Sunday, November 20, 2016

Do Larger Deficits Stimulate Spending? Depends on Where the Funding Comes From

November 21, 2016

Do Larger Federal Budget Deficits Stimulate Spending? Depends on Where the Funding Comes From

The U.S. equity markets have rallied in the wake of Donald Trump’s presidential election victory. Various explanations have been given for the stock market rally. President-elect Trump’s pledge to scale back business regulations are favorable for various industries, especially financial services and pharmaceuticals. Likewise, President-elect Trump’s vow to increase military spending is an undeniable plus for defense contractors. But another explanation given for the post-election stock market rally is that U.S. economic growth will be stimulated by the almost certain business and personal tax-rate cuts that will occur in the next year, along with the somewhat less certain increase in infrastructure spending. It is this conventional –wisdom notion that tax-rate cuts and/or increased federal government spending stimulate domestic spending on goods and services that I want to discuss in this commentary.

Although I have been a recovering Keynesian for decades, I got hooked on the Keynesian proposition that tax-rate cuts and increased government spending could stimulate domestic spending after having taken my first macroeconomics course way back in 19 and 65. I was so intoxicated with Keynesianism that I made a presentation about it in a political science class. I dazzled my classmates with explanations of the marginal propensity to consume and Keynesian multipliers. My conclusion was that economies need not endure recessions if only policymakers would pursue Keynesian prescriptions with regard to tax rates and government spending. Reading the body language of my classmates, I believed that I had just enlisted a new cadre of Keynesians. That is, until one older student sitting in the back of the class raised his hand and asked the simple question: Where does the government get the funds to pay for the increased spending or tax cuts? I had to call on all of my obfuscational talents to keep my classmates and me in the Keynesian camp.

When I graduated from college with a degree in economics, I still was a Keynesian, perhaps a bit more sophisticated one, but not much. At graduate school, I became less enchanted with Keynesianism. But Keynesianism is similar to an incorrect golf grip. If you start out playing golf with an incorrect grip, you will have a tendency to revert to it on the golf course even after hours of practicing at the driving range with a correct grip. Bad habits die hard. So, even though I had drifted away from Keynesianism, it was easy and “comfortable” to slip back into a Keynesian framework when performing macroeconomic analysis. Yet, I continued to be haunted by that question my fellow student asked me:  Where does the government get the funds to pay for the increased spending or tax cuts?

I guess I am a slow learner, but after a number of years in the “real world”, away from the pressure of academic group-think, I realized that tracing through the implications of where the government gets the funds to finance tax-rate cuts and increased spending is the most important issue in assessing the stimulative effect of changes in fiscal policy. And my conclusion is that tax-rate cuts and increased government spending do not have a significant positive cyclical effect on economic growth and employment unless the government receives the funding for such out of “thin air”.

Let’s engage in some thought experiments, beginning with a net increase in federal government spending, say on infrastructure projects. Let’s assume that these projects are funded by an increase in government bonds purchased by households. Let’s further assume that the households increase their saving in order to purchase these new government bonds. When households save more, they cut back on their current spending on goods and services, transferring this spending power to another entity, in this case the federal government. So, the federal government increases its spending on infrastructure, resulting in increased hiring, equipment purchases and profits in the infrastructure sector of the economy. But with households cutting back on their current spending on goods and services, that is, increasing their saving, spending and hiring in the non-infrastructure sectors of the economy decline. There is no net increase in spending on domestically-produced goods and services in the economy as a result of the bond-financed increase in infrastructure spending. Rather, there is only a redistribution in total spending toward the infrastructure sector and away from other sectors.

What if a pension fund purchases the new bonds issued to finance the increase in government infrastructure spending? Where does the pension fund get the money to purchase the new bonds? One way might be from increased pension contributions. But an increase in pension contributions implies an increase in saving by the pension beneficiary. The pension fund is just an intermediary between the borrower, the government, and the ultimate saver, households or businesses saving for the benefit of households. Again, there is no net increase in spending on domestically-produced goods and services in the economy.

What if households or pension funds sell other assets to nonbank entities to fund their purchases of new government bonds? Ultimately, some nonbank entity needs to increase its saving to purchase the assets sold by households and pension funds. Again, there is no net increase in spending on domestically-produced goods and services in the economy.

