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We have only ourselves to blame for manufacturing’s decline

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Reposted from The Reading Eagle


We have only ourselves to blame for manufacturing’s decline

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.

What happened?

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.

13 Responses to “We have only ourselves to blame for manufacturing’s decline”

  1. China Watcher says:

    Why would we expect the Chinese to cooperate with such a scheme by selling us enough currency to drive the yuan’s value up to a point consistent with normal market forces? We can print the dollars freely (ignoring the longer term inflationary consequences), but they control the flow of capital out of China. As they are sitting on a couple trillion worth of dollar assets and a couple trillion of non-dollar assets, all the People’s Bank of China would have to do is force Chinese to convert their yuan for dollars in China. Someone will have to explain how we can make them sell their currencies internationally when they don’t want to.

  2. Will Wilkin says:

    The problem with currency exchange rate wars is the other parties can always play the same game, it never ends, its a moving target. That is why it seems to me a Balanced Trade policy using Import Certificates issued in the same amount as exports would cut through the international games and bring the control of our trade back to ourselves, no cooperation needed from any other country for our policy to achieve the balanced trade we need to revive American manufacturing and employment and eliminate the huge annual drain of wealth the trade deficits cause.

  3. Mo says:

    Going off sound money is what led to manufacturing’s demise in the US. Every since the US left the gold standard in 1971, the US has had increasing trade and budget deficits. Anytime a country inflates faster than a trade partner it usually leads to trade deficits and causes input prices to rise faster thus making the country uncompetitive in export markets. Having an overvalued currency also hurts but if it’s coupled with high savings then it helps to neutralize some disadvantages of having an overvalued currency. However, when an overvalued currency is coupled with low savings and inflationary consumption, then it leads evenutally to capital consumption and the emergence of rustbelts.

    The Great Depression wasn’t caused by high interest rates but was the result of an easy monetary policy in the 1920s that setup a boom and bust cycle which was followed with very bad fiscal and monetary policies afterwards to prevent the correction that should have occurred. The 1921 depression showed that the quicker the liquidation, the quicker the recovery.

    For an example of bad policies that prolonged the depression lets review the policy of trying to prop up wages from 1929-1932. Hoover after the crash of 1929 was jawboning businesses to keep wages up in an environment where the money supply decreased by over 30%. So by trying to keep wages at the level before the deflation, businesses could only afford to keep less workers so unemployment increased. Other examples of bad policies was that the gov’t increased taxes to fund public works projects that had the effect of generating some employment but on net there was job losses as businesses slashed employment.

    So the depression was prolonged because of bad policies that propped up wages, increased taxation, regulations and tariffs. These policies had the effect of decreasing revenues, profits and increasing costs for the private sector. Keynes General Theory in 1936 really was a prescription to use monetary policy to counter-act the effects of the increased government intervention due to Hoover and Roosevelt. By using monetary policy to inflate prices, prices for goods would rise to offset the higher costs of doing business due to the propping up of wages, increased taxation and burdensome regulations.

    • Will Wilkin says:

      Hi Mo, Glad you’re here, you always make me think.

      I’ve been thinking particularly about your idea that abandoning “sound money” is the key to our economic history, that abandoning the gold standard in 1971 led to our subsequent 36+ years of trade and budget deficits, and that these trade deficits are rooted in loss of competitiveness through inflation of input prices.

      To me, it seems you reduce all economic history to a quantitative system of prices, whereas I believe there are more qualitative and social developments explaining our decline, though they will of course also be registered quantitatively.

      Rather than leave the flow of international trade to a calculus of prices, I would assert the primacy of community stability, ultimately expressed as national interest. By that I mean the community of citizens, in the interest of stability of their community, enforce certain trade controls in order to ensure the stability and long-term viability of economic enterprises around which people’s lives are organized. Real-life networks of human life and economy are based on these enterprises and the institutions they support. When these networks are disturbed, so too is the welfare of those people, in their individual experiences and also in the damage to the larger system on which they depend, yielding larger social multiplier effects. If the disturbance is great enough, it ultimately threatens the viability of the social system itself. And much human misery results.

