America first

Last month, The Economist published a couple of articles highlighting the extent of the extraterritorial reach of US policy and its implications. There has long been a supposition that the wave of bank fines issued by US regulators since the financial crisis has fallen disproportionately hard on foreign institutions, and The Economist cites evidence suggesting that over three-quarters of the $25bn it has levied in fines have been aimed at European banks. The evidence also seems to suggest that anti-corruption fines fall hardest on non-US companies, with eight of the top 10 fines levied under the Foreign Corrupt Practices Act falling on non-US companies.

The Deepwater Horizon disaster in 2010 added to suspicions that the playing field may not altogether be level. BP was fined more than $20bn for "gross negligence and willful misconduct”, in addition to $45bn of outlays in compensation and clean-up costs. Meanwhile, Houston-based Transocean, the company that owned and operated the oil rig which exploded, was hit with a fine of $1.4bn and Halliburton – the company responsible for doing the cement work which was the primary contributor to the well blow-out – escaped with a fine of $1.1bn.

As The Economist points out it is hard to prove that “America treads more lightly at home than abroad.” US firms generally have a pretty clean track record. But a very insightful piece into the murky takeover of French company Alstom by GE suggests that there are some dark forces at work. Alstom was already the subject of an investigation by the US Department of Justice into allegations of corruption when a senior Alstom official was arrested by the US on bribery charges. He entered into a plea bargain on the understanding that his jail term would be significantly reduced, but in the event served five years in detention. Shortly after the guilty plea, Alstom began to explore the possibility of a deal with GE. The Economist suggests that the DOJ’s investigations “distorted Alstom’s sale process, giving an edge to a potential American purchaser.” But “in order to be legitimate, a legal process must be transparent and independent – and be seen to be so. In this case, the legal process and the commercial one become uncomfortably intertwined.”

All of this goes to the heart of one of the biggest economic concerns underpinning the current shift towards economic nationalism – the idea that countries are increasingly prepared to use their leverage to secure their own interests rather than uphold the rule of law. The US is better placed than most to flex its muscle given the dollar’s position as the global reserve currency. Under the Obama Administration, which increasingly started imposing secondary sanctions, the US began a policy of issuing sanctions against any non-US individual or business which did not adhere sufficiently to US sanction regulations. Since dollar transactions ultimately almost always have to be conducted via US banks, the US authorities are in a position to obtain information on virtually all global dollar transactions and can use their leverage over access to the dollar payments system to extend their judicial reach.

I first became aware of this at a seminar three years ago which discussed business opportunities in Iran following the end of sanctions. Despite the optimism that Iran was once again being welcomed back into the international fold, many of the bankers present warned that they were very uncertain as to their position in the event they were required to provide dollar funding for Iranian projects. Although sanctions against Iran had formally ended, the US authorities even then were less willing to provide the green light. The election of Donald Trump suggested that all parties were wise to be circumspect given subsequent efforts to renew the sanctions.

Such apparently capricious policymaking raises a question of what this might do to the status of the US dollar as the world’s reserve currency? The choice of reserve currency is determined by three main considerations:

1. Size. Large economies generate a lot of foreign exchange transactions which puts a lot of currency into circulation; 
2. An advanced financial system which offers liquidity and a range of ancillary services;
3. Stability. The currency needs to act as a store of value. Political stability is another prerequisite.

The dollar continues to fulfil all these requirements. But increasingly, the likes of the euro zone and China have to weigh up whether the advantages of using the dollar are sufficient to outweigh the associated political costs. There is also a question mark on the US side. The Triffin paradox, which was first outlined in the 1960s, highlights that in order to meet global demand, the issuer of the reserve currency must be prepared to run a current account deficit. But as the current account deficit increases, so the external value of the reserve currency declines, thus reducing the willingness of creditors to hold it. In a world in which President Trump appears unwilling to sanction a rising external deficit, logically the flow of dollars into the rest of the world might be expected to slow.

Just because the dollar remains the dominant reserve currency today does not mean that it always will be. Prior to 1918, the US dollar accounted for a negligibly small share of global foreign debt with the UK accounting for 90% (chart). Within the space of five years, however, the dollar increased its share of global reserves to almost 40%. The US gained at the UK’s expense due to having a bigger economy, less indebtedness and a quantum leap in sophistication of financial markets following the foundation of the Fed in 1913. Between 1918 and 1945 there was not one single global reserve currency: The US and UK shared the burden.Who can say that we will not move towards a multipolar world in future?

I am not suggesting that we are yet at anything like the watershed moment of a century ago. But history suggests that changing trade patterns and a shift in the balance of economic power may be setting up the dollar for a reduction in status as other currencies take up some of the slack. Wielding the big stick, as President Trump is doing today, might hasten the search for alternatives.

