Christopher Casey: GDP is Designed to Advance the Keynesian Interventionist Agenda

My third and last post on 'GDP week'.

At the Mises Institute, Christopher Casey writes that GDP (statistical G-R-O-W-T-H) has represented an economic tool (designed by Keynesians) to justify political interventionism (bold mine; footnote omitted)

GDP purports to measure economic activity while largely divorcing itself from the quality, profitability, depth, breadth, improvement, advancement, and rationalization of goods and services provided.

For example, even if a ship — built at great expense — cruised without passengers, fished without success, or ferried without cargo; it nevertheless contributed to GDP. Profitable for investors or stranded in the sand; it added to GDP. Plying the seas or rusting into an orange honeycomb shell; the nation’s GDP grew.

Stated alternatively, GDP fails to accurately assess the value of goods and services provided or estimate a society’s standard of living. It is a ruler with irregular hash marks and a clock with erratic ticks.

As proof, observe this absurdity: in 1990, Soviet GDP equaled half of US GDP, according to the 1991 CIA Factbook. No one visiting the Soviet Union in 1990 would believe their economy came close to 50 percent of the quality and quantity of the goods and services produced in America. GDP-defined production may have been strong, but laying roads to nowhere, smelting unusable steel, and baking barely edible breads stretches the definition of “production.” And this describes the goods which were actually produced. There is no accounting for the opportunity cost of forfeited essential goods and services.

How can this be? Why does GDP poorly reflect economic size and vitality? The blame largely resides with three fallacious concepts embedded within GDP “measurements”:

(1) intermediate goods (e.g., steel) must be eliminated to avoid “double counting”;

(2) government expenditures consist of viable economic activities; and

(3) imports should be netted against exports.

The Overstatement of Consumption

Which transactions should be included within GDP? Since most products consist of other products, GDP architects attempt to avoid “double counting” transactions by largely including only final goods and services produced. By their methods, the production of a car is counted (as an increase in inventory), but the metal, rubber, and plastic purchased in its creation is not. But the rules behind what makes a transaction “final” are arbitrary. The logic could just as easily justify including the sale of an automobile to a consumer and disregarding its previous production. In addition, any “final” transaction during a given time period does not necessarily include intermediate goods produced in that same time period: metal, rubber, and plastic purchased today will likely be for a different car produced or sold in a different (future) time period.

Regardless as to the arbitrary nature of determining final sales and notwithstanding the problem of temporally matching intermediate goods with their associated final sales, the exclusion of certain “intermediate” transactions simply excludes massive volumes of economic activity. Thus, GDP understates the economy as a whole while grossly overstating its consumption component relative to business investment. A better measure of overall production was created in 2014 when the US Commerce Department began publishing Gross Output which incorporates intermediate transactions. Using Gross Output, the commonly cited statistic of consumption accounting for 70 percent of all economic activity quickly falls to a mere 40 percent. 

The Treatment of Government Expenditures as Productive

If GDP purports to measure economic activity which benefits society, the inclusion of government expenditures is dubious. GDP “produced” in the Soviet Union is no different than GDP “produced” by any government — the difference is but one of scale. All government spending is to some degree malinvestment, for as Murray Rothbard noted:

Spending only measures value of output in the private economy because that spending is voluntary for services rendered. In government, the situation is entirely different ... its spending has no necessary relation to the services that it might be providing to the private sector. There is no way, in fact, to gauge these services.

The absence of voluntary action renders prices impotent, and without true price discovery, benefits cannot be ascertained. This does not mean all goods and services provided by government would cease to exist; rather, some production (e.g., hospitals, schools, roads, etc.) would revert to the private sector. To the extent government expenditures for goods and services would be produced by the free market, the true government contribution to GDP may be positive but overstated (it currently approximates 20 percent of US GDP). A more accurate depiction of economic activity would reduce if not eliminate the contribution of government expenditures. Or perhaps, as Rothbard argued, the higher of government receipts or expenditures should actually be deducted from GDP since “all government spending is a clear depredation upon, rather than an addition” to the economy.

The Problems of Subtracting Imports from Exports

As Robert Murphy has noted several times, the netting of imports against exports in determining GDP seriously understates the contribution of trade to overall economic activity. To wit, an economy which exports $1 and imports $1 will have the same GDP contribution (zero) as one which exports $100 billion and imports $100 billion. Obviously, the latter economy would be far worse off with the sudden cessation of trade.

A fixture of GDP is the mercantilist mentality of treating exports positively and imports negatively. Why are exports additive to GDP while imports are deductive? If the goal of GDP is to measure the goods and services provided to people within a geographic region, imports — not exports — are the benefit. Exports are but payment for imports. The problem and confusion arises because the GDP calculation unrealistically excludes other forms of payment: it should make a difference if imports are funded with increasing debt levels or if funds are accumulated from previous years of compensated exports. If China converted over $1 trillion in US debt instruments into imports of American goods and services, its people benefit today, but under GDP accounting, the negative impact of imports would offset greater consumption and/or government spending (the increase in GDP was previously realized in the years during which exports created a trade surplus).