      If global trade, based on nothing but sheer prices, were uninhibited, the flows of capital and enterprise would be too volatile to support such real-life human endeavors like raising children in a local community, or developing one’s career in a stable industry. So too would be disrupted the reliable networks of economic interdependence in the larger national market, to which are tied the economic and existential stability of millions of our fellow citizens. These networks of economic interdependence include jobs and retirement systems and social insurance, including Social Security. Which leads us to the need for political intervention in the market, by and in the interests of those communities of human beings affected by that market.

      In other words, the community, at levels municipal up to national, and no doubt globally too to some degree, requires political intervention in the market, in order to counteract instability and disruption of human economy. These interventions can and must take many forms, from the valuation of money, to the treatment of labor or the environment, to the the flows of goods across borders. These interventions are necessary because ultimately economy is about human beings, not prices.

      I should qualify that. IF the political system were not bought out by anti-social special interests, but rather allowed genuine expression of the public, that is, NATIONAL interest (and I realize that is a HUGE counterfactual “if”), THEN political intervention in the market would serve to stabilize those local (up to national) economic enterprises and institutions to support maximum human welfare for those whose economic existence is derived from those economic arrangements. By enterprises I mean companies, and by institutions I mean every communal organization from school systems and municipalities to systems of social insurance and retirements.

      But unfortunately, the political system HAS been bought out by powerful antisocial private economic and political interests. They are constituted as Wall Street investment banks and multinational corporations, as armaments contractors and the official governmental deployers of military power. To get rich and temporarily run the world, the principals of these institutions run them in ways that undermine the viability of the larger national interest, including all the more local levels of that national interest. Thus we have fiscal cries from municipal through state and national levels, and policies liquidating our national economic health even as corporate profits boom. Multinational corporations and financial industries buy so-called free trade policies, while armaments contractors and their patrons in State and Defense are rewarded with undeclared illegal unConstitutional aggressive war applications in multiple countries.
      As these policies encourage offshoring American industries and jobs for higher profits elsewhere, for corporate profit and diplomatic advantage, those accruing the wealth and power now must seek to cut Social Security and Medicare, because they have off-shored the manufacturing engines of wealth-creation that formerly supported the social contract. In other words, they have run the country into the ground for their own short-term selfish interests, economic and imperial.

      Well Mo, I hate to be so negative. But this is the truth as best I can tell. Our county’s decline is not explained by prices, gold, or even markets. It is explained by greed and betrayal, by megalomania and militariomania (confession: I made that word up because its the right word here). The principals of those institutions, public and private, have shown no patriotism, no respect for the human networks of community at the local to national level, no commitment to the long-term viability of American prosperity. And so our infrastructure decays, our industries are off-shored, our Treasury is bankrupted for war and war hardware. And because the class that has accrued such fabulous wealth in this process has also bought the Republican and Democratic Parties, they enjoy historically low taxes, unwilling to pay for infrastructure, governance or the social contract. In fact, they like America in decline, they are rich and powerful –at least for the moment.

      Regarding low savings and “inflationary consumption,” which you say lead to “capital consumption and rustbelts,” I submit there is no crisis of savings but rather a deliberate underinvestment by the super-wealthy because they do not perceive interest (maximum profit) in investing in America’s future. They as a class, and in their corporations flush with cash, do not have patriotic spirit to pay taxes for American infrastructure, nor patriotic spirit to invest in American economic growth. The 1%, not just as a class in rhetorical terms but a class controlling 40% of America’s wealth, have staked their future with the profits of multinational corporations, rather than with the prosperity of the USA. And so they give us the “fiscal cliff,” an artificial panic into cutting the social contract because they really have exported the wealth-creating manufacturing that would have paid for it. Similarly, rustbelts are the result of multinationals abandoning America’s cities to deploy their capital where labor is cheaper and subsidies higher.