What if foreign entities purchase the new government bonds? Where do these foreign entities get the U.S. dollars to pay for the new U.S. government bonds? By running a larger trade surplus with the U.S. That is, foreign entities export more to the U.S. and/or import less from the U.S., thereby acquiring more U.S. dollars with which to purchase the new U.S. government bonds.  Hiring and profits increase in the U.S. infrastructure sector, decrease in the U.S. export or import-competing sectors.

Now, let’s assume that the new government bonds issued to fund new government infrastructure spending are purchased by the depository institution system (commercial banks, S&Ls and credit unions) and the Federal Reserve. In this case, the funds to purchase the new government bonds are created, figuratively, out of “thin air”. This implies that no other entity need cut back on its current spending on goods and services while the government increases it spending in the infrastructure sector. All else the same, if an increase in government infrastructure spending is funded by a net increase in thin-air credit, then there will be a net increase in spending on domestically-produced goods and services and a net increase in domestic employment. We cannot conclude that an increase in government infrastructure spending funded from sources other than thin-air credit will unambiguously result in a net increase in spending on domestically-produced goods and services and a net increase in employment.

President-elect Trump’s economic advisers have suggested that an increase in infrastructure spending could be funded largely by private entities through some kind of public-private plan. This still would not result in net increase in U.S. spending on domestically-produced goods and services and net increase in employment unless there were a net increase in thin-air credit. The private entities providing the bulk of financing of the increased infrastructure spending would have to get the funds either from some entities increasing their saving, that is, by cutting back on their current spending, or by selling other existing assets from their portfolios. As explained above, under these circumstances, there would be no net increase in spending on domestically-produced goods and services.

Now, it is conceivable that an increase in infrastructure spending, while not resulting in an immediate net increase in spending on domestically-produced goods and services, could result in the economy’s future potential rate of growth in the production of goods and services. To the degree that increased infrastructure increases the productivity of labor, for example, speeds up the delivery of goods and services, then that increase in infrastructure spending could allow for faster growth in the future production of goods and services.

Another key element in President-elect Trump’s proposed policies to raise U.S GDP growth is to cut tax rates on households and businesses.  To the degree that tax-rate cuts result in a redistribution of a given amount of spending away from pure consumption to the accumulation of physical capital (machinery, et. al.), human capital (education) or an increased supply of labor, tax-rate cuts might result in an increase in the future potential rate of growth in GDP, but not the immediate rate of growth unless the tax-rate cuts are financed by a net increase in thin-air credit.

At least starting with the federal personal income tax-rate cut of 1964, all personal income tax-rate cuts have been followed with cumulative net widenings in the federal budget deficits. So, for the sake of argument, let’s assume that the likely forthcoming personal and business tax-rate cuts result in a wider federal budget deficit. Suppose that households in the aggregate use their extra after-tax income to purchase the new bonds the federal government sells to finance the larger budget deficits resulting from the tax-rate cuts. The upshot is that there is no net increase in spending on domestically-produced goods and services nor is there any net increase in employment emanating from the tax-rate cuts.

My conclusion from the thought experiments discussed above is that increases in federal government spending and/or cuts in tax rates have no meaningful positive cyclical effect on GDP growth unless the resulting wider budget deficits are financed by a net increase in thin-air credit, that is a net increase in the sum of credit created by the depository institution system and credit created by the Fed.

