Buffett’s proposal to balance trade: The column

produce.jpg Well, this may not look like a picture of the trade balance, but it was certainly the nicest pickie that Google Images came up with when I was searching for a picture of the trade balance.  Yum.

I reworked this former post of mine for the Age Business section which published it today. As you will see it has gone through substantial revision of tone. It’s still the case that no-one’s discussing the idea. Sad really.

Warren Buffett is the billionaire from a Norman Rockwell painting who got rich by building a financial counter culture within his investment company Berkshire Hathaway in which managers loved their businesses so much they treated them like owners.

But hes a worried man. Populist Republican presidents like Ronald Reagan and George W. Bush cut taxes without the hard work of cutting expenditure. The resulting government deficits along with falling saving by American households, have seen America go from trade surpluses to large trade deficits as far into the future as the eye can see.

And whos funding Americas profligacy? The Asian countries particularly China who, being huge savers have the funds to invest in America and the interest in continually lifting Americas credit card limit so it can buy Asian goods.

But credit card limits cant rise faster than income forever, and as Buffet reminds us quoting Herb Stein “If something cannot go on forever, it will stop.”

Under current arrangements that adjustment would happen via a drying up of Asian finance, a depreciating American dollar and a resulting slowdown restraining Americas rampant consumption and shifting the competitive balance towards American industry.

Buffetts concern with this solution is reminiscent of Keynes. Keynes thought competitive markets were admirably flexible and efficient. But he also believed that certain macro-markets – he was thinking of labour markets, but one could make similar arguments about asset and currency markets could defy the fundamentals for a long time.

Buffet makes his point with some storytelling economists would call it a model. He invites his audience on a wildly fanciful trip to two isolated, side-by-side islands of equal size, Squanderville and Thriftville.

Squandervillians live it up by borrowing from Thriftville something they can keep doing until theyve mortgaged all their assets, including their land. This process could go on a long time before the market forces an adjustment. And by then what damage might have been done to Squandervilles economic future not to mention its strategic position with its financier Thriftville (Sorry I nearly said China) ?

Buffett proposes a remedy so simple its odd that, given his profile, its received so little attention. Under his system you couldnt import into America without holding permits to do so. And the only way to get a million dollars worth of import permits would be to achieve exports of a million dollars from America or buy them from someone who had.

The system balances trade. And because it uses freely tradeable permits to do so requiring no other restrictions on trade its an extremely efficient way to balance trade.

But why would you want to balance trade? Just as a company can borrow to build a factory, nations can run trade deficits to build their productive capacity. Buffetts concern is that America is not investing its increased borrowing that its just living it up on the credit card.

Even so, its still not clear that what hes suggesting offers any big improvements on the way the adjustment would otherwise occur. I suspect he fears that Americans dont have the ticker to reduce their consumption to balance trade. But if thats the case theyre unlikely to stick with his solution either.

Under his system, as with a more textbook adjustment involving a declining US dollar, imports would become more expensive funding increased exports and real consumption would fall.

Intriguingly, having been introduced in Asia in the 1960s and 70s, these ideas were further developed in Australia in the 1980s though they were applied to a specific industry (rather than the whole economy) in the context of reducing protection. Export Facilitation provided automotive exporters with permits to import duty free into an otherwise outrageously protected market. That helped move automotive production from local assembly of Ford Lasers (though Japan was doing it much more efficiently) to exporting Holdens and Toyotas, which required much lower assistance.

In the 1980s an Australian association the Society for Balanced Trade was actively promoting for Australia the very idea Buffett is now promoting for America. But, sad to say, its motives were simple protectionism the usual mix of special pleading for manufactures and wilful ignorance of basic economics.

I doubt Buffetts idea makes sense for us now.

First, these mechanisms create explicit export subsidies which are illegal under the WTO. And whereas the Americans might be able to secure a change in WTO rules, wed have no chance of achieving this on our own.

Second, though I think our trade deficit is too high, much of its recent rise has been driven by surging investment. If we tried to balance our trade, investment would almost certainly suffer. If we have a problem which I think we do its ultimately driven by inadequate savings. So we should tackle that more directly with surplus budgets, Future Funds and/or expanded super contributions.

Still, three big things can be said for Buffetts re-invention of this Australian idea.

First it avoids picking winners either between industries, or between import substitution and exports. That makes it more efficient and dynamic but minimises political favouritism and the attendant rent-seeking.

Second, in a mercantilist world in which so many developing countries have succeeded with lavish export subsidies Buffetts system might get them importing more to secure their export access to the American market! That not only assists America make the adjustment it should make, it induces the adjustment that the mercantilist developing states should make for their own and others benefit.

