Coyote Blog

From Don Boudreaux at Cafe Hayek:

In yesterday's Wall Street Journal, Lawrence Lindsey wrote
about the Chinese government's policy of not allowing the value of the
yuan to rise against that of the dollar:

America, however, benefits from this arrangement. The Chinese clearly
undervalue their exchange rate. This means American consumers are able
to buy goods at an artificially low price, making them winners. In
order to maintain this arrangement, the People's Bank of China must buy
excess dollars, and has accumulated nearly $1 trillion of reserves.
Since it has no domestic use for them, it turns around and lends them
back to America in our Treasury, corporate and housing loan markets.
This means that both Treasury borrowing costs and mortgage interest
rates are lower than they otherwise would be. American homeowners and
taxpayers are winners as a result.

The Chinese are holding on to a Trillion dollars in US currency, with the main effect of subsidizing lower prices and interest rates for US consumers.  What a deal!  (I took a more tongue-in-cheek approach to the same issue here)  I know most commentators instead want to focus on the threat of China suddenly dumping those dollars, disrupting US markets.  People need to understand that the cost of doing the latter is enormous for China, not only in lost value of their dollar-denominated assets but in lost exports as the value of the Yuan would spike.  To test the hypothesis of holding dollars as a strategic weapon, would you feel more secure in the US if the government held a trillion dollars of yuan?  Why?  I would in fact feel more vulnerable to China, dependent on the health of their economy.  I personally am a big believer that Chinese investments in the US are great, and will act as a stabilizing influence in the future. 

By the way, while the above refers the Chinese government holdings of US financial assets, Cafe Hayek also points to an article by John Makin of the AEI who observes that the trade deficit is a misnomer, as the US is providing services that are not counted, specifically wealth-protection services:

In summary, Makin argues that one of the reasons foreigners sell so
many goods and services to Americans and then consistently refrain from
buying an equivalent amount (in value terms) of goods and services from
Americans is that foreigners have a high demand for "wealth-storage"
services supplied by dollar-denominated assets.

The fact that global savers accommodate U.S.
consumers by keeping U.S. interest rates lower than they otherwise
would be and the dollar stronger than it otherwise would be is simply a
manifestation of America's comparative advantage at supplying wealth
storage facilities.

In
other words, there's no real imbalance.  If the services supplied by
"wealth-storage facilities" were counted in international commercial
accounts as "services," then the U.S. current-account would not be in
deficit.

I have written before about why we should not fear the trade deficit with China, and why the word "deficit" is itself a misnomer, here and here.

A few days ago, I posted that people seem to make strange tradeoffs between the cost of gasoline and the value of their personal time.  Don Boudreaux at Cafe Hayek makes a similar observation about recent calls to reinstate the 55 MPH speed limit, pointing out that slower speed limits may save gas but they cost people time, and time is one resource that is truly finite:

In short, for every 75-miles covered on a highway, reducing the speed limit from
75 MPH to 55 MPH will save a driver $2.58 in fuel cost -- and this assuming that
the increase in fuel efficiency of the average car caused by the lower speed
limit is a whopping 10 mpg.  But the resulting greater time on the road will
cost a driver earning the average non-supervisory wage $5.82 worth of his or her
time per 75-miles driven.

By the way, it is no surprise that this always seems to be proposed by Easterners who have no conception of the travel distances out west.

As a preface, I am not a socialist planner, so I do not presume to make other people's economic trade-offs for them.  If someone out there chooses to collect Pinto station wagons or pay $10 million to go on a Russian space launch, power to them.

That being said, I will observe that gas price concerns seem to drive people to do things that they would not normally do in other contexts.  Market Power quoted this statement from the Washington Post:

"When prices go up, you're going to see some interesting things," said Tom
Kloza, chief analyst for the Oil Price Information Service in New Jersey.
"Saving money on gas is something that's just magical in this country. Rational
thought just doesn't apply to gas."

Market Power was skeptical that such irrationality exists, but I think it may be correct.  Here are a few examples:

1.  Waiting for hours:  A couple of years ago when I lived in Seattle, a local Costco put in a gas station and sold gas for 10-15 cents or so below most of the other local stations.  Every time I went there, there was a huge line -- perhaps half an hour long -- to get gas.  For a fifteen gallon fill-up saving 15 cents and waiting 30 minutes, that equates to $4.50 an hour savings for their efforts, not to mention the extra driving time (and gas!) spent getting to this one spot rather than their local station.  How many people in the line would have driven an extra 10 miles to take a job at $4.50 an hour? 

Lately, I witnessed a free gas promotion where people lined up and waited at least 3 hours for 10 gallons for free gas (people apparently had lined up starting at 4AM for the promotion that began at 8AM.  This is a bit better deal at $10 per hour, but I wonder how many people in the line would have participated in any other endeavor for $10 an hour?  Market Power points to a similar promotion in Sioux Falls, where the value of police time providing security was probably higher than the value of the gas given away.

2.  Save a dollar, pay three extra.  One of the reasons I am unconcerned with gas price gouging is that many gas stations today use gas as a loss leader, hoping to pull motorists into their store or restaurant.  In the language of gouging, what this means is that typically you are getting a great price on gas (given what the dealer's costs are) and are getting gouged on coffee and Twinkies.  Its amazing to me that people who check the Internet to find the place with 5 cents a gallon cheaper gas will then walk into the convenience store and pay whatever for Cokes and water and cigarettes and beer and coffee.  It seems crazy, but the best way to explain it is that for a number of people, a dollar saved on gas gives them far more satisfaction than say a dollar save on soft drinks.

3.  Wagering with the rental car company.  Every rental car company offers you a wager nowadays.  They give you the chance to buy the whole tank of gas in advance for something like 20 cents less than the local market rate.  Assume the local market rate is $3.20, the rental car advance rate is $3.00, and the tank is 15 gallons.  All you have to do to win this bet as the renter is to return the car with less than 1 gallon left.  If you do, you win, otherwise you lose.  Is this a bet you want to take?

But I left something out - the value of your time.  Let's say you value your marginal time at $30, and it take 15 minutes to fill up the rent car yourself.  By taking the fuel option, you save $7.50 of time.  This means to win the bet, including the value of your time, you have to turn it in with less than 3.5 gallons left, or less than 1/4 full.  The other alternative is to not stop and turn it in at the rent car place and let them fill it up at their $6.00 rate.  But even this ridiculously inflated rate for turning the car in part-full is still a better option than the pre-paid fuel as long as you don't use more than half a tank.   And I bet that the vast, vast majority of people who rent cars, particularly on business trips, don't use a half tank (a half tank at 20mpg is about 150 miles).

One of the best tests of my proposition is to see how many businesses
today act as if this gas-price-overfocus is a real phenomenon:  Car
dealerships give away free gas rather than rebates;  many many
companies are having free gas promotions;  gas stations continue to
sell gas at cost to get you in their store.  Basically, businesses
everywhere are betting that their customers will find $30 of gas more
appealing than any other $30 giveaway. 

None of the above bothers me particularly -- people are different and interesting in how they act.  That's why government planning tends to chafe everyone.  In fact, the only part of this supposed irrationality about gas prices that does bother me is the fact that so many people run to the government for price controls and gouging investigations whenever gas prices go up, and so many Congressmen of both parties see value to pandering to these instincts.  This despite the fact that gas prices are still effectively far lower as a percentage of income than they were 25 years ago.  I wish they would all go back to sipping their $8 Starbucks coffees and just deal with it.

Update:  Was on Snopes.com checking out an email that seemed like an urban legend (it was) and saw a sidebar listing gas wars as the #1 urban legend email of the moment.  ExxonMobil seems to be the bad-guy target-of-choice, I guess just because they are the largest.  The "idea" in the email is that if everyone would boycott ExxonMobil and shop at other gas stations, the price of gas would fall.  LOL.  As Snopes points out:

A boycott of a couple of brands of gasoline won't result in lower
overall prices. Prices at all the non-boycotted outlets would rise due
to the temporarily limited supply and increased demand, making the
original prices look cheap by comparison. The shunned outlets could
then make a killing by offering gasoline at its "normal" (i.e.,
pre-boycott) price or by selling off their output to the non-boycotted
companies, who will need the extra supply to meet demand. The only
person who really gets hurt in this proposed scheme is the service
station operator, who has almost no control over the price of gasoline.

Hawaii has given up on its gasoline price control experiment, even as Congress ponders similar actions at the federal level.  I criticized the Hawaiian program here.

Warning:  This post wanders all over the place, from baseball to gasoline prices to star naming to Internet search engines and back to baseball.

Today I was listening to sports-talk radio for a while, and the topic of conversation was "Should major league baseball nullify (or asterisk) Barry Bond's home run records because he is strongly suspected to have taken steroids."  Now personally, I don't believe anyone has broken Roger Marris's single season home run record who was not taking steroids.  How much that bothers me depends on what day of the week you ask me, but my answer to the record book question never varies:  no, the MLB doesn't have to do a thing.  Here's why, though get ready for a digression.

Perhaps the toughest libertarian-capitalist concept for most people to grasp, even tougher than the idea that wealth is not zero-sum, is that of emergent or bottom-up order.  Capitalism is all about order emerging bottom-up:  Market prices emerge without any one person setting them from above;  supply matches demand without any central body coordinating production.  For many people, this process is some sort of black magic not to be trusted -- just observe Congress and their silly proposals on gasoline prices, reminding us of savages who don't understand how nature works performing elaborate rituals to make the crops grow.

