AUGUST 24, 2015
WHO NEEDS WHOM? Every month Americans consume between $30 and $40 billion worth of manufactured goods from China. We sell them $9 billion, a quarter as much as we buy. Meanwhile, we owe them almost 15 percent of our GDP. The Chinese government alone owns over $1 trillion of US government bonds. In many ways, our government budget deficit is financed by Chinese money. Without cheap Chinese goods, our inflation rate would be higher. Without their loans, our interest rates would be higher too. This would make you think that we had better stay on their good side. But in truth, they need us more than we need them.
Imagine, for whatever reason, that the $500 billion-a-year trade between China and the US disappeared. In America, prices at Wal-Mart would skyrocket; Americans would have to pay more for clothes and flat screen TVs. But in China, factories would close, jobs would evaporate, and political turmoil would ensue. If Chinese-American trade disappeared tomorrow, China would suffer considerably more than the US.
Without cheap manufactured goods from China, American inflation would jump, but the United States would weather the storm. For China, the situation would be calamitous. Without an ever growing export sector absorbing rural labor, without new jobs for all those peasants who don’t want to be peasants any more, the Chinese government would begin to lose legitimacy. The Chinese Communist Party retains the allegiance of the people because it has promised and delivered economic growth. Without the demand engendered by America and the European Union, the stability of the entire political system would be threatened. Americans would grumble if they had to pay more for cotton goods, but American democracy would undoubtedly survive. The Chinese Communist Party might not. Sellers need buyers more than consumers need producers.
This is not just a story about China and America. The entire global economy is based on a deal between creditors and debtors, producers and consumers. Certain nations, such as China, Japan, and Germany, are mercantilist. They are happy to work hard and produce more than they consume. Every year they sell more goods and services to other countries than they import from them. For the mercantilists, the key to economic happiness is a trade surplus. Other nations, such as the US, the United Kingdom, Spain, and Greece have trade deficits with creditor nations. That means that every year, they are able to consume more than they produce. They are the grasshoppers of the world economy. Germany and China, on the other hand, are the ants. By producing more than they consume, they save. And those savings don’t stay at home, but rather are lent to the consuming nations, which use them to buy manufactured goods from the mercantilists.
Why do the mercantilists allow such an unequal pact? Jobs. We get cheap goods and services; they get jobs. You would think all the power would be with the mercantilists. They are the productive ones, they have the money. The free traders should be the supplicants, desperate for their specialty steel and their consumer electronics, desperate for more loans. But much of the power, even if they don’t realize it, is with the consuming nations.
Science moves forward by explaining anomalies — explaining events that according to existing theory, should not happen. So, riddle me this: The United States is richer, more developed, has more capital than China. China is growing much faster. According to development theory and all the macroeconomic textbooks, capital should be flowing from the slower-growing United States, seeking higher-yielding investment opportunities in China. Instead capital is flowing uphill from labor-rich China to capital-rich America, from the fast growing less developed nation to the stagnant, sclerotic economy to the North.
Today, US Treasury bills, where the Chinese Central Bank deposits its trillions, barely pay 1 percent. The booming Chinese economy, which for the past few decades has been growing at a nine percent a year, should provide much more profitable investment opportunities. Why don’t the Chinese simply invest at home? During the boom, the period called at that time (but no more) the Great Moderation, self-satisfied apologists for the status quo told us that the Chinese desire to invest in America spoke to the West’s deep, liquid, and safe financial markets. The tranquillity and safety of our financial system is not so apparent anymore. It is not inconceivable, should the dollar devalue, that the Chinese will take a spectacular hit on their dollar investments. So why are the Chinese more desperate to lend us money than we are to borrow it?
You know the answer. They lend us money so we can afford to buy their goods. The mechanism isn’t identical to Sears and Roebuck extending credit to Nebraska farm families in 1911 so they could buy sewing machines with no money down, but the essence is the same. Mail order catalogues sold goods on credit because otherwise they could not move their stock. The Chinese Central Bank sells renminbi and buys dollar- denominated bonds in order to keep their currency undervalued, which in turn keeps their manufacturing exports affordable. Were they not to buy US bonds, the value of the Chinese currency would rise, making their manufactures more expensive on the world market. Chinese export sales would plummet.