GDP is Designed to Advance the Keynesian Agenda

Simon Kuznets (1901–1985) revolutionized econometrics and standardized measurements of GDP, with his research culminating in his 1941 book, National Income and Its Composition, 1919–1938. While not a Keynesian per se, the nature and timing of his research fueled the Keynesian revolution since central planning requires economic statistics. As Murray Rothbard noted:

Statistics are the eyes and ears of the bureaucrat, the politician, the socialistic reformer. Only by statistics can they know, or at least have any idea about, what is going on in the economy. Only by statistics can they find out ... who “needs” what throughout the economy, and how much federal money should be channeled in what directions.

GDP’s faulty theoretical underpinnings and politically motivated acceptance distort the performance and nature of an economy while failing to satisfactorily estimate a society’s standard of living. In fact, Kuznets partially understood this. In his very first report to the US Congress in 1934, Kuznets said “the welfare of a nation [can] scarcely be inferred from a measure of national income.” Yet the blind usage of GDP persists. That its permanence and persistence only serves the Keynesian policies of greater consumer spending, increased government expenditures, and larger exports through currency debasement should not be considered coincidental. Unfortunately, the resulting economic stagnation, debt accumulation, and price inflation are as inevitable as they are predictable.

I wrote about the GDP here.

Regardless of statistical mirages, eventually economic reality prevails. This means that for the Philippines, the obverse side of every politically induced credit inflated BOOM is a BUST.

On the headlong belief on the accuracy of the GDP, this quote largely attributed to Plato seems very relevant

The worst of all deceptions is self-deception 

The Myth of Low Currency Equals Strong Exports: Brazil Edition

Low currency equals cheap exports. That’s the mainstream’s resonant “incantation” as if such a claim represents an a priori irrefutable truth.

In reality, such a claim has really been a myth though. They signify nothing more than propaganda to promote anti competition regulations via Mercantilism that works to favor of vested interest groups (politicians and their allies).

This has been debunked even as far back in the 18th century by Scottish philosopher Adam Smith in his classic Wealth of Nations

As a recent example I pointed out that since Japan’s adaption of Abenomics, such so-called boost to exports through destroying the yen has failed to come about meeting their objectives. Instead this has generated record trade deficits via exploding import growth. The update of charts of the Japan’s exports, imports and trade balance here. 

What Japan’s yen debasement program has only achieved has been to inflate a stock market bubble which has benefited the financial system at the expense of the consumers.

We see the same falsehood being exposed in Brazil where the weak real has brought about faltering exports backed by a decline in industrial production.

From Bloomberg’s chart of the day:

The biggest monthly plunge in Brazil’s industrial output since December 2008 shows policy makers’ confidence that a weaker real will stimulate manufacturing is proving misguided.

The CHART OF THE DAY tracks Brazil’s industrial production index, the real on a percentage-change basis and exports on a rolling six-month average. Output fell in December by the most in five years even as the exchange rate weakened 34 percent since the manufacturing index reached a record-high in May 2011. The currency is the biggest decliner against the U.S. dollar in the last three years among 16 major currencies tracked by Bloomberg after the South African rand.

President Dilma Rousseff said on Feb. 3 that a weaker real would help drive exports this year, an affirmation of Finance Minister Guido Mantega’s comments in September that a currency drop would make Brazilian products more competitive and boost manufacturing. Goldman Sachs Group Inc.’s Alberto Ramos said the government’s optimism isn’t warranted, as companies are hampered by rising labor costs and lack of incentives to modernize.

Low currency equals cheap exports represents a heuristic “oversimplified” way in looking at trade data. Such have been assumed to generalize that all trade are about “cheapness”. 

The reality is that trade, which is a largely function of the private sector conducting voluntary exchanges goods or services across geographical boundaries, are driven by manifold complex intertwined factors: such as subjective preferences of buyers (which are hardly about “cheapness” as cheapness usually indicates low quality or commoditized goods), availability and access to markets, availability and access to financing to facilitate trade, relative ease or convenience of conducting trade, security of transactions and or the institutional protection of market activities (sanctity of contracts) and more. 

Unfortunately “a lie that has been told to often to become a truth” doesn’t apply to mercantilist propaganda, that’s because economic forces will expose on them.

Quote of the Day: Trade is Not a Scoreboard

We need to do better a job explaining how trade does not lend itself to sports metaphors. Exports are not our “points.” Imports are not “their” points. The trade account is not a scoreboard. It is not Team America against the world. Trade is about mutually beneficial exchange between individuals in different political jurisdictions, and to the extent that those kinds of transactions are subject to the whims of politicians, more and more resources will be diverted from economic to political ends.

This is from Cato Institute director Daniel Ikenson debunking mercantilist myths

Mayhem in the US Treasury Markets, No Problem, China to the Rescue!

When you're down and troubled and you need a helping hand and nothing, whoa, nothing is going right.

Close your eyes and think of me and soon I will be there to brighten up even your darkest nights. —James Taylor, You’ve got a friend

China’s government has played the role of “savior” to what could have been a US treasury market crash last May. 

