Open Letter to Rep. Mike Michaud

Capitalism is an economic and social system in which capital and land, the non-labor factors of production (also known as the means of production), are privately owned; labor, goods and resources are traded in markets; and profit, after taxes, is distributed to the owners or invested in technologies and industries.

In reply to RickRussellTX, I'll also try to be brief, but it's not in my nature really.

(1) I'm not sure U.S. manufacturing is actually more complex. Intellectual property affects the value that various factors are entitled to add to products in U.S. markets, but look again at the Alex eReader and the Teclast K9 above. You might never be entitled to buy a Teclast K9 in the U.S., but Teclast is certainly able to manufacture one in China.

(2) It's not about "us" (U.S. citizens) vs. "them" (Chinese citizens). It's about "us" (common citizens of either nationality) vs. "them" (statesmen of either nationality). Chinese authorities are not uniquely entitled to future U.S. tax revenue, but we were discussing distinctions between Chinese "investment" in the U.S. and private investment. I have nothing against the Chinese. My future mother-in-law was Chinese, ethnically, unless her daughter changes her mind, again.

(3) How could China's currency policies not keep it undervalued? Yes, the policy allows us to advance faster along an economic development trajectory, in theory, if we don't simply consume the value of China's "gifts" to us, and if we don't sell them rents imposed upon us in exchange for the "gifts", but we (our statesmen) do sell the rents, and I'm not sure we have invested the value rather than consume it, and even if we have invested it, I'm not sure our progress along the development trajectory is sustainable if and when the gifts disappear.

Are we producing things the Chinese cannot efficiently produce for export? I don't know, but I doubt it. Are we producing things the Chinese don't want to produce for export, because the production is incredibly stupid, things like aircraft carriers and strategic bombers and flak jackets for imperial policemen and mortgage backed securities of dubious value? Yes, I'm very convinced that we are, and I'm convinced that our statesmen are engineering this production even as they sell the rents.

All that said, take a look at this picture of China's aging population, accelerated by the one child policy. I've never had an MRI, but my father possibly has. If and when China's aging population demands more MRIs, coronary bypass operations and pacemakers, will China import these goods, or will more young Chinese stop growing rice inefficiently and start making MRI machines instead?

How the Chinese spend their entitlement to taxes imposed on my children depends on the answer. Maybe my kids find more employment in agriculture, and Chinese kids find more employment making MRI machines, while MRIs become more costly and less accessible to me, or maybe Obamacare entitles me to an MRI while my kids become farmers who can't afford Chinese laptops. Stranger things have happened.

But I rather hope my kids will say, "Hell no, we won't pay!"

look again at the Alex eReader and the Teclast K9 above. You might never be entitled to buy a Teclast K9 in the U.S.

I'm not saying they can't make (and sometimes design) decent electronics. And where the design happens is irrelevant anyway, as multinationals can design anywhere and employ Chinese workers to make the stuff. Supposedly China's value-add to the products they export is only 30-50% anyway.

I'm just saying that the is a real difference between products like cheap laptops and LCD book readers -- which are pretty much made from stamped and molded parts, where the design and tooling are often made in the US or Japan or Germany -- and MRI machines and medical equipment and steam turbine generators and airliners and... (add large complex products here), where serious engineering and scientific acumen must be applied at the production site to assemble correctly and maintain quality.

In fact, I think the difference between electronics (complex design but relatively simple manufacturing and assembly) and other industrial products (moderate to complex design plus moderate to complex assembly) shows you why the Chinese are having such a hard time.
They can solder and glue e-Book readers, but they have a much harder time making engines or avionics.

Even machines of relatively simple design, like motorcycles and lawnmowers, are very hard for the Chinese to build because they don't have the training or the engineering to control quality. When they build these types of things successfully, it almost always at the direction for a foreign MNC that puts its own people on the ground establish the production line and quality control.

Of course, China can learn from this, and the Taiwanese and Koreans did -- that's why Taiwanese and Korean cars and motorbikes are increasingly comparable in quality to the Japanese and German counterparts.

These are genuine competencies that the mainland Chinese have not reproduced. That's why these large, complex, high-value high-margin products are being made in Europe, the US and Japan. That's why Germany is in the position it's in. If these competencies were trivial to reproduce, we'd be driving Chilean automobiles and typing on Jamaican computers.

