There continues to be much talk of currency manipulation with China and Japan usually identified as the main culprits. While there is no doubt that these two have long managed kept their currencies undervalued to boost exports, today's main practitioner of the black art remains hidden.
Unidentified and even herself not fully aware of what she is doing, the German ship of state sails blithely along, racking up record trade surpluses and wreaking havoc in its wake.
Yes, I said Germany. I know it gave up its beloved deutsche mark to join the euro zone and I know that the euro floats and is itself not a manipulated currency like the yuan, the yen, the Swiss franc, and the Brazilian real. But the truth is that the euro is not really a single currency. For instance, does anyone believe that the euro used in Cyprus is the same as the one used even in Greece let alone Germany? Does anyone think that the Spanish euro is the same as the German euro? To ask the question is to answer it.
The EU economy is far from the integration of the U.S. or Chinese markets. This is true in many respects, but most glaringly in finance. The EU may have a common currency but it certainly does not have a common banking or financial system. And here is where the essence of German currency manipulation is most apparent. It is the Germans who have steadfastly resisted any common guarantee of national debts and any common bank supervisor.
The differences in the various euros can be seen in the different interest rates that EU governments pay on their euro bonds. Germany is presently paying 1.58 percent on its long term debt. This compares to a bit over 10 percent for Greece, 6.3 percent for Portugal, 4.67 percent for Spain, 4.38 percent for Italy, and 1.88 percent for Finland just to cite a few examples.
Because the European Central Bank sets a common short term interest rate for short term euro debt and because the eurozone countries all price their exports and domestic transactions in euros, we have the illusion that they use one currency. But the truth is that the international rate of exchange of the euro to the dollar (presently $1.31/E) and other currencies is an average of the rates of the various national euros. As such, the euro today is far too strong for the peripheral countries. Were Italy, for example, to change back to Lira in place of euros, it would be a much devalued Lira that would greatly facilitate Italian exports while making imports from Germany, for instance, much more expensive. At the same time, the present euro is much weaker for Germany than would be any new deutsche mark that might replace it. Thus, German exports are being indirectly subsidized and stimulated and German imports inhibited by an artificially and systematically undervalued currency.
Of course, few in Germany recognize this and even fewer are willing to admit it publicly. At a recent meeting of Chinese and German leaders that I happened to attend in Shanghai, the Germans were robustly proud of their export virtuosity and competitiveness. They insisted that domestic austerity and export led growth were the keys to success and that other countries should imitate Germany, as they believe China has been doing. They argued that German export success is entirely due to the innovativeness and quality of German industry, and they insisted that Germany should not under any circumstances guarantee or take any responsibility for the debt and the health of the banking systems of other eurozone countries. Thus, in effect, they insisted on continuing to manipulate an undervalued German euro. Of course, they would all deny that that is what they are doing. But the denial doesn't change the facts.
Worse, is the fact that as a result of German leadership the whole eurozone is coming more and more to resemble Germany. Trade deficits are falling along with employment and imports while exports are rising somewhat.
The German trade surplus is now $245 billion or 6 percent of GDP. This is the largest surplus of any country despite the fact that Germany's GDP is only the world's fourth largest at about half the size of the Chinese GDP and a quarter that of the U.S. GDP (by comparison, China's trade surplus is about $217 billion). Now imagine that the whole eurozone reached the German surplus level of 6 percent
The global economy would come under severe strain if anything like this number materialized.
A few years ago I suggested that the solution to the eurozone crisis was for Germany to go back to the old D Mark. This would effectively have resulted in an upward revaluation of the German currency and would have automatically devalued the euro against the D Mark thereby allowing the peripheral eurozone countries to achieve growth and debt repayment without the crushing austerity that has now driven unemployment to record levels. Critics accused me of secretly wishing to undermine the euro. Of course, my suggestion was not adopted and the result now is that rather than the euro it is much of the eurozone itself that is being destroyed.
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There was a lot of good stuff in the President's State of the Union address last night, but a lot of it is not going to happen unless the Obama administration stops contradicting itself.
Repairing and upgrading infrastructure and education, facilitating and investing in production of more and cheaper energy, fostering domestic manufacturing and the re-shoring of production and jobs, reforming how we do healthcare to cut costs by paying for results rather than procedures, stoking R&D and innovation, and fixing our broken immigration system are all important and largely (or should be) bipartisan undertakings.
But does the White House understand that it is operating in a global economy, have any idea of what that is, or of how other countries conduct themselves in that environment?