As the US Treasury markets seized up, the Chinese government added $25.2 billion to its US treasury holdings which represents the highest hoard ever.

From China Daily USA:

China, the biggest creditor to the United States, increased its holdings of US Treasury bonds by 2 percent in May to $1.32 trillion, even as foreign demand for the bonds fell for a second consecutive month, according to the US Treasury.

China had increased its holdings of US bonds by 1.6 percent in April, which was revised higher after an initially 0.4 percent drop. Japan, the second-largest buyer, trimmed its holdings 0.2 percent to $1.11 trillion in May…

US residents increased their holdings of long-term foreign securities, with net purchases of $27.2 billion, while foreign investors decreased their holdings by $39.2 billion, said the Treasury report.

The sum total in May of all net foreign acquisitions of long-term securities, short-term US securities, and banking flows was a monthly net of $56.4 billion, said the Treasury Department. Net foreign private inflows were $46.6 billion, and net foreign official inflows were $10 billion.

TIC data shows that total foreign ownership of USTs reached a fresh record of $4097.9 billion in May, surpassing the February highs of $4097.4. 

China’s additional acquisition of $25.2 billion of USTs has been the swing factor. This implies that China’s actions played a crucial role in providing counterbalance to the resurfacing of the bond vigilantes. [The Philippines joined the "you've got a friend" movement adding $.2 billion last May]

This also demonstrates of the deepening dependency by the US government on her Chinese counterpart.

Austrian economist Gary North explains;

The U.S. government is running about a $650 billion deficit this fiscal year. The People’s Bank of China is doing its part to help out. It just bought another $25 billion of this deficit last month.

Why is it doing this? To hold up the value of the dollar.

Why is it holding up the value of the dollar? To make it less expensive for Americans to buy goods made in China.

But then protectionists in Congress scream bloody murder, because China is subsidizing exports to Americans. Then they vote for federal spending that runs a huge deficit. So, in order to hold down government interest rates, the Treasury Department must find buyers of this debt, other than the Federal Reserve System. The Chinese central bank is a large buyer.

So, every time Senator Chuck Schumer of New York insists that China must be stopped from rigging its currency, he is really saying that the Chinese central bank should stop buying IOUs issued by Congress. Then he votes for another spending program.

The Chinese central bank creates money out of nothing, just as the Federal Reserve does. Then it takes this newly counterfeited money and buys U.S. government debt, just as the Federal Reserve does. It bought $25 billion of this debt last month. The Federal Reserve bought $45 billion. So, when it comes to currency-rigging, which central bank is the greater culprit?

This is the race to the bottom. Which central bank will destroy its currency first? Or, if the central banks decide not to inflate any more, which central bank will cease counterfeiting money, thereby causing an economic depression?

The two economies, China’s and America’s, are addicted to the drug of fiat money. The first central bank to quit counterfeiting — the first one to “taper” — starts the international recession. Which will it be?  The first one to stop inflating permanently will turn the recession into a depression. Which will it be?

In May of 2012, the Chinese government has been given direct access to the US Treasury which basically bypasses the crony Wall Street. That reveals of the significance of the US-China relationship.

Such dependancy extrapolates to a Dr. Jekyll and Mr. Hyde relationship where on the financial front, the US and the Chinese government have been operating stealthily as staunchest allies, as against the geopolitical front, which media paints both parties as nemesis or adversaries.

The implication as I wrote a year ago:

Of course the inference from the above statement is that the Scarborough Shoal controversy has been mostly a false flag. What you see isn't really what has been. Politicians and media has taken the public for a ride at the circus.

I would add that not only has the media portrayed conflict between US-China been to promote the military industrial industrial complex, it serves as convenient pretext for the political class of these respective nations involved in territorial disputes, to expand control on their constituents via more financial repression, more taxes, more regulations and other forms of political control...all in the name of nationalism. 

At the end of the day, the world operates in a gamed system.

Has the Decline of the US Steel Industry been about Wages?

The following has not been meant to be a blog post, but a reply to a dear "mercantilist" friend who stubbornly insists that the US Steel industry’s decline has been solely due to "high" wages which require the "inflation" or the Keynesian "money illusion".

Since I am not an expert of the steel industry, I based the following from a variety of studies to debunk such “fallacy of a single cause” political absurdity

I am posting this to share with others, as well as, for my personal reference too. 

The idea that the steel industry has been primarily about high wages is simply not a reality.

The Peterson Institute of International Economics suggested that long years of government interventionism has prompted for the declining competitiveness of the industry

Interventionism in History:

Steel trade has been in turmoil since the late 1960s. Without exaggeration, more Washington trade lawyers work on steel disputes than any other trade issue. To recap the trade saga:

-In 1968, US steel producers filed a series of countervailing duty cases against subsidized European steel- makers. These cases led to “voluntary restraint agreements” that were terminated when the global steel market recovered in 1974.

