The Folly of a Fallacy

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

[This is a draft.  I’m still working on it.  You can see where I’m going with this,]

We have a leader of the largest, most productive, country in the world with also the most strongest military, and he is saying we are being picked on. It is not fair. We run a trade imbalance with Vietnam. They export more to us than we export to them. They are taking advantage of us. And it isn’t just with Vietnam. We run trade deficits with a lot of countries. So, they are all taking advantage of us. How are we paying for all of these deficits? You get the impression from listening to our leader and his supporters, which include many intelligent people, to include academics, that this imbalance in trade is a problem because somehow we have to pay for that imbalance. You may come away with the impression that our buying imports should be paid by our exports, to balance things out. But that is a fallacy. We pay for the imbalance with our productivity. We produce around $30 trillion a year. Only about 30% of that productivity is directly related to international trade; with about 20% being imports and around 10% to 12% being exports. So the imbalance between the imports and exports is paid by the 70% of our economy that is only indirectly connected to international trade. And remember, most of that trade is not conducted by one country to another. The great majority of international trade is conducted by businesses and individuals. Foreign businesses and individuals that sell to Americans earn dollars as a rule and when they acquire dollars they have to do something with those dollars – either spend the dollars or invest the dollars. They may want to convert those dollars into their own currency. That is where Central Banks come in. Central Banks in other countries accumulate dollars during that conversion. There is an exchange rate between the dollars and the foreign currency. Foreign Central Banks also accumulate dollars for their own purposes. Since they do conversions of their domestic currency, they are concerned with the value of their currency vis-à-vis the dollar. They want to control the value of their currency to control inflation in their country. This affects how well their people’s living standards are kept. In a democratically governed country that affects political stability or instability. In a country that is less democratically governed there is the same problem, but the government may use more authoritarian measures in exercising power. If the country has economic policies that emphasize exporting xxxxx then the value of their currency in relation to the value of the currency of the country they are trading with comes into play.

Now these experts will also tell you that because some of these countries have adopted an industrial policy to be an exporting country we are forced to be the consumer of their products.  And to pay for this, our government must run up budget deficits to provide the dollars that they foreigners demand. That is another fallacy.

The International Stock Market Crash, Black Monday 1987: Are We Headed For Another One?

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

With the international stock markets in mass retreat this past week, for the two days after President Trump announced his newly revised tariff trade policies, I am wondering if there are similarities to the stock market crash in 1987.  I am old enough to remember those days and I did have a lot of money in the stock market then, as I do now.  And I am also old enough to have parents and been educated from kindergarten through my college years, including grad school, with folks who directly experienced and came through the Great Depression years of the 1930s – the so-called “Greatest Generation”.  They did not name themselves; and they are not called “The Perfect Generation”.  So let’s look back to the events of 1987 and see if there are parallels to today.

On Monday October 19th 1987, the Dow Jones Industrial Average dropped over 22% that day; the panic selling started right from the get go of the opening bell, following similar losses in the international markets in both Asia and Europe before the New York markets opened.  This was preceded by the previous week that saw the market decline by approximately 10%.  And it was followed by the next day that saw the market continuing to decline by another 10%, before things stabilized with a variety of actions taken by the Fed and others.

Various reasons are given for the crash:

(1) The precipitous decline of the dollar and the failure of international leadership in stabilizing currency valuations.

(2) Persistent U.S. trade and budget deficits

(3) Rising U.S. interest rates, from the Fed (under the new Chairman, Alan Greenspan) and international markets, with concerns about inflation creeping back in to the economy after the Fed, under Chairman Paul Volcker, had tamed inflationary expectations.

(4) Program trading by big money managers

(5) Portfolio insurance hedging by big money managers

(6) Over enthusiastic speculative buying in the stock market (e.g, P/E Ratios too high) earlier in the year that could not sustain itself given the performance of the real economy.  The Dow was up over 40% during the year.

In my opinion, I attribute “The Crash” on that particular Monday to (1), the uncertainty and disruptiveness in the currency markets with respect to the Dollar vis-à-vis the DM (Deutsche Mark) and Japanese Yen.  The other items I feel contribute to “The Crash” but do not explain why “The Crash” happened on that particular Monday and not the week before, two weeks before, or a month before, where all these other conditions were still present.

So let me explain.  But first a little background.  President Reagan was in office when this stock market crash took place and the various causes were going on.  One very interesting thing that took place was his change in Treasury Secretaries while he was in office; and this change took place in the beginning of 1985 as President Reagan’s second term was about to begin.  His first Secretary of the Treasury was Donald Regan.  James Baker was President Reagan’s Chief of Staff.  At the start of President Reagan’s second term these two men switched positions, on their own accord, and notified President Reagan for approval, which they both got.  

