Asiatic Adventurism, Part II

To follow up on the conversation we began the other day… Mr. Obama needs a short, victorious war before the election, but those are thin on the ground unless your name was Moshe Dyan or Golda Meir. Looking at the quotes I have to work with today, I think Barack’s found his war. Unfortunately, the Chinese are going to win it and the figures will come cascading down rapidly, perhaps in time to stampede whatever portion of the electorate isn’t already on the prod.

China isn’t taking kindly to making its products less competitive by adding large tariffs (any more than it does to demands that it revalue its currency), and the very rapid reply to Mr. Obama’s U.N. meeting and the new house bill was to strike swiftly at major US manufacturers. We have to admire their style, none of that tough talk stuff, a simple, polite, “the Chinese government announced Sunday (Ed. Note: a week ago) that it is launching a probe into (the) possibility of the U.S. dumping auto parts and chickens on the Chinese market.” Those in the know had no difficulty reading that as “We have Tyson Foods, Pilgrim, Goodyear, and Cooper Tire & Rubber in our crosshairs, and that’s just for starters.” Somewhere here I had a dignified retort that adjusting the exchange rate by 20% would drive many Chinese firms out of business, which certainly makes sense on the margins they’re working on. The Smoot-Hawley Tariff Act of 1930 raised import duties to record highs and was a large contributing factor in the length and depth of the Great Depression. Protectionism never works out the way proponents think it will.

There are those saying “there, there, now.” “Michael Strauss, chief economist with Commonfund, a money management firm based in Wilton, Conn. said there is not going to be a repeat of the mistakes of Smoot-Hawley. Strauss said both the U.S. and Chinese are smart enough students of economic history to know that the last thing the world needs now is for arguably the two most important economic powers to turn a spat over tires and chickens into something that could derail a global rebound. ‘This is not that big of a deal. You get these battles once in a while and they pass. This is not reminiscent of what happened 80 years ago. Deep down, the U.S. and China know that they need one another. There’s going to be more negotiation than retaliation.'” Right. Now, about the chicken parts and the auto parts…

CNN caroled cheerfully, “But at least one economist thinks cooler heads will eventually prevail and that the brouhaha over tires won’t lead to the China and U.S. levying more tariffs on other goods.”

Kurt Karl, the Chief U.S. economist with Swiss Re weighed in with this opinion: “One would hope we can avoid more of this. There is no positive side to raising tariffs.” “Mr. Karl isn’t too concerned that China would dump Treasurys. He argues that would be the equivalent of China shooting itself in the foot since it would further erode the value of its holdings. Nonetheless, Karl does worry that China could retaliate against the tire tariff with tariffs of its own and even more government subsidies of Chinese manufacturers. That could make the trade deficit worse. And that’s especially true with China since it is also the largest foreign holder of U.S. Treasury debt, owning about $776 billion of Treasurys as of June. If the Chinese stopped buying Treasurys (sic)– or worse started selling them en masse — it could have a catastrophic effect on the dollar and the nation’s fiscal state as a whole.”

Sometimes I wonder if the current government has any inkling that foreigners aren’t just Americans who talk funny. US business can be cowed by threats of higher taxes, Cap & Trade, and Card Check, but when China gets upset it invades Tibet, slams into Japanese ships, and puts over a thousand missiles in the Taiwan Strait. There is a much, ah, closer relationship between business and government, and I rather expect that Beijing will do far more to protect their companies than the Demmies will, particularly companies without Union labor. The whole pie in the sky concept is that tariffs will change the balance “so that U.S. tire makers can compete more effectively with cheaper tires imported from China.” It doesn’t work that way. The reason Americans cannot compete are excessive wages, distrously high taxes, devastating regulations, the cost of the Green dreams, and protection of favored groups, concatenated over decades.