Let’s look at some actual data relating changes in the federal deficit/surplus to growth in nominal GDP. I have calculated the annual calendar- year federal deficits/surpluses, and then calculated these deficits/surpluses as a percent of annual average nominal GDP. The red bars in Chart 1 are the year-to-year percentage-point changes in the annual budget deficits/surpluses as a percent of annual-average nominal GDP. The blue line in Chart 1 is the year-to-year percent change in average annual nominal GDP. According to mainstream Keynesian theory, a widening in the budget deficit relative to GDP is a “stimulative” fiscal policy and should be associated with faster nominal GDP growth. A widening in the budget deficit relative to GDP would be represented by the red bars in Chart 1 decreasing in magnitude, that is, becoming less positive or more negative in value.  According to mainstream Keynesian theory, this should be associated with faster nominal GDP growth, that is, with the blue line in Chart 1 moving up. Thus, according to mainstream Keynesian theory, there should be a negative correlation between changes in the relative budget deficit/surplus and growth in nominal GDP. The annual data points in Chart 1 start in 1982 and conclude in 2007. This time span includes the Reagan administration’s “stimulative” fiscal policies of tax-rate cuts and faster-growth federal spending, the George H. W. Bush and Clinton administrations’ “restrictive” fiscal policies of tax-rate increases and slower-growth federal spending and the George H. Bush administration’s “stimulative” fiscal policies of tax-rate cuts and faster-growth federal spending.







Chart 1

In the top left-hand corner of Chart 1 is a little box with “r=0.36” within it. This is the correlation coefficient between changes in fiscal policy and growth in nominal GDP.  If the two series are perfectly correlated, the absolute value of the correlation coefficient, “r”, would be equal to 1.00. Both series would move in perfect tandem. As mentioned above, according to mainstream Keynesian theory, there should be a negative correlation between changes in fiscal policy and growth in nominal GDP. That is, as the red bars decrease in magnitude, the blue line should rise in value. But the sign of the correlation coefficient in Chart 1 is, in fact, positive, not negative as Keynesians hypothesize. Look, for example, at 1984, when nominal GDP growth (the blue line) spiked up, but fiscal policy got “tighter”, that is the relative budget deficit in 1984 got smaller compared to 1983. During the Clinton administration, budget deficits relative to nominal GDP shrank every calendar year from 1993 through 1997, turning into progressively higher surpluses relative to nominal GDP starting in calendar year 1998 through 2000. Yet from 1993 through 2000, year-to-year growth in nominal GDP was relatively steady holding in a range of 4.9% to 6.5%. Turning to the George H. Bush administration years, there was a sharp “easing” in fiscal policy in calendar year 2002, with little response in nominal GDP growth. As fiscal policy “tightened” in subsequent years, nominal GDP growth picked up – exactly opposite from what mainstream Keynesian theory would predict.

Of course, there are macroeconomic policies that might be changing and having an effect on the cyclical behavior of the economy other than fiscal policy. The most important of these other macroeconomic policies is monetary policy, specifically the behavior of thin-air credit. In Chart 2, I have added an additional series to those in Chart 1 – the year-to-year growth in the annual average sum of depository institution credit and the monetary base (reserves at the Fed plus currency in circulation). “Kasrielian” theory hypothesizes that there should be a positive correlation between changes in thin-air credit and changes in nominal GDP. With three variables in chart, Haver Analytics will not calculate the cross correlations among all the variables. But E-Views will. And the correlation between annual growth in thin-air credit and nominal GDP from 1982 through 2007 is a positive  0.53. Not only is this correlation coefficient 1-1/2 times larger than that between changes in fiscal policy and nominal GDP growth, more importantly, this correlation has the theoretically correct sign in front of it. By adding growth in thin-air credit to the chart, we can see that the strength in nominal GDP growth in President Reagan’s first term was more likely due to the Fed, knowingly or unknowingly, allowing thin-air credit to grow rapidly. Similarly, the reason nominal GDP growth recovered from the George H. W. Bush presidential years and was relatively steady was not because tax rates were increased in 1993 and federal spending growth slowed, but rather because growth in thin-air credit recovered in 1994 and held relatively steady through 1999.

Chart 2

In sum, there may be rational reasons why the U.S. equity markets rallied in the wake of Donald Trump’s presidential election victory. But an expectation of faster U.S. economic growth due to a more “stimulative” fiscal policy is not one of them unless the larger budget deficits are financed with thin-air credit. Fed Chairwoman Yellen, whether you know it or not, you are in the driver’s (hot?) seat.