-In 1977, US steel producers filed a series of antidumping cases primarily aimed at Japanese steel firms. These cases led to a system of minimum reference prices for steel imports, known as the “trigger price mechanism” (TPM). The TPM system was soon extended to European steel.

-In 1974 and 1979, at both the launch and the ratification of the Tokyo Round of multilateral trade negotiations, the US antidumping law was amended (at the insistence of the steel industry and to conform with the Tokyo Round Antidumping Code), making it easier for domestic producers to prevail in antidumping cases.

-In 1982, dissatisfied with the workings of the TPM system, US steel producers filed many antidumping and counter- vailing duty cases. These were resolved by new voluntary restraint agreements, which lasted until 1992.

-In the mid-1980s, trade remedy cases were filed against “new” exporters, such as Brazil and Korea. Most of these cases resulted in high antidumping and countervailing duty penalties.

-In 1989, the United States launched an effort to negotiate a Multilateral Steel Agreement designed to abolish subsidies. The negotiations failed and were ultimately abandoned in 1997.

-In 1992, when the voluntary restraint agreements expired, a new set of trade remedy cases were filed. Many of the resulting penalty duties remain in effect today.

-In March 1999, the House of Representatives passed H.R. 975, Congressman Peter Visclosky’s (D-IN) steel quota bill, 289 to 141. After a spirited debate, bill was defeated in the Senate. The current round of steel trade initiatives essentially renews the 1999 debate.

Why so much trade turmoil? One reason is persistent overcapacity in the global steel industry abetted by widespread market distortions. Persistent overcapacity has translated into cyclically falling prices and industry losses in every business slowdown. Another reason is the combination of rapid productivity growth and slow demand growth. Wheat farmers and steel workers share two traits: both have greatly increased their output per worker-year and both face sluggish demand for their products. The result is a painful secular decline in employment. These forces—in an effort to cushion the domestic steel industry—have provoked a series of rearguard trade actions.

The Unintended Effects from Peterson

Market Distortions

In a normal industry, prolonged operating losses will weed out weak firms. Ideally, steel firms with the highest costs would be the first to close. But the real world is far from ideal. Many plants have closed and steel employment has plummeted. In the United States alone, over the last three years, 18 steel firms went bankrupt and about 23,500 workers lost their jobs. However, it is not production costs but rather market distortions that often determine the global “exit order” of struggling firms. Moreover, these distortions prolong the agony of failing firms by stretching the duration of depressed prices for the whole industry.

One such distortion is cartel practices—private arrangements that enable some steel producers to maintain high prices in their home markets and sell abroad at low prices. Another distortion is public subsidies used to cover huge fixed costs (debt burdens, pension benefits, etc.). The United States is not the worst sinner when it comes to market distortions, but it is hardly free of guilt. Federal guarantee programs totaling several billion dollars have absorbed the pension responsibilities of some bankrupt steel firms and staved off bankruptcy for others.

As a result of these distortions, the least efficient firms are not necessarily the first to close their doors and the industry as a whole sheds its excess capacity at a very slow pace.

Same observation from Cuts International

No different from the Heritage Foundation

The overproduction of steel is due to government intervention in the marketplace. Steel producers, left to themselves, have an incentive to produce only what consumers demand. Otherwise, they would be adding needless costs to their operations. When government intervenes and offers subsidies or other protections, normal market incentives are altered. Government subsidies thus may encourage a steel firm to produce more steel even if it exceeds consumer demand.

Subsidies are a common practice in the steel industry, both around the world and in the United States. For example, the American Iron and Steel Institute reports that between 1980 and 1992, foreign steel manufacturers received over $100 billion in subsidies. In the United States, the steel industry was the beneficiary of more than $1 billion in federal loan guarantees in 2001. When an industry produces more than consumers demand, the surplus puts downward pressure on the price of the product and makes it difficult for firms to earn a profit. As recently as January 10, 2002, even though the price of hot-rolled steel was rising, it was still being sold below cost.

Homegrown problems are another reason why the U.S. steel industry is suffering. Prior to 1968, the year the steel industry began receiving government protection from foreign competition, average compensation in the industry was roughly equal to the average in the manufacturing sector. Today, the average total compensation for the steel industry is $37.91 per hour--56 percent higher than the average compensation in the manufacturing sector. One of the principal reasons for this high average compensation is that the steel industry's very strong unions, without the threat of foreign competition, are able to negotiate high compensation packages for employees.

Harvard School’s Crimson Staff who wrote against the Bush era Protectionist tariff resonates

In defending the administration’s decision, U.S. Trade Representative Robert B. Zoellick said, “The global steel industry has been rife with government intervention, subsidies and protection,” and explained that the American response served to counter the protectionism of other governments. In order to equalize trade opportunities, the administration should not raise America’s trade barriers, but rather continue to break down the barriers of other countries. American tariffs will only lead to retaliatory tariffs, which will weaken the international free market economy and possibly lead to a trade war.