Within Europe, Germany plays the same role as China in the world economy. German banks lend money to the southern European nations, which then use those funds to purchase German manufactures. Without those loans, factories in Stuttgart would be idle. A break-up of the euro would be more devastating to German workers than to Spanish consumers. The German economy has been able to export all over the world because the euro is artificially held down through the weakness of the Southern European economies. Should the euro break up, should a new Deutschmark emerge, its value would soar, German exports would become considerably more expensive in world markets, and German unemployment would jump. A collapse of the euro would be devastating to the bank accounts of Greeks and Spaniards and Italians as the value of their savings would be decimated — but their economies, buoyed by a cheaper currency would soon return to prosperity. Germany would take a longer-term hit. To remain competitive, German workers would have to cut their wages.
During the debacle of 2008, after the real estate bubble popped, the financial system tottered on the brink of disaster, and the world economy contracted, it wasn’t the bubble economies of the US and Great Britain that shrank the most, it was economies like Germany and China which sold manufactures to the bubble nations. Our preconception is that the producer and the creditor have more power than the customer and the debtor, but that assumption may well be out of date. These days, China needs America; the producers need the consumers more than the other way around.
This strikes us as unusual because it contradicts deep-seated evolutionary prejudices. For most of our time on the planet, production has been central to our survival, consumption the easy afterthought. Spearing the woolly mammoth was the exciting bit, worth telling a story about; eating it was pleasurable, but not worthy of painting on a cave wall. Neither cavemen, nor Babylonian landlords, nor medieval merchants required the services of advertising agencies. Marketing barely existed until the early 20th century.
When Marco Polo set off to Xanadu in 1271, selling his wares upon his return was the least of his worries. Traveling across the Eurasian landmass, avoiding robbery and murder and making it home again were the hard parts. Back in Venice, everybody wanted his Chinese silks, supply was limited, demand insatiable. A modern day businessman has the opposite problem. I know nothing of fashion, textile manufacturing, or the intricacies of Chinese import-export, but if I had to, and I had sufficient collateral to obtain a bank loan for working capital, I could hire a young designer fresh from the Fashion Institute of Technology, fly non-stop to Hong Kong, commission a factory owner to make me thousands of dresses, and DHL them back to London. What I could not guarantee is that anyone would want to buy them — certainly not at a price that would allow me a profit.
Capitalism and technology have transformed our world, but we have not yet realized it. Our great grandparents lived in a world of scarcity; we live in a world of plenty. Before 1800, the biggest task of the businessman was making the goods. Today it is selling them. One hundred years ago, a young girl moving from a farm to a big city would probably find work in a textile mill. Today every other 20 something woman in London seems to work in PR.
Look at a pair of sneakers. Nike spends billions advertising, building a brand, using innovative social media, and traditional commercials. Making the sneaker is almost an afterthought. Manufacturing the shoe is cheaper than selling it. An ambitious executive would prefer to work in marketing than in production.
Movies are the same. The hardest part of producing a film isn’t directing the actors or framing the shot or even financing its production. Once the film is in the can and edited, then the really hard part begins: distribution. Ninety-five percent of all films produced today do not get distributed or are only shown in a local theater to a handful of friends. Major motion picture studios often spend as much on marketing a movie as on making it.
Or take a look at your own life, or a friend who works for himself. All freelancers know the hard part isn’t the work. Using your skills is satisfying, even pleasurable. Sitting by the phone, waiting for it to ring, or cold calling clients is the nightmare. An independent contractor, be he a carpenter, accountant, or cameraman may have all the skills to do a fine job, but unless someone is willing to pay him, his talent means nothing. You might be a great worker, but your boss will fawn over the least likely customer more than he will over you. Customers are more valuable than workers.
These examples, macro and micro, international and personal all demonstrate that today demand rather than supply is the bottleneck of growth. Producers are plentiful; it is consumers that are scarce. In the old fairy tales, the hardworking ant triumphed over the flighty grasshopper but today, the ants only flourish at the grasshoppers whim. We may be importing goods from China but they are importing demand from us, and these days, demand is way more precious than anything else.
Global economic stagnation is due to lack of demand, nothing else.
According to the introductory textbooks, economics is the study of scarcity. We cannot satisfy all our needs so we make choices and tradeoffs. But today it is demand rather than supply that is the constraint on production. Perhaps it is time to rethink our understanding of the economic problem. Labor is available, technology keeps zooming forward, capital is plentiful. The only thing that is scarce is customers. Demand is the only bottleneck in the world economy.
More than five years since the end of the financial crisis, the economy has barely recovered. Wages are stagnant, secure full-time jobs in short supply, interest rates microscopic, corporations uninterested in hiring or investing in productive capacity. We have known for some time that technological progress can be a job killer. ATMs have replaced bank tellers, cheap software has replaced bookkeepers and secretaries. Soon the self-driving car will eliminate truck and taxi drivers. Even professionals like lawyers and doctors are not immune to the threat of ever-smarter software. Human labor becomes less and less essential to production. Every year, we can make more stuff with less work.
