Predictions for 2017

Hello friends,

You need a break. You have been entertaining friends and family and you need an excuse -- any excuse -- to sneak into your office or garage and pretend to be doing something important. So here it is -- Davidson's annual predictions for the new year. What better excuse than that?

I have never lived through a time when forecasting was more useless. But that doesn't mean that you have to remain dormant until the next epoch of predictable boredom. I hear people making predictions all the time. I heard one women in Target the other day telling her son that if he didn't eat the pepperoni on his pizza,  his wiener would fall off.

Anyway, I thought it my personal duty to share my thoughts about 2017 with you:

• The government will make driving while texting legal and will start a new promotion called Texting, Weed, and Driving. Nancy Pelosi was quoted in the Bloomington Herald Times as saying that if drivers are going to be distracted then they should be REALLY distracted. Hu Ha. 
• National Debt will be renamed National Advantage and economists will write hundreds of articles about why Advantage will make America great again. 
• Global change activists will demand that President Trump expand the wall to the west around California and then up to Seattle. An eastern expansion would include Florida up to Maine. Of course, Mexico will be asked to pay for it. They will pay with Tequila.
• The Stones will make a new album devoted to all their fans from the 1960s. The lead song will be I've Got Those Swollen Prostate Blues. 
• Bloomington's Mayor will rename Christmas. It will now be called Freeze Your ASS Off Day. 
• Amazon's request to merge with AT&T, Google, and Uber will be allowed. Once the merger is consummated, the new company will be larger than the US government and will replace it. All Congressional representatives will be sent home and given pensions that will expire when hell freezes over. 
• China will "merge" with all the countries of the Pacific Rim. After attempting to integrate California and Washington, they will balk and say something like, "We like their music but they are way too wacked out for us." The US will be stuck with both coasts. 
• All the countries of the European Union except for Germany will leave the EU and join something called the BrEntrance.
• To stave off future security issues and tackle European financial instability, Greece will be sold to Russia and the resulting country will be named Grussia. The GDP of Grussia will soon fall lower than Haiti's.  
• Donald Trump will get a new hair style -- he will shave his head and sell his locks to the highest bidder.  

Lesson 1. International Trade Ignorance

Those of you who can count will recognize that my last lesson was Lesson 16 and therefore you were expecting Lesson 17 this time. Unfortunately I checked the records and I never had a Lesson 1. I started with 2. Sheesh. So I am naming today’s main plate Lesson 1.

This lesson is about international trade. International trade is a lot like pho, the Vietnamese soup. A lot of people really like it but almost no one knows how to prepare it. Otherwise Campbell’s would have canned it already. We're similarly ignorant about international trade. When my fifth grade teacher called me ignorant, I was very hurt. But later I realized it did not mean I was terminally stupid – only that I didn’t know very much. I was willing to go with that.

I fear that our President-Elect is a bit ignorant about international trade. I also fear that he will read this post and ask me to be Secretary of Doggie Bags, but the truth is that most of us are ignorant about international trade. So no insult is intended.

One of my professors once talked about international trade in terms of the tail that wagged the dog. Unless you have a really small dog with an unusually large tail, you expect the dog to wag its tail. So saying international trade is like the the tail wagging the dog ought to have your ears perked and your tail wagging.

What my professor meant is that there used to be a day when trade pretty much meant one thing – countries selling goods to each other. "Goods" implies a tangible, e.g. a manufactured product or an agricultural product. You can imagine a time when much of world trade was coal or corn or clothing or cars. Countries loved to export goods because it expanded their ability to sell. The more they sold, the more incomes and employment grew.

So exporting goods was really cool. It was the big dog. You were the coolest kid on the continent if you could export your goods to other countries. That’s what many people think is what international trade is all about. Exports of goods! In 2015, the US exported $1.5 trillion of goods. Go team.

The interesting thing about an export of goods is that a bunch of foreign currency comes into world markets to pay for your goods. What do we do with all those foreign currencies? They are pretty but papering your walls with it can only go so far. Then some bright bulb thought, "Hey, with all this foreign money, maybe I could buy things from other countries!" So export countries would use the foreign currency to buy goods from other countries. Imports go hand in hand with exports. And more important, imported goods can really help your country – especially if you import things that help you to be happier and more productive.

So exports of goods imply imports. While exports have an important role for national goals, imports of goods are also part of that equation. If a country imported only Twinkies, then maybe you might want to rethink the value of the imports. But countries often import vital things they can’t get at home.

Nowadays most of the world has discovered services. Services are intangibles which essentially disappear once they are consumed. A float down the Rhine might cost you $20k but on your way home all you have left are some nice memories and the JD bottle you stole from your room fridge. Travel, tourism, entertainment, communications, utilities, healthcare, etc. are services. In the US today, about 70% of what we spend goes for services. So whatever I wrote above about goods adheres equally to services. Services exports augment a nation’s output and employment; services imports fill in what we don’t or shouldn’t make ourselves. In 2015, US services exports were $743 billion.