Failure to adapt with technological changes has also been a factor:

From the US Bureau of Labor and Statistics Technology and its effect on labor in the steel industry

Advancement in a technology led to productivity boom that led to a decline in employment

Again from the BLS:

From Multinational Monitor.org or “Fifteen Years of Neglect Have Left the Industry in Crisis - And Thousands of Workers Without Hope”

Since the early 1970s, when Japan became the world's leading steel producer, the industry has followed a policy of disinvesting in low-profit operations and diversification into oil and other industries. U.S. Steel has led the way: once the nation's largest industrial corporation, its share of the market has dropped from 75 percent in 1906 to around 20 percent today; and its major mills at Gary, Indiana, and Fairfield, Alabama were constructed at the turn of the century.

Instead of rebuilding, the industry has relied on outdated technology. According to Ira C. Magaziner and Robert B. Reich in their recent book Minding America's Business, the industry "made small, incremental investments to obtain `cheap' capacity rather than make the larger, more aggressive, and riskier investments that could have led to superior productivity.

A 1986 MIT paper analysis the significance of technology

This paper exemplifies a techno-economic-strategic analysis in which key characteristics of technologies are first analyzed, economic consequences are then derived, and strategic implications are followed. Additionally, it demonstrates how technological innovations coupled with critical fixities of a firm can partially explain the entry, exit, and performance of firms in the U.S. steel industry. Because of the reluctance of existing firms to switch to new technologies, entrants using these new technologies entered the low carbon steel market and earned an extra profit. The existing integrated firms would rather have suffered accounting losses than replace their obsolete equipment as long as the cash flow remained positive.

From a 2012 Princeton Paper by Allan Collard-Wexler and Jan De Loecker Reallocation and Technology: Evidence from the U.S. Steel Industry

There is extensive evidence that large gains in productivity can be attributed to reallocation of resources towards more productive plants. This paper shows the role of technology and competition in the reallocation process for the American Steel industry. We provide direct evidence that technological change can itself bring about a process of resource reallocation over a long period of time and lead to substantial productivity growth for the industry as a whole. More specifically, we find that the introduction of a new production technology spurred productivity growth through two channels.

First, the entry of minimills lead to a slow but steady drop in the market share of the incumbent technology, the vertically integrated producers. As minimills were 11 percent more productive, this movement of market share between technologies is responsible for a third of productivity growth in the industry.

Second, while the new technology started out with a 25 percent productivity premium, by the end of the sample, minimills and vertically integrated producers are very similar in terms of efficiency. This catching-up process of the incumbents came about from a large within reallocation of resources among vertically integrated plants. On the other hand, minimills productivity grew moderately, and almost entirely because of a common shift in the production frontier.

As as consequence of productivity growth, prices for steel products fell rapidly, though at different rates for those products which minimills could produce, versus those they could not. Markups decreased substantially, reflecting that prices fell more rapidly than production costs. This indicates increased competition for U.S. steel producers, which further drove increases in productivity.

The Economist went against Bush steel tariffs and cited the puffed up high costs from labor union privileges of “legacy liabilities”

Tariffs fail to address the real problem—high costs, including “legacy liabilities” in health-care and pension benefits. Many companies will fold anyway. When they do, putting workers out of a job and rendering those promised benefits null, the tariffs will only make the victims, as consumers, even worse off than they would have been

Failure to address inefficiencies through bankruptcy laws are another:

From Cato’s Dan Ikenson’s How Subsidies and Protectionism Weaken the U.S. Steel Industry

Some say that industry consolidation is necessary, but that significant legacy costs are preventing mergers and acquisitions. That may be true, but consolidation is not the only alternative for eliminating inefficient capacity. Attrition works too. Attrition works if the inefficient firms are liquidated in bankruptcy, and their assets are auctioned to the highest bidders.

The largest obstacles to attrition are subsidy programs like the Emergency Steel Loan Guarantee Program, unrealistic unions seeking to prevent shutdowns, and the U.S. trade remedy laws. Inefficient operations need to be retired, and this can be accomplished only if market signals are not distorted by these interferences.

When an operation is inefficient and losing money, access to investment naturally dwindles. Attempts to mitigate this outcome perpetuate the root problem. Although its expansion is being considered under different legislation pending in Congress, the Emergency Steel Loan Guarantee program should be abolished

The Living Economics says in Blocked Exit that a combination of the above have prompted for the decline in competitiveness of the US Steel Industry

In a mature industry with a saturated market such as steel, demand comes largely from replacement of existing products and normal growth. Generally, existing capacity that was inherited from the phase of explosive growth is much more than is necessary for current demand. Ideally, market competition should eliminate higher-cost producers in favor of lower-cost producers. However, all steel-producing countries have tried to preserve their production capacity regardless of cost efficiency considerations. In the U.S., for example, many factors have helped to delay consolidation of its steel industry:

First, U.S. bankruptcy laws have unnecessarily delayed the steel industry consolidation process. Although 28 U.S. steel companies have filed for bankruptcy since 1997, including the nation's third and fourth largest, not many have actually gone out of business altogether. Chapter 11-bankruptcy protection often keeps the incumbent creditors at bay while allowing the bankrupt companies to receive new loans to continue production.

