America’s burgeoning trade deficits threaten Greenspan’s legacy. (This article was first published in the March 1 , 2004 issue of the American Conservative.)
For those who watch the American economy, the Internet boasts few more useful resources than the web site of the Federal Reserve. In a few clicks you can mine data on everything from the level of interest rates on Black Monday to the growth of steel production under Eisenhower. Whether the topic is the trend in semiconductor prices, the impact of weather on retailing, or the most efficacious way for corporations to break bad financial news, someone at the Fed has studied it and has posted his findings.
Strangely, though, one crucial economic concern gets short shrift: international trade. Not only are there no trade statistics, but America’s perennially rising trade deficits have received virtually no attention from the Fed’s monograph writers in recent years.
This blindspot faithfully reflects the mindset at the top. Fed chairman Alan Greenspan consistently tiptoes around the subject of trade. Indeed, the worse America’s trade figures have become, the less willing he has been to look the trade trend in the eye.
Yet when future historians look back on America’s economic performance in recent decades, no problem will loom larger in retrospect than that of the deteriorating trade position—and, as a result, no reputation is destined to come in for more extensive revision than that of the Sphinx of Constitution Avenue.
Although the Fed chairman has no direct control over trade policy, he is in a uniquely powerful position to moderate the climate of opinion in which that policy is set. It is fair to say that where economic matters are concerned, he enjoys far greater trust than any president. In any case, he has been in office far longer than any president: already he has served under no less than four. Whereas each succeeding president could plausibly spin the trade trend as a temporary aberration and bequeath the painful task of rethinking trade policy to his successor, Greenspan can offer no such alibi. One of his most important responsibilities is to safeguard the value of the dollar. Trade ranks with inflation as one of the two key determinants of the dollar’s long-run external purchasing power. Trade, moreover, is of pivotal importance for America’s continued leadership of the world community.Although the press airbrushed the problem out of the picture during the economic euphoria of the late 1990s, the trade deficits never went away. In fact, as the American public is belatedly beginning to discover, they got far worse —so much so that the monthly deficits under George W. Bush are sometimes higher than the total annual deficit in his father’s last year in office.
In the past year we have seen a dramatic rise in the number of talking heads who openly question American trade policy. In the academic world, MIT economist Lester Thurow has suggested that America’s trade deficits could trigger a 50 percent-plus collapse in the dollar’s external value, and this in turn would lead to a global depression. Meanwhile on CNN, Lou Dobbs fulminates nightly about the impact of imports on American manufacturing jobs. In the world of business, critics of U.S. trade policy include that ultimate financial heavyweight, Warren Buffett. Even investment banker Robert Rubin, who as Clinton’s treasury secretary did much to create the trade problem, has now added his voice to the hue and cry. Then there is Henry Kissinger. Obliquely criticizing American trade policy at a conference last summer, he suggested that a nation that had lost its manufacturing base could not long remain a world power.
Figures to be published in March will show that expressed as a percentage of GDP the current-account trade gap has now topped the psychologically important 5 percent level. This is the worst performance since American economic records were first published in the 19th century. By comparison, the notorious U.S. trade crisis of 1971-72 was a mere blip. The trade deficit in 1972, at 0.5 percent of GDP, was less than one-tenth the current level. Yet the 1972 trade deficit seemed so troubling in prospect that President Nixon was forced to devalue the dollar and cut its erstwhile “sacred” link with gold.
The recent trade performance stands in particularly stark contrast to America’s days of greatest relative economic strength in the first seven decades of the 20th century. This was a period when, thanks mainly to the extraordinary exporting prowess of America’s huge manufacturing industries, the U.S. showed a trade surplus in all but 11 years—and did so despite wages that were then five to ten times higher than in Japan and Germany.
Not only is a 5 percent current account deficit unprecedented in American economic history, but it is shocking by all previous world standards. Other major nations have incurred percentage deficits approaching this scale only at times of extreme economic distress, most notably during the two World Wars and in their immediate aftermath. The only time any of the six most economically important nations ever ran a trade deficit of more than 5 percent of GDP was Italy in 1924—hardly an auspicious precedent given that economic problems helped pave the way for Mussolini’s seizure of dictatorial powers.