In fact, this whole issue of emergent order vs. grand design is actually a point of incredible inconsistency in American politics.  Observe certain liberals, strong secularists who reject the concepts of God and intelligent design in favor of evolution and bottom-up emergent order in the natural world, but then in turn reject emergent order in human relations and economics in favor of top-down not-so-intelligent design as run by the federal government.  You have only to remember back to Katrina to see the public demand for, followed by the spectacular failure of, top down relief approaches.

The other day I had an argument with a friend about one of those commercial star registries -- you have probably heard the commercial-- pay $X and have a star named after someone you love.  My friend was appalled.  He said - "do you know that they have no authority to name those stars.  Don't people know its not official.  They just put your name in a book somewhere - but its not the official book in Switzerland (or wherever the hell he said it was)."  My reaction was -- so what?  Who had the right to call the other one "official"?  The standard star naming by scientists is accepted because it is useful.  But that doesn't mean I can't come up with my own naming system.  Let's see, I think I am going to rename the Orion constellation as "Warren".  Yes that's much better.  Now, its unlikely anyone else will find a useful reason to adopt this same convention.... The fact is that the star names we use represent a consensus that has emerged over time.  In many cases, constellations and stars had competing names (e.g. Big Bear vs. Big Dipper) that still have not been fully reconciled. 

Or here is an example that might work better for modern Internet users.  The Internet does have an official central body that sets addressing conventions.  They set up the rules by which I can lease the rights to www.coyoteblog.com and the 12-digit IP address that is attached to it.  This is the "official" way to address the web.

But early on, as web sites proliferated, entrepreneurs attempted to impose their own order on the Internet, sort-of the equivalent of suggesting an entirely new set of names for stars.  Yahoo and AOL both developed huge hierarchical directories, effectively imposing a nested-tree addressing system over the Internet's flat addresses.  And for a while, these approaches prospered, as users found these to be a more useful way to organize the Internet.  Then, along came search engines, like Altavista and then Google, and yet a new organizational paradigm was proposed, in effect a third different set of names for the Internet constellations.  Again, users found this keyword and link-popularity approach superior to hierarchical trees, and search engines have prospered while the old directories have languished. 

The point is, no one gave Google a license or top-down authority to reorganize the Internet.  They just did it, like thousands of others tried at the time.  Of these thousands of different approaches, no single smart man picked Google as the approach that everyone should use.  Rather, individuals tried all these different approaches, and over time a consensus emerged that Google was the most useful.

Which -- and I know you thought I forgot -- brings us back to Barry Bond's records.  Individual baseball records don't actually have any meaning to the game of baseball itself -- baseball is played for team wins and losses and ultimately for team championships.  So while individual hits and home runs may have mattered in getting to a champion, the fact that Barry Bonds hit 73 home runs in a year has no real meaning within the context of declaring a team as champion.  It has meaning only in the way that fans react to it. 

One proof of this is the fact that people focus so much on the single-season home run record.  Is this record more inherently valuable than say, the single season triple record?  Triples are actually harder to hit, so you might argue that the triple record is more interesting.  No one from official MLB offices ever declared the single season home run record to be among the most important.  But over time, a fan consensus has emerged that people are far more intrigued by the home run record, so most everyone can name Barry Bonds at 73 home runs but only a geek would know Chief Wilson at 36 triples.

I contend that Barry Bond's 73 home run record  (and his lifetime home run record, if he ever gets that) will take care of themselves without any action from the league office.  Over time, fans will decide for themselves if Bond's 73 is better than Marris's 61.  Today, for example, most discussion of pitching records excludes the period before 1915 or so, which people refer to as the "dead ball" era.  Someday, fan consensus will emerge that they are OK with steroid-driven records (as they have become comfortable with Gaylord Perry's records despite his use of the illegal spitball) or else they are not OK and batting stats from the past decade will be excluded as the "juiced player era".

As a follow-on to yesterday's guess-who quote, guess who recently said this:

So I have been forced to conclude that in all of those great free
market texts by Ludwig von Mises, Friedrich Hayek and all the others
that there is a footnote that says, by the way, none of this applies to
agriculture. Now, it may be written in high German, and that may be why
I have not been able to discern it, but there is no greater contrast in
America today than between the free enterprise rhetoric of so many
conservatives and the statist, subsidized, inflationary, protectionist,
anti-consumer agricultural policies, and this is one of them.

Club for Growth has the answer.

By the way, I agree with this statement completely. 

I don't think you will be able to guess who just wrote this in the LA Times:

The current frenzy over Wal-Mart is instructive. Its size is
unprecedented. Yet for all its billions in profit, it still amounts to
less than four cents on the dollar. Raise the cost of employing people,
and the company will eliminate jobs. Its business model only works on
low prices, which require low labor costs. Whether that is fair or not
is a debate for another time. It is instructive, however, that
consumers continue to enjoy these low prices and that thousands of
applicants continue to apply for those jobs.

Reason's Hit and Run has the answer.  I expressed similar thoughts here.

Thanks to Reason's Hit and Run.

Want to get worked up about price collusion in the oil industry?  Don't waste your time.  No study has ever found collusion effects that raised US gasoline prices more than a few percent, and only for a very short period of time.  The reason is that in a free market, there is too much incentive for new entrants undercutting a price collusion attempt.  Railroads and airlines have probably the most severe economic incentives to collude, and they have never pulled it off for any period of time EXCEPT when the government stepped in to enforce the arrangement (e.g, airline controls pre-deregulation).

If you want to see a real cartel at work raising prices at the expense of consumers, check out this from the Mises Blog:

The raisin agricultural marketing order (AMO), with roots in the
Depression-era Agricultural Marketing Agreement Act, is rationalized as
a way to "stabilize" prices. However, it allows the Raisin
Administration Committee (RAC), controlled by producers, to determine
how much of each crop can be sold, with the rest forced into storage.
That power to jointly restrict output to raise price makes it a cartel.
A cartel with so many members would not usually succeed, and the mere
attempt would be prosecuted if antitrust laws were applied, but AMOs
are enforced by the government, through the USDA...

The RAC "stabilization" is accomplished by restricting sales, often
substantially. "Free tonnage" has been as low as 53% of the crop in
2001, and less than 80% in most years. That helps producers by harming
consumers, turning price "stabilization" into price enhancement....

The raisin cartel's effects on American consumers can also be seen
in the gap between the "free tonnage" prices and "reserve pool" prices
for raisins destined for low value markets. In 2001, those prices were
$877.50 per ton versus $250 per ton; in 1998, it was $1250 versus $357;
in 1984 and 1994, the differential approached 10 to 1.

The feeding frenzy that the media has been salivating over for days can begin, now that Exxon-Mobil (XOM) as announced quarterly profits.  They reported net income of $8.4 billion on $88.98 billion in sales, for a net income margin of 9.4%.  Previously I observed that 9.4% for a peak profit in a cyclical industry is pretty average, and that over the last decade oil company profits have been below average for the whole of US industry.

In fact, most investors found these profits to be disappointing.  You know you have a fun CEO job when half the country is pounding on you for profits being too high and the other half are pounding on you for profits being too low.  The fact is that XOM and other large US oil companies don't get the benefit of rising oil prices that they did, say, 40 years ago.  US oil companies no longer own most of their overseas reserves since many of their foreign operations were nationalized by countries in the 1960s  (with the US government refusing to lift a finger to protect these US assets, one of the early instances of the no-blood-for-Exxon argument).  Today, XOM must pay near market rate for much of this crude, either in arms-length purchases or through royalty agreements stacked in the favor of local governments.

So what can you folks who are screaming about high gas prices and obscene oil company profits do?  Well, you could tax all these "windfall" profits away, like Ford and Carter did in the late 1970s.  Of course, you would still be paying $3 for gas, but the profits would go to the US Congress to spend, who I am sure will do an excellent job.  Probably could pay for another bridge in Alaska.  Or, you could somehow ban oil companies from making a profit, and drop gas prices by that 9.4%, or about 28 cents.  This would get you $2.72 gas instead of $3.00 gas.  Feel better?  Of course, in either scenario, oil companies would stop making any investments in refining or oil exploration.  Supplies would quickly begin to fall (I won't go into it now, but take my word for it that refineries and oil wells require constant reinvestment just to keep running at current capacity) and I would bet it would take less than a year for that 28 cents to be right back in gas prices due to shrinking supply.

OK, what else could we do?  Well, we could cap gas prices.  Which is a fabulous idea, as long as no one who drives a car has anything better to do than sit in lines all day.  Or, we could regulate oil like we do telephones and electric utilities.  Highly regulated electric utilities make a net income margin of 7.1%.  If we regulated oil companies down to 7.1%, then this would reduce gas prices from $3.00 to $2.93.  So a huge and inflexible and costly national regulatory structure would save about 7 cents a gallon.  Oh, and since for most of 10 years oil company profits have been less than 7.1%, then, a utility type regulatory environment would likely raise gas prices and profits in most years. And of course you would get all the business flexibility, creativity, and customer service currently demonstrated by your local electric and phone company.

So what government action should a irate gasoline customer demand?  Well, I know this answer goes against years of education that the role of government is to step in and take over when any little aspect of life is not quite what citizens want it to be, but the correct answer is "none".  Its like the line from Wargames:  "A strange game. The only winning move is not to play."