When people subtract national imports from exports, they are doing a legitimate operation. For example, if exports are less than imports of goods and services, we call that negative number a trade deficit. That causes frowns. We don’t like deficits. But in reality the negative number is telling you only one thing directly – currency going out exceeded currency coming in. What this negative number tells you – for example, a deficit of goods and services of $500 billion in 2015 – is that $500 billion did not return to the US via imports of goods and services. So what? It does NOT tell you that the US is in a half-billion dollar hole. In fact, what we know is that the nation got benefits from the exports AND it got benefits from the imports. Adding them together, we got about $5 trillion of benefits to the country in 2015.

I see you are tiring. Give me 10 burpees. The best part is coming.

What we have left out of all this is a huge part of trade call financial stuff. Okay, there is a more technical term but for now remember that the trade deficit left $500 billion of dollars around the world that people did not want to use for US goods and services. 

Notwithstanding wallpaper, foreigners who hold all those dollars can use that money and more if they want to buy financial stuff in the USA. They can open up an account  at the IU Credit Union. They can buy corporate or government bonds. They can buy shares of Apple or shares of an index fund. They can also acquire or merge with Apple or the Crosstown Barber Shop.

Wow. And they are not limited by that $500 billion left over from the trade deficit. They can invest all they want. And I don’t have to convince you that when foreigners buy US assets, it is a good thing. It is good because US firms find it easier and less costly to raise capital for investment. It is good because it lowers US interest rates. It is good because it can infuse the latest technology and innovations into American companies.

In 2015, foreigners increased their ownership of US companies (what we call foreign direct investment or FDI) by around $350 billion dollars. That’s not how much they owned – that’s how much they INCREASED their ownership in that one year. They increased FDI by around the same amount in 2014. In those two years, foreigners increased their ownership of portfolios in America by about $736 billion. Money is gushing into the USA. Between this portfolio investment and the FDI, we are talking about an increase of dollars buying US assets of more than $1.4 trillion.

Here’s the point: Trade includes cross border transactions of goods, services, foreign direct investment, portfolio investment, and more. Anyone who focuses on one of these to the exclusion of the rest is not telling you the full story. International trade is great for the USA. Yes, we have a trade deficit. But we also have a pile of very valuable imports of goods and services flowing in and a waterfall of the world’s savings wanting to invest here. Anyone who suggests that we should jeopardize the latter so as to remediate the trade deficit in goods is not understanding the meaning of international trade.  

Manufacturing Employment by the Numbers

The populist shift in the world these days seems to be driven in large part by employment. In the USA, the lament seems focused on manufacturing employment (ME). So I decided to take a little trip down memory lane to see what has happened to US ME, especially within the context of a little history, globalization,  and NAFTA. As you might guess my conclusion is that the data does not support the idea that trade, unfair or fair, is mostly responsible for robbing the US of its manufacturing prowess and employment.

Has US manufacturing employment declined? Yes. See the table below. In 1948 ME was about 14.3 million workers and represented almost 25% of the US workforce. But that was a long time ago and I hadn't even heard of JD then. ME grew after that and peaked in 1979 at 19.4 million workers. But already – before globalization – ME had fallen to less than 20% of the US employment in 1979. Point – a downward trend had begun without globalization or Nafta. Between 1948 and 1979 ME fell from one-quarter to one-fifth of US total civilian employment.

Even 1979 was a long time ago. At that point I was mixing JD with Coke and grooving to disco music. Between 1979 and 1994 the number of MEs fell from 19.4 million workers to 17 million. By 1994 ME was down to 13.8% of total employment. So before Nafta or before the fall of the Soviet Union (1991) could impact trade very much, ME was down to less than 14% of all US jobs. Note the fall from 25% to 20% to 14% from 1948 to 1979 to 1994.

It took another 12 years to push ME down even farther. By 2006 and just before the world economic crisis, US ME has fallen to 14.2 million workers and accounted for just under 10% of all employment. So in those 12 years ME fell by another 2.8 million workers and by another 4% of the total employment.  This was the time period in which NAFTA, the opening of China (in the 1990s), and other major global forces were in full bloom.

But it would be exaggerating the truth to say that globalization was responsible for all of the ME declines between 1994 and 2006. For example, whatever was causing firms to replace workers with machines before 1994 was surely still operating after 1994. And another important cause of falling ME was recessions. After the recession in the early 2000s, ME fell from more than 16 million to about 14 million workers. After the 2008 recession ME fell from about 14 million to about about 11.5 million. We expect many of those jobs to come back if and when the economy regains its former strength. But for now recession aftermath continues to impede ME.