Paul L. Kasriel
Founder, Econtrarian, LLC
Senior Economic and Investment Advisor
1-920-818-0236


“For most of human history, it has made good adaptive sense to be fearful and emphasize the negative; any mistake could be fatal”, Joost Swarte

Tuesday, November 1, 2016

The Fed Began Tightening Policy in October and No One Knew It, Maybe Not Even the Fed

November 1, 2016

The Fed Began Tightening Policy in October and No One Knew It, Maybe Not Even the Fed

I am so old that I can remember when the Fed tightened policy without any public announcements, often between FOMC meetings. Sometimes it took several days after the Fed implemented the tightening for a consensus to develop among Fed-watchers that a tightening had, in fact, taken place. But, at least, the Fed knew immediately when it had implemented a tightening. I believe that the Fed commenced a stealth tightening of monetary policy in October. But one possible difference between this current tightening and the tightenings of yesteryear is that it is not clear that even the Fed realizes that a tightening has occurred of late.

The reason I believe that the Fed has tightened monetary policy is because of the deceleration in the growth of thin-air credit, that is, a deceleration in the growth of credit created by the Fed and the commercial banking system. One element of the Fed’s contribution to thin-air credit is the reserves created for the depository institution system. These reserves are held at the Fed. The other component of thin-air credit created by the Fed is the currency held by depository institutions in their vaults and the currency held by the nonbank public. Depository institution reserves held at the Fed and currency is often referred to as the monetary base. Depository institutions are commercial banks, S&Ls and credit unions. Commercial banks account for over 90% of the total assets of depository institutions. Depository institutions create thin-air credit by granting loans and purchasing securities. Plotted in Chart 1 are the 52-week annualized percent changes in the sum of commercial bank credit plus the monetary base from November 4, 2015 through October 19, 2016. From January 1960 through September 2016, the median year-over-year growth in this thin-air credit aggregate was 7.1%. From November 4, 2015 through October 19, 2016, the median 52-week annualized growth in this thin-air credit aggregate was 4.4%. In the 52 weeks ended October 19, 2016, the annualized growth in this thin-air credit was 2.8%. Annualized growth in total thin-air credit of 4.4% is weak in an historical context. 2.8% annualized growth is very weak.
Chart 1

Commercial banks are doing their part to create thin-air credit. Chart 2 shows the 52-week annualized growth in commercial bank credit from November 4, 2015 through October 19, 2016. From January 1960 through September 2016, the median year-over-year growth in commercial bank credit was 7.4%. In the 52-weeks ended October 19, 2016, the annualized growth in commercial bank credit was 7.9%. So, banks have been cranking out thin-air credit at a robust pace. Therefore, it must have been a recent sharp slowdown in the growth of the monetary base that caused the relatively sharp deceleration in the growth of total thin-air credit.
Chart 2


Plotted in Chart 3 are the Wednesday weekly dollar levels of the monetary base from November 4, 2015 through October 26, 2016. You will notice two distinct plunges in the level of the monetary base. The first distinct plunge started in December 2015. This was when the Fed hiked its target federal funds rate level by 25 basis points. In order to get the federal funds rate to rise toward the Fed’s desired higher level, the Fed needed to reduce the supply of reserves available to depository institutions relative depository institutions’ demand for reserves. But why has the level of the monetary base plunged starting in late September 2016? The Fed did not raise its target federal funds rate level at the September 2016 FOMC meeting (although overnight bank funding costs have crept higher).
Chart 3

The net dollar change in the monetary base, consisting of liability items on the Fed’s balance sheet, in the six weeks ended October 26, 2016 was a decline of $277 billion. The net dollar change in Fed assets, largely securities owned by the Fed and discount window loans to depository institutions, during this period was a decline of $27 billion. So, the bulk of the $277 billion decrease in the monetary base must have been due to some other Fed liability items that absorb, or drain, funds from the financial system. One of those liability items that comes to mind is Fed reverse repurchase agreements with money funds and primary government securities dealers. When a money fund enters into a reverse repo with the Fed, the money fund, in effect, makes a short-term loan to the Fed, receiving as collateral for that loan some Treasury securities that the Fed has in its portfolio. A Fed reverse repo drains reserves, one of the components of the monetary base, from the depository institution system.  To the money fund, entering into a reverse repo is a substitute for purchasing a Treasury bill. Both are short-term and both are guaranteed by the federal government. Chart 4 shows the behavior of Fed reverse repurchase agreements with money funds and primary government securities dealers from November 4, 2015 through October 26, 2016. Fed reverse repos shot up in late December 2015, presumably to reduce depository institution reserves in order to push up the federal funds rate to its higher desired level. But why did Fed reverse repos spike up in late September and early October of 2016?
Chart 4