You don't know what you've got 'til it's gone

Viewed in a global context Brexit is very much a sideshow. However, it is all part of a global backlash against the status quo which is perceived to have acted against the interests of citizens in the developed world. Nowhere is this more evident than in the actions of the Trump administration which earlier this month imposed higher tariffs on the first $34bn worth of imports from China and threatened to escalate still further, thereby risking Chinese retaliation and a further step on the path towards a global trade war. The biggest danger in all of this is the prospect that the current global economic architecture could well be jeopardised, which may not be perceived to be a problem in Hicksville USA or Smalltown England, but might result in turning our back on the most successful period of prosperity generation in world history.

To put some figures on it we rely on the database put together by the late Angus Maddison which looks at very long runs of GDP data. Measured in real terms, the increase in world GDP between 1950 and 2000 outstripped anything seen in the previous two millennia, rising at an average annual rate of 3.9% versus 0.2% in the preceding 1950 years (chart). The same is also true of the US, although its most rapid growth occurred during the early years of the industrial revolution. Nonetheless, average US growth of around 3.5% per year between 1950 and 2000 compares pretty favourably with the 4.4% rate recorded during the nineteenth century. Growth is not everything, of course. When comparing living standards, what matters is the absolute level of income. Whilst it is true that US per capita income growth has stalled over the last decade, the US still ranks ninth in the world behind three oil-rich Gulf states, four smaller European economies (Norway, Luxembourg, Switzerland, Ireland) and Singapore. For the record, Chinese real income per head is just 23% of US levels.

It might suit some American politicians to claim that their country has never had it so bad, but the US is still a pretty good place to be. The US has attained these lofty heights, thanks to an exceptional period of technical innovation – which it drove – and a huge rise in world trade which allows it to buy products more cheaply from other parts of the world, thus allowing American citizens to spend their excess income on other products. Whilst it is true that China is closing the gap with the US, per capita GDP growth has recently slowed to an annual rate of less than 3%. At current rates, it will take China 55 years to reach current US  levels and assuming China is able to sustain a 2.75% growth rate way out into the future (which is unlikely) and US incomes grow at 1% per year, it will take the better part of a century for China to match US living standards.

Worse still, the US Administration appears to have no concept of the gains from trade. As The Economist put it a few weeks ago, “Trump appears to see the world as he saw the New York property market, a place of screw or be screwed.” China may be stealing US technology and engaging in sharp practices to ensure that the playing field in the Chinese market is far from level, but that does not mean that the US should cut off its own nose to spite its face. Adam Smith – a hero of many on the right – argued in his 1776 publication The Wealth of Nations that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage.

The US may no longer be the world’s primary producer of traditional industrial products such as steel, but it is still the world’s most technically advanced nation which in the past 20 years has given us Facebook, Amazon, Netflix and Google (the so-called FANGs) which also happen to be the largest global companies by market cap. Moreover, many companies rely on outsourcing production to external markets, and retaliation in response to US actions would imperil global value chains and force a rethink of how companies operate across borders with unanticipated consequences.

But rationality is not the order of the day. Western historians will probably look back at the first two decades of the 21^st century as a golden period punctuated by a severe crisis that prompted irrational policy choices. They do say that you don’t know what you’ve lost until it’s gone. I miss the good old days even before they have ended.

Donald's rhetoric trumps rationality

I have no axe to grind regarding President Donald Trump. I am not a fan but unlike the Brexit issue I have no skin in the game. So when I say I don't like much of what I heard during Trump's inauguration speech, I say it as an economist and a citizen of the world (which in Theresa May's eyes makes me a citizen of nowhere).

I tuned in just as Trump got into full flow. But I shuddered at the passage which contained the phrases: 

"We have defended other nations' borders while refusing to defend our own ... One by one, the factories shuttered and left our shores with not even a thought about the millions and millions of American workers that were left behind ... From this day forward, it's going to be only America first, America first ... Protection will lead to great prosperity and strength." 

I am critical of British politicians who play the nationalist card and I am not impressed by leaders of other major nations who do the same. Imagine what the reaction in the British press would be if German politicians said similar things. But when an American president takes such a tack, we know that this could be very damaging to the world economic and political order upon which our prosperity has depended for so long.

As an economist, I question the notion that protectionism will make the US economy stronger. My immediate reaction was "has he learned nothing from long dead US politicians Smoot and Hawley?" Standard economics states that raising tariff barriers simply increases the costs to consumers who ultimately have to pay. It's the same reason I am so concerned that the UK will fail to get a deal with the EU and we have to fall back on WTO rules which raises the costs of most imports.

