Op-Ed Analysis


 

America May Have to Abandon Free Trade with China

China Is Unlikely to Embrace Western Norms on the Economy

 

By Peter Morici

Oct. 22, 2018 (First published at MarketWatch) 

American manufacturers and farmers victimized by China’s mercantilism and retaliatory tariffs had better settle in for a long trade war. Beijing is not likely to cave quickly to President Donald Trump’s demands.

At issue are China’s notorious barriers to competitive foreign products – high tariffs and a maze of administrative obstacles and industrial policies that promote indigenous technology-intensive activities through subsidies, requirements that foreign companies form joint ventures and transfer technology to access its markets, and rampant theft of foreign intellectual property through state-assisted industrial espionage and counterfeit goods.

Frustrated that negotiations – such as the Mar-a-Lago process – failed to yield meaningful offers from China, Trump levied 25% tariffs on $50 billion of imports from China this summer. In September, he added 10% on another $200 billion and in January, those are expected to escalate to 25%.

China responded by canceling high-level bilateral talks and appears to be content to ride out Trump. Beijing sees him struggling with Democratic obstructionism in Congress and is likely banking on a big setback for Republicans in the midterms and Trump’s eventual defeat in 2020.

It sees Mexico and South Korea accomplishing deals with Trump that will hardly move the needle on their trade balances with the United States, Canadians and Europeans resisting his pressure, and American economists predicting grave harm to the U.S. economy from Trump’s aggressive policies.

Yuan is down

Since June 1, the yuan is down more than 7% -potentially obviating most of the effects of the 10% tariff on $200 billion. China’s provincial governments and state banks can ladle on subsidies and no-payback loans to keep businesses afloat and exporting. And Beijing can undertake selective liberalization to attract foreign investors.

For example, Exxon is working on a deal for a petrochemical complex in Guangdong without the usual joint-venture partner. Beijing can roll back these policies after tensions ease but it is miscalculating.

At stake is not merely the $350 billion bilateral trade imbalance but who achieves global leadership in fields like artificial intelligence, robotics, supercomputing and human brain-computer interface.

Democrats on the Hill and leaders in Europe and Japan recognize the potential for these technologies to drive economic growth, create and destroy millions of jobs, alter espionage and warfare, and change relationships between citizens and governments.

Regarding the latter, Beijing has imposed an Orwellian order to quell minority opposition and impose strict adherence to behavioral norms in its Western provinces and elsewhere with facial recognition and ubiquitous cameras – don’t jaywalk if you want to rent an apartment!

Western leaders don’t like how China is using predatory trade and industrial policies to seize leadership – and what it will do with it – anymore than do Trump trade hawks Peter Navarro and Robert Lighthizer. Differences with U.S. allies are over tactics.

Industry leaders almost always dislike changes in the regulatory environment. They adjust investments to protectionist policies, and are now objecting strenuously to the change in U.S. policy toward China.

Business Roundtable is screaming

We ran into the same problem back in the 1980s and ’90s when we liberalized trade in the North American auto sector – the Big Three had configured their investments to conform to pre-NAFTA production requirements imposed by Mexico and Canada to access their markets. Now, the Business Roundtable is screaming about Trump’s use of tariffs to open China.

Ultimately, China has enormous staying power. It has huge dollar reserves, it can selectively liberalize to attract the investments it considers vital, and divert what it sends to U.S. markets to Europe, Japan and other destinations.

Then it is up to the Europeans and Japanese to act. They are insisting on negotiations in the World Trade Organization. We have been talking with Beijing for the better part of three decades about liberalization, and it simply does not want to embrace Western norms.

At that point, Trump, or whoever succeeds him if he loses the 2020 election, could manage the commercial relationship with China absolutely – tougher tariffs and quotas to force down the trade deficit, strong financial sanctions, and limits on Chinese students at U.S. universities. And demand that our trading partners expel China from the WTO lest the United States withdraw from the global trading body.

Quite simply, America may have to abandon any hope of free trade with China.