      Debating causes of the Great Depression does not seem pertinent to our challenge to fix the Great Deterioration (yes, my term again) we are now experiencing. But I will say that supporting high wages then is similar to what we need to think about now: how to GROW our economy back into prosperity and full employment. The most direct approach to such revival seems to me to implement a balanced trade policy, using Import Certificates issued in the same amount as exports, which would divert $600Billion or more every year out of trade deficit and into domestic manufacturing. Think of how many manufacturing jobs that would directly create! Then think of how many additional multiplier jobs in service and construction sectors could also be created! There have always been taxes and regulations and tariffs, so it would be wrong to blame them for Depression. The Great Depression is interesting but the world in which our economy is now collapsing is quite different. Consider our industries have been off shored for maximum profits to the 1%, and, due to the free trade policies, the remaining industries face the onslaught of 500,000 importers anxious to flood our markets with their wares. The effect on American workers and industries is predictable: it is a collapsing GDP, shriveled tax base, and expanded social safety net obligation. Socially, that is what “free trade” policies continue to bring. Fiscally, they bring nothing but threats of austerity, i.e., historic attacks on the social contract. Again, this is not the result of currency values or regulations or taxes, but rather free trade policies and complete abandonment of all patriotism in corporate and public governance.

  4. Mo says:

    Will your description of whats wrong with economy is all related to unsound money. Under Bretton Woods the top 1% made maybe 30 times the average worker, now its over 300%. Without any anchor to money, fiat money can be created at will and gets directed to special interests. Under a sound monetary system, the dismantling of the US industrial base could not have occurred the way it has with fiat money.

    • Will Wilkin says:

      Please explain how the US could even create a “sound currency?”

      • Mo says:

        The preferred sound monetary system is when a currency like the dollar is defined as a certain weight of a metal like gold. The constitution defined the dollar as a certain weight of silver and gold which in essence fixed the exchange rate between the two metals. What should have originally been done was to define the dollar as a certain weight of one metal and then allow other metals like silver to be made into coins at a fixed weight where it would float against gold. By fixing the exchange rates between the two metals it wound up causing one metal to circulate at a time because one metal would become undervalued to the other as the market exchange rates changed.

        Because of the huge amount of debt outstanding today and large amount of monety that has been created the last 30 years, it would take a huge rise in the price of gold to back all currency and demand deposits in circulation today. So to transition to a sounder monetary system without having to increase the price of gold sharply, the following first steps below could be a start back on the road to sound money.

        Some first steps:

        -Allow the unlimited coinage of gold and silver at defined weights to be used as currency where the value of the coins reflect market value.
        -The Fed could purchase a significant amount of treasury securities and then cancel them to reduce the debt burden of gov’t.
        -Implement 100% reserve banking because fractional reserve banking increases maturity mismatching where too many long term investments get financed by very short term financing which thus sets up the stage for the boom and bust cycle.
        -Reduce wasteful gov’t spending especially spending not occuring in the US.
        -Allow interest rates to float to reflect the real level of savings in the economy.

  5. Will Wilkin says:

    Hi Mo, I disagree when you say that my “description of what’s wrong with economy is all related to unsound money.” I find your theory highly reductionist and ideological. It ignores trade policy, it ignores politics and all the economic interventions (regulation, taxes, how much and what kind of public investment, social insurance, etc) it brings, it ignores the many human motives that are not determined by prices but rather qualitative choices about what is important in life and society. It ignores the distribution of wealth and power, it ignores the quality (both relatively and absolutely) of infrastructure and education and technology. All these factors combine to shape the larger dynamic of economic and social development, and there is no way all these factors are driven by the role of gold and silver in the economy. You seem unwilling to think about any of these factors except, apparently, as epiphenomena of the value of the dollar in relation to gold.

    I ask you to consider that all these QUALITATIVE human, social, and political factors I name are in play simultaneously, and their dynamic is central to whether jobs are here or abroad, central to the size of our economy and to how much unemployment there will be, central to choosing what public investments are made, central to whether the quality and price of our goods are competitive in trade, central to the rate of growth in labor productivity and the standard of living of our citizenry. To somehow assume that basing the dollar on gold will automatically and perfectly regulate all these complex human social choices is like reducing all of society to a math equation. You forget about the human dimension, about choices and values and interests vying for influence and a piece of the pie.