To the extent that the trade trend has penetrated Greenspan’s consciousness, he has stubbornly insisted on viewing it through rose-tinted spectacles. Greenspan’s message on trade is the simplistic one of a thousand undergraduate economics textbooks: trade benefits the consumer. And of course this is true—to a point. For a small closed economy such as that of, say, 1950s-era Ireland (with a population of three million and a per capita income about one-tenth of America’s), the benefits of a more open trade policy are undisputable. What the textbooks rarely mention is that the larger an economy is, the less it stands to gain from international trade. The fundamental benefit of trade is to enable producers to achieve greater scale economies. But in most industries, scale economies are subject to diminishing returns. Certainly for an economy the size of America’s, it is not at all obvious that, even were all its trade partners to play by the rules of perfect free trade, American producers in most industries would gain much on balance from competing on a global rather merely a national scale. And in reality, many nations are far from perfect in their observance of the rules.
This has greatly exacerbated the negative impact of foreign trade on American joblessness and industrial decline. Over the years, American industries most exposed to international trade have generally turned in a far poorer performance than more sheltered ones. Consider some facts:
America’s share of world manufacturing has fallen from 60 percent in 1950 to less than 25 percent today.
Corporate America’s share of the world’s total foreign direct investment fell recently to just 21 percent—down from 47 percent in 1960.
According to economist Richard Du Boff, non-U.S. companies account for nine of the ten largest electronics and electrical equipment manufacturers, eight of the ten largest auto makers, seven of the ten largest oil refiners, five of ten pharmaceutical firms, and four of six chemical producers.
Even in aerospace, one of the last remaining areas of American industrial strength, the writing is on the wall. Last year, Europe’s Airbus for the first time bested Boeing in deliveries of completed planes. And the new Boeing 7E7, which is expected to be launched in 2016, will be largely a foreign plane in terms of its manufactured inputs and, by Boeing’s own admission, Japanese partners will account for much of the most advanced work.
In supercomputers—so vital for U.S. national security and once one of America’s most avidly defended industrial strongholds—American leadership is a thing of the past. Although it was widely reported in the early 1990s that American supercomputer makers had staged a comeback after losing the lead in the late 1980s, this has proved to have been a mirage. As of 2002, a Japanese laboratory had built a supercomputer whose processing power matched that of the 20 fastest American supercomputers combined.
At the level of ordinary Americans, the pattern of worsening U.S. trade balances correlates closely with declining manufacturing employment. As economist Pat Choate has pointed out, the United States has lost more than four million labor-intensive manufacturing jobs in the last decade. Of these, more than half disappeared in just the last three years. The result is that manufacturing’s share of total employment had fallen to 10.7 percent by last year—versus 18.2 percent in 1989 and 33.1 percent in 1950.
Manufacturing’s falling share in total employment correlates closely with a pattern of stagnant middle-class income growth. These days most families need two incomes to maintain the sort of lifestyle that fathers alone could deliver a generation ago. In 1960, fewer than 27 percent of all married women living with their husbands worked. By 2000, the figure had risen to 62 percent. Forty years ago, moreover, only 19 percent of such women with children under six worked. By 2000, this share was 63 percent.
If the immediate problems associated with the rising trade deficits are troubling, the consequences for America’s future are positively frightening. Because its manufacturing base has shrunk so drastically, the American nation is like a household whose income lags behind its soaring spending. To pay the bills, a profligate household must either run up credit or sell the family silver. Neither option is attractive. In the long run, loans must be repaid, and in the meantime interest mounts up. As for selling the family silver, one can do that only once. Either way there will be a reckoning. And the longer it is postponed, the more painful it will be.