Third, whether or not theres a role for such policies in developed countries, they offer a vastly superior mechanism for using trade policy to respond to balance of payments crises than is currently provided for within current WTO rules which continue to permit the application of temporary, selective tariffs.

Sadly Buffetts intervention has sparked almost no serious interest from economists. I wonder why? Maybe economists cant figure out where to place it on that spectrum between free trade and protection that helps them work out where they stand. Is it protectionist? Kind of. But implemented cleanly it would also produce freer trade than almost any country actually has.

Back in the 1970s and 1980s economists spilled oceans of ink exploring the costs of new forms of protection, such as voluntary export restraints, though the bottom line was pretty clear from the outset avoid where possible. They spent far less time exploring new mechanisms, like export processing zones and export facilitation, that were increasingly important in Asias trade liberalisation and development but ambiguously placed on the free trade versus protection spectrum. Partly because of that, Australian economists took too long to understand (and so revise, their previous hostility towards) export facilitation in the car industry.

And so it has been so far today.

The more things change . . .

This entry was posted in Economics and public policy, Politics - international. Bookmark the permalink.

11 Responses to Buffett’s proposal to balance trade: The column

  1. David Rubie says:

    Nicholas Gruen wrote:

    But why would you want to balance trade? Just as a company can borrow to build a factory, nations can run trade deficits to build their productive capacity. Buffetts concern is that America is not investing its increased borrowing that its just living it up on the credit card.

    A possibly ignorant question: Won’t the credit provider in this case simply cease providing credit increases? Or is the real problem that China has very poor risk management in this case (brought on by their insistence on the continuing use of foreign exchange controls)?

    I realise the consequences are pretty dire for a collapse in confidence in the US currency, but increasing regulation like this would surely be a massive inducement to “game” the system of import/export credits with scams.

  2. observa says:

    I’m inclined to the Austrian view that this is all the result of lax money, creating malinvestments, which must eventually be corrected. If you take that view, the question arises as to why so long for the correction? I think the answer lies in demographics. How so?

    Ignoring the more recent Asian tigers, the world economy in the post war era, largely consisted of the MDCs and they had a special demographic characteristic, which would become obvious in the (unpredicted) stagflation of the 70s. Essentially if you pumped any extra money(or govt demand) into that economy then, it would immediately show up as price inflation as the glut of youth/ new household formers pushed on the capacity of the economy to accommodate their insatiable demand(unlike that of their parents)Couple that with the explosion of women into the workforce and the economy couldn’t cope with full employment either, the latter problem it has just about managed to solve nowadays. That was the unprecedented stagflation of the 70s. Fast forward to today and lax money has very different effect IMO. Put extra money supply into the baby boomer demographic’s hands now and they go and buy assets with it, trusting that this will keep them in their retirement. What’s more the govt actively encourages them to do so with super and they can negatively gear to speed up the process as well. With rising asset prices, why wouldn’t any thrifty outsiders want to lend to them too, particularly if they can invest freely in the game as well (no exchange controls), with the hope of retiring alongside them too, when they get citizenship as business immigrants naturally. Everybody’s happy playing the new demographic game, except the Austrians on the sidelines who are shaking their heads like Mr Buffett. The question we really need to ask ourselves right now is this- How much of current super fund drawdowns by existing retirees, is being covered by real returns to capital and how much by asset price inflation? That game of musical chairs, like unfunded govt super schemes past, will only play out fully when all the baby boomers paying into the system now are no longer paying in, but drawing down. IMO we have a way to go before the Austrians are proved right in a very big way. It’s the money supply stoopids!

  3. JC says:

    nick

    Buffet is a fruit cake when it comes to economics and a darn bit dishonest too. It seems that the sage has no problems raising other peoples taxes when he pays very little income tax himself. In fact Buffet would be well down the list as a taxpayers each year and would quite possibly rank with mid levels executives.

    Several years ago Buffet’s salary was about US$100,000 at Berkshire. His firm have never paid dividends. Most of his deals like the company jet are part of the perks of his office. In fact Berkshire actually owns NetJet one of the largest providers of private jets in the country.

    Buffet thinks he should be the only person who is rich.

  4. jimmythespiv says:

    …….and, JC, Buffett, like Kerry Packer, is a mercantilist at heart.

  5. observa says:

    “If we have a problem which I think we do its ultimately driven by inadequate savings. So we should tackle that more directly with surplus budgets, Future Funds and/or expanded super contributions.”

