No private sector tire repairman would keep pumping up a flat tire again and again without patching the leak, but that is exactly what our governing class keeps trying. The Obama administration and the Democratic Congress have been pumping the economic tire without patching the trade deficit leak for a year and a half now.
The preliminary data for second quarter GDP, released on Friday (July 30) by the Bureau of Economic Analysis (BEA), show U.S. economic growth slowing from a 3.7% rate in the first quarter to a 2.4% rate in the second quarter. But the details were even worse. A full 1.0% of that 2.4% was due to produced goods that went unsold due to lack of demand. In fact, demand for American products rose at a paltry annual rate of just 1.4%!
The U.S. economy has now been depressed for a full two and a half years, ever since the fourth quarter of 2007. And with the current growth rate amounting to a paltry 1.4%, the near term prospects do not look good at all. The United States is clearly locked in a persistent recession with little prospect for recovery at any time soon.
The details of Friday's data divide up what is produced into five categories. Three describe the sources of domestic demand: household demand for Consumption, business demand for fixed Investment, and Government demand for goods and services. As shown in the table below, these three were up, partly as a result of the many stimulus giveaways of the Democratic Congress and Obama administration, designed to create a "summer of recovery" before November's congressional elections.
Growth In US GDP During 2nd Q
The worsening trade balance (exports minus imports) caused American demand to leak abroad. During the second quarter of 2010, our rapidly expanding trade deficit reduced U.S. economic growth by a full 2.7%, almost twice the real growth of the American economy. This increasing trade deficit is being driven by the deliberate policies of those governments that have been manipulating trade for years in order to grow their economies at the expense of our industries and economy.
Obama's Biggest Mistake
President Obama made his biggest mistake when he chose to expand the U.S. government instead of requiring balanced trade. In February 2009 he sent Secretary of State Hillary Clinton to China to beg the Chinese government for loans. The Taipei Times reported on February 23, 2009: "In Beijing, she called on Chinese authorities to continue buying US Treasuries, saying it would help jump-start the US economy and stimulate imports of Chinese goods."
We do not know which of the administration's economists urged her to request loans from China but loans have the opposite effect; they encourage imports which has a negative effect on the economy! (See above table.) If she had instead demanded that the Chinese government allow its people to buy our products, we would not have needed Chinese loans.
President Obama's policy has not changed much since then. On July 8, 2010, just after China finished making a miniscule adjustment of less than 1% in the dollar-yuan exchange rate from 6.83 yuan per dollar to 6.78, Treasury Secretary Timothy Geithner issued a report to Congress which pretended that China is not manipulating its currency. But a change of less than 1% makes little difference when the Chinese currency is being kept undervalued by what some estimate to be as much as 40%. President Obama also lets the other currency-manipulating countries manipulate their trade with the United States. For example, he lets the European courts loot Intel, in order to help Intel's rival AMD, which was lured to Germany through German-government subsidies. And it lets many other Asian countries flood us with products that are kept inexpensive through currency manipulations.
Scaled Tariff: The Conservative Alternative
There is a conservative alternative that would reduce the federal government budget deficit and bring back American manufacturing. We recommend that the United States enforce the International Monetary Fund's Article of Agreement (Article IV) which requires that countries "avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members."
We have devised a scaled tariff, targeted at the currency-manipulating countries as identified by more than $100 billion worth of reserves already accumulated through currency manipulations by the end of 2009, according to a table published recently by the U.S. Treasury Department:
- China - $2,399 billion
- Japan - $997 billion
- Russia - $399 billion
- Saudi Arabia - $397 billion
- Taiwan - $348 billion
- Korea - $265 billion
- India - $259 billion
- Brazil - $229 billion
- Euro Area - $195 billion
- Singapore - $187 billion
We would scale each currency-manipulating country's tariff rate to collect 50% of our trade deficit with that country. The rate would go up when that trade deficit goes up, down when that trade deficit goes down, and go to zero when that trade deficit gets so close to balance that the tariff rate would be under 5%. In order to make it sensitive to changed policies in the currency-manipulating countries, it should be recalculated each economic quarter, based upon our trade deficit with each country over the most recent four quarters.