More on why gas prices are still well below their historic peaks here.

The following is from our Chinese sister publication called Panda Blog:

Our Chinese government continues to pursue a policy of export promotion, patting itself on the back for its trade surplus in manufactured goods with the United States.  The Chinese government does so through a number of avenues, including:

• Limiting yuan convertibility, and keeping the yuan's value artificially low
• Imposing strict capital controls that limit dollar reinvestment to low-yield securities like US government T-bills
• Selling exports below cost and well below domestic prices (what the Americans call "dumping") and subsidizing products for export

It is important to note that each and every one of these government interventions subsidizes US citizens and consumers at the expense of Chinese citizens and consumers.  A low yuan makes Chinese products cheap for Americans but makes imports relatively dear for Chinese.  So-called "dumping" represents an even clearer direct subsidy of American consumers over their Chinese counterparts.  And limiting foreign exchange re-investments to low-yield government bonds has acted as a direct subsidy of American taxpayers and the American government, saddling China with extraordinarily low yields on our nearly $1 trillion in foreign exchange.   Every single step China takes to promote exports is in effect a subsidy of American consumers by Chinese citizens.

This policy of raping the domestic market in pursuit of exports and trade surpluses was one that Japan followed in the seventies and eighties.  It sacrificed its own consumers, protecting local producers in the domestic market while subsidizing exports.  Japanese consumers had to live with some of the highest prices in the world, so that Americans could get some of the lowest prices on those same goods.  Japanese customers endured limited product choices and a horrendously outdated retail sector that were all protected by government regulation, all in the name of creating trade surpluses.  And surpluses they did create.  Japan achieved massive trade surpluses with the US, and built the largest accumulation of foreign exchange (mostly dollars) in the world.  And what did this get them?  Fifteen years of recession, from which the country is only now emerging, while the US economy happily continued to grow and create wealth in astonishing proportions, seemingly unaware that is was supposed to have been "defeated" by Japan.

We at Panda Blog believe it is insane for our Chinese government to continue to chase the chimera of ever-growing foreign exchange and trade surpluses.  These achieved nothing lasting for Japan and they will achieve nothing for China.  In fact, the only thing that amazes us more than China's subsidize-Americans strategy is that the Americans seem to complain about it so much.  They complain about their trade deficits, which are nothing more than a reflection of their incredible wealth.  They complain about the yuan exchange rate, which is set today to give discounts to Americans and price premiums to Chinese.  They complain about China buying their government bonds, which does nothing more than reduce the costs of their Congress's insane deficit spending.  They even complain about dumping, which is nothing more than a direct subsidy by China of lower prices for American consumers.

And, incredibly, the Americans complain that it is they that run a security risk with their current trade deficit with China!  This claim is so crazy, we at Panda Blog have come to the conclusion that it must be the result of a misdirection campaign by CIA-controlled American media.  After all, the fact that China exports more to the US than the US does to China means that by definition, more of China's economic production is dependent on the well-being of the American economy than vice-versa.  And, with nearly a trillion dollars in foreign exchange invested heavily in US government bonds, it is China that has the most riding on the continued stability of the American government, rather than the reverse.  American commentators invent scenarios where the Chinese could hurt the American economy, which we could, but only at the cost of hurting ourselves worse.  Mutual Assured Destruction is alive and well, but today it is not just a feature of nuclear strategy but a fact of the global economy.

Panda Blog goes on to ask that their government end these distorting policies, for the sake of China's future.  I for one kindof hope that they keep subsidizing the stuff I buy over at Wal-mart...

The media is just longing to make current gas prices into a crisis.  And you can already see them gearing up to bash oil companies for "record" profits (by the way, when reading the profit announcements, pay attention not to just total dollars but to profit margins, then read this).

Glenn Reynolds links this gas price chart this morning at Random Useless Data, showing that in real terms, gas prices are still below their peaks, and not at "all-time highs."

I took this one step further, based on the assumption that it isn't the price per gallon that matters for gas, but the price to drive a fixed mileage, say 100 miles.  Since average automobile fuel economy has continued to improve, in real terms we are far below the peak cost of gasoline.  Using this and this MPG data (for passenger cars) and the inflation adjusted gas prices here, I got this chart (1979 dollars)

By the way, just so you know my personal incentives, there are very few people out there who run a business whose fortunes are more sensitive to gas prices than my recreation business.  This will not be a very good summer for me, but if we leave the market alone to do its work, things will likely be better in 2007.  Intervention by Congress will pretty much assure that things will get worse.

After spending gobs of electrons on this post about the US trade deficit explaining why it is not a debt, and is not even necessarily bad, I got a depressing number of comments and emails like this one:

The trade deficit is a debt. We cannot get the dollars back we have
spendt unless we export to get them back. It is called an external debt
for a reason. It is called a current account debto for a reason.

Aaaaargh.  It is depressing that we can get such economic ignorance, particularly in a self-righteous way.  The crappy media coverage of these issues has people convinced that it just has to be this big old debt out there someone is going to have to repay someday. 

OK, I will try again.  But in response to this specific post, it is only called "external debt" or "current account debt" rather than "deficit" by really, really sloppy media people who have no idea what they are talking about (unfortunately, there are a lot of these).  And a deficit is not a debt, though it can sometimes create a debt.

I try to be very respectful of my readers.  I never delete a comment, unless it is spam/bot stuff or in a few cases where commenters have asked me to.  So it is only with the deepest respect that I say the following:  Please do not bother to comment on this post if a) you do not understand the difference between the federal government deficit and the trade deficit and/or b) you do not understand the difference between an account deficit and a debt.  Seriously.  Just take my word for it that you need to educate yourself a bit first, and then feel free to leap into the debate.  (Update:  This was a poor tone to adopt, see here).

First, A Thought Experiment

This is not meant to constitute proof, but for those who are concerned that the trade deficit is potentially disastrous for our economy, I can only ask, When?  Because we have been running a substantial trade deficit as a nation for over a quarter of a century, and by all accounts, over that same time period, we have had just about the strongest economy in the world.  In fact, I would propose that the causation is more likely just the reverse.  Because we have had a strong economy, with extraordinary wealth creation, we have taken some of that wealth and spent it on goods from other nations.  And because we have the safest nation in the world in which to invest, demand for our local investments tends to shift exchange rates in a way that increase the trade deficit.

In the late 80's and early 90's, everyone was in a panic about Japan.  We were running a massive trade imbalance with Japan.  They were going to buy all of our real estate.  Their government was tipping the scales in their own favor.  They were purposefully depressing the yen to encourage exports.  Blah, blah, etc, etc.  And you know what happened?  They subsequently went into a decade and a half long recession they are only just now climbing out of, and we had one of the strongest economies in history. 

How do the Dollars Get Back?

With a couple of exceptions that don't really change our conclusions, dollars do follow a closed loop.  In other words, if we send them to China or India, they generally eventually come back.   The question is how.  To understand this, it is first important to understand that the balance of trade deficit only measures some monetary flows.  In particular, it looks at the balance between manufactured goods traveling between two countries.  If the US has a $20 billion trade deficit with China, it means that they shipped $20 billion more of manufactured goods to us than we shipped back to them.  It includes some but not all services.  It does not include goods or securities or investments purchased by foreigners that remain on US soil.

To understand how the dollars come back from China in a closed loop is to, in a sense, ask the question of what monetary flows are not included in the trade deficit.  If we have a trade deficit with China, there are a number of things it can do with its extra dollars:

1. It can do nothing with them - just hold them in a big pile
2. It can lend the money to people buying their products
3. It can buy certain US services
4. It can buy US goods, but not take them out of the US
5. It can buy US public and private securities and real estate

Lets look at each in turn

1.  China can do nothing with them - just hold them in a big pile

Two words:  In-Sane.  By just holding them, they would effectively be sticking them in a mattress and foregoing any interest or investment income.  It's just not going to happen.  And don't say, well they could just put the dollars in a Chinese bank.  Fine, but the only way the Chinese bank is going to pay interest on dollars in the bank is if they turn around and invest the dollars in dollar-denominated investments.  One way or the other, the money, if it does not buy anything else, will get invested, which we will deal with in point 5.

I know there are paranoiacs that worry that the Chinese, despite the financial disincentives, will hold these dollars anyway in a big vault or something out of spite.  Gee, hurt me, hurt me.  Holding our dollars in a big mattress in Peking does nothing to hurt us.  And dumping them all on the market simultaneously may sound scary to conspiracy theorists, but in practice it would hurt them worse than it would hurt us, and the pain would be relatively short-lived  (just ask the Hunt brothers about this strategy).

2.  China can lend the money to people buying their products

I suppose that for those who don't get the federal deficit and the trade deficit mixed up, this is what they assume is happening, that Americans are borrowing from the Chinese to finance manufactured goods purchases.  The only problem is that it is not happening, at least to a greater extent than any normal purchase-financing arrangements.  Take corporations such as Wal-mart, a huge buyer of Chinese stuff.  Is Wal-Mart going into debt to buy Chinese stuff?  No, and certainly not to the Chinese. 