This change however would involve more than a switch in personnel, it was a switch in President Reagan’s economic policies.  During President Reagan’s first term, the Fed under Chairman Paul Volcker was continuing its policy of combating high inflation and the concomitant built-in high inflation expectations with prohibitive very high interest rates approaching 20%, which resulted in the most serious recession for the United States since World War II.  But as the nation was recovering, and the economy was improving by 1983, the Fed was bringing down the high interest rates, but very slowly because of uncertainty in the banking sector.  [Notably the failure of Continental Illinois Bank in 1984, viewed at the time as a systemic problem, and some instability with the Savings and Loan Sector of the banking sector.]  

So the high interest rates along with the improving American economy in 1984, 1985 made the value of the dollar very high in comparison to its trading competitors – Japan, which was doing extraordinarily well, and West Germany.  The high value of the dollar vis-à-vis with the DM and Yen, two manufacturing economies that were very competitive with the U.S., made it difficult for U.S. manufacturers who operated both domestically and internationally, resulting in large trade deficits for the U.S. vis-à-vis large surplus countries like Germany and Japan.

Of course, when there is a deficit in the Current Account (of the Balance of Payments method of accounting) due to trade, those dollars that go overseas must come back into the U.S.  This is accounted for in the Balance of Payments by the Capital Account which tracks capital flows from country to country.  So the U.S. was experiencing capital flows back into the U.S.  If you recall in the 1980s, Japanese investors were buying up large commercial real estate projects, to include Rockefeller Center in New York City.  Foreign investors also bought U.S. treasuries and bonds, helping to finance the huge government budget deficits the Reagan Administration was running up.

Treasury Secretary Regan, a Wall Street veteran, looked upon this exchange favorably.  When James Baker replaced him as Treasury Secretary, he did not share this outlook, and was able to convince President Reagan that it was detrimental to the U.S. manufacturing sector of the economy; and, it would cost the Republicans votes and possibly their majority in the Senate.

After taking office, Baker will negotiate his way with our other major trading partners and arrive at the Plaza Accord later in 1985.  This is to stabilize the major currencies – depreciate the dollar while getting our other major partners to raise the value of their currencies.  And the dollar did depreciate by 20% up to Black Monday, while there was some improvement in the federal budget deficit.  But both Japan and West Germany, their Central Banks, were trying to keep their currencies on a favorable level with the depreciating U.S. dollar.  This annoyed Secretary Baker.

There was another meeting of the major trading partners, this time was the Louvre Accord in early 1987.  The same thing, Secretary Baker trying to stabilize the dollar against the other major currency, wanting the exporting nations – namely Japan and West Germany – to do more to stimulate their economies so Americans goods would have more of a market.  While there was “agreement” there was still reluctance to find parity.  The dollar continued to depreciate, but was still not competitive, to the annoyance of Baker.

Also in mid-1987, President Reagan will announce the appointment of  Alan Greenspan as the new Chairman of the Federal Reserve.  He will take that position in July.  He will work with the Administration, but he, like Volcker before him, has the economy and the banking situation to deal with.  Inflation is starting to pick up, so Greenspan, like Volcker, is continuing to increase interest rates, which normally would raise the value of the dollar.  But the dollar while still dropping and too high for Secretary Baker.

So, with that background, let’s lead up to Black Monday with the action going on the week before.  During this week the dollar is precipitously dropping, and it is a big news item.  Will the U.S. intervene in the markets to support the dollar?  The U.S. stock market, as well as other markets, are showing strains and in a degree of turmoil.  Secretary Baker finds the West Germans in particular indifferent.  In mid-week when he is asked if the U.S. will support the dollar, he replies [something to the effect] “If the markets want to drop the dollar, so be it!”  And the rest of the week, that is what the dollar does, continue sharply dropping – now along with stock prices.  And that is how we head into the weekend.

Now I am not sure which day it is, but I believe it was Saturday when one of the West German ministers – the Finance Minister I believe – makes a statement about the situation and says West Germany is anticipating a rise in inflation and will raise its interest rate because they see it as a threat which would affect growth coming on with the possibility of a recession.  This would mean the DM will have a more favorable standing vis-à-vis the dollar, and not the parity sought from the Louvre Accord; the exact opposite of what Secretary Baker wants the West Germans to do in stimulating their economy so American goods would have a better market in West Germany.  He is infuriated by the West German’s remark, and says over the weekend, he will let the dollar depreciate even more.