The President announced that he is launching talks to conclude a Trans Atlantic Free Trade Agreement (TAFTA) between the United States and the European Union. This is a worthy initiative that I, along with a few others, have been promoting for nearly twenty years. It's worthy because the EU is by far the world's largest economy and the economic relationship between the U.S. and the EU dwarfs any other. The United States sells three times as much to the EU as it does to China, for example. Furthermore, the EU's attitudes and policies on international trade and investment are very similar to our own and its markets most nearly match ours in terms of openness to outsiders. EU wages are, if anything, higher than ours, as are its environmental, health, and safety regulations. So there will be no race to the bottom in a TAFTA. Nor are the euro and the pound sterling manipulated currencies, and the EU anti-trust regime is fully as tough as that of the United States. I believe a TAFTA could add 2 to 4 percentage points to U.S. GDP. So far so good.
But then the President reiterated a line from his inauguration address which said that the Trans Pacific Partnership Free Trade Agreement that he is hoping to complete with Canada, Mexico, Peru, Chile, New Zealand, Australia, Brunei, Singapore, Malaysia, and Vietnam (and possibly Japan) by October will level the playing field and promote American exports and jobs. He essentially equated the two proposed deals.
But they are in no way comparable. For starters, the TPP is likely to undermine the North American Free Trade Agreement (NAFTA) and the Caribbean Area Free Trade Agreement (CAFTA) and result in the loss of more than a million jobs in Mexico and the Caribbean, along with nearly 200,000 jobs lost in the United States. This is because under NAFTA and CAFTA textile producers in the Caribbean and Mexico who use U.S.-made fiber and yarn receive duty free access to the American market. The only manufacturing industries in the Caribbean are based on this deal, as is much of Mexico's manufacturing industry. These deals were done in the 1990s in part to mitigate illegal immigration and illegal production and shipment of drugs to the United States. A TPP will remove the tariffs on textile imports from much of Asia and take large chunks of the U.S. market away from Caribbean and Mexican producers and give it to Vietnamese producers that are heavily controlled and backed by their government, according to studies by the Mary O'Rourke Partners Group of economic analysts.
But that's just a small part of the problem. The main part is that the TPP does not at all address the issue of trade-related currency manipulation in which governments actively adopt policies aimed at promoting their exports and reducing their imports by lowering the value of their currencies. A good recent example is that of Japan. Before being elected, the new Prime Minister Shinzo Abe called for devaluation of the yen. Upon election he immediately began introduction of policies and rhetoric aimed at reducing the value of the yen. Not surprisingly, the yen has devalued by nearly 30 percent over the past few weeks. That would far outweigh any removal of a 5 percent tariff that might be achieved in a TPP deal. Yet the TPP has nothing with which to combat this kind of currency policy.
And it gets a lot worse. On Monday, I received an urgent email from an old friend in Tokyo who is a former top economist for Goldman Sachs. He had just seen on Bloomberg a comment by Treasury Undersecretary Lael Brainard saying in answer to a question about Tokyo's recent actions that the administration supports Abe's policies to stimulate the Japanese economy. In other words, the Obama administration apparently approves of Abe's efforts to weaken the yen as a way of subsidizing Japanese exports, many of which come to America, a country that needs to reduce its trade deficit in order to keep economic growth and job creation going.
Asked my Tokyo friend: "Do these people have any brains? Who do they work for? Who?"
Well, they all work for the president, and he hasn't figured out yet that the TPP and fiddling with currency values to promote trade surpluses and promoting manufacturing in America don't go together. So it was a good speech, but a very mixed message.
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I told you Obama is lucky didn't I? Everything fell his way one more time. The EU moved a half step toward eventual euro bonds and of all people, it was arch conservative U.S. Supreme Court Chief Justice John Roberts who saved Obama Care by making the tax argument that Obama's own lawyers had downplayed. I mean, you have to admit it. Luck is better than skill any day.
So, with the Supremes backing him up and the Europeans taking decisions that have the markets soaring today, it looks like the skids are being greased for an Obama return to the White House in November.
But while the news from Europe was positive, it was far from signaling the end of the game. To be sure, establishing the European Stability Mechanism (ESM) as the single body in charge of recapitalizing Europe's ailing banks is a big step in the right direction, it still leaves much unclear and undecided. For starters, the bailout fund still doesn't technically exist. It must be formally approved by each of the 17 countries that use the Euro by July 9. That's coming up fast. So there is not much time for further conferencing if there are any unseen bumps in the road. Then there is the small question of where the money is coming from. The main focus of the ESM at this moment is to assist Spain and Italy by recapitalizing the Spanish banks and be reducing the cost of public debt issues for both countries. But 30 percent of the ESM's capital is supposed to come from Spain and Italy. Does this mean they're partially going to bail themselves out?