The recent spike in Fed reverse repurchase agreements with money funds and primary government securities dealers might be related to a change in money fund regulations that went into effect in mid-October 2016. On July 23, 2014, the Securities and Exchange Commission amended Rule 2A-7 of the Investment Company Act of 1940. Rule 2A-7 pertains to the regulation of money market mutual funds. Among other things, the amendments to Rule 2A-7 require institutional prime and institutional municipal money funds to float their daily net asset values. That is, a prime money fund must mark-to-market the value of its assets daily rather than automatically valuing each share at $1.00. Money funds marketed to individual household investors, retail money funds, are allowed to continue valuing a share at $1.00. An institutional prime money fund invests primarily in non-government guaranteed short-term fixed-income securities such as commercial paper and large negotiable bank-issued certificates of deposit. The amendments to Rule 2A-7 allow institutional money funds that invest in government-guaranteed assets to continue valuing a share at $1.00. As mentioned, these amendments to Rule 2A-7 went into effect in mid-October 2016.

According to Investment Company Institute data, in the 52 weeks ended October 26, 2016, the total assets of institutional prime money funds declined by $774 billion. In this same time period, the total assets of institutional government money funds increased by $763 billion. One likely motivating factor for this shift out of prime money funds and into government money funds by institutional investors is the amended Rule 2A-7. Whatever the motivation for this shift in portfolio preference by institutional investors, the result has been an increase in demand for short-maturity government-guaranteed fixed-income securities. One important component of the supply of short-maturity government-guaranteed fixed-income securities, U.S. Treasury bills, has not kept pace with the increased demand. In the 12 months ended September 2016, the amount of Treasury bills outstanding increased by only $289 billion. But there is another source of supply of government-guaranteed short-maturity fixed-income securities available to money funds – reverse repurchase agreements with the Federal Reserve.

It is conceivable, then, that the money fund reforms incorporated in the amendments to SEC Rule 2A-7 might have inadvertently contributed to the recent Fed tightening of monetary policy by inducing money funds to step up their use of Fed reverse repurchase agreements, which drain reserves from the financial system. Of course, the Fed could have offset the drain in reserves resulting from the increased volume of reverse repos by injecting additional funds into the financial system through the Fed’s purchase of securities in the open market. But the Fed has not done this.

As mentioned above, in the six weeks ended October 26, 2016, the monetary base contracted a net $277 billion. During this same period, the increase in Fed reverse repurchase agreements with money funds and primary dealers accounted for a net $78 billion of the $277 billion decline in the monetary base. So, there must have been some other factor on the liability side of the Fed’s balance sheet that was contributing to the contraction in the monetary base. That factor is U.S. Treasury deposits at the Fed. When the Treasury receives revenues from tax payments and/or security sales, these receipts often first appear in the Treasury’s deposit account at the Fed. For example, when I pay my taxes, my checking account balance decreases by $X, my bank’s reserves at the Fed decrease by $X and the Treasury’s deposit account at the Fed increases by $X. Reserves have, thus, been drained from the financial system. If the Treasury is not immediately going to spend these additional funds, it often redeposits a part of its increased balances at the Fed with private depository institutions. This restores part of reserves that were previously drained from the financial system when the tax or securities payment were first deposited in the Fed’s account at the Fed.  But to the degree that Treasury deposit balances at the Fed increase, reserves are drained from the financial system by that amount, all else the same.

For reasons not known to me, both the Treasury’s overall cash balance and its balance at the Fed have been increasing significantly starting in 2015. In the six weeks ended October 26, 2016, the Treasury’s deposit balance at the Fed increased a net $168 billion. The Fed could have injected reserves into the financial system through securities purchases to offset this $168 billion reserves drain from higher Treasury balances, but it didn’t. Rather, as mentioned above, the Fed let its assets decline a net $27 billion during this six-week period.