This is a talking point on the Sunday news shows in the U.S.  Now I’m out in California, on West Coast time on Sunday.  But Sunday afternoon and evening, West Coast time, is Monday business hours in Asia.  And the Asian markets are taking this news in and it doesn’t take much to digest it.  There is panic selling in all the Asian markets.

And I did not stay up past midnight, West Coast time, to follow the European markets opening Monday morning, but the rout on the markets continued.  In fact the London market – the FTSE – was down by a bigger percentage than the New York markets at the end of the day.

So my feelings are it was those remarks over the weekend that set off the panic selling, because the New York market dropped precipitously as soon as it opened.  Program trading did not even kick in at the opening bell.  The panic selling started in Asia, continued in Europe, and went right into the U.S. markets.

The devices traders used in the U.S. markets accelerated the selling panic, but they did not cause the panic, they were only responding to the panic that was already there.  The Asian markets and European markets did not have the accelerants, like program trading, to the degree the American markets had; and they still had their markets collapsing that day.  So anyway, that is my take on “Black Monday”.

Now what is going to happen this weekend with the response to Trump’s tariffs.  Because since Trump announced his stance on the tariffs in midweek, all the markets – in the U.S., Asia, and Europe – each day have lost at least 3% to 5%.  That is a Big Deal!  And Sunday West Coast time in the afternoon and evening is what???...the Asian markets are open.

Asia is our main trading/manufacturing competition; not Canada and Mexico.  The trade between the U.S. and Canada and Mexico is integrated and coordinated.  It is two-way and with many trips back and forth to support manufacturing in all the partnership.  The main competition to the North American alliance comes from Asia.  Asia runs the surplus in the trade of goods, and the U.S. is the big deficit nation – a deficit in the trade in goods, we run a surplus in the trade of services.    If there is going to be a big negative impact from Trump’s tariff policies, it will be in Asia.  They will react first.  So look to the Sunday markets for a clue.

We have already seen Canada’s Liberal Party leader, Mark Carney, who may win the upcoming election, firmly but diplomatically denounce President Trump’s actions.  He said, “Our relationship with the United States is over.”  And said it needs to be re-negotiated.

So as of Saturday afternoon, West Coast time, as I write this I have not heard much news on the response by foreign countries to Trump’s tariffs; only a small news item that Trump still intends to keep the tariffs on.

And I will remind you, like I have reminded others going back to when Trump first decided to run for president in 2015, that this guy has had six business bankruptcies during his career; and that was his main business – construction and casino/hotel operations – not including side ventures like Trump Champagne, Trump Steaks, Trump Airline, and Trump University.  The last one was in 2009, when he refused to make a $50 million loan payment and wanted to renegotiate it with the lender.  He argued with his Board of Directors.  They reduced his stake in the company and fired him as the CEO.  And the company went through the process of selling off its assets.  Now the irony is that at that time in 2009, Mr. Trump was still doing ‘The Apprentice’ show where he was showing his make-believe business acumen and firing people.

I do not know what the outcome of all this will be.  I am not making any predictions.  I do think there are some interesting parallels with 1987.  Trump seems to dig into situations without resolution, and without a willingness to change, passing the blame off to others.  The markets have dropped almost 10% in the two days since his tariff announcement.  Whether it will continue with an orderly retreat, a massive sell-off in a panic like “Black Monday”, or maybe even reverse course and recover sanity, remains to be seen.

Stay tuned for Sunday; it could be a prelude to the next step.  And we will see what happens.

The Manufacturing Sector In Our Economy - From the 1960s to today

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

Let's look at some data.

1. Did NAFTA take our manufacturing jobs? NAFTA went into effect in 1994. From 1994 to 1997 we increased manufacturing jobs.

2. When did we start to lose manufacturing jobs during the Globalization period of the 1990s? It was after the Asian Financial Crisis of 1998. In order to control their capital flows into and out of their countries -- failure to control is what led to the Crisis -- Asian countries, like South Korea -- adopted industrial policies that made them exporting countries, where they tried to control their surplus trade status.

3. And the big drop off in our manufacturing employment was after 2001. That is when China got trade status from the WTO.

Some experts will tell you the drop off of manufacturing employment after 2001 was due to automation in the factories. If that were true the productivity should have increased. But as you see, it was in a declining trendline.

Quite frankly, it is plain to see the 1960s, especially the peak performance years of 1965/1966, as the standout for the manufacturing sector as well as the overall economy. We almost doubled our manufacturing capacity in that decade. And since 2000 the rate of increase in manufacturing capacity has been stagnant. This isn't something that other countries did to us; we did it to ourselves by our economic policies which failed to incentivize investment in this area and instead encouraged investment in other venues.