In addition, the huge retiree benefit liabilities of weak companies have deterred potential acquisition by stronger companies. In an extraordinary bid to salvage the industry, USX-U.S. Steel Group proposed buying its troubled competitors Bethlehem Steel Corp., National Steel Corp. and Wheeling-Pittsburgh Corp. in early December 2001. But the $13 billion retiree healthcare and pension liabilities of the acquisition targets have stalled the consolidation process.

Even weak steel companies may have out-sized political clout. The industry remains big in swing states of presidential elections such as Pennsylvania, Ohio and West Virginia, where a good portion of 600,000 retired steelworkers live. It is understandable that these states want to preserve the steel companies and their suppliers that provide local and state taxes and jobs.

The idea that high wages alone has been the culprit for the dearth of competitiveness that merits either protection or inflation as a solution has simply been unfounded and wishful thinking, bereft of reality.

This of course, has raised by the great dean of Austrian school of economics, Murray N. Rothbard, who dismissed the impact of inflation and other forms of protectionism to solve what is a politically engendered problem.

On inflationsim…

And every week at his Philadelphia salon, the venerable economist Henry C. Carey, son of Matthew and himself an ironmaster, instructed the Pennsylvania power elite at his "Carey Vespers," why they should favor fiat money and a depreciating greenback as well as a protective tariff on iron and steel. Carey showed the assembled Republican bigwigs, ironmasters, and propagandists, that expected future inflation is discounted far earlier in the foreign exchange market than in domestic sales, so that the dollar will weaken faster in foreign exchange markets under inflation than it will lose in purchasing power at home. So long as the inflation continues, then, the dollar depreciation will act like a second "tariff," encouraging exports as well as discouraging imports.

…as well as other nonsensical interventionists excuses:

The arguments of the steel industry differed from one century to the next. In the 19th century, their favorite was the "infant industry argument": how can a new, young, weak, struggling "infant" industry as in the United States, possibly compete with the well-established mature, and strong iron industry in England without a few years, at least, of protection until the steel baby was strong enough to stand on its two feet?

Of course, "infancy" for protectionists never ends, and the "temporary" period of support stretched on forever. By the post-World War II era, in fact, the steel propagandists, switching their phony biological metaphors, were using what amounted to a "senescent industry argument": that the American steel industry was old and creaky, stuck with old equipment, and that they needed a "breathing space" of a few years to retool and rejuvenate.

One argument is as fallacious as the other. In reality, protection is a subsidy for the inefficient and tends to perpetuate and aggravate the inefficiency, be the industry young, mature, or "old." A protective tariff or quota provides a shelter for inefficiency and mismanagement to multiply, and for the excessive bidding up of costs and pandering to steel unions. The result is a perpetually uncompetitive industry. In fact, the American steel industry has always been laggard and sluggish in adopting technological innovation--be it the 19th-century Bessemer process, or the 20th-century oxygenation process. Only exposure to competition can make a firm or an industry competitive.

So there you have it, so while wages may have been a factor, it has been miniscule compared to the myriad political interventionism (subsidies, protection, inflation and etc…), the dearth bankruptcy laws, trade unions, and other political influences (lrentseeking, cartels etc…) which have prevented the US steel industry from adjusting to market forces, as evidenced by the failure to embrace technological advances.

Yet the proposed solution of more interventionism will only wound up in worsening of the current status.

For protectionists, the story has always been the same; address the symptoms and not the disease with the more of the same prescription that led to the disease.

Other references:

-Stefanie Lenway, Randall Morck and Bernard Yeung Rent Seeking, Protectionism and Innovation in the American Steel Industry

-ITA.doc.gov The U.S. Steel Import Crisis Global Steel Trade: Structural Problems and Future Solutions

-Wikipedia.org History of the steel industry (1850-1970)

Does Unemployment Cause Deflation?

I was apprised by a dear friend that in a part of the US, call center jobs have been migrating to the Philippines. Such phenomenon he sees as having a “deflationary” impact on the US economy. 

Such popular reasoning is fairly simple. Lack of jobs equals a fall in aggregate demand. Falling demand leads to falling prices. Falling prices result to more job losses. Thus the circular reasoning translates to an endless loop: a deflationary spiral.

The bottom line from such aggregate demand framework is that unemployment causes price deflation.

Of course, the alternative implication is that the Philippines, like China through alleged currency manipulation, has been “stealing jobs” from Americans.

And equally this means that for them, the optimal political solution is to inflate or apply protectionist measures or apply both against countries like the Philippines or China.

Have job losses or unemployment resulted to price deflation as alleged?

Here is a list of the largest world unemployment rates from Wikipedia.org.

Since there are many nations with over 10% in unemployment rates, I will only reckon with nations with over 50% in unemployment rates

Nauru 90%

Vanatu 78.21%

Turkmenistan 70%

Zimbabwe 70%

Mozambique 60%

Djibouti 59%

Given the huge unemployment rate, then we assume that these countries, according to the aggregate demand theory, to be in a deflationary depression.