Well, are individual Americans going into debt to buy Chinese.  Maybe, but the key point is that they are not going into debt because what they are buying is Chinese.  They are going into debt because Americans, for whatever reason good or bad, are saving less and choosing to buy more on credit.  This would be happening if what they were buying was Chinese or American made.  In other words, American consumers may have debt, but that debt would exist even if we had no trade deficit with China.  It is a personal choice people are making that has no relation to the source of goods.

3.  China can buy certain US services

Note that many US services are not included in the trade deficit calculations.  If Chinese companies engage McKinsey & Co. consultants in the US to figure out how to sell more stuff to Wal-mart, those payments for services are probably bringing dollars back to the US from China, but aren't included in the trade calculations.  This really is just a subset of point four:

4.  China can buy US goods, but not take them out of the US

Many, many of the dollars the Chinese end up with come back to us in this way.  As did many of the dollars the Japanese had in the eighties.  If a Chinese company uses dollars not to buy US goods and take them back to China, but buy them and consume them in the US, then this does not show up in the trade numbers.  Chinese and Japanese companies bring their US dollars to the US to build factories and infrastructure.  This is sometimes why it is said that the trade deficit is not a measure of differences in cash flows, but of a difference in where goods are consumed. 

If you flip the equation around, the Chinese have a wicked balance of stuff deficit.  They are sending a lot more manufactured goods to the US than they get back.  I could argue that Chinese workers are getting hosed, since they only get to enjoy a fraction of the goods they produce for themselves, since a large portion of the product of their labor is sent overseas for others to enjoy.  Hmmm, doesn't sound so bad that way.

5.  China can buy US public and private securities and real estate

Of course, what happens with a lot of the US dollars the Chinese find themselves with is that these dollars get invested in US investment vehicles, from real estate to government bonds to private equities.  There are several points that need to be made here:

a.  Just Because Chinese invest in US Government Bonds does not make them or the balance of trade responsible for this debt

As I intimated above, a lot of people get the US federal budget deficit confused with the trade deficit.  Making this confusion worse, the Chinese use a lot of the dollars they earn in trade to buy US Government Bonds that help finance the federal budget deficit.  Now, by buying a lot of government bonds, one might argue that the Chinese lower interest rates and make government borrowing easier, thus making the federal budget deficit worse since there is a ready source of debt financing. 

While there may be a link here, it is tenuous at best.  If the government was a private company, then its borrowing level might rationally fluctuate up and down based on interest rates and capital availability.  But the US Government is not this rational.  It runs a budget deficit primarily because legislators and bureaucrats alike have the incentive to spend other people's money to protect their jobs and power base.  This happens equally at 3% interest rates and 9% interest rates.  It happens equally if guys from Peking or Omaha are buying government bonds.  In fact, one could argue that Chinese reinvestment of their trade dollars in US securities actually marginally reduces the government debt by reducing interest costs.

This same argument holds equally true for Chinese investments in private debt.  Chinese dollars may increase borrowing slightly, but only because the influx of their cash reduces borrowing costs.

b.  Chinese Ownership of US Assets is GOOD

In the Japanese scare of the 1980's, everyone was freaked out that the Japanese were buying up American assets and real estate.  During that time, while I almost never play the race card, it was almost impossible not to come to the conclusion that some racism had to be involved in this fear.  America had welcomed, in fact, had prospered, via foreign investment for years.  For a century, the US has been the safest place for foreigners to put their money,something we should be proud of  -- A sign of strength, not weakness.

But suddenly, everything was different because the new buyers were Japanese.  Note the following:

Despite the notoriety of
Japanese investors, the British have the largest U.S. direct investment
holding"”with the Dutch not far behind"”as has been the case since
colonial times. In 1990 the United Kingdom held about 27 percent of
foreign direct investment in the United States, significantly greater
than Japan's 21 percent. The European Economic Community (EC)
collectively holds about 57 percent. Moreover, according to research by
Eric Rosengren, between 1978 and 1987, Japanese investors acquired only
94 U.S. companies, putting them fifth behind the British (640),
Canadians (435), Germans (150), and French (113).

But no one was complaining about the British, Canadians, Germans, or French.  Only the Japanese.  I have to come to the conclusion that there was some racism involved, with the same primal fears at work that caused us to ship US citizens of Japanese decent off to concentration camps in WWII but we did not do the same of citizens of German or Italian decent.  And in this case, it could not have been security concerns.  Since 1945, Japan is one of the most pacifistic nations in the world- we probably face a bigger security threat from Belgium than we do from Japan.

I get the same feeling today with the China panic that I did twenty years ago with Japan.  Its a race and a culture we don't understand well, so we get xenophobic.  People lament that China is a real security threat, and that certainly is true to an extent.  But ask yourself this - Is China more or less of a threat to hurt us if their economy, their financial prosperity, and most of their assets are tied to the US?  Is China more or less stable now that their people are not starving and they are rapidly developing the largest middle class in the world?

Conclusion

If you are still having trouble understanding, the problem may be that you insist on thinking of economics as zero-sum.  This is the fallacy of 18th century mercantilists, who saw the economy as a big fixed tank, and if more flowed overseas than flowed back, the tank level would fall until the country was bankrupt.  There are at least two key fallacies here:

1. Wealth is not zero-sum.  It is created.  It is expanded.  Some can even be spent frivolously on big ass plasma TV's from China and we are still wealthier than we were decades ago.
2. Trading has value in both directions.  As mentioned above, looking at only the currency side of trading misses a lot.  By definition, in a free trade, both sides believe the trade increases the value to themselves, or they would not have made the trade.  So trading per se, no matter what the currency flows, can only lead to wealth creation, not its destruction.

Postscript - New Mercantilism

Lamenting the trade deficit is always a precursor to interfering with free trade.  It is important to note that free trade has always led to prosperity, while protectionism has always led to stagnation. 

Several protectionists today are trying to make the argument that OK, that might have been true in the past, but today is different, and today, free trade is uniquely bad.  Economist Paul Craig Roberts made this argument, that, as Don Boudreaux summarizes it:

the American standard of living is threatened by the world's growing
prosperity, improved education, better governance, and greater fluidity
of capital and resources to move in search of higher returns

Boudreaux, a writer at the fabulous Cafe Hayek, does a good fisking of this argument, but I think I can demolish it even faster.  By this logic, California would be better off if the eastern part of the US was suddenly impoverished and made educationally backwards.  This is absurd.   Sure, the industrial east suffered some temporary dislocations as the south modernized and competed for factories.  But this was only temporarily.  As the south got richer, it wasn't a contest between regions for a fixed number of factories, the number of factories and jobs grew, so that all parts of the country had more. 

Is there anyone who thinks that half of the US would be better off
economically if the other half were turned into a third world nation?  Is there any company executive that thinks they could survive if half their market went away?  So why is half the world better off if the other half is impoverished?  If you are saying, gee, the only reason I can come up with is that zero-sum fallacy Coyote keeps talking about, go to the head of the class.

Update:  In comments and emails, my readership educates me that citizens of German and Italian decent were interned in WWII as well.  While I knew that Germans and Italian POW's were interned in large numbers in the US in WWII, I was not aware of internship of US citizens with German or Italian blood, though the programs for these nationals do seem more limited than the west coast movement of Americans of Japanese decent.   My first and second generation German immigrant family members never reported being harassed in any way, either publicly or privately, during the war and most all served either in the US military or war production industries.  I will still stick by my core point that investment in the US by Asian nationals is not treated the same as investment by European or Canadian nationals.

I have also gotten a number of emails and comments on the differences between various trade and current account deficit indicators.  I tried to avoid getting into all that, assuming, I think rightly, that it would just clutter up the argument and would not substantially affect the conclusion.  Just for the record, though, there are many different metrics, that range from narrow measures of manufactured goods flows to much broader measures of capital and services flow.  You can assume that 90% of the time, the media article you are reading about the deficit probably does not correctly describe the metric it is using.

In perhaps the best example I have seen since Paul Ehrlich of zero-sum thinking, junkscience.com links to this article at the BBC:

A study by the New Economics Foundation (Nef) and the
Open University says 16 April is the day when the nation goes into
"ecological debt" this year.

It warns if annual global consumption levels matched the UK's, it would take 3.1 Earths to meet the demand.

How many times does this sort of stuff have to be wrong before it stops getting printed by "science writers" in the media.  Malthus made the same argument over a century ago, and Ehrlich has been making one bad prediction after another along these lines since the late 60's  The report relies on this concept:

The findings are based on the concept of "ecological
footprints", a system of measuring how much land and water a human
population needs to produce the resources it consumes and absorb the
resulting waste.

Of course, no one mentions that this "ecological footprint" number has changed dramatically with technology, not only in the last 200 years but even in the last 30.  For example, total US Farm acreage has fallen for the last fifty years, while agricultural production has grown between two and five times in the same period.   Its a stupid, meaningless analysis that says that if nothing else changed, and suddenly consumption went up, there would be a crisis.  It relies on the lack of imagination of both the authors (and to an extent, the audience), arguing that since they can't think of any way to grow production any further, it must not be possible.  I can just picture these guys as prehistoric man sitting in a cave making the same pronouncements of disaster for the species, all while their peers are busy outside playing with bone tools under the big black monolith.

More on the zero-sum fallacy here.

A pair of news stories has me spooked tonight.  This first is via Instapundit, and is a story of human pettiness that would be funny if the stakes were not so high:

President Chirac and three of his ministers walked out of the room
when Ernest-Antoine Seillière, the leader of the European business
lobby UNICE, punctured Gallic pride by insisting on speaking the
language of Shakespeare rather than that of Molière.