In 2015 ME was down to a humble 8.3% of total US employment. That’s a steep fall from the 25% it garnered in 1948. During those years many factors were impacting ME in the USA.  Equipment, robots, and other capital improvements have displaced labor continuously. Globalization has caused some US producers to move offshore and has allowed other countries to compete for US consumers, thus displacing workers. Recessions always caused temporary declines and they continue to do so.

ME employment fell from its peak of 19.4 million workers in 1979 to about 12 million recently.  It is not easy to decompose that decline and to know exactly how much of it was caused by globalization.  Conversely it is not easy to say by how much globalization increased ME in the USA. Surely as foreign firms have geared up to compete internationally US business productivity has benefited by importing new capital, parts, and assemblies—making US firms more competitive and allowing them to expand output and employment in the USA.

Don’t be easily persuaded to think that globalization and free trade agreements have decimated US ME. Note that ME in 1948 was not the major US employer. Even back then ME accounted for only 25% of jobs. It is true that ME declined to 12 million jobs today. But the numbers say that globalization is only one of  many things causing US ME to decline. It is foolish to think that extreme nationalistic and protectionist policies will do anything to stop or restore these changes in US economic structure.

Table. Manufacturing Employment (ME)
Selected Years since 1948

Year    Millions  % of Total Employment
1948      14.3               24.5
1979      19.4               19.7
1994      17.0               13.8
2006      14.2                 9.8
2015      12.3                 8.3

Strong Dollar. Who are We Going to Blame Now?

President-elect Trump rode into Washington on a horse named Unfair Competition. One part of the story is how other governments manage their currencies so as to gain a competitive advantage against the US. And while I agree that countries sometimes do that, such currency manipulations are not among the dominant forces now. If anything we in the US are the one’s causing our manufacturers to lose competitive advantage.

Why worry? Or was that What me Worry? Regardless, in the last month (between November 4 and December 2) the dollar went soaring. It rose in that short time by more than 10% against the Japanese yen and 8% relative to the Mexican peso. It rose by about 5% against the euro and the Brazilian real and by lesser amounts against the Korean won and the Chinese renminbi. It held steady against the Canadian dollar. When the dollar rises by such large amounts US exports are less competitive in global markets. So we fret. This puts US exporting companies at a disadvantage. Clearly the bad guys must have done this to us!

But alas, I don’t think that is true. Most experts are saying that we did it to ourselves. Experts are saying that the Trump bump is making people more optimistic about the US economy. This optimism makes US assets like bonds and stocks much more appealing to investors. It also emboldens Ms Yellen and her band of Federalies to raise interest rates. Thus we are receiving a tsunami of attention from global investors who must first buy dollars so they can buy our very attractive assets. This revived love of dollars means a higher value for the dollar.

This is not a trick played on us by evil China or Mexico. The negative impacts on US exporters are because investors have concluded that Trump will be good for the US economy – at least for a while. Even before this latest wave of foreign investment, the world marveled at how the US recovered after the global recession while other countries continued to struggle. This has been lifting the dollar for some time and has made life difficult for US exporting companies. During the last two years the dollar rose by 13% against the renminbi. It also rose by 8% against the yen and by almost 30% against the euro. 

This doesn’t look like unfair currency manipulation to me. It has more to do with US policy and economic performance. It is market forces working in a global economy.

So maybe we should dispense with the unfair competition talk and ask ourselves what we really want. If the "experts" are correct, then it appears that the best way to help US exporters is to do something to make the US weaker and grow more slowly. But that is tantamount to throwing the baby out with the bath water.

Instead, if we really want to help our exporters, we ought to have policies that do not weaken our trading partners. When they get stronger they will buy more – and some of that extra spending will be directed toward US goods and services. Slapping tariffs on goods we import from key trading partners will do nothing but weaken them, make the dollar stronger, and smack our exporters. Are you sure that’s what we want to do?

One last point. The last time I looked it took two to tango. It also takes at least two to do JD shots but that’s a different story. Trade is more than an export story. While the optics are vivid with respect to exporters and their workers – countries gain with strong imports and with strong inbound and outbound investment. Keep in mind that when the dollar appreciates and negatively impacts exports – that same rise in the value of the dollar improves the situation for importers and makes foreigners more interested in investing in the US. Keeping in mind that many US imports are business goods that add to US productivity, a high and rising dollar is sometimes on net, a great boon to American business. The optics of the latter are less clear than the export story but nevertheless are important.

Summary: We should be alert to real rather than imagined unfair competition. Let's stop tilting at windmills. Competitive advantage of a country is determined by more than export sales. Policy should focus on the many avenues in which trade enhances American well-being.