 

Peter Morici is a professor emeritus at the University of Maryland Smith School of Business, former Chief Economist at the U.S. International Trade Commission, and seven-time winner of the MarketWatch best forecaster award in competition with 41 other top economists. (See his economic forecasts here.)

 

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Powell Has Lost His North Star and the Fed Is Flying Blind

Fed Risks Raising Interest Rates too Much as the Compass Spins Wildly

 

By Peter Morici

Oct. 15, 2018 (First published at MarketWatch) 

 

Federal Reserve Chairman Jerome Powell is in an unenviable position. Folks expect him to fine-tune interest rates to keep the economy going and inflation tame but he can’t make things much better – only worse.

Growth is nearly 3% and unemployment is at its lowest level since 1969. What inflation we have above the Fed target of 2% is driven largely by oil prices and those by forces beyond the influence of U.S. economic conditions – OPEC politics, U.S. sanctions on Iran, and dystopian political forces in Venezuela and a few other garden spots.

When the current turbulence in oil markets recedes, we are likely in for a period of headline inflation below 2%, just as those forces are now driving prices higher now.

Overall, long-term inflation has settled in at the Fed target of about 2%. The Fed should not obsess about it but keep a watchful eye.

Amid all this, Powell’s inflation compass has gone missing. The Phillips curve, as he puts it, may not be dead but just resting. To my thinking, it’s in a coma if it was ever alive at all.

That contraption is a shorthand equation sitting atop a pyramid of more fundamental behavioral relationships. Those include the supply and demand for domestic workers and in turn, an historically large contingent labor force of healthy prime-age adults sitting on the sidelines, the shifting skill requirements of a workplace transformed by artificial intelligence and robotics, import prices influenced by weak growth in Europe and China, and immigration.

Of course, Mariner Powell has his North Star – what economists affectionately call R* (R-Star), but it is no longer at a fixed position in Powell’s sky.

R* is the federal funds rate that neither encourages the economy to speed up or slow down. However, with businesses needing much less capital to get started or grow these days and for decades China and Germany-the second and fourth largest economies globally-racking up current account surpluses and savings to invest abroad, it is no wonder the forces of supply and demand have been driving R* down to historically low levels.

With long-run inflation at 2%, current estimates put the nominal R* at a bit below 3%. That’s just three more quarter-point rate increases away.

Overshooting could kill the recovery but how is Powell to know?

Miner Powell’s canary has gone AWOL. Historically, economists and financial types have looked to the yield curve for the warning croak that the economy is headed for recession.

When I wrote about a flattening yield curve on MarketWatch early last December, the 10-year less 30-day Treasurys was about 120 basis points. Now it’s about 100, and folks are even more nervous.

Although the gap is supposed to tell us about investor expectations for growth-a wide spread meaning optimism and a narrowing gap the threat of recession – these days, long rates are significantly affected by factors quite beyond the U.S. economy.

Increasingly, the dollar is the currency of payment for import contracts – 40% of imports worldwide are invoiced in dollars even though the United States is only about one-tenth of the market. And populist movements in Europe and political uncertainty elsewhere have driven private-asset managers and savers into dollars. Consequently, foreign private actors – not just foreign central banks – have a ravenous appetite for Treasurys and dollar-denominated deposits.

The economists at the Fed are really econometricians bent on estimating all these relationships with ever-more-complex statistical techniques but they only have historical data. The parameters keep shifting, and historical information can only inadequately tell us their values.

All the Fed can do is feel its way with an eye toward price pressure in the core. In the 1950s, we hit unemployment below 3%, and it could go much lower than 3.7% without much inflation.

We have strong reason to believe the equilibrium short-term rate is no more than 3% – though on that Chairman Powell is agnostic. And if we take Federal Open Market Committee policy statements and the plot chart at face value, Powell and his colleagues intend to drive the federal funds rate to well above that by 2020.

That’s dangerous stuff.

 

Peter Morici is a professor emeritus at the University of Maryland Smith School of Business, former Chief Economist at the U.S. International Trade Commission, and seven-time winner of the MarketWatch best forecaster award in competition with 41 other top economists. (See his economic forecasts here.)