When M Seillière, who is an English-educated steel baron,
started a presentation to all 25 EU leaders, President Chirac
interrupted to ask why he was speaking in English. M Seillière
explained: "I'm going to speak in English because that is the language
of business."

Without saying another word, President Chirac, who lived in
the US as a student and speaks fluent English, walked out, followed by
his Foreign, Finance and Europe ministers, leaving the 24 other
European leaders stunned. They returned only after M Seilière had
finished speaking.

That's the silly part, but the underlying issue that was being discussed is not so silly:

In the absence of his President, M Seillière gave warning about the
dangers of the "economic nationalism" being pursued by the French
Government. The summit, aimed at restoring confidence in the future of
the EU, has been overshadowed by a row over the tide of protectionism
sweeping the continent, with Tony Blair and Angela Merkel, the German
Chancellor, cautioning about the danger of raising barriers to foreign
competition.

What has me really worried is that the US, the only vaguely consistent defender of free trade in the world for the last 60 years, is having the same discussion, initiated not so much by the economic problems in Europe but by security issues.  As I warned earlier, Congress seems ready to use the events of the Dubai ports mess and the fear of 9/11 to clamp down on foreign investment (sorry, $ required I think):

Building on their win in the Dubai ports deal, U.S.
lawmakers are moving to gain leverage over a swath of foreign
investments in the U.S., an effort that business leaders and President
Bush's aides warn could harm the U.S. economy.

In the first serious legislative move, Senate Banking
Chairman Richard Shelby (R., Ala.) released the summary of a bill
Friday that would greatly expand the array of foreign acquisitions
subject to automatic scrutiny and would require the administration to
notify lawmakers as soon as it begins to review any foreign
transaction. The bill also would require the administration to rank all
countries according to their relations with the U.S. and their support
for weapons-control deals. Approvals would then depend in part on the
ranking of a company's home country.

The administration would have to report to Congress on
why it approved or rejected any transaction, but the bill wouldn't give
lawmakers the power to veto a deal, as many critics feared.

Business groups and Bush administration officials
expressed immediate alarm over several provisions in the bill, which
Shelby aides claim has the support of other members of the Banking
Committee. In a letter to Sen. Shelby this week, seven groups
representing the nation's top banks and finance companies warned that
legislative proposals making the rounds of Congress "would threaten
job-creation prospects for the U.S. economy" and "reduce U.S. economic
growth."

Building on their win in the Dubai ports deal, U.S.
lawmakers are moving to gain leverage over a swath of foreign
investments in the U.S., an effort that business leaders and President
Bush's aides warn could harm the U.S. economy.

In the first serious legislative move, Senate Banking
Chairman Richard Shelby (R., Ala.) released the summary of a bill
Friday that would greatly expand the array of foreign acquisitions
subject to automatic scrutiny and would require the administration to
notify lawmakers as soon as it begins to review any foreign
transaction. The bill also would require the administration to rank all
countries according to their relations with the U.S. and their support
for weapons-control deals. Approvals would then depend in part on the
ranking of a company's home country....

The administration would have to report to Congress on
why it approved or rejected any transaction, but the bill wouldn't give
lawmakers the power to veto a deal, as many critics feared.

Business groups and Bush administration officials
expressed immediate alarm over several provisions in the bill, which
Shelby aides claim has the support of other members of the Banking
Committee. In a letter to Sen. Shelby this week, seven groups
representing the nation's top banks and finance companies warned that
legislative proposals making the rounds of Congress "would threaten
job-creation prospects for the U.S. economy" and "reduce U.S. economic
growth."

This sucks, particularly in the light of a president who has at best been only a luke-warm defender of free trade and who seems to have entirely misplaced his veto pen.  It is an interesting statement on how far this president has wandered from his party's traditional roots that I would greatly prefer to have his predecessor Bill Clinton in office for this fight.  Clinton was certainly a mixed blessing for us anarcho-capitalists, but he was always a strong and articulate defender of free trade, even to the extent of opposing the strong protectionist wing of his party.

In addition to the security issues involved, I have also tackled the overblown fears about trade deficits here, among other places.  For those of you in Arizona concerned about free trade, I know that Congressman Jeff Flake, one of the few remaining folks in Congress who understands free markets and small governments, shares some of these same concerns about rising protectionism.  I hope those of you in his district will continue to send him to Washington to serve us, and I would like to see where our other AZ Congresspersons stand on free trade.  I don't want to pre-judge, but this is one of those issues where I have no trust that McCain (for example) will land on the correct side of the issue.  I fear that conservatives are going to feel the need to flog the security horse right through the November elections, no matter what other principles get trampled in the process.

As a final note, I could add the current backlash against immigrants as
the third leg of this story on rising economic nationalism.  One of the
things that has surprised me the most in getting comments to this blog
is how many people who accept global free trade as right and beneficial
in turn support strong restrictions on immigration (Cafe Hayek comments on economist Robert Samuelson as one such person).
I see free trade and free immigration as having exactly the same
philosophic roots, based in the fact that our rights to trade,
associate, etc. stem from our humanity, not our citizenship.  I won't repeat my argument but you can read it here;
if you are pro-free-trade but anti-immigration, I ask that you give me
five minutes to make the case that no one else seems to want to make
today.  And even if you don't accept the philosophic similarities,
economicly open immigration and free trade are nearly identical issues,
each involving the free flow of labor, capital, and goods across
borders.  If you still can't see the similarity, here is a quick
example:  If I decide that my best sourcing decision is to subcontract
my tech support to Claude in France, I can do this equally well by
either straight outsourcing to Claude where he lives today (global
trade) or by encouraging Claude to move to the US to do the work for me
here (immigration).

As a followup to this post on security as a Trojan horse for protectionism, I wanted to link this article in the WSJ($) called The Perils of Protectionism:

Fifty-six percent of the economists polled in the latest WSJ.com
forecasting survey -- conducted in the aftermath of a flap over foreign
management of U.S. ports -- say protectionism will lead to some
slowdown in U.S. growth over the next several years, and 8% predict
that the slowdown will be significant....

The ports controversy came at a time of growing concern about
protectionism around the world. It followed the blocked bid by China's
Cnooc Ltd. to acquire Unocal Corp. last year and emerged as European
governments angle to prevent high-profile utility deals within their
borders. The fear is that if governments take steps to shield their
countries' businesses, international trade and investment flows could
be reduced. Corporations will find it more difficult to reach new
markets.

Protectionism is unambiguously bad," said David Berson, chief economist
at Fannie Mae. Indeed, the free flow of capital across national borders
is conventionally looked upon by economists as a long-term good, and
69% of those surveyed say foreign ownership of U.S. assets is positive
for the economy in the long run.

One example of why the protectionist arguments are short-sighted is demonstrated by this passage from the same WSJ article:

While the ports row has receded, the U.S.'s large bilateral trade
deficit with China, which was $17.91 billion in January, remains a
flashpoint. Some lawmakers complain the imbalance has been inflamed by
an artifically low exchange rate for China's yuan against the dollar.
Though Beijing modestly revalued the yuan last summer, allowing it to
float in a narrow range against a basket of foreign currencies, critics
have continued to lash China's currency policy and call for further
revaluation.

So the Chinese government is artificially subsidizing the US economy through reduced prices of Chinese goods via a low valuation for the yuan vs. the dollar.  And that's a bad thing?  If the Chinese government is holding down the exchange rate, then they are in fact taking their money and the money of their citizens and pumping it into lower prices for US consumers and lower interest rates on US government debt.  Ooooh, color me really concerned.

As far as the "well, we're going into debt to pay for our consumerism" argument, I and others have tried and tried to educate the world that the trade deficit is not a debt, and running a trade deficit is not bad.

I was stuck in the airport at Salt Lake City on Sunday for a bit due to a large snowstorm** and I was trapped watching the CNN airport channel (which certain airports make unavoidable -- you can't get away from the TV's in a way reminiscent of a variety of distopian novels).  Anyway, I heard some discussion about differences between poor and rich nations, and all the usual easy-to-prove-false memes came out to explain the differences.  Natural Resources:  So why do resource-rich Russia and sub-Saharan Africa do so poorly?   Colonialism:  How do you explain Hong Kong, Australia, and Canada?  Exploiting labor:  So why aren't the most populous countries the richest?  Luck:  How do countries like Haiti have so consistently bad luck for over 200 years?

So here is Coyote's First Theorem of Wealth Creation, first expounded in this post on the zero-sum economics fallacy:

Groups of people create wealth faster in direct proportion to the degree that:

1. Their philosophical and intellectual
   culture values ordinary men (not just "the elite", however defined) questioning established beliefs and social patterns.  This is as opposed to having a rigid orthodoxy which treats independent thinking as heresy.
2. Individuals, again not just the elite, have the ability through scholarship or entrepreneurship to pursue the implications of their ideas and retain the monetary and other rewards for themselves.  This is as opposed to being locked into a rigid social and economic hierarchy that would prevent an individual from acting on a good idea.   