And every year we can make more stuff with less capital as well. Ever improving technology lowers the cost of capital goods — those products necessary to make consumer goods. Camera, lighting and editing gear of quality good enough to produce a feature film used to cost hundreds of thousands of dollars. Today, you can shoot a movie and wow the crowds at Sundance on your iPhone and cut it on your laptop. Cheaper capital goods mean we need less capital. Back in the 19th century, it took billions of dollars to build the cutting edge technology of the day. Railroads and steel mills required massive amounts of money before they could begin to turn a profit. Today’s digital world is much more economical. You can build an app with a tiny investment, just enough money to hire a handful of software engineers and feed them pizza and Red Bull. Even traditional industries like steel-making require considerably less capital than they used to.
The world today is awash with money. Cash is plentiful and cheap. Near zero interest rates tell us the supply of capital far exceeds its demand. The function of interest rates is to align desired savings and desired investment. Lower rates make saving less tempting and investing more so. But today, despite interest rates lower than they have been since Babylonian times, the desire to save remains far greater than the desire to invest. Corporations are making huge profits, but instead of using those retained profits to build factories or hire workers, they are happily sitting on piles of cash.
Economists call it secular stagnation: a shortfall in demand caused by an imbalance between our societal desire to save and our desire to invest. Savings, whether deposited in a bank account or used to buy a bond, sterilizes demand. Money under a mattress sits there, unused, useless, creating no jobs. Only when savings are turned into investment (or for that matter consumption) does demand rise to meet supply.
Traditionally, and according to all the finance textbooks, corporations are supposed to absorb societal savings in order to invest in productive capacity. The corporate sector should be a net borrower, taking money from the rest of the economy in order to buy machinery so as to make workers more productive. No longer. Today, corporations are net lenders. With capital goods becoming more inexpensive, they need considerably less capital in order to increase output.
We have the technology, the labor, the capital. Customers are all we lack. Recessions, by definition, are a shortfall in demand during times when the economy’s productive capacity exceeds its desire to purchase. Problems of supply are intractable: during a famine you cannot just create more grain. Problems of demand can be solved by mere political will.
Fortunately, we know how to stimulate the economy, create jobs, end unemployment. Keynes (and FDR) figured this out 80 years ago. They recognized the only reason one third of Americans were “ill housed, ill clothed, ill fed” was that close to one third of the nation was also out of work. Give them jobs, put money in their pockets, and the economy had the capacity to supply their needs. World War II ended the Great Depression not by killing civilians, destroying factories, and shattering the lives of millions, but by increasing government deficits which finally put the unemployed to work and gave them money to spend.
Since the financial crisis, policy makers have tried to stimulate the economy by keeping interest rates low and flooding bank balance sheets with cheap money. They hope that low rates will discourage savings and stimulate investment, and that banks loaded down with cash will lend more. So far this trickle down strategy has not been particularly successful. There is an easier way to stimulate demand: helicoptering money into individuals’ bank accounts. Give everyone $5,000 and watch the economy take off. Our economic problems can be solved, painlessly, if we finally recognize that demand is the only thing the world economy misses.
We can stimulate growth in two ways. The first is a basic income guarantee, giving every adult citizen enough money to survive. This would function the same way as a tax cut, except instead of giving money to the richest among us, a basic income guarantee would increase demand by giving money to everyone. A basic income guarantee would be much more stimulative than the equivalent tax cut because ordinary people are much more likely to spend their windfall straight away, unlike the rich beneficiaries of a tax cut who are more likely to save. Helicopter-money gooses consumer spending, which increases private sector profits, finally giving them reason to hire and invest.
The other path is public sector spending — ideally investment in infrastructure and education. Secular stagnation is caused by an imbalance: the private-sector desire to save is not matched by its desire to invest. If the private sector does not want to invest, then the public sector must take up the slack and become the investor of last resort.
And those investments are needed. Even if the private sector would prefer to sit on its piles of cash, we still need massive investment. The insult that is JFK airport in New York reminds us how much better we could make our country. The roads, bridges, schools, and airports of America certainly need improvement. If individuals and firms want to save but cannot find profitable places to invest, then the government can solve both problems. By issuing bonds, it creates safe assets, and by using those funds to fix infrastructure, it creates jobs today and makes the country stronger tomorrow.
Advances in technology are offering us a free lunch. Labor is plentiful and skilled. Capital is cheap and available. Demand is the only problem facing the world economy. Once we realize this, all our problems are solvable. All we need is the political will to force our elites to spend our way out of our troubles.