good news is that deficits have bounced off their lows, and imports in particular, led by energy, appear to be headed for a long-term decline. Even more good news is found in the fact that the deficit as compared to the size of the economy is still relatively modest by world standards. And every dollar spent overseas at least has the potential to come back to shore as something bought from the United States.

But today’s deficits are also a cause for major concern among economists and policymakers. First, they could well set new records again when the economy returns to health. Second, the gradual export of manufacturing capability to China and other nations suggests that the deficits may be structural and permanent and only likely to grow—although this trend has slowed lately. We just don’t have enough to sell into world markets. Third, our trading partners, again notably China, must finance the deficit through investments in U.S. securities, which only pushes the problem into the future.

Governments, notably the U.S. government, may want to reduce deficits, but attempts to control deficits through policy, tariffs, or taxation are notoriously difficult and usually have negative unintended consequences elsewhere in the economy (see #98 Protectionism). In fact, government policy to stimulate consumption (see #2) has the opposite effect. When the government sent tax stimulus checks in 2008, or reduced FICA taxes in 2011–2012, how much of that money do you suppose was spent to buy foreign cars or electronic gadgets?

When governments stimulate consumption, especially here in the United States, they inadvertently stimulate the deficit too. Countries that have lower consumption patterns (indicated by higher savings rates) typically have trade surpluses (again, China, but also Germany, Japan, and others). One of the best ways to lower the deficit is to stimulate savings—although this too can get out of hand and lead to deflation (see #19), as has been the case in Japan.

Why You Should Care

Just as you need to keep your own financial house in order, you should also be concerned about a nation that consumes more from abroad than it produces. It’s not a good thing over the long term. Not that you should or even can buy all of your goods from the United States, but all else being equal, a good or service sourced from the United States helps the economy, and one sourced from overseas hurts it.

96. BALANCE OF PAYMENTS AND CURRENT ACCOUNT

The balance of trade (covered in the previous entry) is part of a bigger trade picture. The balance of trade measures the flows of physical goods and services, and is a major component of the balance of payments. But the balance of payments goes further to measure the flow of payments—the financial flows—between countries. Thus, the flow of financial capital to purchase securities or to make foreign direct investments (see #94) is also included. It is a measure, at day’s end, of how much total worth or wealth is coming out of or going into our collective wallet.

What You Should Know

You’ll hear the term current account used frequently to determine where we are and where we are going. The current account is the sum of current activity from trade (imports and exports) and short-term financial flows like dividends and interest. The capital account—showing flows in favor of fixed asset investments and foreign direct investments—goes together with the current account to create the total balance of payments. Current account figures represent where we are short term with respect to international cash flows, and the current account deficit, like the trade deficit, gets a lot of attention from economists and policymakers.

Why You Should Care

Economists watch the balance of payments and the current account deficit or surplus to get the big picture on the health of the economy and the transfer of wealth from one nation to another. While knowing about the balance of payments may help you understand the evening news, it’s the balance of trade that’s truly important. As an individual, you can only affect the balance of trade through your consumption and saving decisions.

97. TRADE AGREEMENTS

Trade agreements, or trade “pacts,” are made between countries, usually multiple countries in a region, to remove trade barriers and to facilitate trade between them. The goals are to encourage trade, to achieve gains from comparative advantage, and to mutually benefit the economies of the pact members. Trade agreements achieve the same results as globalization (see #91), but usually on a smaller, more regional scale.

What You Should Know

A trade pact is a negotiated agreement between countries stipulating terms of import and export of some or all goods and services that might flow between them. Agreements usually cover tariffs and other taxes, and in some cases may contain social, environmental, or other stipulations governing trade in mutually beneficial ways. Most are “free” trade agreements, allowing free movement of goods and services across member borders. Critics of trade agreements follow the path of globalization critics, and typically work to include environmental, labor, and product safety requirements in the agreements.

For Americans, the largest and most significant trade agreement in recent years is the North American Free Trade Agreement (NAFTA). The agreement, ratified in 1994 between the United States, Canada, and Mexico, is the largest in the world measured by combined purchasing power. NAFTA opened borders for almost unrestricted movement of goods and services, subject to environmental rules consistent with U.S. policy. NAFTA led to the opening of large maquiladora (border zone) factories in Mexico to serve Mexican markets, boosting Mexican economic growth to a degree.