Yet there is an argument that this is conventional thinking and we should be approaching the problem differently. Indeed, a young journalist asked me this week if tariffs are such a bad thing. In effect, he was asking whether the pursuit of economic efficiency really is the be all and end all. Given the times in which we live, it is a question which deserves an answer. I suspect the answer lies in the extent to which they serve the national interest. The national interest in this case is not simply about the economic costs and benefits, because on these grounds there is no case. It is about taking back control – a slogan we heard so often during the Brexit referendum. Ironically, the message from Theresa May was that the UK wants more free trade, rather than less, which seems to contrast with the Trump view. Trump’s appeal is to those who believe that the pace of change has been too rapid, and my guess is that American voters might tolerate higher import tariffs for a while but ultimately realise they are economically self-defeating. But tariffs may simply have to be tried to remind a new generation of why the world has spent 70 years trying to reduce them.

Think of the US auto industry. The area around Detroit declined (as did the British Midlands) because the cars built there were more expensive and technologically inferior to those produced by the foreign competition. Domestic consumers took the view that they got better value for money by looking elsewhere. Imagine they didn't have that choice. Imagine that instead US workers continued producing cars and stayed put in Michigan. This would have reduced the internal migration of skilled workers, with the result that currently-dynamic urban areas would have grown more slowly and there would be fewer resources available to be allocated to higher value-added sectors such as tech or fracking. In short, there would have been less dynamism. If that is what the public wants, that is their choice. But as my friends on the other side of the Atlantic tell me, that is not the American way.

Then there is the problem of retaliation. If the US erects barriers, you can bet its trading partners will respond. American companies have pinned their hopes for many years on the Chinese market – whether those hopes have been realised is another matter. But they will be shut out of the world's most dynamic major market and will lose global market share as a consequence, especially if China were simultaneously to open up to the Europeans. And it is not as if the US does not have world class companies which compete globally. Microsoft, Apple, Google and Amazon have revolutionised the world, and did not arrive in their present incarnation behind tariff barriers. They depend on being able to sell around the world, and rely on global supply chains to stay competitive. Its global banks have survived the financial crisis in far better shape than their European counterparts and still play a huge role in the global financial architecture.

We should also not ignore the soft power which the US enjoys. Netflix is changing the way the world watches TV; Hollywood blockbusters are still the films most people talk about; its universities are ranked as amongst the best in the world. Moreover, the US issues the world's pre-eminent reserve currency. This should not be underestimated: Controlling access to dollar markets gives the US unprecedented economic and financial leverage.

All told, the US is in a far stronger position than Trump’s supporters believe. Admittedly, we no longer live in a world of unchallenged American power – the rise of China has seen to that. But the US has more to lose than gain if Trump really does set off down the protectionist path. We can only hope his team is less impulsive than he is.

Truth and lies

Having watched the second US presidential debate between Hillary Clinton and Donald Trump, there was little doubt in my view as to who had the better of the argument. Trump was big on promises but Clinton far better on the facts. However, that does not mean all people thought that the Democratic nominee carried the day. It was classic rope-a-dope stuff. In fact, it reminded me of watching the middleweight boxer Herol Graham, who was extremely skilled in the art of ring craft. He was so evasive that before he turned pro, he used to make money in pubs by tying his hands behind his back and asking customers to try and lay a punch on him. He was so good that no-one ever got close. Until one day he got into the ring with Julian Jackson, one of the hardest punchers in the business, who hit poor Graham so hard he was unconscious before he even hit the canvas.

The question is can Clinton find a sucker punch to knock out Trump? Early on during Sunday’s bout, The Donald survived a few uncomfortable early rounds, but managed to come through the period when he was subject to criticism for misogynistic comments which would surely have felled many seasoned politicians. And I was amazed when the moderator, Anderson Cooper asked, “can you say how many years you have avoided paying personal federal income taxes?” Trump’s answer was, “No, but I pay tax, and I pay federal tax, too.” A politician who refuses to answer questions like that normally has no chance in an election. But like Herol Graham, Trump slipped the punch in a masterful fashion and it seems that whatever you throw at him, Trump keeps on coming. Welcome to the world of post-truth politics.

We have had our own experience of this phenomenon in the UK during the EU referendum campaign. It seemed not to matter what arguments were put forward – if they did not fit with the stylised “facts” which determined the nature of the campaign, then they were obviously “lies”. This clip, which shows Boris Johnson testifying before the Treasury Select Committee in March, highlights how the Brexit camp were able to distort the truth in ways which sound reasonable but were in fact a total misrepresentation of EU laws for the  purposes of making a domestic political point.

Of course, the past master at truth distortion is Russian president Putin who, according to The Economist leads “arguably the country (apart from North Korea) that has moved furthest past truth, both in its foreign policy and internal politics.” It went on to note that during the Crimean campaign “state-controlled Russian media faked interviews with “witnesses” of alleged atrocities, such as a child being crucified by Ukrainian forces; Vladimir Putin, Russia’s president, did not hesitate to say on television that there were no Russian soldiers in Ukraine, despite abundant proof to the contrary.”