 

Our capacity utilization was great during 1960s, and has tapered off since. Remember now, the capacity added in the 1960s was almost doubling while we were at maximum utilization. We still have good utilization at 70% to 80%, but we are not adding to capacity like we did in the 1960s.

Trump's National Security Strategy???

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

Article out today with the AP:

Canada and the EU swiftly retaliate against Trump’s steel and aluminum tariffsCanada and the EU swiftly retaliate against Trump’s steel and aluminum tariffs

President Trump says he got involved in the Russo-Ukraine War because he wants to bring peace. This, while he conducts a trade war, not with our adversaries, but our allies.

The GDP (nominal) of Canada is a little over $2 trillion and the GDP (nominal) of Mexico is about $1.8 trillion -- both of which Trump says are taking advantage of us. The GDP (nominal) of California is $4.1 trillion; the U.S. is around $28 trillion.

Remember that as you start to pay more for a wide variety of things, because we do a lot of business with both nations back and forth.

The Ukrainian War is Putin's quagmire, his Vietnam. Why you would want to help Putin out of that while the Ukrainians want to fight for their homeland, is beyond me.

If there is a national security strategy there, I have not been able to figure it out. And that is without bringing in the repercussions concerning China.

Let us start a Ukraine War, to really free Ukraine

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

Concerning Trump's meeting with Zelenskyy today:

Just a hypothetical here: “This aggression will not stand!”

Those were the words of President Bush in 1990 when Saddam Hussein, the dictatorial Iraqi leader, invaded his neighbor, an oil-rich nation, Kuwait.  In Operation Desert Storm we injected the U.S. Military into the Middle East to extract the Iraqi invasion of Kuwait which started the Persian Gulf War in 1990. The U.S. had no defense treaty with Kuwait in 1990 or prior to that. President Bush did go to the United Nations to get a resolution to support the U.S. military effort with a coalition of over thirty countries. The resolution was to kick the Iraqi troops out of Kuwait, and not to invade Iraq; which is what we did.

Let’s do the same thing for Ukraine. Except we will never be able to get a UN resolution. But we should be able to get a European coalition, if not more. Kick Russia out of Ukraine, include Crimea; but do not invade Russia. Quietly dare China to enter in the conflict on the side of Putin.

And if Putin wants to use nuclear weapons, even though we would not be in Russian territory; well, we have nuclear weapons also.

What do you think would happen? And how long would this clean-up operation last?

Blood, Sweat, and Tears versus Appeasement -- The War in Ukraine

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

AP article out today:

Trump warns Zelenskyy to quickly negotiate war’s end with Russia or risk not having a nation to lead

There is a war going on in Ukraine, with Ukrainians, not Americans, dying.  And Trump is negotiating an end to the war in Saudi Arabia, but will not have the Ukrainians present at the negotiations.  What is the analogy here?

Some would make a comparison to Kissinger negotiating with the North Vietnamese to end the American forces involvement in the Vietnamese War.  President Nixon looked at the American involvement in the Vietnamese War as a distraction from pursuing our national security objectives vis-à-vis Russia/Soviet Union.  

The Paris Peace Accords were finally signed in January 1975, which allowed the U.S. to withdraw troops from South Vietnam; and the North Vietnamese agreed to withdraw their involvement in South Vietnam and leave the fighting between the South Vietnamese and Vietcong.  That latter part was violated by North Vietnam after the American withdrawal, and South Vietnam fell quickly right after that.

But that did allow Nixon to negotiate the Anti-Ballistic Missile Treaty (ABM) with Russia just before that.  And just after that was the Helsinki Accords which ushered in a period of détente between the Western Alliance and Russia.  Nixon’s détente replaced the prior policy of containment against the growing influence of communist aggression after World War II. 

But is that what we have here in Ukraine?  What is to be gained with Putin’s Russia in ending this war in the manner Trump is pursuing?  Russia is not the power she was in the Cold War.  Putin has shown his own ineptitude in combat.  By being tied down in Ukraine, Putin has  been unable to pursue larger goals elsewhere – in the Middle East, Syria in particular, being disruptive to European democratic movements, although the Right Wing populist movements have had a life of their own,  thwarting NATO expansion along his border, keeping the state of Georgia in check along his southern border, let alone the reordering of the Russian economy to a military posture to prosecute the war in Ukraine while the Russian people lost part of their consumer economy and have experienced shortage of goods, higher inflation, and higher interest rates.  In effect, the Ukraine War has neutered Putin’s ability to misbehave elsewhere.