The Japanese have done it, but took about 50 years to reach the pinnacle of engineering and scientific competence.

China is, perhaps, 10 years into that climb, and faces some unique challenges as you point out with demographics and resources. They also have unique advantages of population, and they have Taiwan, which was already well on the way. I can't predict the future, so I don't know how they will proceed.

In this larger picture, Chinese currency policy (and undervalue, if it's legitimate), is not such a big deal.

But I certainly agree that financing government through sale of debt is rotting us to the core.

Supposedly China's value-add to the products they export is only 30-50% anyway.

But I don't know what that really means. China's value added to an Alex eReader might be only 30-50%, because Spring Design is entitled to a royalty on the product manufactured in China, while many similar exclusive rights also operate. Is this royalty "value added" in a meaningful economic sense, or is it another rent imposed on U.S. consumers? My kids don't hold patents on these devices either.

If Teclast may not sell a competitive device in the U.S., because Spring Design may exclude the competition simply through patent protection, how much richer are my kids as consumers of this type of device? I don't pretend to know the answers to these questions, but I'm skeptical.

where serious engineering and scientific acumen must be applied at the production site to assemble correctly and maintain quality.

I hear this sort of thing all the time, but I sat beside all of these Asian kids in college, studying science and engineering, twenty-five years ago, and they were often the brightest kids in the class. I'm not the least bit convinced that they lack the acumen to engineer high tech production. I rather suppose that they are engineering high tech production in China now.

They can solder and glue e-Book readers, but they have a much harder time making engines or avionics.

No offense intended, but that sounds a lot like chauvinistic, wishful thinking to me. Since when are the Chinese having such a hard time? I hear their economy is recovering very nicely, and they'll probably be on the moon in this decade, not that I think that's anything to crow about.

Even machines of relatively simple design, like motorcycles and lawnmowers, are very hard for the Chinese to build because they don't have the training or the engineering to control quality.

Maybe I'm bamboozled by popular media, but that's not what I'm reading at all. Warren Buffet now drives an electric car made in China, after investing heavily in the manufacturer. Maybe the day of the electric car hasn't arrived yet, but when this sort of major, technological change does occur, we could discover that Chinese industry has already leap-frogged us.

Interesting that you are for government intervention that just happens to be aligned with business. You also ignore labor market manipulation.

See 20 CFR 655 / 20 CFR 656 and the implementation of such anti-US manipulation. It was written to acquire talents not already in the US(and no other purpose), but ignores the idea that US citizens already have them. It manipulates the market such that US citizens are forbidden from any advantages, favoring the citizen-hostile(who make the original request to offshore), body-shop, and labor-relations firms that benefit from such policies. But then that wouldn't look good for you or someone like Mankiw (whom already was called out for his opinion in favor of such).

I can't believe I actually voted for this guy.

Don't give them any ideas. I'm sure the Democrats would outlaw technology if they could....They'd love to have CBS, NBC, and ABC controlling all the debate.

“China’s currency manipulation essentially subsidizes Chinese exports and imposes tariffs on foreign imports. This presents an insurmountable trade barrier to U.S. manufacturers.” ~ Michaud

More than 50% of 'Chinese' exports are actually MNC exports. So who is being subsidized, really?

It is odd that more is not being said about the historical similarity between Japan's currency issues and those now regarding China's currency issues. Here is something along those lines from Scott Sumner:

From the Money Illusion:
"As you may recall, back around 2005 a number of Congressman were insisting that the Chinese revalue the yuan by 27%. In fact, they did revalue their currency by 22% over the next 3 years. But now we are told they need to do another 20% to 40%. And people wonder why the Chinese are so frustrated with the West. Does this game ring any bells? I seem to recall that back around 1970 the US government kept insisting that the Japanese trade surplus was caused by an undervalued yen. Then the yen was revalued 20%, but the “problem” continued. Then another 20%, then another 20%, then another 20%, then another 20%. The yen has now gone from 350 to 90 to the dollar. My math isn’t very good, but that sure seems like a lot of 20% revaluations. And the Japanese still run a current account surplus that is more than half the size of China’s surplus, despite having less than 1/10th China’s population. I think it’s fair to say that international economists have become increasingly skeptical of the notion that simply by manipulating nominal exchange rates you can eliminate current account imbalances that represent deep-seated disparities of saving and investing. But I guess hope springs eternal. Maybe this time it will finally work."