China, for example, just by cracking open the spigot on #2, however inadequately, has gone from a country with mass starvation in three or four decades to one where the worry-warts of the world are scared of juvenile obesity.  To a large extent, this theorem is really just a poor restatement of Julian Simon's work.  Simon's key point was that the only relevant resource was the human mind, from which all wealth flows.  All I have done is break this into two parts, saying that to create wealth a society has to value the individual's use of his mind and has to allow that individual free reign to pursue the products of his thinking.

One of the applications where I think this is useful is to explain the great millennial hockey-stick curve.  No, not the temperature hockey stick, which purports to show acceleration of global warming, but the wealth curve.  The world's growth of per capita wealth was virtually flat for a thousand plus years, and then took off in the 19th and 20th centuries.  I previously explained this hockey stick using my wealth creation theorem:

Since 1700, the GDP per capita in places like the US has
risen, in real
terms, over 40 fold.  This is a real increase in total wealth, created
by the human mind.  And it was unleashed because the world began to
change in some fundamental ways around 1700 that allowed the human mind
to truly flourish.  Among these changes, I will focus on two:

1. There was a philosophical and intellectual
   change where questioning established beliefs and social patterns went
   from being heresy and unthinkable to being acceptable, and even in
   vogue.  In other words, men, at first just the elite but soon everyone,
   were urged to use their mind rather than just relying on established
   beliefs
2. There were social and political changes that greatly increased
   the number of people capable of entrepreneurship.  Before this time,
   the vast vast majority of people were locked into social positions that
   allowed them no flexibility to act on a good idea, even if they had
   one.  By starting to create a large and free middle class, first in the
   Netherlands and England and then in the US, more people had the ability
   to use their mind to create new wealth.  Whereas before, perhaps 1% or
   less of any population really had the freedom to truly act on their
   ideas, after 1700 many more people began to have this freedom. 

So today's wealth, and everything that goes with it (from shorter
work hours to longer life spans) is the result of more people using
their minds more freely.

The problem (and the ultimate potential) comes from the fact that in
many, many nations of the world, these two changes have not yet been
allowed to occur.  Look around the world - for any country, ask
yourself if the average
person in that country has the open intellectual climate that
encourages people to think for themselves, and the open political and
economic climate that allows people to act on the insights their minds
provide and to keep the fruits of their effort.  Where you can answer
yes to both, you will find wealth and growth.  Where you answer no to
both, you will find poverty and misery.

Update:  This article from Frank Moss, linked at Instapundit, takes these same concepts forward into the future.

What role will startups play in the future?

I see tremendous economic growth from startups from 10 years ago.
Entrepreneurs will go from the 1,000 startup ventures funded in the
last 10 to 20 years to ideas coming from people working together in
network-based environments, using computers to dream up innovations in
a way they never did before. It could be people in developing countries
with low-cost computers.

You talk about education and the bottom-up effect that millions
more people will play in societal advances. How do you see this
unfolding?

We will undergo another revolution when we give 100 million kids a
smart cell phone or a low-cost laptop, and bootstrap the way they learn
outside of school. We think of games as a way to kill time, but in the
future I think it will be a major vehicle for learning.

Creative expression (is another area). No longer will just a few
write or create music. We will see 100 million people creating the
content and art shared among them. Easy-to-use programs allow kids to
compose everything form ringtones to full-fledged operas. It will
change the meaning of creative art in our society.

We are already seeing early signs of it in blogs. The source of
creative content is coming from the world. That revolution will go well
outside of the written word to all forms of visual and performing arts.

** Kudos by the way to the SLC airport - when I drove in, I couldn't see 10 feet in front of me on the road due to the snow, and I was sure that I would be trapped for the day.  Living in Phoenix, where air traffic is backed up if someone sneezes on the runway, I didn't think any planes would be landing and taking off for hours.  In fact, operations continued right through the blizzard, and my flight was delayed less than an hour, including de-icing time.  Amazing.  Now if only the SLC airport could increase their security capacity - its only been, what, 4.5 years since 9/11 and most airports seem to have licked this problem.

Check out this very nice NY Times article (I think it is outside the firewall) on Harvard economist Edward Glaeser and his takes on urban economics and housing markets.  One study of his that resonates with me is his research about just how much modern regulation and zoning is contributing to the high cost of housing:

Glaeser and several colleagues considered two explanations. First, the
possibility that builders in the metro area were running out of land and that
home prices reflected that scarcity. The second hypothesis was that building
permits were scarce, not land. Had the 187 townships in the metro area created a
web of regulations that hindered building to such a degree that demand far
outstripped supply, driving prices up?

Almost as a rule, Glaeser is skeptical of the lack-of-land argument. He has
previously noted (with a collaborator, Matthew Kahn) that 95 percent of the
United States remains undeveloped and that if every American were given a house
on a quarter acre, so that every family of four had a full acre, that
distribution would not use up half the land in Texas. Most of Boston's metro
area, he concluded, wasn't particularly dense, and even in places where it was,
like the centers of Boston and Cambridge, there was ample opportunity to
construct higher buildings with more housing units.

So, after sorting through a mountain of data, Glaeser decided that the
housing crisis was man-made. The region's zoning regulations "” which were
enacted by locales in the first half of the 20th century to separate residential
land from commercial and industrial land and which generally promoted the
orderly growth of suburbs "” had become so various and complex in the second half
of the 20th century that they were limiting growth. Land-use rules of the 1920's
were meant to assure homeowners that their neighbors wouldn't raise hogs in
their backyards, throw up a shack on a sliver of land nearby or build a factory
next door, but the zoning rules of the 1970's and 1980's were different in
nature and effect. Regulations in Glaeser's new hometown of Weston, for
instance, made extremely large lot sizes mandatory in some neighborhoods and
placed high environmental hurdles (some reasonable, others not, in Glaeser's
view) in front of developers. Other towns passed ordinances governing sidewalks,
street widths, the shape of lots, septic lines and so on "” all with the result,
in Glaeser's analysis, of curtailing the supply of housing. The same phenomenon,
he says, has inflated prices in metro areas all along the East and West Coasts.

One of his other areas of research was new to me.  Glaeser argues that the long-lived nature of housing is part of what keeps cities like Detroit and St. Louis around long after the economic and demographic logic would have had them die. 

Glaeser and Gyourko determined that the durable nature of housing itself
explains this phenomenon. People can flee, but houses can take a century or more
to finally fall to pieces. "These places still exist," Glaeser says of Detroit
and St. Louis, "because the housing is permanent. And if you want to understand
why they're poor, it's actually also in part because the housing is permanent."
For Glaeser, this is the story not only of these two places but also of Buffalo,
Baltimore, Cleveland, Philadelphia and Pittsburgh "” the powerhouse cities of
America in 1950 that consistently and inexorably lost population over the next
50 years. It is not just that there were poor people and the jobs left and the
poor people were stuck there. "Thousands of poor come to Detroit each year and
live in places that are cheaper than any other place to live in part because
they've got durable housing still around," Glaeser says. The net population of
Detroit usually decreases each year, in other words, but the city still attracts
plenty of people drawn by its extreme affordability. As Gyourko points out, in
the year 2000 the median house price in Philadelphia was $59,700; in Detroit, it
was $63,600. Those prices are well below the actual construction costs of the
homes. "To build them new, it would cost at least $80,000," Gyourko says, "so
there's no builder who would build those today. And as long as those houses
remain, the people remain."

There's a lot more in the article, including a positive economic take on the role of roads and automobiles that he sets in counterpoint to the typical aesthetic arguments against sprawl. 

I found this next bit supremely ironic, though it matches my observations of these cities as well:

Zoning and housing supply ultimately determine not only who lives in a city but
also the very nature of these places. Boston, San Francisco and Manhattan are
obviously becoming rarefied destinations, mostly for America's elites (Glaeser
calls the cities "luxury goods"), with housing floating beyond the reach of the
young and the middle class. These cities' economies are in the process of
becoming boutique, too, accommodating only the most skilled and privileged.
Their desire to limit construction and grow not in buildings and population but
in prices has, in effect, begun to shape their destiny.

Residents of these cities turn up their noses at the aesthetics and red-state politics of places like Houston and Phoenix, piously believing that all the while they are the true friends of the poor, while at the same time putting in place a government-enforced housing system that only the rich can afford, driving those of moderate incomes to, well, Houston and Phoenix.

This last observation provides a fitting conclusion:

And what surprises him is that the changes in how we have treated property
rights for the last 40 years "” who gets permission to build, the size and
location of what owners are permitted to build "” have been the subject of
virtually no national dialogue, even as the effects on prices, in his view, have
been extraordinary.

In today's Opinion Journal, the WSJ editorializes against the proposal to even further raise marginal income tax rates in California, to the highest in the country save in New York City.  The Journal argues that this is chasing productive, high income people out of California:

The
latest Census Bureau data indicate that, in 2005, 239,416 more
native-born Americans left the state than moved in. California is also
on pace to lose domestic population (not counting immigrants) this
year. The outmigration is such that the cost to rent a U-Haul trailer
to move from Los Angeles to Boise, Idaho, is $2,090--or some eight
times more than the cost of moving in the opposite direction.

I had seen this Uhaul metric before.  The logic is that Uhaul has to keep its fleet of trucks and trailers balanced.  If everyone is going one way with them, say from California to Utah, then they are going to end up with an enormous yard full of vehicles in Utah unless they 1)  pay to backhaul the trucks to CA empty, which is really expensive, or 2) increase the price of the route to Utah and decrease the price of the route back until they are in balance or until the price of the preferred direction covers the backhaul costs.