    • Mo says:

      There are lot of factors that go into determing human behavior with regards to economic choices. However, unsound money tends to facilitate some of the worst aspects of human behavior like greed. Since money is the medium of exchange and is used for economic calcualtion it affects all aspects of society. Lets look at some examples:

      -The large redistribution of wealth from the middle class to the top 1% has occurred since end the of Bretton Woods because now special interests can have unlimited money directed to their interests.
      -Inflation causes future costs to be higher than anticipated which thus leads to increased budget deficts.
      -Inflating the money supply faster relative to trade partners leads to trade deficits.
      -Inflation causes a shortfall in gov’t expenditures thus leading to increased taxes.
      -Regulations become more costly to implement due to inflation.
      -The political process becomes severely distorted where special interests that benefit from inflation become too dominant in politics.

      I guess to note, fiat money can be used to make some social investments that would be beneficial to society. However, just to get some favorable investment would continue to take an extreme amount of persistence from the public.

      In my opinion it is better to have a monetary system that is rules based like a commodity backed monetary system instead of a highly discretionary fiat monetary system like today. History has shown time and time again that highly discretionary fiat monetary systems never last and that eventually the value of paper money goes to 0.

  6. Jerry says:

    The “corporatism” of Mussolini, Hitler and other fascists has become the defacto world standard outside the USA. You can call it socialism for businesses if you prefer, but it works as follows:

    Most foreign governments own most of their manufacturing capacity (instead of private ownership) and subsidize their products to be DUMPED into US markets so they can be sold below cost if necessary in order to destroy the American competition. The foreign companies effectively have the resources of an entire nation behind them vs. the limited resources of an American firm.

    The money invested in “dumping” can be recouped after the American firms are out of business. When a business has the resources of an entire government behind it, taking a loss that would be ruinous for a US firm is no big deal.

    My favorite recent case study would be Evergreen Solar — an American firm that developed an exciting new solar cell company that the Chinese knew they couldn’t compete with on a level playing field.

    Consequently, the Chinese flooded the market with cheap solar cells until Evergreen Solar was strangled while still in the cradle. After the bankruptcy proceeding, China swooped in, purchased the patents, much of the equipment and hired on the key personnel to move the entire operation en masse to China. And oh by the way, the taxpayers of Massachusetts gave up quite a bit of revenue to encourage Evergreen Solar to build in their state in the hopes of all the great jobs they were going to get. America shouldn’t try to compete at fascism with fascists. Just quit trading with them altogether.

    • Tom T. says:

      It is the game of monopoly where those with power adjust the rules of the game so that they never lose. It is rigged.

      I have seen in my own industry where the definition of efficiency was always corporate efficiency and not economic efficiency. Politicians and judges used this “cover” to help corporations defraud the markets. It has had a terrible effect on economic efficiency, you know, the one where free markets send price signals in the market. Instead, the price signals in the market are all managed by those corporations with market power. It substitutes corporate efficiency for market efficiency. I have seen it in our judiciary, our legislative and our executive branches first hand.

      The whole bank debacle was a perfect example of this—- Wall Street tricked politicians (willingly tricked that is) into separating economic risks with economic rewards and it crashed the system. Much of the same tricks were played prior to and leading up to the Great Depression. It is sad that we have to repeat recent history– just 90 years ago— because our politicians are so incompetent or corrupt.

      I have said it before– we have more politicians who should be in federal prison instead of making policy in this country than at any time in my life.

      Tom T.

    • Mo says:

      Jerry what enables foreign companies to sell below cost is the unlimited amount of credit they get that is created out of thin air with computer keyclicks from their central banks. This allows companies to sell products below cost for as long as it takes to wipe out competition.

      It’s important to note that countries like China that do this have high savings. China’s savings rate is close to 50% of GDP. The US on the other has very low total gross savings. All the years of printing money to fund wars and malinvestments that have raised commodity prices hundreds of percent have really hurt the US industrial base. For instance before the Iraqi war oil averaged $30 a barrel, now it averages over $100.

  7. Cornelius says:

    The Federal Reserve is destructive to the economy as well. I remember their solution to inflation in the 80s. Interest rates soared and people lost their homes as a result. Today’s 0 percent interest rate is part of the bailout. It’s the part that nobody will be paying back. They want investors to gamble in the stock market, the casino where the the house always wins and the average investor gets screwed. It may not do much for the deficit but the Federal Reserve has to go along with their dangerous economic policies.


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