Reposted from The Reading Eagle
Allen B. Rosenstein | December 4, 2012 |Reading Eagle
Don Rongione, president and CEO of Bollman Hat Co., Adamstown, has made an eloquent case for manufacturing in America (“It matters,” Business Weekly, Aug. 21). He cites increasing Chinese labor costs as a potential leveler of the trade playing field.
Increased Chinese production costs will help, but are not significant in the long run. Both Germany and Japan have higher labor rates, better life quality than the U.S. and commanding trade surpluses. Yet, in 1950, the United States was the world’s leading financial and industrial power.
Economic history is probably the most practical guide to the future. Economics, like math, is not a science, but a means for modeling complex systems.
Consider two economic theories: those expressed in Adam Smith’s treatise “The Wealth of Nations,” and the idea of using low-cost capital to limit inflation.
The Great Depression
The stock market crash of 1929 was exacerbated by increased capital cost and capital’s reduced availability. The bank prime interest rate was 5.5 percent to 6 percent, and banks stopped lending. Beginning in 1933, during the depths of the Great Depression, the Federal Reserve drove bank prime down to 1.5 percent to provide economy-building capital. For more than a decade, the U.S. prime rate held at 1.5 percent, spurring investments to create new wealth and nourish American industry and commerce. By 1950, after 17 years of low-cost capital, the U.S. had become the world’s leading manufacturing, financial and economic power.
No response to China
Popular economic theory traditionally held that inflation is controlled by increasing the cost and reducing the availability of capital. Such policy limits borrowing and slows business activity.
Beginning in the 1960s, after decades of prime-rate stability and negligible inflation, the Federal Reserve steadily increased interest rates to head off possible inflation. The higher return made U.S. Treasury obligations more attractive to international investors. The attendant increase in U.S. exchange rate and consequential loss of domestic investment in manufacturing capacity compromised America’s trade competitiveness.
It took 20 years, until the early 1980s, for our trade advantage to disappear. High prime rates inflated the dollar and drove up its international exchange rate to create an insurmountable obstacle for U.S. exports. The U.S. began consistently running trade deficits – importing more than it exported – and the trade balance has not recovered.
Extensive empirical data show the swelling trade deficit devastated U.S. industry. In 1994, China unilaterally increased the China/U. S. exchange rate by 49 percent. Five other nations followed suit, including Germany, Japan, Sweden and South Korea. In other words, by the stroke of a pen, without changing any production costs, our products instantly became more expensive in China. And the same product produced in China became 49.7 percent cheaper in the U.S. The U.S. trade deficit exploded.
It is a sad commentary on six decades of American political and economic leadership. The U.S. passively accepted unilateral exchange-rate manipulation by other nations without exercising the Federal Reserve’s mandate “to counter disorderly conditions in exchange markets through the purchase or sale of foreign currencies .” No legislative action is required.
There is no rational economic or political theory to justify a large sovereign nation’s acceptance of destructive exchange rates. Lower prime interest rates usually are accompanied by lower inflation. It is difficult to find a credible political or economic theory to justify the economic damage that we have created. Our nation’s future cries out for prosperity-creating, low-cost, self-funding capital and long-term investment in the nation’s most precious asset: its physical, human and financial infrastructure.
Dr. Allen B. Rosenstein is a professor of engineering emeritus at UCLA and founder of Pioneer Magnetics Inc., a California-based manufacturer and designer of power systems. He is a nationally recognized authority on the decline of American manufacturing.