Note: there is no price inflation figure for Nauru

Vanatu’s inflation rate (chart from Index Mundi) Positive inflation.

Turkmenistan price inflation rate (chart from tradingeconomics.com) Positive inflation.

Zimbabwe’s post hyperinflation CPI (chart from tradingeconomics.com) Positive inflation.

Mozambique’s inflation rate (chart from tradingeconomics.com) Positive inflation.

Djibouti’s inflation rate (chart from tradingeconomics.com) Positive inflation.

Surprise, ALL 5 nations with the largest unemployment have ZERO account of price deflation!

So what’s wrong with such a claim or theory?

The fundamental premises are essentially misplaced:

-People all think the same or people don’t think at all. People mechanically and homogeneously follow the circular reasoning that falling demand leads to falling prices in a perpetual feedback loop to an eternal hellhole.

-People’s don't have marginal utility. All people share the same set of values, priorities, incentives and time preferences. 

-People are not human. People simply stop eating, drinking or clothing or finding shelter under a deflationary spiral. Maslow’s hierarchy of needs have been jettisoned out of the window. People are caught in a stasis, freeze like a deer caught in headlights, where demand totally evaporates.

-When people don’t think or when people think the same or when people stop being people then obviously the demand and supply curve, the law of scarcity and opportunity costs becomes inapplicable or ceases to exists.

-Capital has been nonexistent to people who act or behave in aggregates.

-Inflation is NOT a monetary phenomenon so does the consequent deflation.

In the real world, economies are vastly complex, with millions of spontaneously operating parts such that wages represents only part of the myriad of factors that influence the economic environment.

Other real factors are equally or even more important, e.g. proximity to markets, size and categories of markets, state of basic infrastructure, access to credit, connectivity, technology and labor, quality of labor force, comparative advantage/s, state of legal, political and regulatory institutions and environment, tax levels, state of economic freedom, depth of capital markets, monetary regime and much more.

Most important is property rights. When property rights are not secure, no one will dare to invest no matter the relative lower, if not the lowest costs, in terms of labor wages. Who invests in North Korea or in the above 5 nations with the largest unemployment (presumably the cheapest labor force) in the world where one's capital are likely to be arbitrarily seized by the incumbent authorities?

These are real factors that can't be seen as having neutral effects on people's incentives or which operates on a vacuum. 

How about the solution where government must step in to provide jobs, by inflation or protection? 

Well government, of course, comprises of people too.

Under the aggregate demand framework, the political class have been glorified as representing “superior” set of people in terms of knowledge and virtues, relative to the market which is seen as inferior non-political people, that lays ground for interventions on so-called “market failures”.

Such is an unalloyed myth. If the romance on politics is true, then inflation or deflation won’t exist. There won’t anything known as economics.

The reality is that inflation and protectionism represents two sides of the same coin: the political economy of destruction.

As the great Ludwig von Mises explained (bold mine)

By destroying the basis of reckoning values—the possibility of calculating with a general denominator of prices which, for short periods at least, does not fluctuate too wildly—inflation shakes the system of calculations in terms of money, the most important aid to economic action which thought has evolved. As long as it is kept within certain limits, inflation is an excellent psychological support of an economic policy which lives on the consumption of capital. In the usual, and indeed the only possible, kind of capitalist book-keeping, inflation creates an illusion of profit where in reality there are only losses. As people start off from the nominal sum of the erstwhile cost price, they allow too little for depreciation on fixed capital, and since they take into account the apparent increases in the value of circulating capital as if these increases were real increases of value, they show profits where accounts in a stable currency would reveal losses. This is certainly not a means of abolishing the effects of an evil etatistic policy, of war and revolution; it merely hides them from the eye of the multitude. People talk of profits, they think they are living in a period of economic progress, and finally they even applaud the wise policy which apparently makes everyone richer.

But the moment inflation passes a certain point the picture changes. It begins to promote destructionism, not merely indirectly by disguising the effects of destructionist policy; it becomes in itself one of the most important tools of destructionism. It leads everyone to consume his fortune; it discourages saving, and thereby prevents the formation of fresh capital. It encourages the confiscatory policy of taxation. The depreciation of money raises the monetary expression of commodity values and this, reacting on the book values of changes in capital—which the tax administration regards as increases in income and capital—becomes a new legal justification for confiscation of part of the owners' fortune. References to the apparently high profits which entrepreneurs can be shown to be making, on a calculation assuming that the value of money remains stable, offers an excellent means of stimulating popular frenzy. In this way, one can easily represent all entrepreneurial activity as profiteering, swindling, and parasitism. And the chaos which follows, the money system collapsing under the avalanche of continuous issues of additional notes, gives a favourable opportunity for completing the work of destruction.

The bottom line is that previous interventionists policies, e.g. policy induced boom bust cycles, regulatory mandates, entitlements etc..., have resulted to such lack of competitiveness which neo-mercantilists try to shift the blame onto the others. Yet they are asking for more of the same thing that led to this or they seek doing the same thing over and over again but are expecting different results.