This line is worth repeating: "And the Japanese still run a current account surplus that is more than half the size of China’s surplus, despite having less than 1/10th China’s population."

Cry for the messenger boys! Cry for the typing pool, and the file clerks!

First, to avoid the inevitable criticisms here, I'll say again that the problem with Chinese mercantalism, for the United States, is on this side of the trading relationship as much as it's on the Chinese side. If the Chinese monetary authority wants to make us a gift of Chinese currency, that's fine with me in isolation, even if it's not so fine for Chinese merchants who could obtain more value for their goods otherwise.

The problem is that Chinese monetary authorities may "invest" their dollar surplus in entitlement to U.S. tax revenue and similar rents imposed on U.S. citizens. If they couldn't, they'd necessarily invest otherwise. They might buy U.S. mortgages for example, and of course, they have bought U.S. mortgages, but when the mortgages proved not so secure, our own government imposed the losses on U.S. taxpayers instead.

Without this aspect of "capitalism" as it really exists, the mercantalist policy would ultimately be self-defeating, but this aspect of "capitalism" does exist, so I can't be so sanguine about the effect of Chinese mercantilism on me and my children here. If I choose to see only the free renminbi and ignore the rents purchased with a dollar surplus, I'm oblivious to the potential harms, but I can't ignore the rents.

I also can't ignore the malinvestment stimulated by the Chinese monetary policy. This policy pushes the U.S. economy faster along an economic development trajectory than it would travel without the policy. Sure, we can always produce other things. If the Chinese sell us laptop computers more cheaply than we'll produce the same goods, we can buy laptop computers from China and produce something else ourselves instead.

But if the Chinese supply of cheap laptop computers doesn't reflect sincere preferences of Chinese producers, I expect it not to last. When it stops, we'll pay more for the computers and produce less of the other things that we thought, based on the distorted market signals, we could produce. Our premature boom in the other goods will become a bust.

How many of us are already producing unsustainably based upon the distorted market signals? I don't know, but I do know that China bought a lot of mortgage backed securities and that the purchases, among other things, stimulated a boom in home building that ultimately became a bust. I also know that China has four times the U.S. population. Those are sobering thoughts.

This argument makes as much sense to me when the Chinese print money to manipulate the price of dollars in their currency as it does when the Fed prints money to manipulate the price of credit, and I don't see Don addressing the argument at all. If the Chinese policy does not create malinvestment, I need to understand why.

I never understood why anyone said China was engaging in capitalism. It's corporatism/merchantalism/fascism. But a free market, supported by full property rights and courts to enforce them? No way.

I think you might have a good point, if I'm understanding you correctly, and assuming I'm not missing something. If I understand your point, government bailouts paid for by the rest of us also end up bailing out Chinese investors.

What I'm not sure of, is why that is worse than bailing out U.S. investors. I don't have any particular interest or think that it is *better* in any way to bailout U.S. investors over Chinese investors. I don't know that I really see a difference other than lines on a map. But maybe I'm missing something? Why does it hurt us *more* when bailouts rescue bad Chinese investors than when they rescue bad U.S. investors?

It's more than the bailout. China bought mortgage backed securities when they couldn't buy enough Treasury securities, and we've now converted the mortgage backed securities into Treasury securities for them, but if they had only bought Treasury securities, they'd still own entitlement to U.S. tax revenue, entitlement to rents imposed on U.S. citizens, because that's what a Treasury security is, and that's all it is. Every sale of a Treasury security to anyone is a bailout.

Of course, when I say "we've converted", I mean the United States government has converted. I don't literally mean that I had anything to do with it. I had nothing to do with it. I opposed it every step of the way, and I still oppose it.

Bailing out U.S. investors is also a problem, but U.S. investors can't create entitlement to consume Chinese goods in order to purchase entitlement to U.S. tax revenue. The problem of bailing out Chinese monetary authorities is compounded by the fact that they hold this authority.

