A while back I explained why the current federal budget deficit was small and either a minor matter or even a positive force because it was created by a tax cut. I promised to discuss the balance of trade deficit which also bothers some of my non-economist friends. It has been more than a year since the earlier blog and I can’t think of anything interesting or original to say.
The balance of trade is in itself irrelevant.
The balance of trade is in itself irrelevant. It just means we are buying more products than we sell. Only old-line labor leaders and people who think manufacturing is god care about the balance of trade.
The balance of payments is the relevant issue because it includes
services and royalties. Having the world buying the old tv program
Bay Watch for $1 billion is just as important as selling them $1
billion worth of pork rinds. The former, Bay Watch royalties, is in the
balance of payments, the latter, pork rinds, are only in the balance of
trade. Our balance of payments is negative, 7% of our GNP.
Does it matter what the balance of payments is? No! Because if we buy
more than we sell, there are two consequences: (1) the rest of the
world sends us money to buy stock and raise our stock market, or sends
money to buy government bonds and lower our interest rates; (2) the
dollar falls relative to the Yen and the Euro so we self-correct by
facing higher prices of imported goods and the rest of world faces the
temptation of lower U.S. prices and buys more of what we sell.
The first is what is happening because the dollar is quite strong. The consequence is the rest of the world has been sending us money to buy bonds and we Americans are enjoying low interest rates. We are taking the low interest rates and having a fling at buying and building houses.
I didn’t mention inflation or deflation in my boring economics lesson.
They haven’t been an issue for 20 years and they probably won‘t be in
the future. We have had a steady cost of living since the mid-1980s'
Reagan tax cuts. The outgoing Fed chairman was opposed to both
inflation and deflation and made sure we didn’t have either. The
incoming Fed chairman is committed even more strongly to the same
policy and he intends to be public about his detailed
inflation/deflation goals.
Our incoming Fed chairman needs to be appreciated as a great
economist. Ben Bernanke is the hero who gave the right advice to the
Japanese when they made a serious mistake in 1989 and intentionally
deflated their stock market and their housing prices. Japan faced ten
years of deflation and no growth. Japan didn’t take Bernanke’s advice
at the time, which was tax cuts, support for bank lending and a
generous money supply.
Instead, the Japanese took the advice of Paul Krugman who recommended traditional 1938 Keynesian policy: deficit government spending to the hilt. Krugman’s advice was wrong and created ten years of humiliation for the Japanese government and a grey, miserly life for most Japanese.
Fortunately, George W. Bush appreciated the knowledge and wisdom of Ben Bernanke and appointed him Fed chairman, a job well deserved.
Unfortunately for the million Lefties who read the New York Times, Paul Krugman, the Times’s popular op-ed columnist, continues to give his readers the same smelly pile of ideological economic advice that is stuck in his brain, like a broken vinyl record. Krugman has never had the self-honesty to admit he gave the Japanese painfully wrong advice that didn‘t work, and he has never changed his views.
A footnote. One of Bernanke’s brilliant economic observations is that
interest rate can’t go below zero. Obvious to you, but not to
economists. The consequence is that deflation can get out of control.
When the interest rate falls to zero, as it did in Japan for the past
fifteen years, lenders get more valuable money back from their
borrowers than they originally loaned, but the value of the assets
backing the loan also falls, so banks stop lending and everything gets
worse.
Another point, which hasn’t been understood by almost anyone, is why the Reagan tax cuts and the recent G.W. Bush tax cuts are so effective at creating economic wealth. It doesn’t help to shout Laffer Curve. Laffer Curve is a description, not an explanation.
The answer came from my friend John Tepper Marlin in the late 1980s when he was railing against high military spending. John demonstrated, empirically, that military spending has a much lower multiplier than general consumer spending. One dollar of military spending gets circulated and generates another $1.50. One dollar of consumer spending gets circulated and generates another $4.00.
Turns out all government spending is like military spending: a low multiplier. So any money removed from taxes and spent by consumers is several times more productive. Just the issue of a multiplier.