I had never tried this myself.  I always wondered if the examples people use in articles like this are hand-selected or representative.  So I tried, at random, LA to Salt Lake City  (I have Utah on the brain, I guess, because we are going skiing up there next week, woohoo!)  and chose a date far enough in the future I didn't run into any random demand peaks.  A one-way 26-foot truck rental from LA to SLC on May 15 was quoted at $1888.  The same truck from SLC to LA was quoted at $299!  Try it yourself.

Frequent readers of my blog know I am a big supporter of open immigration, but it cannot be a good thing to send a quarter of a million of your best educated and most productive people out every year and backfill them with lower-skilled, under-educated immigrants. 

Daniel Weintraub has a nice take on our health care system in a post recently in the Sacramento Bee.

Imagine for a moment that your employer was required by law to buy a
plan to manage your nutrition needs - rather than simply paying you a
wage, out of which you buy the food you want to eat.

Or suppose the government required your employer to pay for a housing
plan, rather than paying you and letting you decide where and how to
live.

Finally, consider what it would be like if the company you work for was
mandated to design and finance a transportation plan for you, with a
list of options for how you could get to work and back home each day.

Each of these scenarios brings a few things to mind.

First, you'd probably get paid a lot less than you do today, because
your employer would be diverting much of your current wages to pay for
these plans instead.

Second, you would have less choice than you do now, because your
employer would have to standardize these food, housing and
transportation plans to fit the needs of many workers.

Third, the service you would get from your local grocery store,
landlord or automobile dealer would probably be worse, since your
relationship with each of them would now be muddled through the entry
of a third party, your employer. Your local grocer would have a greater
incentive to try to satisfy his real customer - your boss, or worse,
the food management company your boss chose - than to serve your needs.

Fourth, the costs of each of these goods would tend to rise over time -
especially if you and your fellow employees were able to eat as much as
you liked, or live in any size house or drive as far as you wanted
within the choices provided. While large employers might be able to use
their superior bargaining power to drive down costs a bit, their power
in the marketplace would be outweighed by the increased cost of
providing food, housing and transportation in quantities unlimited by
the discipline that comes when a consumer pays for something
out-of-pocket.

Finally, as the costs did start to rise, you would feel less secure
about where your next meal was coming from, or whether you'd have a
place to live tomorrow or a car to drive to work. With the management
of these essential items in the hands of a third party, you'd feel
vulnerable, worried about whether they might cut back on your choices
or on the quality of the offerings in order to save money.

Beyond these arguments, there is the threat of using publicly funded health care as a Trojan Horse for complete government micromanagement of our lives.

After you finish this post, I have an updated post on the same topic here.

Well, the US trade deficit is up again, and you can be sure the news was accompanied by a lot of moaning and groaning and soul-searching.  The main reason that all the media and the majority of Americans freak out over large trade deficit numbers is that they look at the American economy as a large bank vault with a fixed supply of money on the shelves.  They reason that if more money is going out of the vault to buy things than is going back in from sales, then eventually the vault will go empty and we will be bankrupt.  Either implicitly or explicitly, those who fear trade deficits perceive the trade imbalance to be red ink, something bleeding out of a fixed supply.

This view of the trade deficit as a being a growing and unsustainable debt is wrong.  I will try to explain in a couple of ways.

The micro view

Lets first look at it from the perspective on one individual.  Lets say Fred made $50,000 this year, and lives in a US where, before he makes his spending decisions, trade is exactly in balance with China.  Fred spends some of his income on rent, and invests some in some nice US equities.  And he takes $1000 of what he just made that he might have saved and buys himself a nice Chinese-made plasma TV so he can really enjoy the Superbowl next year.

So, where's the debt?  One can argue that net savings is lower (perhaps - we haven't gotten yet to where the Chinese are spending their extra US dollars), but Fred seems to have increased the trade deficit without incurring any debt.  In fact, Fred is actually better off, since in a free society no one engages in a transaction that doesn't return more value than one spends.  In this case, the plasma TV provides more than $1000 of value back to Fred, or else he would not have engaged in the transaction. 

Yes, many people are buying Chinese TV's with consumer debt, but these same people are buying much more American stuff with consumer debt as well.  To the extent that there is or is not a "problem" with people taking on too much consumer debt, this problem is absolutely unrelated to the country of origin of the goods they are buying.  You can max out your Visa card on American stuff just as easily as on Chinese stuff.

But wait, you say.  The reason the debt is not obvious is from the way I structured the problem.  I assumed the rest of the economy was static while Fred was making his decision.  But if Fred had bought American, somewhere in the US economy there must have been less debt.  So we will tackle this next.

The Economy is Not Zero Sum

Repeat please:  The economy is not zero-sum.  Never has it been so hard to convince people of a concept that should be so obvious.  I used up bushels of electrons explaining why the economy is not zero sum here, but the short proof is easy:  Look at the world in 1900.  Look at it today.  The world as a whole and most every individual is far richer.  The fact is that economies create wealth every day, and free economies create a LOT of wealth.

At the heart of every argument that the trade deficit is bad is the mercantilist notion that the US economy is a bank vault leaking funds.  But this analogy that seems to be in everyone's head is flawed.  The supply of money or wealth in the US, in the vault, is constantly growing.  If you really have to think of it as a vault, then think of what's inside as rabbits rather than gold bars.  Does anyone doubt that if you start with a hundred rabbits and every year sent a few to China that you might still have more rabbits than you started with in the vault?  A free economy is like a group of rabbits on Viagra.  Even if the Chinese took billions of dollars they got from selling goods to the US each year and burned the money in a big bonfire, the US still would be growing in wealth.

Of course, the vault analogy sucks for a larger reason, that the US economy is deeply integrated with that of the rest of the world.  In fact, much of the wealth creation comes from this very integration, providing a more robust division of labor and a deeper well of creativity and entrepreneurship than any one country could achieve on its own.  And the dollars we send overseas don't stay there, they come back.  But we will address this next.

So What do the Chinese do with Those Dollars?

OK, so we are all short-sitedly (at least according the the "progressive" intelligentsia) sending dollars to China to satisfy our consumerism.  So what do those Chinese do with those dollars?  They can't spend them domestically, because stores and vendors in China don't accept dollars any more than the Wal-mart down the street from me accepts Yuan.

Most all the dollars have to come back to the US, or the person in China holding them gets no value.  You could say, well that person can take them to the bank and exchange them for Yuan, and that is true.  But that bank would not accept the dollars for exchange unless it knew it could get them back to the US, or had another client that needed them to make a purchase in the US.  So, the dollars will have to come back to the US to purchase something.

Some of the dollars come back to purchase US goods and raw materials, but of course this is less than the total dollars the Chinese have to spend, or else there would be no trade deficit.  In fact, this all that the words "trade deficit" really means.  It means that of the dollars the Chinese receive from sales to the US, only a portion is used to buy American goods that are shipped back to China.  The rest goes to buy American .. something else.

What?

Well, some of it goes to purchase American goods that stay in the US.  Lets shamelessly steal an analogy from Don Beadreaux and Jack Wenders.  If Chinese companies buy American steel and lumber and ship it to China, it shows up in the trade balance.  If they buy the same products and build a factory in the US, it does not.  The Chinese use a lot of their dollars to invest in buildings, real estate, capital assets, factories, production facilities, etc. in the US.  And this is bad, how?  I know that since the Japanese investment boom of the eighties, there are lots of folks who call themselves "liberal" who suddenly got very upset about foreigners owning US-based assets.  It is impossible for me to see this concern as anything but xenophobia and racism, since hundreds of years of Dutch, Canadian, and British investment never worried a soul but Japanese and Chinese investment has everyone in a lather. 

By the way, if you worry about China as a security threat, wouldn't you rather see them invested in the US economy, and therefore have a strong interest in our continued prosperity?  One could easily wonder why Saudi Arabia does not use their power over oil reserves to screw with the US like they tried to do in the early 70's.  The reason is that all of their wealth is invested in dollar and euro-denomitated assets.   People worry about the power the Saudis may have to mess with our economy, but their reinvestment of dollars back in our economy has made this a game of mutual assured destruction.  The same thing is occuring with China.

The other thing the Chinese do with the money is invest in dollar-denominated financial assets, which in many ways is just an indirect way of investing in the same capital assets listed above.  They will invest dollars in equities and, yes, debt securities.  But the fact that the Chinese choose to spend their dollars on debt securities does not mean that the trade deficit is causing the debt.  If the Chinese had a predilection for debt securities, more so than say an American holder of dollars, one might argue that this predilection drives down interest rates a bit and therefore might increase total debt, but this is a fairly tenuous chain of causation and not, I think, what seems to be bothering folks who panic over the trade deficit.  In fact, one can argue that the causation runs more strongly the other direction, that the large US budget deficit keeps the dollar higher than it might otherwise be, increasing the trade deficit.

So when people lament that "we now consume much more than we produce", they are making a meaningless statement because the we in the first part are not the same as the we in the second part.  The US and the Chinese are sending equal amounts of money back and forth - its has to be, over the medium to long term, or exchange rates would crash.  All the trade deficit means is that there is a difference in WHERE Chinese and Americans consume the goods.  Americans consume Chinese goods in the US.  The Chinese consume some of the US goods it buys in China, and then consumes the rest in the US.  The trade deficit represents the net amount of American goods and services the Chinese buy in the US and choose not to haul back to China.  Instead, they take ownership of the American goods here, in the form of capital assets or financial securities that represent ownership or calls on the cash flow of these capital assets. 