Here’s an interesting slant: “It’s not uncommon for the government to side with certain industries to protect American workers,” said Keith Hembre, chief economist with First American Funds in Minneapolis. “These tariffs wouldn’t be happening if the unemployment rate was substantially lower.” Huh? The tariffs were imposed because unemployment is high? People without job will be better off if prices go up? Oh, silly me: the expectation is that rather than paying higher prices for Chinese enterprising Americans will go in competetion with dollar stores and Wal-Mart.

Another fellow with a good grasp of the obvious: “A trade war would be very detrimental to the U.S. and the global economy,” said Michael Pento, chief economist with Delta Global Advisors, Inc., a money management firm. “We should have fair, open trade. But our banker right now is the Chinese, and it’s best not to bite your banker’s hand.” The government’s idea of “fair, open trade” being for the Chinese to make less money.

The backroom boys understand rough and tumble Chicago-style politics, but they are woefully ignorant of the world of diplomacy and business. Sensible observers realize that a trade war would stifle any little seeds that are beginning to sprout and assist the slide straight into deeper depression.

Tariffs and import duties have three purposes: to make money for the government, as punitive measures, and — in theory — to make imported goods align more closely with the price of domestic production. The retaliatory use was demonstrated when Mr. Obama and his friends smacked China with an additional 35% tariff starting about now on small tires. (A year later the penalty portion of the tariff will be reduced to 25%, and even lower the third year before being phased out.) Never mind the double talk, the problem was that China had captured 15% of the market and a major U.S. tire manufacturer had closed down a plant, firing 5000 voters. The day the news came out tire managers raised their prices immediately, which makes perfect sense to anyone who understands economics and opportunity. Between then and September 26th store owners were reaping the windfall profits that the government will appropriate from now on. The result of the grandstanding was punishing American consumers, not the Chinese. American tires do not look more attractively priced, Chinese tires just cost more.

Politicians are forever attempting to rig the game, and it never works. China can make a short bathrobe and market it through Wal*Mart for four bucks. The thought is that by levying import duties, the price of the Chinese version can be made to approach the cost of an American-made robe, which we will pretend is $12.00. (It isn’t, of course. Be prepared to spend at least $80 to $125 for a cuddly bathrobe.) In order to make American goods priced competitively, a duty, or tariff, of 200% of the retail value would have to be imposed. Chinese eat very funny things and have odd writing, but that doesn’t mean they’re dumb enough to attempt to sell a unit at three times the original costs and projected profit. The upshot is whatever Third World nation was making fuzzy bathrobes quits or markets them elsewhere, American robe manufacturers don’t sell any more, and most of us do without a new robe or go raid Good Will. In addition to which, the government does not making an enormous profit in return for permission to market wares here. Governments are very bad about not recognizing that it is rarely possible to make any of us behave in ways deleterious to our own best interests. The Chinese won’t sell at a loss, must of us will do without before we buy $175 bathrobes, no tariffs will clank into government coffers, and union labor will continue to price itself out of business.

If there is anything a moribund economy does not need it is a trade war. What it needs is conditions favoring job creation and renewed consumer spending. Government is desperate, however, since the last figure I saw indicated tax revenue collection is down 25%! A whooole lot uh spendin’ ain’t goin’ on. Those in charge of the circus on the Potomac don’t get this. “The trade deficit with China has soared in recent years, hitting a record high in 2008. This is a concern for obvious reasons: If we continue to buy a lot more from China than we sell to them, more U.S.-based manufacturing jobs could be lost.” 2008 was an Obama ago, and US manufacturers do not go out of business primarily because of cheap imports, although that hit the tire people hard — and deservedly so. U.S. tires were more expensive and no better. The only change is that the $50 Chinese tire now costs $80, but we’re still buying Chinese. True, the government rakes off the tariff, but that’s an expensive short-term fix.

This is going to have to run to a third segment in order to discuss current adventuring by Asiatics and how it is that the Chinese really are able to set the value of their own currency, as unlikely as that sounds to those of us who believed ForEx had something to do with it. Until then, if you want a high ticket item from China it sounds wise to pick it up now.

Linda Brady Traynham
Whiskey & Gunpowder

October 8, 2010

The Daily Reckoning