Taxing the World

Steven Den Beste is one of my favorite bloggers to read primarily because his mind works somewhat like my own mind. Last week, he had a post about the link between Chaos Theory and Economics. First I want to talk about our nagging Trade Imbalance with other nations.

TRADE IMBALANCE

Den Beste writes:

"We seem to be able to "unilaterally" begin an economic recovery. We can do that even if the rest of the world is in recession. And there have been times when the US was in a boom and the rest of the world sat it out. It seems as if most of the other major economies in the world can only begin to grow if we already are doing so, and that's because their economic growth relies on exports – more often than not, to us."

Den Beste references this article at the International Herald Tribune about the pending increase in interest rates and then goes on:

"And in fact, most other nations generally drive economic recovery using exports.

Which means they can't recover unless someone else is recovering who wants to buy lots of their stuff.

Which usually means the US, which has had a chronically high trade imbalance for a hell of a long time, causing some to predict that we're heading at high speed for a cliff."

I have come to view our Trade Deficit as a tax on other nations. Let me spell it out for you.

1) Americans want the most for their money. They do not really care where a product is made, so long as it performs the function for which it is purchased, and it is cheaper than another.

2) Products which can be made cheaper abroad are shipped abroad to be made, raising the standard of living in poorer countries. Products which are marginal, and are produced in other countries which rely on exports to drive their economies tend to be either directly subsidized by competing governments (Airbus comes to mind) or indirectly subsidized through tariffs.

3) Because America is ruthlessly competitive, low productivity jobs tend to outsourced leaving Americans only those jobs at which it is most productive and most competitive. This optimizes our economy at the expense of everyone else who doesn't follow our model.

So how is this a tax on other nations? If France subsidizes an industry, it is effectively taxing its own people in order to lower the price of its output to compete with American made products. Every time you buy a French government subsidized product over a non-subsidized American product, you are personally collecting a small tax on some French citizen.

Also, since France wants to "protect" its textile workers from "unfair" competition of, say, Chinese textiles, it places a tariff on Chinese-made clothing. Since some Chinese clothing still gets bought in France, the French buyer is once again paying an extra tax for Chinese clothes. But since creating a trade barrier for Chinese made textiles lowers overall demand for Chinese textiles in France and in the rest of Europe, as well, it ends up lowering the overall international prices of Chinese textiles worldwide. Since we have low trade barriers with China, we are effectively profiting at the expense of citizens of countries who erect trade barriers. So once again, we are personally collecting a tax on citizens in countries with high trade barriers every time we purchase a Chinese-made shirt.

Those who argue against the desirability of a Trade Deficit are Mercantilists. That is, they see intrinsic value in money itself, versus the goods that money can be exchanged for. But Den Beste strips away the veneer of this argument when he acknowledges that our paper money is "money they [The Fed] conjure out of thin air." So, money has zero intrinsic value. The only real value it has is in the amount of goods it can be exchanged for.

That is why the Trade Deficit bogeyman is really a strawman. If I can trade my USA Ten Dollar bill for four Chinese made shirts, but a Frenchman can only get three Chinese made shirts for his Ten Euro Bill, who is more wealthy? People do not wear money, they cannot drive money, they cannot eat money. Midas was a true Mercantilist. He was wealthy in money and gold beyond imagination. Everything he touched turned into money. But he eventually starved to death because when he touched a piece of food, it turned to gold before he could swallow it.

In reality there is no Trade Deficit. In order for us to experience a real Trade Deficit, we would have to get lower value in goods in return for our money. But because of our low trade barriers, we actually get more value for our money than other countries do. So what if I ship a boatload of paper money to Singapore, as long as I am getting a fair value in Goods in return. After all, people actually wear clothes, listen to radios, watch TV's, eat food, and really use the Goods we exchange our money for.

The essential fallacy in the Mercantilist point of view is expertly summarized in the essay about French Economists Frederick Bastiat at the Dallas Federal Reserve website. I highly recommend you read the entire essay, but some stimulating tidbits follow:

"Bastiat argued primarily that those voting for protectionist policies were voting for scarcity over abundance. How is it ever possible, he asked, that the average person and, presumably, the nation can prosper by restricting the supply of precisely those things people need?

Allow me to emphasize this point, at the risk of repeating myself. There is a fundamental antagonism between the seller and the buyer. The former wants the goods on the market to be scarce, in short supply, and expensive. The latter wants them abundant, in plentiful supply and cheap. Our laws, which should at least be neutral, take the side of the seller against the buyer, the producer against the consumer, of high prices against low prices, of scarcity against abundance.

They operate, if not intentionally, then logically on the assumption that a nation is rich when it is lacking in everything".[3] (Bastiat's emphasis)

This is the central failing of the Mercantilist Doctrine. It says that money is worth more than the goods it is traded for. It is a fallacy. Furthermore, the direct exchange rate of currencies is also a poor measure of value when a currency's value is artificially elevated because of protectionist policies of governments. A true measure of currency value fluctuations must take into account government tariffs.

The Mercantilist Response:

"The protectionists answered such arguments by appealing to the fear that foreigners would take away the nation's money by "flooding" France with their goods. This fear was a result of two centuries of the popularly accepted mercantilist doctrine in Europe. Mercantilism claimed that physical money was wealth, and when one traded goods for money, the person surrendering the money "lost wealth" in the exchange. What was assumed to be true for individual trades was, by extension, assumed also to be true for the nation as a whole. "Trade deficit phobia" was a common theme during this period. The primary reason Adam Smith wrote his great 1776 work, An Inquiry into the Nature and Causes of the Wealth of Nations, was to refute mercantilism. Bastiat often found himself repeating Smith's arguments 75 years later. And we are still having this debate nearly 150 years after Bastiat's death!"