I think the proper analogy of Trump’s attempt to settle the Ukraine War is the Munich Agreement of 1938 which came to be known as appeasing the dictatorial ambitions of Hitler.  Hitler invaded part of Czechoslovakia and annexed it to Germany.  The principals at the negotiations were Britain and France vis-à-vis Hitler’s Germany and not the Czechs; and Britain’s Chamberlain caved in to Hitler’s  aggression.  Chamberlain’s “Peace For Our Time” appeasement turned into Churchill’s “blood, toil, tears, and sweat” to prepare Britan for battle.

Are we going to let Putin nuclear blackmail us?  Ask Estonians, who have a border approximately 40-miles from the suburbs of Saint Peterburg; they have provided military support to Ukraine before the 2022 invasion.  Ask Finlanders who petitioned to join NATO after the 2022 invasion, but said nothing of NATO membership when Putin first invaded Ukraine in 2014.  Why was the Russian aggression of 2022 more threatening to Finland than the aggression in 2014?  Who is the real nuclear power?

With some Americans saying that Trump is a threat to democracy, but their opposition to him has been ineffective, could it be that a little man in Ukraine would be the unravelling of Trumpism?  Like Churchill, Ukrainian President Volodymyr Zelenskyy, fighting for his country's very existence, saying that the American president is trapped in a “disinformation bubble”, has put Ukrainian blood, sweat, and tears to stand in opposition to another aggression in Europe, an aggression that should be recognized for what it is, a threat to world order and not just to Ukraine or Europe.  Whatever problems we have can be reversed for the better.  The American  Experience has shown us to be resilient and able to recover from past mistakes and to renew our strength based on universal values.

 

Economics Without The B.S.**: 

[**  Double entendre intended.]

Article out today with the BBC: '

What key players want from Ukraine war talks

What key players want from Ukraine war talks

1. Not at the talks: Ukraine

1.a. Not at the talks when Trump's Secy of State "negotiated" with the Taliban (whose representative was released from jail in Pakistan so the Americans had somebody to "negotiate" with) -- the legitimate Afghan government, and Trump agreed with the Taliban request to force the Afghan government release 4,000 Taliban prisoners when Biden was president.

1.b. Not at the talks when Secy Kissinger negotiated with the North Vietnamese to end "The American War" -- the legitimate South Vietnamese government, which would collapse after the American military withdrawal.

2. So is there are lesson here? 

2.a. Vietnam would "recover" decades later. 

2.b. I don't know what you want to say about Afghanistan, except leave it up to them to settle their own problems. 

2.c What is the lesson for Ukraine, which may have been democratic before the Russian invasion in 2014, but was dysfunctional before the election of Zelensky in 2019?

3. If it is a European problem, and not an American problem, what is the lesson for Europe? They have been on a free ride to their own security guaranteed by the American military presence for decades. When do they step up, when you have an ambiguous Trump Administration representing what are supposed to be American/NATO national security interests? Is that the way Trump carries out national security strategy? Those are called negotiating skills?

4. Either way, I will go back to what I said a couple of years earlier:

4.a. I don't think the American military ever thought Ukraine could defeat Russian, and that the war would end with a negotiated settlement.

4.b. Whatever remains from Ukraine will get membership in the EU, and will lean toward Europe for its culture and not Russia.

4.c. And if Ukraine does not get NATO membership, it will get a security guarantee. This I am not so sure about. They need an American security guarantee, and better yet American troops stationed in Ukraine, just like we have troops in Estonia which is right on the Russian border.

4.d. So if Trump is unwilling to make an American security guarantee and with American troops, will Europe step up?

4.d.(1). Germany is the problem here. They are ambivalent (some Germans, not all, having mixed feelings in dealing with Putin/Russian since there is business they would give up; whereas Trump is ambiguous, you don't know what he will do with Putin/Russia.

4.d.(2). And China is watching all of this play out. What about Taiwan?

5. I thought Biden's unstated strategy in Ukraine was pretty good. He didn't think Ukraine could defeat Russia, but if they want to continue to fight, support them. 

5.a. That kept Putin tied down in Ukraine, so he couldn't operate elsewhere -- like Syria, or anywhere else. Ukraine was Putin's Vietnam.

5.b. And that put China at a disadvantage. They were supporting Putin. This antagonized the Europeans. Prior to the Russian invasion in 2022, China was trying to make strategic inroads in Europe; the Europeans put that on "hold" while the war in Ukraine continues.

5.c. If Trump is such a genius negotiator, how is he going to remake the map? Are we likely to have the world security arrangements split into three of four alignments rather than two? And is spreading democratic values, which has not been working now (in my opinion) since the 1990s, still part of our national security strategy? -- which was established under Truman after WWII and carried out successfully up till Reagan.