The economics of aggregatism, thus, has mostly been about pretentious or pseudo-economics wrapped in populist anti-market politics constructed from heuristics, political religion and cognitive biases, or might I say, a grand deflation in logic.

The Political Pretense called Currency War

A geneticist recently claimed that human intelligence has been on a gradual decline due to the extensive use of fluorides in the water supply, pesticides, high fructose corn syrup and processed foods. 

I have a different opinion. If true, then I would say that the main culprit has been the public’s worship of state, from which untruths, as conveyed by media, politicians and their apologists, envelops its essence. Blind belief in political falsehood makes people lose their intellectual bearings.

Just recently the Japanese government has been blamed by her counterparts as Russia, South Korea and the Bundesbank for inciting, if not escalating, a “currency war” via open ended bond buying program to devalue the yen. The implication is that Japan’s “currency manipulation” polices signifies as “beggar thy neighbor” policies that have been implicitly designed to hurt other nations.

A “currency war” is another term for competitive devaluation which according to Wikipedia.org represents “a condition in international affairs where countries compete against each other to achieve a relatively low exchange rate for their own currency” where “states engaging in competitive devaluation since 2010 have used a mix of policy tools, including direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing.”

Yet one would notice that the balance sheets of major central banks, all of which have been skyrocketing, and which allegedly reflects on “direct government intervention, the imposition of capital controls, and, indirectly, quantitative easing”, currency wars in the light of competitive devaluation has been an ongoing event since 2008 as shown in the chart above. 

In short, neither has this been an exclusive Japan event nor has been a fresh development.

And this has also not been limited to major central banks but extends all the way to emerging Asia and to China as well, the Philippines included. (chart from the Bank of International Settlements)

In short, global central banks have been in a state of “currency war” or “currency manipulation” since 2008.

This article is not meant to absolve Japan's policies but to expose on what seems as political canard.

In reality “currency war” or “currency manipulation” or competitive devaluation is simply nothing more than inflationism. The great Ludwig von Mises defined inflation as

if the quantity of money is increased, the purchasing power of the monetary unit decreases, and the quantity of goods that can be obtained for one unit of this money decreases also.

While there may be technical difference on what a central bank buys to expand her assets through a corresponding expansion of currency liabilities, the fact is that “quantity of money is increased”.

The assets of Swiss National Bank have mostly been in foreign currency reserves (as of November 2012) while the Bank of Japan has mostly been in JGBs (as of September 30, 2012). Table from (SNBCHF.com)

American neo-mercantilists have labeled “currency manipulation” on nations, who allegedly use of accumulation of currency reserves as exchange rate policy, from which they call their government to impose protectionist countermeasures such as China.

As I wrote previously this represents naïve thinking.

While the technical reasons why countries accumulate foreign currency reserves are mainly for self-insurance (for instance Asia reserve accumulation has partly been due to the stigma of the Asian Crisis) and from trade, financial and capital flows (NY FED), the real “behind the curtain” reason has been the US dollar standard system. Such system allows for a “deficit without tears”, or unsustainable free lunch by the use of the US dollar seingorage to acquire global goods and services that results to seemingly perpetual trade deficits. 

Deficit without tears, as the late French economist and adviser to the French government Jacques Rueff wrote in the Monetary Sin of the West (p.23), “allowed the countries in possession of a currency benefiting from international prestige to give without taking, to lend without borrowing, and to acquire without paying.” 

And this has been the main reason for America’s “financialization” and the recurring policy induced boom bust cycles around the world, which essentially has been transmitted via the Triffin dilemma or “the conflict of interest between short-term domestic and long-term international economic objectives” of an international reserve currency

Thus blaming China or even the Philippines for reserve currency accumulation seems plain preposterous and only represents political lobotomy.

Currency war or currency manipulations serves no less than to “cloak the plea for inflation and credit expansion in the sophisticated terminology of mathematical economics”, to quote anew the great professor Ludwig von Mises from which “to advance plausible arguments in favor of the policy of reckless spending; they simply could not find a case against the economic theorem concerning institutional unemployment.”

And may I add that pretentious public censures account for as ploys to divert public’s attention or serve as smokescreens from homegrown government “inflationist” policy failures.

Since major central bank represented by the G-20 knows that by labeling Japan as instigator of currency wars would be similar to the proverbial pot calling the kettle black, they went about fudging with semantics to exonerate Japan’s political authorities.

From Bloomberg,

Global finance chiefs signaled Japan has scope to keep stimulating its stagnant economy as long as policy makers cease publicly advocating a sliding yen.

The message was delivered at weekend talks of finance ministers and central bankers from the Group of 20 in Moscow. While they pledged not “to target our exchange rates for competitive purposes,” Japan wasn’t singled out for allowing the yen to drop and won backing for its push to beat deflation.

This doesn’t look like a “war”, does it?

At the end of the day, currency war, or perhaps, stealth collaborative currency devaluation (perhaps a modern day Plaza-Louvre Accord) maneuvering means that central bank shindig will go on; publicity sensationalism notwithstanding.