Aside from a few industries like textiles and auto assembly, NAFTA didn’t create the “giant sucking sound” famously promised by then-presidential candidate Ross Perot. According to a World Bank study (see #99), NAFTA did as much to strengthen exports out of the entire bloc as it did to increase American imports from Mexico. At the risk of gross oversimplification, NAFTA is a classic microcosm of globalization, where the comparative advantages of Mexico (abundant semiskilled labor), America (know-how), and Canada (resources) are combined to produce efficiencies and a more competitive larger player on the world stage.

NAFTA and its Central American sister CAFTA roll right off the tongue, but they are by no means our only major agreements. The United States has free trade agreements with twenty other countries, and is party to many bilateral and multilateral agreements. There are more than thirty operating trade agreements worldwide covering major regions of the world: Southeast Asia (ASEAN), the Middle East (GAFTA), and South America (Mercosur) serving as examples.

Why You Should Care

Trade agreements between countries or regions create economic efficiencies that usually result in lower prices for goods and services, and open new markets for businesses already located in member countries. These are both good things for you—so long as you aren’t in a job or profession vulnerable to dislocation to one of the trading partners. In a larger sense, a rising tide of more competitive production lifts all boats, for the economies involved become more productive and more competitive on the world stage.

When one starts to see Mexican-made bars of soap on American store shelves, it could be time to step back—why can’t that soap, a simple product, be made in America? Is the manufacturing cost so much lower that it overcomes transportation and all the administrative costs of moving it two thousand miles across a border? When economic dislocations become excessive one must examine the reasons why. Is Mexican labor cheaper or better, or is it simply that the cost of doing business in the United States—driven in part by health care costs—is too high? Free trade agreements can mask real problems in member economies—or make them worse than need be. As an individual, you should take advantage of less expensive goods and expanded markets but also be aware of the reasons driving the trade agreement in the first place. Nobody wants to hear a “giant sucking sound.”

98. PROTECTIONISM

Let’s say you’re a U.S. company in the business of making baseball gloves. You make a pretty good glove, have a good brand, and good relationships with the stores that sell your gloves. You make a decent living at it, not a ton of money, but a decent living despite the fact that your business costs are on the upswing—higher labor costs, health care costs, energy prices, you name it.

Then, suddenly, a new Asian manufacturer hits the market with good gloves—not much of a brand, but a much lower price, because of lower labor costs, health care costs, and so forth. You want to compete, but you can’t. So if you had good friends in high places, you might ask the federal government to impose a tariff on the import of baseball gloves. That’s an example of protectionism.

What You Should Know

Protectionism is a deliberate economic policy implemented to guide or restrain trade between countries, mainly through protective tariffs, or taxes, on imported goods, but sometimes through import quotas or some other tactic. The goal may be to collect tax revenue, but is more likely to protect the fortunes of specific businesses or industries within the country imposing the protective measures.

Protectionism has led to numerous battles and debates through history. Recent policy has leaned away from protectionism as more economists and policymakers embrace the benefits of globalization. Protectionism has been looked on less favorably since the disastrous protectionist initiative during the Great Depression as part of the Smoot-Hawley Tariff Act of 1930. That act tried to support U.S. businesses by protecting them from imports, but all it did was hurt foreign economies, which then spent less on U.S. goods, prolonging the Depression. That experience is the cornerstone of most economists’ feelings today: that protectionism ultimately hurts those it is trying to help, and prolongs the life of inefficient businesses and industries to the long-term detriment of everyone.

Protectionist sentiment and activity often leads to the slippery slope known as a trade war. Country A slaps a duty on a product from Country B, so Country B slaps a duty on a product from Country A. And so it goes, until trade between the two nations is all but choked off. Both sides have certain industries that gain from the protection and certain other industries that lose because their export markets are cut off. In the end, nobody wins.

Some argue that protectionism only levels the playing field; that is, foreign goods hitting U.S. shores aren’t taxed, while domestic producers are. The argument gains strength when looking at many overseas businesses operating with overt or covert government subsidies. But still the prevailing opinion is that outright protectionism in most cases does more harm than good.