In the old days, before Fed policy change announcements, Fed-watchers, observing the monetary base declining and bank overnight funding interest rates rising (see Chart 5), likely would have concluded that the Fed had tightened monetary policy. But to the best of my knowledge, no one, including the Fed, has indicated as such. But in terms of the deceleration in the growth of thin-air credit and the drift up in overnight bank funding interest rates, the Fed has tightened monetary policy in recent weeks. What’s more, assuming that the October 2016 employment report, to be released Friday, November 4, is not a washout, the Fed is likely to formally tighten again at the conclusion of its December 13-14, 2016 FOMC meeting by announcing a 25 basis point increase in its target level for the federal funds rate. This will imply that the Fed will have to reduce the monetary base even more in order to push the federal funds rate up toward its new desired higher level. In turn, this will imply a further deceleration in the growth of thin-air credit from an already anemic current 52-week growth rate of 2.8%. Investors, get ready for slower U.S. economic growth in the first half of 2017. And Fed, get ready for a barrage of criticism from the administration of the next President, whoever it is.
Chart 5


Paul L. Kasriel
Founder, Econtrarian, LLC
Senior Economic and Investment Advisor
1-920-818-0236





Sunday, October 2, 2016

The Imposition of Import Restrictions Is a Recipe for a Declining Standard of Living

October 3, 2016

The Imposition of Import Restrictions Is a Recipe for a Declining Standard of Living

Both 2016 U.S. presidential candidates of the two major political parties are, to greater and lesser degrees, advocating the imposition of restrictions on U.S. imports if foreign exporters engage in “unfair” trade practices. Regardless of whether foreign exporters engage in perceived unfair trade practices, I believe that the imposition of restrictions on U.S. imports would result in a decline in the standard of living of Americans in the aggregate.

The benefit to an economy from trade is imports, not exports. When U.S. workers produce goods and services that are exported, neither those U.S. workers nor other U.S. residents get to consume those exported goods and services. Rather, the foreign recipients, the importers of these goods and services, consume them. Exports are what we have to give up in order to obtain imports. The fewer exports we have to give up to obtain a given amount of imports, the better off we are.

Let’s run a little thought experiment. Suppose that the Chinese government, embracing the mercantilism that Adam Smith excoriated way back in 1776, provided Haier Group, a Chinese-based home appliance manufacturer, a subsidy such that enabled Haier to offer refrigerators for sale in U.S. for $1 each. Should the U.S jump on this deal of $1 dollar refrigerators or impose a tariff on Haier refrigerators so that their U.S. price was closer to those of Whirlpool and Frigidaire refrigerators? If you were a worker at or a stockholder of U.S. Whirlpool and Frigidaire, you would lobby for the tariff on Haier refrigerators. But those of us who do not earn income from Whirlpool or Frigidaire would most likely opt for the $1 Haier refrigerators.

If we allowed imported Haier refrigerators to be sold in the U.S. for $1 each, would workers and stockholders associated with Whirlpool, Frigidaire and their suppliers be economically harmed? Yes, initially. Would U.S. residents, in the aggregate, benefit from the imported $1 Haier refrigerators? Yep. We could purchase more refrigerators and still have a lot of income left over to purchase other goods and services. Our increased demand for other goods and services would result in additional hiring, production and profits in industries not directly related to Whirlpool and Frigidaire. Some of those     laid- off Whirlpool and Frigidaire workers would find employment in those industries experiencing increased demand as a result of the lower-cost imported refrigerators. As a result of the Chinese government’s subsidy to Haier, we in the U.S. would be able to consume more refrigerators and more of other goods and services at a lower general price level, all else the same. That is, in the aggregate, the American standard of living would rise.

I can hear you now. This is typical ivory-tower analysis. In the real world, a lot of those laid-off would not be able to get re-employed in other industries quickly or at a comparable wage rate because of inadequate skills or geographical-mobility issues. Let’s assume that this is the case for all laid-off workers in industries related to the domestic production of refrigerators. Let’s also assume that there are many more families that purchase refrigerators than there are families involved in the domestic production of refrigerators. Under these circumstances, the U.S. government could impose a tariff on imported Haier refrigerators at a level such that the revenues from this tariff could be transferred to the displaced workers, leaving them monetarily no worse off while leaving everyone else better off.  This tariff would result in the price of U.S. refrigerators being higher than $1 but less than what the price was before the Chinese government started subsidizing Haier.