Anyway, you can find more here at Cafe Hayek.

Postscript:  By the way, the US has run a trade deficit of a magnitude that panics people for over two decades.  If this is bad, surely we would be able to find the damage somewhere.  But the US over the last two decades has had the strongest economy in the world.  I suspect that a lot of people would answer "we have run up a huge debt".  But any increase in total debt in the US is not relevant to the trade deficit, or only tangentially related as discussed above.  The Federal debt is run up because the politicians are all spending whores who support their reelection with "good works" paid for with our money.  Consumer debt, which may or may not be "too high", is based on individual spending and saving choices, and is unaffected by whether a person buys an American or Chinese TV.

Some days, I just don't have the energy to issue yet another rebuttal of serial economic ignorance.  But the folks at Cafe Hayek never seem to get tired.  You can find thoughtful rebuttals to accusations that Oil prices are too high, Wal-Mart prices are too low, and the minimum wage needs to be raised.

Quite a while back, I suggested that a better use for HOV lanes would be to charge money for their use, thereby creating a new revenue stream to increase future freeway capacity and beginning to experiment with peak pricing.

Several years ago, I sent in a proposal to the Arizona
Dept. of Transportation for their new HOV lanes in the Phoenix area,
though I never got a response back.  I suggested that HOV lanes
probably did not really increase carpooling, since they probably just
shifted vehicles that would have already been carrying 2+ people into
the faster lane.  Why should I get this artificial subsidy of a
dedicated lane when I am driving my kid to a soccer game but not when I
am driving myself to do productive work?  Either way, the lane is not
changing my behavior.

Anyway, I suggested that instead, AZ DOT should create a
number of special passes for exclusive use of the HOV lane.  The number
of passes should be set as the largest number that could be issued
while keeping the HOV lane moving at the speed limit at rush hour.
Maybe 5000?  Anyway, they would have the stats to set the number, and
it could be adjusted over time.  I proposed that they then auction off
these passes in a dutch auction once a year.  I posited that the
clearing price might be as high as $1000, thus raising $5,000,000 a
year that could be used for other transportation projects.

I suggested that $1000 as the clearing price might be low.  For some workers and businesses, 20 saves minutes a day might be worth thousands of dollars a year.  Some wealthy people would buy it just because they can, or as a status symbol.  I observed that many people were buying hybrids in Washington DC solely so they could use the HOV lane, putting a price of at least $5000 (based on the hybrid's price premium over similar non-hybrids) on HOV lane use.  In this example, I posited an annual pass, rather than a toll, solely because we have not toll roads here and no infrastructure at all to support tolls and a customer based unused to paying them.

Apparently, Lynn Kiesling, the DC/Northern Virginia area may soon experiment with exactly this concept, charging a congestion-variable price for HOV lane use while giving a discount to carpools.  Apparently the idea already is in use in SoCal.

A number of politicians are calling for taxing "windfall profits" driven by the "price bubble" in gasoline and oil.  Previously, I narrow-mindedly opposed this, arguing that the whole point of the pricing signal being sent is to call for new supplies, which won't happen if the government takes the money away from suppliers.

I say narrow-mindedly, because I have had an epiphany.  I realize now that it is indeed unfair for sellers to benefit from such a pricing bubble.  However, I think the politicians are wrong for looking at oil, since that bubble is only small potatoes.  I propose we start with the much bigger bubble:  In housing prices.  In a time of housing shortages, it pains my heart to Americans profiteering from artificially high prices.  Besides, oil companies actually do something useful with their windfall profits, like finding more oil; home sellers will just blow their proceeds on a big screen TV or something.

My proposal is that the government set a "fair price" for housing, based on a standard rate of appreciation.  The price of the house in a base year, such as 1970, adjusted for the CPI is a good starting point, but a process can be created modeled after Hawaiian gas pricing regulation to set up the exact standard.   Every house in the country then will be appraised.  Any house selling for or appraised for an amount above the 1970 price+CPI adjustment will be deemed as having reaped windfall profits.  The government is authorized to seize 100% of these windfall profits.  When this program is a success, we should then consider a retroactive program to seize windfall profits from the Internet stock bubble.

So, for all you who were supporting government intervention into gasoline pricing and profits, this must make you feel even better, since it is a much, much bigger bubble.  Right?  Or was it somehow more fun when Exxon was a target instead of, say, you?

Update:  I thought it was obvious, but I guess not from the email I have gotten:  I am being sarcastic here.  I would oppose a "windfall" profits tax on oil, houses, Internet Stocks, Pokeman cards, or whatever. 

The WSJ ($?) had this editorial on Saturday:

We keep hearing the word "bubble" to describe
industries with rapid and unsustainable rising prices. Hence, the
Internet bubble, the telecom bubble, stock market bubble, and now, some
analysts believe, a housing bubble. Yet for some mysterious reason no
one speaks of the oil bubble -- though prices have tripled in two years
to as high as $70 a barrel.

Reviewing the history of oil-market boom and bust
confirms that we are in the midst of a classic oil bubble and that
prices will eventually fall, perhaps dramatically. Despite apocalyptic
warnings, the world is not running out of oil and the pumps are not
going to run dry in our lifetimes -- or ever. What's more, the
mechanism that will surely prevent any long-term catastrophic shortages
in energy is precisely the free-market incentive to make profits that
many politicians in Washington seem to regard as an evil pursuit and
wish to short circuit.

The best evidence for an oil bubble comes from the
lessons of America's last six energy crises dating back to the late
19th century, when there was a great scare about the industrial age
grinding to a halt because of impending shortages of coal. (Today coal
is superabundant, with about 500 years of supply.) Each one of these
crises has run almost an identical course.

First, the crisis begins with a spike in energy prices
as a result of a short-term supply shock. Next, higher prices bring
doomsday claims of energy shortages, which in turn prompts government
to intervene ineffectually into the marketplace. In the end, the advent
of new technologies and new energy discoveries -- all inspired by the
profit motive -- brings the crisis to an abrupt end, enabling oil and
electricity markets to resume their virtuous longterm downward price
trend.

The limits-to-growth crowd has predicted the end of
oil since the days when this black gold was first discovered as an
energy source in the mid-19th century. In the 1860s the U.S. Geological
Survey forecast that there was "little or no chance" that oil would be
found in Texas or California. In 1914 the Interior Department forecast
that there was only a 10-year supply of oil left; in 1939 it calculated
there was only a 13-year supply left, and in 1951 Interior warned that
by the mid-1960s the oil wells would certainly run dry. In the 1970s,
Jimmy Carter somberly told the nation that "we could use up all of the
proven reserves of oil in the entire world by the end of the next
decade."

We can ridicule these doom and gloom predictions
today, but at the time they were taken seriously by scholars and
politicians, just as the energy alarmists are gaining intellectual
traction today. But as the late economist Julian Simon taught, by any
meaningful measure oil (and all natural resources) has gotten steadily
cheaper and far more bountiful in supply over time, despite periodic
and even wild fluctuations in the market.

Technorati Tags:  Energy, Economics

Arizona Watch makes a great observation about water use here in the desert.  All-too-often, the anti-growth folks use the water issue to try to make us feel like Phoenix is heading toward some parched apocalypse.  Arizona Watch makes the following point:

Scott Patterson's "Swimming in the desert," is dangerously miss-informed. To
advance his anti-growth agenda, he predicts future water shortages in Arizona
due to urban population growth. Urban growth is not to blame.

Nearly 70% of Arizona's water is used for agricultural purposes. What's more,
the cost of water for agricultural use is significantly lower than for
industrial or household use. The problem is not that people live in this desert,
it's that people inefficiently grow crops in this desert, and the inefficiency
is encouraged by price controls on water. If water costs for agriculture were
not subsidized, then market pricing would ensure a plentiful supply of water for
generations to come.

Read the whole thing for the cites to the actual statistics.  I cannot understand why water can't be sold at a market rate.  If you subsidize water prices, and more people then come to the desert than the water supplies can support, is it the fault of the individuals who show up, or is it the fault of the government that can't seem to allow markets to operate when it comes to water?  This is yet another example of the government creating a problem with regulation, blaming the adverse results on the free market, and using the ensuing mess to justify more regulation.

Farmers in particular are getting paid by you and me, in the form of subsidized water, to try to grow wet-country crops out here in the desert.  This water subsidy is on top of the huge farm subsidies Arizona farmers get, including over $100 million a year in cotton subsidies alone.  The government is paying farmers to dump tons of water on cotton plants in the desert that grow perfectly well without irrigation in many other states. 

Postscript:  Farmers really have done an amazing job lobbying for themselves in this country.  They are particularly succesful here in Arizona, where the largest farms are owned by Indian tribes, that have the added lobbying strength of protected-group status.  The other night I was serving out my painful 7 hours or so in drivers ed. class when it was mentioned that us urban dwellers will get a huge fine for not having our 4 year old strapped down in a car seat, but rural pickup truck drivers in Arizona can legally have a 6-month-old rolling around in the back of a bouncing pickup truck without any restraint and be perfectly legal.  Why the difference?  Because the farmers wanted it that way.