How To Bring Back Manufacturing: Why Deficits Matter

While today Americans are called consumers, there was a time where we were not only consumers, but producers. Until the latter half of the 20th century, our country was a manufacturing powerhouse that not only produced goods for our domestic consumption, but sold to countries around the world. In the place of manufacturing, America has evolved in to a service oriented economy. While we still produce a great deal, we consume far more than the value of goods produced here, and as a result, we run gigantic trade deficits with our largest trading partners. While many argue that we are better off than ever and goods production is not necessary for us to have a thriving economy, our collective standards of living have not increased significantly since the height of our manufacturing in the 1960’s. The purchasing power of the dollar has steadily declined while the inflation adjusted wages of millions of middle class individuals have stagnated. Many of our cities across the Midwest and North East are decaying shells of what they once were in their economic zenith over half a century ago. What happened? Is it because of free trade that our manufacturing is gutted? Is it simply companies searching for cheaper labor and lax environmental standards that have left us unable to compete? While often cited as the culprit, they are unequivocally not the reason why trade is so drastically off balance in favor of other countries. The most important factor that has enabled other countries to run trade surpluses with the United States is our fiscal deficits that allow other countries to manipulate their currencies relative to the value of the Dollar. While politicians are quick to blame our trading partners, we need to take a long, hard look at our own fiscal policies that have enabled sustained trade deficits to begin with and make the difficult but necessary choices to pay down our debt. Doing such will not only help to balance trade but provide stability in the purchasing power of our currency and increase the amount of capital available for investment, resulting in greater economic output and higher standards of living for Americans of all economic backgrounds.

When container ships show up at the port of Los Angeles to unload intermodal containers filled with goods, they are often sent back to China empty or loaded with junk (such as computer parts, waste, ect) of far less value than what was delivered. The difference is made up with dollars, US Dollars to be exact. The seller of the goods will go to the bank in China to exchange these Dollars for the Chinese currency, the Yuan. As these transactions take place constantly, the banks in China accumulate large amounts of dollars. What do they do with this money? Normally, when a country accumulates large amounts of foreign currencies, their currency will rise in value relative to the other currency. Hence, the Yuan would rise in relative value to the Dollar based on the fundamental supply and demand relationship of the currencies. The problem for China is that if their currency rises in value, it makes their goods more expensive to purchase for United States costumers. In which case, the goods from China gradually become more and more expensive so long as we’re running giant trade deficits with them, to the point where it makes more sense to produce goods in the United States than it does China. What does China do to stop this? They buy our debt in the form of treasuries. It’s no coincidence that countries that we run the largest trade deficits with—China, Japan, and Saudi Arabia—are also the largest foreign holders of US debt. Why are they buying our debt? There’s only one reason: it’s the only way they can reduce their stock of United States Dollar holdings without their currency appreciating against ours. There’s literally no other financial instrument that is so liquid, abundant, and stable in value that can be purchased to reduce dollar holdings without reducing the value of our currency. We can point the finger to these countries for stealing our industry all we want, but ultimately we are enabling them to turn our trading relationship to their advantage every time we borrow money, which unfortunately is quite often, and in large amounts.

Reducing our government deficits, let alone paying down our debt, is going to require significant sacrifice. Both political parties will have to make compromises, and it will not be possible to put our country on a path of fiscal surpluses without cutting unnecessary services and expenses and raising taxes. We’ll have to make changes to Social Security and Medicare, together the largest source of government outlays, to ensure their long term solvency while ensuring seniors are sufficiently provided for financially and medically. We’ll have to eliminate wasteful military programs and withdraw from conflicts that are not critical to national security. We’ll need additional tax revenue as well which would be best in the form of a sales tax or value added tax as to not discourage savings, investment, and production. We’ll need to encourage private investment in our infrastructure by allowing new transportation to be built along highly trafficked rights of ways, such as highway easements and rail corridors owned and operated by federal and state governments. Digging ourselves out of the massive fiscal hole that we’ve dug ourselves into will likely result in a short term decline in our Gross Domestic Product given that GDP is in part measured by the amount of treasuries that are purchased by other governments (capital inflow). We’ll have to maintain a robust level of immigration to keep the overall size and output of the economy growing for the time being. There will be changes in the economy that will require the downsizing of some sectors, such as finance and retail, so our resources can be reallocated towards production and investment.  But all of this is a small cost to pay for long term economic growth and increased output with higher standards of living for all Americans. It will rebalance our economy so that our economic output is highest with a balance between consumption and investment. It will be simply impossible for other countries to run large, sustained trade surpluses with the United States and help to rebuild our productive capacity. Our currency will remain strong, capital will accrue, and job opportunities will become more abundant. Our debt is not just some abstract threat to our future generations, but a chief cause in the loss of our manufacturing and a decline in our economic output. It is something we need to coalesce to address today.