Here's how the numbers of our proposal would work with China. In 2009, we imported $305 billion from China, but the Chinese government only let its people import $86 billion from us, creating a trade deficit of $219 billion. An initial tariff rate of 36% on $305 billion of imports from China would be designed to collect $109.5 billion (50% of $219 billion) in tariff revenue (if the trade deficit were to continue at the 2009 level). This would still be less than the under-valuation of the yuan which makes Chinese products about 40% less expensive than they would normally be in world markets.
The Chinese government could reduce our tariff rates by taking down their many tariff, non-tariff, and currency-manipulation barriers to our products starting, perhaps, with the barriers listed by the United States Trade Representative in the 2010 National Trade Estimate (NTE):
- Duties on American products including their 30% tariff on large motorcycles, their 30% duties on most video, digital video, and audio recorders and players, and their 35% duty on American raisins.
- VAT tax on American-produced diammonium phosphate (DAP) fertilizer while Chinese produced monoammonium phosphate is sold tax free.
- Directives which restrict buying to domestic sources.
- Restrictions preventing American companies from selling a wide variety of financial and insurance services in China.
- Delaying the sale of legitimate American DVDs and CDs while freely permitting their piracy.
The following is a list of the initial tariffs that would come out of our proposal from the 2009 trade numbers:
- China - 36%
- Russia - 35% (estimated from incomplete data)
- Saudi Arabia - 26%
- Singapore - 18%
- India - 12%
- Japan - 11%
- Taiwan - 11%
- Korea - 6%
- Euro Area - 5%
- Brazil - 0%
Some fear a trade war with China and some of the others which would reduce trade. But, we have little to lose from a decline in one-sided trade which would stimulate American factory production. If these countries were to react with counter-tariffs instead of taking down their barriers to our products, they would face increasing tariff rates on their products. If they were to react by rapidly selling off their U.S. Treasury bonds, there are plenty of buyers including the Federal Reserve. And what would China do with the dollar proceeds? Sell them and drive the dollar down and make us more competitive around the world?
During the first year, the scaled tariff could collect about $170 billion of revenue, enough to seriously dent our budget deficit. But the amount collected would gradually decrease as the currency-manipulating countries would increase their purchases from us and as Americans would reduce their imports from currency-manipulating countries. Americans would buy more from American producers and from non-manipulating countries, such as Mexico, which buy more from the United States as they get richer. The result would be higher American incomes, more than making up for the higher cost of products imported from countries that limit their imports from us.
This entire policy would be in complete compliance with a WTO rule which lets trade deficit countries restrict imports in order to avoid balance of payments problems. In accordance with that rule, the entire tariff program would end as soon as American trade would reach approximate balance.
This plan would be opposed by misinformed progressives who have been claiming that that the Smoot-Hawley tariff made the Great Depression deeper than it would have been. But those who have studied the Great Depression know that this is not true. For example, in her Encyclopedia Britannica entry about the Great Depression, Council of Economic Advisors Chair Christina Romer wrote: "Scholars now believe that these [protectionist] policies may have reduced trade somewhat, but were not a significant cause of the Depression in the large industrial producers."
Despite their bad reputation, tariffs are actually as traditional as apple pie. They were the main source of federal government revenue from our country's founding until Woodrow Wilson enacted the progressive income tax. Their main drawback is that they can be used to protect one or another politically-powerful industry, at the expense of other industries. But the scaled tariff would be an across-the-board tariff. It would not pick winners and losers. It would not only boost production by those Americans who compete with imports, but it would also increase American exports.
Its only drawback is that it would reduce the loans we are receiving from the currency-manipulation governments, resulting in higher U.S. interest rates, making it more expensive for the federal government to borrow. The higher interest rates would encourage Americans to save. And the federal government could reduce interest rates by moving toward a tax system that leaves household savings and undistributed business profits untaxed.
The greatly increased investment opportunities would increase business investment, despite the higher interest rates. The result would be a rapidly expanding private sector and an expanding GDP.
The authors maintain a blog at www.idealtaxes.com, and co-authored the 2008 book, Trading Away Our Future: How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it's Too Late, published by Ideal Taxes Association.