Even assuming this all gets sorted out quickly and smoothly and that the ESM gets enough money to achieve its objectives, the fact remains that they are still short term objectives. Italian Prime Minister Mario Monti has succeeded in persuading and scaring the Germans into recognition of the need for unified banking and for measures to reduce the cost of Spanish and Italian public debt service. That is a signal accomplishment. But by itself it won't stop the repetition of market ups and downs and crises over the euro. There will have to be further follow on measures to establish credibility and confidence.
These will have to include some kind of centralized control over European national budgets along with pan European taxation and the issuance of Eurobonds guaranteed by all the member states or at least by those that share the Euro. At the same time, the problem countries and even countries like France that aren't yet identified as problem countries but that are suffering from declining competitiveness must demonstrate their long term commitment to fiscal responsibility, labor market flexibility, and the achievement of lasting competitiveness. Finally, the European Central Bank must act more like the U.S. Federal Reserve in acting to do whatever it takes to stimulate growth.
As the European Union slips inexorably further into crisis and perhaps recession, the negative impact on the United States is inevitably going to be substantial. At the same time, slowing growth in China, South America, India, and elsewhere will also have an important impact.
The whole world will now be reemphasizing export led growth and the favorite target market place will be that of the United States. Among the G-20 nations, only America will be without a comprehensive growth strategy. The likelihood is that the U.S. trade deficit will rise significantly while unemployment remains high. This is, of course, not necessarily a winning political formula for the U.S. presidential election.
Both President Obama and Republican candidate Romney need to articulate a serious growth program that goes beyond the standard talking points on stimulus and cuts in government spending. I'm going to help them by outlining here a few key ideas of what they might propose.
Given the high level of U.S. government debt and of the federal budget deficit, further stimulus is bound to be limited, whether it be as a result of tax cuts or of increased spending. Thus the main avenue to growth must be through reduction of the U.S. $800 billion trade deficit. This can come from a combination of importing less and exporting more. America can produce more of what it consumes and export more of what it produces. The program is very simple and straight forward.
The most important step will be for the candidates to articulate that their top national security priority, more important than Iran's nuclear program or the so-called Pivot to Asia, will be to produce and provide tradable good and services from an American base. Make it in America. Provide it from America. Those must be the touchstones of the new national strategy.
In recent months it has become clear that there is already a trickle of manufacturing and industrial activity coming back to the United States from Asia. Booz &Co. along with the Boston Consulting Group, have done analyses demonstrating that production in a wide variety of industries can increasingly be done competitively from an American base, at least for purposes of supplying the American market. To further stimulate that trend, U.S. corporate taxes should be made competitive with those of other leading countries. This means rates should be somewhere between 15 and 25 percent.
The United States is the only major country without a Value Added Tax (VAT). Because this tax is rebated on exports to the United States and added on to the price of U.S. exports to countries having a VAT, the tax currently acts as a subsidy for imports into the U.S. market and as a tariff on U.S. exports to foreign markets. This situation must be corrected by adoption of a VAT by the United States.
Washington needs to announce that it will selectively match the targeted investment incentives offered by the likes of Singapore, China, and France to attract investments in targeted industries like biotech and semiconductors. What I mean here is not that the U.S. has to proactively offer these things, but it needs to offset the offers of other countries that are aimed at drawing the production out of America. At the same time, the U.S. could propose negotiating disciplines in the WTO on such offers.
Similarly, Washington must have a policy of countering currency manipulation. For example, Japan recently intervened in currency markets to weaken the yen as an aid to Japanese manufacturers, and especially auto manufacturers. China, Brazil, Korea, and others routinely engage in such actions which tend to act to the disadvantage of U.S. based production. Again, U.S. counter-policies could be coupled with calls for negotiation of international disciplines on currency manipulation.
Jawbone, jawbone, jawbone. No executive should ever leave the president's presence or that of a presidential candidate without being asked when he or she is going to invest and produce more in America. When executives are in China, all they hear is the question of when they are going to put production and R&D into China in order to maintain a good image there. They need to hear the same refrain in America.
Investment in infrastructure, creation of an infrastructure bank, and dedication to keeping the United States at the cutting edge of infrastructure will be essential. For example, Korea's advanced high speed Internet infrastructure means that certain kinds of R&D can only be done there. The United States must be able to match this capability.
America must adopt labor-government-business cooperation similar to that of Germany, Scandinavia, and Japan. There should be regular consultations and discussions among these three key entities on how to make and keep America competitive. Joint setting of national objectives and undertakings to keep budgets, inflation, and investment on target will be extremely valuable.
Support for R&D and development of pre-competitive technology by government has always been a major pillar of U.S. competitiveness. The success of the Agricultural Extension Agencies, of the Defense Advanced Research Projects Agency (DARPA), and of Sematech and the National Science Foundation must be maintained and extended.