I'm not one of "us" in the U.S. collective. I don't see the problem as U.S. vs. China. I see the problem as U.S. statesmen and Chinese statesmen vs. me and mine.

"The problem is that Chinese monetary authorities may "invest" their dollar surplus in entitlement to U.S. tax revenue and similar rents imposed on U.S. citizens."

Who offers these debt instruments to the Chinese?

The Congress, FNMA, Goldman Sachs, AIG, ...

Not me.

Right. There may have been some mild undertone in my question :-)

If the Chinese had not underwritten these loans, would someone else have done so? Would our government and commercial banks have offered the same rates to Europeans and Japanese and Arabians and Canadians and Australians?

I think the answer is probably yes. BEA data for 2008 (the most recent year with finalized numbers) indicates that foreign owned US assets are just over $23 trillion. So China's $700B is not trivial (about 3% as I figure it), but I'm not seeing strong evidence that there is a lack of buyers. Foreign investment nearly quadrupled from 1998 to 2008, probably because many countries are less poor than they used to be.

I have a hard time seeing Chinese monetary policy as THE REASON for the housing boom, or as a basis for quick action.

Now, what you say about response of the manufacturing environment to the influx of Chinese products is probably true. But is it bad? I mean, if the companies that would have made cheap laptops are instead making MRI machines and medication pumps and drilling for oil and performing consulting for foreign companies and... with all that foreign money that the world keeps pumping into our economy, and all the money we save by buying Chinese products that they have artificially devalued, isn't it better to spend that money on things that have higher profit margins or better returns on investment than cheap laptops?

Who buys the entitlement to tax revenue doesn't increase the tax burden, but the fact that Chinese monetary authorities may buy it by creating entitlement to the produce of Chinese citizens is certainly relevant. If Australia conducts a similar monetary policy, the effect is the same. I have nothing against the Chinese for being Chinese.

I didn't say that Chinese monetary policy was THE REASON for the housing boom, but it was a contributing factor. China isn't the only nation on Earth, but it is one of the fastest growing economically, and it does have four times the U.S. population and a long way to grow before reaching productive parity with the U.S.

I don't know how bad the effect of China's monetary policy on the U.S. manufacturing environment is. I also don't know how bad (or good) the effect of current U.S. monetary policy is, but I do see similarities between the two. Maybe the Fed can drive U.S. development forward by entitling more people to organize more resources speculatively, by extending more credit more cheaply. Maybe the Austrian theory of the business cycle is bunk, as Bernanke says it is. I'm persuaded by the Austrian arguments, but I don't pretend much certainty about anything. My problem with Don's analysis is inconsistency. Why should I believe one and disbelieve the other?

If we're making MRI machines instead of laptops here, only because Chinese laptops are subsidized, only because Chinese producers make laptops for export instead of laptops (or other goods) for Chinese consumption, only because Chinese authorities distort markets, then ultimately, if and when less distorted Chinese preferences assert themselves, we'll be making too many MRI machines. Right?

If we're really so much better off building MRI machines and consulting for foreign companies, why aren't we accumulating entitlement to Chinese tax revenue? Why do we have such a huge current account deficit? I understand the Laffer argument, but something doesn't seem to add up. Is our productivity really growing so much more rapidly? Is future demand for MRIs really so great, and why is an MRI so much tougher to make than a laptop? I'm skeptical of these assumptions.

By the way, if you want to know the opinion of somebody who understands a *heck* of a lot more about this than I do, I recommend Scott Lincicome:

http://lincicome.blogspot.com

Read it and have little disagreement with it.

I can tell you know your economics better than I do (pity me, the humble MBA), so if you should want to smack me around, please put on gloves :-)

<font size="-1">If we're making MRI machines instead of laptops here, only because Chinese laptops are subsidized, only because Chinese producers make laptops for export instead of laptops (or other goods) for Chinese consumption, only because Chinese authorities distort markets, then ultimately, if and when less distorted Chinese preferences assert themselves, we'll be making too many MRI machines. Right?</font>

True, but does that matter? Industrial production shifts all the time in response to genuine changes in supply and demand -- should this artificial pressure worry us too much. If the Chinese currency is truly undervalued by government edict, then we truly gain wealth in a very direct sense when we buy their products (unless undervalued means something other than what I think it means).