Bastiat's reply:

Like Adam Smith, Bastiat believed that there was "nothing so foolish as discussing the so-called balance of trade."

...

The confusion between money and wealth is an old and stubborn problem. Bastiat saw the distinction clearly, while the protectionists, relying on the old mercantilist doctrine that money is wealth, failed to grasp the consequences of this view. Bastiat makes a simple but powerful point that we would do well to remember when examining, say, our own national income statistics:

Similarly, restrictive measures, while reducing the abundance of things, can raise their prices to such an extent that, if you will, every person is, in monetary terms, just as rich as he was before.

Whether an inventory shows three hectoliters of wheat at twenty francs, or four hectoliters at fifteen francs, the result will be sixty francs in either case; but, are the two quantities the same from the point of view of their ability to satisfy wants?...

Man does not live on nominal values, but on commodities actually produced; and the more he has of these commodities, regardless of their price, the richer he is.[5] (Bastiat's emphasis)

Bastiat goes on to say that there are two ways of obtaining wealth - Production and Plunder. And excessive taxation to artificially support industries is Plunder. As I said before, read the entire thing.

CHAOS AND FREEDOM

My original Major in College was Physics; then I flirted with the idea of Majoring in Economics, but having come from a background of Engineers and Industrial Workers, I wasn't sure exactly what an economist would do to earn a living; so I majored in Engineering. Since finishing my schooling in 1991, I have primarily been in the Controls business, both environment and industrial; so, I understand exactly what Den Beste is talking about when he speaks of oscillating systems, and trying to damp the oscillations in control loops to get a more stable system.

Proportional (oscillating) control loops are easy to create, with the amplitude and durations of the control loop being the main variables. In theory, the process of trying to damp the oscillating characteristics of control loops is done by using integration and derivation to mitigate the time lag variable in the feedback input. There is a "learning" ability built into most controllers to help do this, but it requires getting the Integral and Derivative factors into a generally acceptable range. In practice, this is an iterative process. We play with the numbers until the curve starts looking better. Then we upset the system to see how fast or slow it responds to change, and adjust the numbers accordingly. It is a little too complex to try to explain without a demonstration, but over time, you get a knack for tuning control loops.

Unfortunately, Economics has a whole lot more factors entering the picture, and it is difficult to obtain even short-term stability in a model because there are constantly changing variables beyond the control of the model maker which upset the process before one can observe stability. So in theory, creating a stable economic model is possible, just like tuning the control loop on a plastic extruder is possible. But in practice, it is beyond the capability of economists to do so.

But the desire for stability is understandable. Who wouldn't like to have a reliable model to predict future economic activity? And this is the desire that Central Government Planning types act upon when trying to micromanage the economies of the world. Do most central planners REALLY want to limit the freedoms of everyday people? Probably not. But what they do want is Reliability. And the only way that can be achieved is by limiting the amount of input from "outside" factors on the economy. In Practice, this means limiting the choices that individual people can make which might upset the Central Governing Economic Model. It means limiting freedom.

Central planners essentially have a low risk tolerance. They are willing to sacrifice freedom for predictability. And it is your freedom and my freedom they put on the alter of Central Control. At heart, I am convinced that most of these people genuinely believe they want to do this for our collective good. And they are so invested in the "model", they are blind to the effects of central control.

I am reminded of the Daniel Webster Quotation.

"Good intentions will always be pleaded for every assumption of authority. It is hardly too strong to say that the Constitution was made to guard the people against the dangers of good intentions. There are men in all ages who mean to govern well, but they mean to govern. They promise to be good masters, but they mean to be masters."

In the final analysis, the only "Stable" model which can be created is economic stagnation, the results of which are widespread poverty, unemployment, and eventually starvation. The only reason Europe has gotten away with their romance with Central planning is their declining population growth rate. And even that is unsustainable. Central Planners are more enamored with their theoretical models than with the lives of ordinary people, and they prey on the natural fear of Chaos that many humans have. Either way, it is important for Freedom loving People to resist them, regardless of their intentions. Chaos needs to be embraced, not shunned, for out of chaos comes prosperity, and only in chaos can freedom's flower bloom.

Update: Of Course, I failed to mention that Chaos Theory is about being able to affect seemingly chaotic systems, and that there is some value to trying to mitigate the harsher effects of the capitalist system. But there is a difference between leading and controlling. Leaders rely on voluntary compliance of societies based on the persuasiveness of their arguments, and they are not immune to accountability. Also, in free societies, we have our choice of leaders to follow. So if following one path proves to be an unwise decision, free societies can change leaders and go in another direction.

But Centrally controlled societies adhere to a "perfect ideal" philosophy, and many times the people are told to be patient because the eventual success of the centrally planned solution is inevitable. This effectively eliminates negative feedback which is counterproductive.

So it is not wrong to try to affect the economy. It is even virtuous. And in so far as the Fed can effectively help temper the oscillations in the Boom/Bust cycle, I am all for it. But I don't believe eliminating them is a good goal. There is a pruning effect in the Bust cycle that is necessary for long-term growth and prosperity. Call it the Summer/Winter theory of economics, but I don't think we should try to eliminate the Boom/Bust cycle any more than we should try to eliminate the Seasons. That doesn't mean I am against Central Heating and Air Conditioning, though.

Update: Bill Hobbs linked to this article