President Obama has set a target for doubling exports. Nothing wrong with that, but if exports double while imports triple, nothing will have been gained. Both Romney and Obama should announce that they will set targets for balancing trade. With no trade deficit, America would gain 4 to 5 million jobs with no need for debt funded stimulus programs.
This nine point program, if adopted, would assure U.S. economic vitality and leadership for a very long time to come.
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As the G-20 talks get underway, we're thrilled to have Clyde Prestowitz guest-blogging for us over the next few days. Clyde is the president of the Economic Strategy Institute here in D.C. He served as counselor to the secretary of Commerce during the Reagan administration and as vice chairman of the President's Committee on Trade and Investment in the Pacific.
Be sure to check out his most recent book, The Betrayal of American Prosperity: Free Market Delusions, America’s Decline, and How We Must Compete in the Post-Dollar Era as well as his piece, Lie of the Tiger, from the November print issue of FP. -JK
First, Barack Obama was shellacked in last week's congressional elections. Then, the U.S. president was garlanded in India and Indonesia. Now he's in Korea, where he's about to be waterboarded by the G-20.
Oh sure, the G-20 will come up with some paper-over language that will allow everyone to sign on to some vague agreement that it might be a good idea to achieve global rebalancing at some undetermined time in the next century. But this is just what the Japanese would call tatemae -- the packaging or superficial appearance of things. The honne -- the truth or actuality -- is that whether he knows it or not, the U.S. president has arrived in Seoul to preside over the end of the Flat World.
In fact, the Obama administration is demonstrating a lot of schizophrenia about this. In India, Obama couldn't stop spouting the conventional wisdom about how international trade is always a win-win proposition and how those who express concern about the offshoring of U.S. services jobs to India are just bad old protectionists.
At the same time, however, Treasury Secretary Tim Geithner is calling for some kind of deal for the G-20 governments to take concrete actions to reduce their trade surpluses or deficits. To be sure, Geithner has quickly backpedaled from his original proposal that governments would set hard numerical targets for the allowable limits of surpluses and deficits at 4 percent of GDP. His first fallback position was that the numbers would be only voluntary targets or reference points. When that elicited a new round of incoming fire he retreated further to the current proposal for agreement that each country will take the measures it thinks necessary to reduce excessive surpluses and deficits. Hardly much of a deal at all.
Yet even this is a revolution. No matter how watered down, Geithner's proposal is a call for managed trade. It is an implicit admission that contrary to 50 years of the preaching of economists, trade deficits matter. Even bilateral trade deficits can matter if they are big enough because they distort capital flows and exacerbate unemployment in the deficit countries. Further, it is an admission that unfettered, laissez-faire free trade is not self-adjusting and therefore not really win-win.
This implicit admission by Geithner has been manifested even more strongly (but still implicitly) by some of our leading free-trade economists and pundits. Thus, Paul Krugman, a Nobel Prize winner and long a champion of conventional free trade has called for tariffs on imports from China. So has Washington Post columnist and eternal free trader Robert Samuelson, and even the Financial Times' economics columnist Martin Wolf has suggested that some offsetting response to China's currency manipulation might be necessary.
But Obama isn't going to get agreement to any of that in Seoul. None of the other countries want to face the fact that the United States cannot be Uncle Sugar and the buyer of last resort forever. In fact, Obama has asked both the Germans and the Chinese to help out a bit by consuming more and exporting less. The Germans told him bluntly to get lost and the Chinese told him somewhat more politely to get lost. So the honne is that the Germans, because they're Germans, and the rest of Europe, because it is in terrible financial shape and can't borrow any more, are bent on creating jobs by dint of export-led growth. Essentially, they are saying they are going to create jobs by taking U.S. jobs. The Asians are saying and doing the same thing. Neither Asia nor Europe is likely to take steps that will achieve significant rebalancing in any reasonable period of time. That, of course, means no new jobs for Americans.
The big question is whether or not Obama will respond to that refusal by taxing foreign capital inflows, imposing countervailing duties on subsidized imports, matching the tax holidays and other investment incentives used by China and others to induce off-shoring of U.S. production, and challenging the mercantilist practices of many Asian countries in the World Trade Organization (WTO). These are all measures that he could take himself in an effort unilaterally to reduce the U.S. trade and current account balances and thereby create jobs for Americans.
If he does, he is sure to be harshly criticized by the apostles of the conventional wisdom. But if he doesn't he is sure to be toast in two years.
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Clyde Prestowitz is the president of the Economic Strategy Institute and writes on the global economy for FP.