The same logic applies to nations. As the Federal Reserve should be acutely aware, it is a fundamental fact of economic life that every dollar a nation incurs in current account deficits must be funded by a dollar of foreign finance. In the case of the U.S. trade deficits, much of the foreign funding comes from foreigners buying U.S. Treasury bonds. Some comes from foreign banks lending to American counterparts. Much of the rest comes from foreigners buying American real estate and equities.
In an increasingly troubling trend that has its roots in the trade imbalances, foreigners are even buying some of America’s largest corporations outright. The United States is selling the family silver.
Such pillars of American industry as Amoco and Chrysler have been bought by foreigners. In 2002, Lucent, heir to the fabled technological riches of Bell Labs, sold its optical fiber business to Furukawa of Japan. Meanwhile IBM announced the sale of its disk drive business, a crucial high-tech operation that has played a historic role in the development of the global computer industry. Again the buyer was Japanese, in this case Hitachi.
Large parts of Wall Street have also come under foreign control. Names like Scudder Investments, Bankers Trust, First Boston, Alliance Capital, Republic Bank, Kemper Corporation, Alex Brown, and Dillon Read may still sound American, but these former pillars of the American financial establishment are now controlled from places like Zurich, Frankfurt, Paris, and London.
Even the American book-publishing industry is now largely foreign owned. On one estimate, German companies alone now account for more than half the industry. American publishers that are now German-owned include Random House, St. Martin’s Press, and Farrar, Straus & Giroux. Even President Clinton’s memoirs are to be published by a foreign-owned publisher, the Knopf imprint of Random House. (Random House was taken over by the German Bertelsmann group in 1998.)
The U.S. has already sold so much of its asset base that its economic standing on the world stage has been significantly undermined. While this may not be obvious to the American public, it is shockingly clear in figures compiled by the International Monetary Fund. These show that between 1989 and 2000, America’s net foreign liabilities ballooned from $47 billion to $2,187 billion.
Moreover in a highly alarming development, America’s problem of foreign indebtedness is now feeding on itself. In the words of the British fund manager Marshall Auerback, America has entered a banana-republic-style “debt trap.” The nub of the problem is in the vast and ever rising flow of dividends and interest payments that the United States must now remit abroad to foreign owners of American assets.
The picture looks even bleaker in light of the likely denouement: devaluation of the dollar. Already in the last year we have seen a significant fall in the dollar, particularly against the euro. But the message of the continuing monthly trade deficits is that even at today’s exchange rates, most American manufacturers are still seriously uncompetitive. Thus it is tempting to suggest that a much more drastic devaluation is needed to bring U.S. trade into balance. Unfortunately all the evidence is that in the conditions of contemporary America, devaluation simply won’t work—or at least will not work in any reasonable period.
On paper, devaluation seems the right solution. After all, it immediately makes American goods cheaper to foreign consumers and should thus powerfully stimulate exports. Similarly, at home devaluation should enable American producers to win back domestic market share previously lost to imports.
All this, however, is dependent on the assumption that a nation’s manufacturing industries have plenty of unused capacity available to take advantage of post-devaluation opportunities. In America’s case, this assumption has long since ceased to be valid. After 30 years of merchandise trade deficits, once formidable manufacturing capacity has been wiped out. Thus in the short- to medium-term, devaluation will actually prove counterproductive. This is because import volumes will hardly decrease while import costs, as expressed in dollars, will rise considerably. The backfire will be particularly marked in the case of imports from advanced manufacturing nations like Japan and Germany. These nations now increasingly specialize in making goods that America no longer knows how to make—items like advanced materials (such as the super-strong composites used in planes), key components (such as the more complex parts in cell phones), and sophisticated capital goods (everything from the semiconductor industry’s “steppers” to television broadcasting equipment).
This helps explain why three years ago the U.S. government’s own Trade Deficit Review Commission, in an extraordinary move that went largely unnoticed at the time, strongly hinted that America’s current account imbalances were spiraling out of control. In an unusually outspoken report, it suggested that, even assuming the deficit in visible trade did not deteriorate further, mounting debt service costs would push the current account deficit to 7.5 percent of GDP by 2010.