If we can make more money from MRIs *right now* while China sells us their subsidized laptops, surely we'll have that money (or the investment assets purchased with it) available to us as the policies shift.

(Note that I chose MRIs randomly, since my gut was telling me they were too complicated for the Chinese to make, and some minimal research suggests that I was mostly right. I did find some evidence that multinationals are making some MRI parts there.)

And if the policies do shift and China's currency suddenly normalizes to the international markets, they might start buying more of the things we make -- the things they can't afford now due to their undervalued currency. That could buffer the current account deficit.

<font size="-1">...why aren't we accumulating entitlement to Chinese tax revenue? Why do we have such a huge current account deficit?</font>

Perhaps in part because our government is mortgaging our future by issuing record debt and spending the money on useless wild good chases?

OK, well, too political. I'll be honest, I truly don't know.

I theorize that, if we were not selling so much debt to foreign investors who seem to hold it in incomprehensibly high esteem, the dollar would have dropped more rapidly in response to the trade deficits that started in the 80s, forcing our consumer purchasing power to equalize much more rapidly, stimulating domestic manufacturing.

Would that be a better world? Austerity might have humbled us and kept us out of foreign entanglements, or curbed consumerism, or forced us to look to more effective ways to educate our children to prepare them for a more competitive future, etc. We may pay for that for a long time.

Or it may have motivated us to activate our overdeveloped military and steal things. I think it's probably best not to speculate.

True, but does that matter?

It matters to you if you're the guy making the MRI machines when the correction occurs. Sure, dislocation happens regardless, but dislocation is painful, and less pain is better than more pain, in my utilitarian way of thinking. I'll have a headache occasionally, no matter what I do, but that's no reason to pound my head against a wall. In economic terms, dislocation is costly, because resources are idle for periods of time. Excessive dislocation does not optimize production.

The Chinese currency can only be undervalued by government edict, because the Chinese monetary authority accumulates dollars. If I create my currency to fix the price of your currency in my currency, if that's my monetary policy, then I can only keep the price of your currency above its market price. I can't keep it below the market price this way. To lower the price of your currency in my currency, I must sell your currency to holders of my currency, but I can't create your currency in order to sell it. If I'm selling your currency continually, I'm not accumulating it.

Some of us gain when we buy subsidized Chinese goods, but this gain is not the only effect. Again, Chinese authorities may "invest" their dollar surplus in rents imposed on U.S. citizens, specifically entitlement to U.S. tax revenue, i.e. Treasury securities. If they couldn't, I'd have less of a problem with the surplus, but they can and they do.

That it's "our fault" makes no difference to me, because I'm not one of "us". I'm not a Congressman. I'm not a Federal employee (anymore). I'm not an executive at Lockheed Martin or Goldman Sachs. I don't gain from this growing rent pressure. I lose. If I buy the subsidized imports, I gain a bit and lose a bit, but since I'm not gaining from the rents (being primarily a rent payer), I'm presumably losing more than I gain, because people who are primarily rent recipients also buy the imports.

If we can make more money from MRIs *right now* while China sells us their subsidized laptops, surely we'll have that money (or the investment assets purchased with it) available to us as the policies shift.

The means of producing an MRI machine might not be very useful in producing laptops when the price of laptops rises. We must then reorganize these means, and the reorganization is costly. Furthermore, when this shift occurs, China is entitled to impose rents (taxes) on U.S. citizens, because it has bought entitlement to the rents from our statesmen with its dollar surplus. China doesn't buy this entitlement to my tax revenue from me, of course. I don't gain from the transaction, because I'm primarily a taxpayer rather than a tax consumer.

Note that I chose MRIs randomly, since my gut was telling me they were too complicated for the Chinese to make, ...

I doubt that. I suppose China has already leap-frogged the U.S. in high tech manufacturing. The Chinese can't produce everything under the sun, but they can produce practically anything under the sun in growing quantity. Here's an example of a product very similar to the Alex eReader, soon to me Border's answer to Amazon's Kindle and Barnes and Noble's Nook. Border's eReader hasn't even reached the shelves yet, and this Chinese manufacturer is already showing a very similar device. The Border's device was designed in the U.S., to some extent, but it's probably to be manufactured in China anyway.