    The rub here Nicholas is that you are talking about real savings as distinct from nominal ones. The problem with the money supply horse having bolted over a number of years, is that currently people(particularly all those baby boomers nearing retirement) feel their nominal savings are adequate and real, both now and into the future. The Austrians would say lax money has fooled them to conclude that. If money supply had been held stable, the real state of their savings would have been immediately apparent to them and no doubt they would have adjusted their behaviour accordingly, long before now. Curiously enough, govt Future Funds may be in exactly the same boat here, unless they are used to invest in real, productive investments, say in capital hungry countries like China and India, rather than helping to inflate the MDC asset price bubble further. Even that may prove futile when the bubble bursts. If the problem really was caused by cranking the printing press then there’s only one logical solution. We all need a lesson in real savings and investment.

  6. paul frijters says:

    I’m with JC on this. Buffet’s ideas are bunk. The reason they are bunk is noted by Nicholas himself when he talks about others countries having increased their exports:

    “which so many developing countries have succeeded with lavish export subsidies”

    exactly. Why refuse an underpriced good if it is offered to you? If someone else is daft enough to sell you something below cost price, you buy it now. And you buy it on credit, especially if other countries (like Japan and China) are kind enough to give the credit to you at heavily subsidised low interest rates whilst the investments you make in those countries are high divident earners. Why refuse all these free lunches? Buffet’s ideas make no sense for the states, and they dont make sense for Australia. There is something to be said for increasing savings by letting the government do the savings, but forced import permits are not the way to go.

  7. derrida derider says:

    And I’m with JC and PJ too. Not only that, but there are other problems with an export facilitation system – eg how do you treat invisible exports and imports in services? For the US, these are a massive proportion of their exports.

    And sorry, Nic, but I still get amused at your special pleading for the auto manufacturers’ favorite rort.

  8. observa says:

    “There is something to be said for increasing savings by letting the government do the savings,”
    I would have thought logically you couldn’t have it both ways Paul, in the sense that why shouldn’t our Govt hop in for a free lunch too? Again, the Austrians would say they know why not.

  9. paul frijters says:

    observa,
    I’d advocate government involvement in savings on the basis of basic paternalism: the average person is too myopic to save enough so a benevolent government forces them into it, partially by changing the status quo savings option (yes, unless) and partially by directive (forced contributions, future funds, etc.). Nothing to do with trade per se. You can save smart as a government though: print bonds which you sell to Asian central banks. Pay the low interest rates on matured bonds from taxes. And invest the funds raised into these heavily subsidised Asian export companies.

  10. David,

    Yes, the credit card limit won’t rise forever but it can rise a very very long way above where it is now. In an efficient market that would have its own effects on the interest rates at which the lending would take place but I expect the adjustment will be less smooth than we might like. Even so I still think you need good reasons to depart from the ‘natural’ course of events and to prevent current and capital accounts operating efficiently in relation to each other – which they can’t if you mandate balanced trade.

    I’m not sure how much Buffett’s system could be gamed. It couldn’t be gamed any more than tariff and other subsidies can be gamed with physical goods. With invisibles one can imagine larger problems in some areas.

  11. JC says:

    The trouble with Buffet is that he would be much better off spending his time trying to figure how to invest the $35 billion in surplus cash he has rather than worrying about export/import transfer coupons.

    Warren should try to explain how the US trade deficit in the earlier part of this decade was about the same as a % of GDP.

    Yet on the 28 June 2001 the US index a compendium of currencies weighted against the US dollar was 121. The Dollar index is a weighted basket of currencies traded on the futures markets in Chicago.

    It is now 82, which means there has been about a 32% drop in the value of the US dollar. The index disguises the real weakness of the Dollar against say the Euro where it fell from its highs of 2001 when it was 84 cent’s to the present rate where the Euro buys you 1.35 cents.

    Oil has risen from about 27 bucks a barrel to 65 these days.

    The US trade deficit is largely a monetary problem created by the US printing far too many dollars and the Chinese (in particular) taking is those dollars who then are forced to print large amounts of Yuan because of the peg.

    As an aside

    Warren was against the income tax cuts ( they didn’t effect Warren of course, so Warren didn’t have a problem with them).

    The US has finally done the right thing and begun to price airport usage fairly. Heavy planes were charged a lot more than smaller jets and props despite the fact that size doesn’t really matter all that much when accessing an airport. Small jets took slots at major US airports during peak times for as little as 200 bucks a take off or landing when the other carriers were being charged multiples of that.

    Of course Warren was up in arms about this suggesting it was unfair. So it seems that when taxes etc., directly impinge on Buffet he doesn’t like them just like anyone else. In this case Netjet (think its called) was going to get hit with extra charges.

Leave a Reply to observa Cancel reply

Your email address will not be published. Required fields are marked *

Notify me of followup comments via e-mail. You can also subscribe without commenting.