By all accounts, the outlook has worsened since 2000. Choate predicts that, absent drastic policy changes, America’s current account deficit could reach 10 percent of GDP within a decade.
Only one man has the capacity to provide effective leadership on this: the Federal Reserve chairman. But Greenspan has long since proved himself incompetent to the task. The key charge against him is a startling one: a signal lack of intellectual curiosity. Faced with a trade trend that has defied all textbook theory, he has monumentally failed to ask intelligent questions.
When U.S. trade deficits first emerged in the 1970s, the universal assumption was that, rather like a self-righting lifeboat, the American economy was subject to semi-automatic influences that would eventually bring imports and exports back into balance. In particular, it was believed that, as foreign investors sold the dollar in response to rises in the trade deficits, American policymakers would be forced to make timely adjustments. In any case, to the extent that foreign selling reduced the dollar’s exchange rate, this would automatically promote American exports while discouraging imports.
The dollar was supposed to be the canary in the mine. This expectation was fostered by extensive practical experience elsewhere, most notably in the United Kingdom, whose economic history in the 1960s and 1970s was punctuated by repeated trade-driven runs on sterling.
The puzzling thing is that though many foreign investors have sold the dollar over the years, they have never dumped it on a sufficiently large scale to jolt Washington into appropriately robust policy changes. Still less has the dollar’s declining trend served to bring imports and exports into balance. Contrary to all textbook theory, certain players in the world’s financial markets have assiduously bought enough Treasury bonds and other American assets to make sure the dollar’s landings have been soft. In particular, the government of Japan systematically bought U.S. Treasury bonds for decades. More importantly, by dint of its regulatory powers over Japanese life-insurance companies and other institutional investors, it has funneled a huge share of Japanese private savings into American assets. Similar policies have long been pursued in Taiwan and South Korea. Recently China has followed suit—on a scale that is now second only to Japan’s.
Why have these nations appeared so happy to eat dollars? In the case of Japan, the U.S. media has suggested the motive is to prop up weak Japanese manufacturing industries. In reality, the competitiveness of Japan’s industries is hardly in doubt. Japan’s current account surpluses, at about four times China’s, are by far the world’s largest.
Another explanation is that the East Asians are so enchanted with America’s economic prospects that they see U.S. Treasury bonds as a sure thing. Not only has Greenspan not questioned this media-fostered canard, but he seems delighted to embrace it. Yet it does not stand up to even cursory scrutiny. In the higher reaches of East Asian society, it is universally understood that the United States is in steep decline. Thus the East Asian financial authorities are fully aware that in the future, as in the past, their nations’ dollar investments are likely to prove duds.
Their buy-the-dollar policy makes no sense on a stand-alone basis. It makes eminent sense, however, as part of a larger strategy. That strategy is to facilitate a historic shift in the world’s manufacturing center-of-gravity. The Japanese have an adage that explains it all: “Ebi de tai o tsuru”—“Use a shrimp to catch a sea bream.”
Though Greenspan has a record of perfect probity as a public official, he risks his entire legacy over his incompetent handling of trade. The graceful thing for him to do would be to admit what is now becoming obvious: that he has underestimated the seriousness of the trade trend. Following that, he should resign to make way for a younger, more energetic person to tackle the nearly intractable crisis. By the very act of nobly falling on his sword, Greenspan would powerfully dramatize the nature of the crisis and thus help galvanize the nation for inescapably tough measures.
If, by contrast, he hangs on, he may succeed for a few more years in sweeping the crisis under the carpet. But in the absence of drastic policy changes, the truth will come out, probably in the form of a devastating dollar crash.
By making a graceful exit now, Greenspan can hope to be remembered for his intellectual courage in admitting his mistakes. On the other hand, if he hangs on, the result will be certain obloquy: he will be fated to be remembered as the man who lost America.
Eamonn Fingleton is the author of Unsustainable: How Economic Dogma is Destroying American Prosperity.