The trust-your-gut instinct has been supported by a general erosion of trust in institutions and the proliferation of social media, which allows people to cut themselves off from those with different viewpoints and to hear only what they want to hear (so-called homophilous sorting). Such behaviour should (and does) worry economists. Although I argued recently that there is a strong normative element in economics, we rely very heavily on economic data to support our arguments. So when Trump tells American voters that “we’re the highest taxed nation in the world” he is way off. When he tells them he can eliminate the US national debt “over a period of eight years” while still pushing a "very big tax cut," he is living in fantasy land. When he says (as he did after winning the New Hampshire primary) that unemployment is "probably 28, 29, ... 35 percent; I even heard recently 42 percent," it’s pretty easy to go to the BLS website and see that they are reporting a figure around 5%. In plain terms, he is pandering to the prejudices of that part of the electorate which wants to believe that because things are not as rosy as they once were, they must be a lot worse than the government is telling them.

It was the same story during the Brexit referendum, when we were spun a web of lies based upon Michael Gove’s deceit that “people in this country have had enough of experts.” This led to a situation in which all the dire predictions of what Brexit might do to the economy were ignored because the fact that the UK runs a trade deficit with the EU “proves that the EU exports more to the UK than the UK does to the EU”.  The fact that 47% of UK exports go to the EU whilst only around 16% of EU exports go in the other direction rather suggests the opposite. As the US politician Daniel Patrick Moynihan once said, “Everyone is entitled to his own opinion, but not his own facts.”

2001: The dawn of a new revolution?

Fifteen years ago today terrorists flew two aircraft into the World Trade Center in New York, and the world has never been the same since. Although the US economy and stock market had been weakening for some time – for example, it took the NBER until November 2001 to determine that the US economy slid into recession in March 2001 – it truly marked, in my view, the point at which the 1990s boom could be said to have ended. Although on the surface the economy recovered relatively quickly, the event proved to be a traumatic national event which saw the US unleash its military might on the Middle East and profoundly changed American politics in ways which are still being felt today.

It was around the same time that we began to take much more notice of the rise of Chinese economic power. Whilst it would be wrong to suggest that the shift away from the unipolar economic world of the 1990s began this day fifteen years ago, it is easy to understand why this parallel might be drawn. Despite the efforts of Barack Obama to heal many of the wounds which were created by 9/11, Donald Trump has tapped into a surge of anger regarding the decline of the US. There is no doubt that the relative position of the US has diminished as China has ascended: In 2001, the US economy was eight times the size of China measured in simple dollar terms. By 2015 it was only 60% larger. In PPP terms, the IMF reckons that the Chinese economy is now larger than the US. However, this is a very different thing to saying that the US is in decline:  After all, the dollar value of US output has increased by 69% since 2001.

But the ordinary working man and woman have felt the squeeze. Median US household income in 2014 was reported just below $54,000, having peaked at $57,843 in 2009. Thus the purchasing power of the average household has declined by around 7% since the end of the 1990s, and in inflation-adjusted terms, this decline is even bigger. This is attributed partly to falling household size – after all, if you only have to support one person rather than two, then life has got rather better rather than worse.  It is also partly due to a rise in the number of low-skilled immigrants who populate the lower end of the income scale. But there is little doubt that in the US – as in most other parts of the industrialised world – the majority of the working population does not feel as though they have benefited from the recovery which is apparent in the headline economic statistics such as GDP or unemployment.

One factor which has contributed to this apparent slowdown is the deceleration in productivity growth. Back in 2001 the talk was of a productivity revolution, triggered by advances in ICT. Today, we worry that these advances are about to supplant labour rather than complement it. As Paul Krugman once remarked, “productivity isn't everything, but in the long run it is almost everything.” Over history, rising productivity has gone hand-in-hand with rising living standards and if it is not growing particularly rapidly, it should come as no surprise that our living standards are not progressing at the same rate as they once did. Economists continue to debate why this should be the case. It could be that many of the advances in productivity are simply not being captured properly in the data (I’ll come back to that another day) or, as Robert Gordon was pointing out back in 2001, many of our recent technological innovations do not offer the same boost to productivity as those in the past.

Either way, the last fifteen years have seen significant economic changes. These are partly the result of geo-political changes but perhaps more importantly they reflect socio-economic shifts. We may not have known it at the time, but perhaps the years around the turn of the century marked the start of a third industrial revolution driven by the dawn of the digital age. It took 60-80 years starting around 1760 for the first revolution to fully make its presence felt, whilst the period 1860-90 arguably marked the duration of the second. On the basis of past trends, we may thus only be halfway through the transition period of the third industrial revolution. For Stanley Kubrick, 2001 was the year of a space odyssey. For Americans, it marked the first significant attack on the US mainland. For future historians, it may yet go down as the start of a new era in world economics.