Of course, we make a lot more aircraft carriers and strategic bombers than the Chinese, but those products don't add to our prosperity. They subtract from it.

And if the policies do shift and China's currency suddenly normalizes to the international markets, they might start buying more of the things we make -- the things they can't afford now due to their undervalued currency. That could buffer the current account deficit.

I don't see that happening. We're a leading economy. We produce things that the Chinese aren't producing for themselves because they can't afford them. If individual Chinese producers earned more of the value of their produce (and Chinese monetary authorities earned less of it), they'd likely consume more of their own produce.

Food is a possible exception, because China's agricultural sector is much less efficient, and China's population, though younger now, ages much more rapidly. Also, without the national borders, many more Chinese would use their dollar wealth to move to the United States, and this migration could absorb the U.S. housing surplus rapidly, but of course, we absolutely do not have free international trade in labor.

Chinese statesmen create entitlement to consume the produce of Chinese citizens out of thin air, and U.S. statesmen create obligations of U.S. citizens out of thin air, and the Chinese statesmen may exchange entitlement to the produce of Chinese citizens for obligations of U.S. citizens. We have lots of this trade. It has nothing meaningfully to do with "freedom", but we have lots of it. Cross border trade in labor is far more restricted, by the statesmen. The statesmen do these things for themselves, not for "us".

Perhaps in part because our government is mortgaging our future by issuing record debt and spending the money on useless wild good chases?

Sounds persuasive to me.

I'll keep this short, as I think we're reaching an impasse position that has more in common than different.

(1) I guess I'm not as concerned about the economic dislocation as you, as it seems to me that any change in Chinese policy is likely to be mandated slowly, and the overlap of high-complexity US products with low-complexity Chinese products was low before they became an economic powerhouse, and I think remains low today. We didn't make laptops then and we don't make them now. I concede that we may be staying out of some intermediate-tech industries because of Chinese price pressure, though.

(2) The problem of US government debt purchased by foreign investors and sovereign powers is a problem created by *us*, not by currency policies in China. China's currency policy makes it easy for them to keep buying US debt specifically with US dollars they get from trade, sure, but as I said I don't see a lack of buyers in the last 10 years among nations that choose not to lock their currency against ours. Japan owns almost as much debt, yet their currency floats only on interest rate adjustment.

So the entitlement to future debt payments is hardly unique to China, even if they are the lead buyer of our government debt instruments. I certainly concur that it is rent-seeking on their part, although we'll see how much good it does them when the oil states switch to Euros.

(3) If China's currency policies really do keep it undervalued, then buying Chinese products really does constitute a wealth transfer to us by definition. We should be able to use the resources thus gained to become more competitive -- better education, infrastructure etc. so that we are prepared for changing global markets and economic dislocations.

Are we choosing to do that? Probably not, but that doesn't mean the wealth transfer itself is bad.

We're a leading economy. We produce things that the Chinese aren't producing for themselves because they can't afford them.

But are we producing things the Chinese cannot efficiently produce for export? That's the more relevant question.

OK that was not very short.

To avoid shrinking to the right, I'll continue at the bottom of the page.

Prof. Boudreaux- can you respond to this article by Warren Buffett?: http://money.cnn.com/magazines/fortune/fortune_...

He's wrong, but his argument is intuitively persuasive. It'd be nice to have a response from you to point to when I debate friends who cite Buffett's hypothetical.

Excellent article. I especially like the idea of "intergenerational inequities."

Corey,

Refuting Mr. Buffet's *specific* claim is extremely easy. The article was written in Nov. 2003. The last full month for which we have currency values is Feb. 2010.

Nov. 2003
EUR to USD 1.170892
Yen to USD 0.009156

Feb. 2010
EUR to USD 1.367933
Yen to USD 0.011088

Annual Rate of Return
EUR to USD 2.521%
Yen to USD 3.112%

So, I guess Mr. Buffet's investment was relatively inflation-resistant, but he didn't exactly make big money on this deal.

I read this.