 

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The Fourth Industrial Revolution Will Beget a New Politics

Technologies of the Future Are What’s Driving Trump’s Trade Policies

 

By Peter Morici

Oct. 8, 2018 (First published at MarketWatch) 

 

Now playing on your handheld devices and in more robust growth is the Fourth Industrial Revolution – mobile computing, intelligent and remarkably dexterous robots, and the gradual fusion of human intelligence, artificial intelligence and machines. It will profoundly alter how the economy grows and American politics.

The first three waves of industrialization – water power and steam to mechanize production, electric power to facilitate mass production, and electronics and information technology to automate production – were terribly dependent on massive investments in plant and equipment.

Robust economic expansions have been defined by consumers’ willingness to splurge on big-ticket items like cars and homes, and businesses’ appetite for grand projects – Fulton’s steamboat, railroads, auto factories and highways, and most recently, shale oil and pipelines.

All that is changing.

The economy is now on track to register 3% growth in 2018 for the first time in a dozen years but auto and home sales are flat and corporate investments in hard business assets – factories, machines and computers – are hardly rocketing.

Businesses have learned to use capital and human resources much more efficiently. Productive young professionals seem to be more interested in being near the hubs of intellectual activity – city cores – and buying new gadgets and streaming services than owning a home, big lawn and the latest hot car.

Businesses are dropping the college degree or certificate from technical school as a requirement for many positions. To the dismay of academics, kids seem to be learning as much that is useful in this new economy playing on their smartphones and laptops as they do in the classroom.

At the cutting edge, Google was launched with $25 million in 1999 and grew into a $23 billion enterprise in five years. Now finding that two-year colleges don’t impart the technology skills businesses require, Google is offering eight and 12-month certificate programs through Coursera that connects graduates with employers like Bank of America, Walmart and GE Digital.

Productivity growth, after languishing during the Obama presidency, is taking off again. This permits businesses to offer low-skilled workers opportunities for bigger pay increases, often through in-house training programs. As many businesses automate, they are training semi-skilled line workers to maintain machines and even become software engineers.

All this is happening, just as Generation Z – those born after 1996 and raised in the jaws of the financial crisis – is entering the labor force. They are more focused on career and financial success, more sober (they don’t party nearly as much) and even more tech savvy than Millennials who preceded them.

More diverse – little more than 50% are white. Raised by Baby-Boom moms in non-traditional careers, they are more comfortable with women and men working side-by-side and in racially mixed groups.

All this spells change for the faculty at universities, businesses and the political class.

Young folks are bargaining with colleges and often selecting the best value as opposed to the most prestigious choice – or skipping college altogether – and forcing universities to trim costs. Some MBA programs and law schools are downsizing.

Businesses can’t discriminate-workers and good skills are too scarce – and young employees won’t tolerate it. That will be bad news for the new age Democrats like Alexandria Ocasio-Cortez who are reskinning Hillary Clinton’s identity politics.

Similarly, the anti-Trump wing of the GOP’s obsessions with the sanctity of the WTO and tariffs on automobiles and agricultural commodities are tragically misplaced. Just about anything of value can be made or grown on any continent these days.

What really matters is the artificial intelligence that goes into cars, the genetics of the seeds, and the apps in your palm. That’s what is driving Trump’s trade policy – look at the extensive protections for American intellectual property in the deal just struck with Mexico and Canada.

President Donald Trump grasps all this in ways his critics can’t comprehend, or is backing into it thanks to Federalist Society screening his judicial nominations and Ivanka promoting Labor Department apprenticeship programs.

The GOP may well get skewed in the midterms and Trump denied a second term but history tends to focus more on presidential accomplishments – deeds that changed the direction of the country or defined progress – than on character flaws.

It will speak of a man who saw a new age coming but was vilified by those invested in the past.

 

Peter Morici is a professor emeritus at the University of Maryland Smith School of Business, former Chief Economist at the U.S. International Trade Commission, and seven-time winner of the MarketWatch best forecaster award in competition with 41 other top economists. (See his economic forecasts here.)

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