Who are the real losers in the $1 Haier refrigerator deal? Chinese taxpayers. They end up subsidizing U.S. consumers of Chinese-produced refrigerators. Moreover, China will be using more of its resources to produce refrigerators for U.S consumption. This leaves fewer Chinese resources to produce other goods and services for Chinese residents to consume. In effect, the Chinese taxpayers would be providing “foreign aid” to U.S residents. How do you say “thank you” in Mandarin?

Okay. Let’s come down from the ivory tower to the real world. In September 2009, President Obama imposed additional tariffs on imported Chinese tires of 35%, 30% and 25% in years one, two and three, respectively. The President was responding to a finding by the U.S. International Trade Commission (ITC) that imported Chinese tires were causing “market disruption” to the U.S. domestic production of tires. A labor union representing U.S. tire workers requested the inquiry by the ITC. A study by the nonpartisan Peterson Institute for International Economics (PIIE) found that the total cost of these new tire tariffs on Chinese tires resulted in higher tire costs to U.S. consumers of around $1.1 billion in 2011. The PIIE study estimated that a maximum of 1,200 jobs were “saved” in the U.S. tire-production industry by these additional tariffs. Thus, the cost to U.S. consumers per U.S. tire-production job saved was around $900 thousand in 2011. Furthermore, the PIIE study estimated that because of the increased cost of tires to U.S. consumers, these consumers had to reduce expenditures on other goods and services, which resulted in the loss of 3,731 other jobs in the retail sector. So, the price of tires increased to American consumers and they had to cut back on their consumption of other goods and services – a drop in the American standard of living by any other name.

The $1.1 billion of additional tire costs on American consumers via a higher tariff on imported Chinese tires in 2011 works out to $13.27 per U.S. family in that year – not an exorbitant  amount. But, instead of imposing the tire tariff, if the U.S. government had increased taxes on every U.S. family of 64 cents and transferred those additional tax revenues to the 1,200 domestic tire-production workers who would have lost their jobs without the higher tariff, the laid-off tire-production workers would have been no worse off monetarily in 2011 and everyone else would have been better off than with the tariff.

Why didn’t those citizens not employed in the tire-production industry write President Obama and/or their federal legislators to protest the imposition of the higher tariff on imported Chinese tires? Because $13.27 more annually per family due to higher tire tariffs was only 0.02% of the 2011 median family income --small potatoes. Why didn’t the 3,731 retail workers who lost their jobs because of the higher tire tariffs protest? Because they probably could not connect the dots between the increase in the tire tariffs and the decline in other retail sales. But those in the U.S. tire-production industry could clearly see that less expensive Chinese tire imports were adversely affecting their livelihoods and they had lobbyists and union leaders who were going to squawk about it.

Whether foreign governments conduct fair or unfair trade practices, there will be certain U.S. industries harmed economically as imports increase. But there will be more U.S. residents who benefit economically from these increased imports than will be harmed. If our federal legislators took into consideration the economic well-being of Americans in the aggregate, they could devise a system to compensate those harmed by the increased imports so as to leave them no worse off. Extra taxes or tariffs would be needed to fund this compensation. But these extra taxes/tariffs would be low enough to leave those who benefitted from increased imports better off than before. Because the “losers” from increased imports are easier to identify than the more diffuse “winners”, it is politically more expedient to argue in favor of import restrictions than a more rational compensation program that would leave the “losers” from imports no worse off economically and everyone else better off.

In sum, if the trade-restriction rhetoric being voiced by the presidential candidates of both major political parties turns into actual trade restrictions after the election, the standard of living of Americans in the aggregate will be adversely affected. We will end up with slower growth in goods and services available for us to consume and a higher rate of consumer inflation. Adam Smith must be spinning in his grave.

Paul L. Kasriel
Founder, Econtrarian, LLC
Senior Economic and Investment Advisor
econtrarian@gmail.com
1-920-818-0236