Mercantilism is back with a vengeance

‘The fundamental principles of mercantilism and neo-mercantilism are: direction of economic life by the authorities; the belief that money is wealth; exports are better than imports (thus protection and subsidies must be given to exporting industries); similarly tariff barriers on imports and the belief that a country can prosper only at the expense of others.’  (Faustino Ballve, 1956)

There is no lack of economists who express their disapproval of mercantilism, but who unfortunately agree with all or most of its principles as set out in the above quotation. This is redolent of Lewis Carroll ‘believing in six impossible things before breakfast’.

Even free market-leaning economists and journalists often fall into this fundamental trap: for example ‘mercantilism is bad but exports trump imports’.

An associated fallacy at the heart of Keynesianism is that unemployment is due to saving. Yet the result of increased saving is a shift from consuming towards capital formation, which itself creates employment of the same magnitude, with the benefit of greater production further down the line as the newly created capital equipment is put to use.

This is so obvious that even Keynes must have seen the fallacy, and indeed according to his intimate friends he was on the point of making a public declaration of this, but unfortunately died without having done so. This failure was an enormous boon for the politicians of this world who are still peddling a voodoo doctrine because it suits their own ends. It is very sad that the press, which is supposed to guard and promote our freedom, is for the most part peddling the same dope.

It was therefore with great sadness that I recently read two successive articles in the Daily Telegraph by its excellent and front ranking economics journalist Jeremy Warner, on 11th and 12th of August. Sadness, because the implication is that most of the press - let alone the politicos - is not going to change its general stance any time soon.

Mr Warner’s underlying point seems to be that the root cause of the debt crisis around the world is‘calamitous trade imbalances’ whichmean that‘creditor and debtor nations are ripping each other apart’.  Thus we need a ‘global solution’ via another G20 summit – this despite the fact that the previous one was nothing but a junket for the politicos. Thus also China needs to ‘abandon its mercantilism’ by ‘increasing the value of its currency’. Presumably by so doing it will increase its imports and reduce exports. But the idea that more exports than imports is ‘favourable’ is wrong. Indeed from the viewpoint of the country receiving a balance of imports clearly the consumers are better off. What on earth is the point of working to give your hard-won production away? The sole reason for exporting goods is to pay for imported goods.

Nobody would worry about a ‘trade imbalance’ between say Lancashire and Yorkshire, concerned that another War of the Roses may be on the way. In fact there is always a balancing item in the shape of an increase or decrease capital items, i.e. lending or investment. If this lending and investment is counted as ‘trade’ as it surely should, then the whole problem disappears in smoke!

So it would be absurdly stifling if all countries had to put themselves in a straitjacket of equating ‘exports’ and ‘imports’ (thus leaving out lending, borrowing and investment) year in and year out. This whole idea is so clearly nonsensical that one can only marvel at the political nous and influence of exporters. Of course Chinese exporters, German exporters and exporters around the world want a leg up, as do lots of other interest groups.  But that does not make the leg-ups sensible. The German government may also want to help the Euro by propping up other countries, but German citizens, who would pay for it, adamantly do not. At some point the citizens will surely win, and rightly so.

In other areas, Mr Warner appears to have reverted to Keynesianism (not surprising because Keynesianism and mercantilism are joined at the hip).  Having referred a few months ago to the Keynesian economist Paul Krugman as the great Paul Krugman he suggests that ‘in uncertain times the private sector stops spending and investing and saves the consequent surplus instead.’

But saving is investing; it enables companies to reduce some of their immediate consumer output and build further capital formation so as to produce more consumer goods later. Savings and investment are synonymous – even hoarding money under the bed has the same result via deflation – and saving is particularly necessary after a false boom. Mr Warner appears to be oblivious of the role of interest rates in the complex trade-offs between (a) consuming now and (b) saving now and enjoying later the greater fruits due to investment in capital equipment in the meantime.

This knowledge gap is surprising because Mr Warner is aware of F. A. Hayek who made the above paragraph crystal clear in his book Prices and Production.

Please Mr Warner, give us a glimpse of the real you. And if Hayek’s explanation of the crucial role that free-market interest rates play in the balancing of immediate consumption versus less production now but much more consumption later then please write about it and its consequences for interest rates directed by a central bank – a central bank that, like the large majority of central banks around the world, was formed to wage wars, and emphatically not to abolish market interest rates. It is the latter that will always be calamitous.

Can someone please explain why central banks control interests rates? A partial answer is given in the article in that central banks were formed to help wage war. That is now in the past. Surely in a freemarket interest rates should be set by the market. Or, am I missing something?
In my view, a central bank's purpose is to gain control of a nation's money supply. Once that happens, the state can do whatever it wants.

Does everyone (or indeed anyone) at the IEA really believe that trade deficits don't matter? Or that such deficits can be permitted to exist forever without accruing severe negative consequences? Or is it that people at the IEA all really and truly believe that everything can be solved with the magic of interest rate policy? I'm not sure which I find more incredible: that any reputable economist could support any of these viewpoints, or that this article should attract so little adverse comment from them?

Personally I see so many contentious points in this article of Terry Arthur's that it is difficult to know where to start, but perhaps the best starting point is here:

(i) "Nobody would worry about a ‘trade imbalance’ between say Lancashire and Yorkshire..."

Well actually many people in the economics community do worry about regional trade imbalances as well as national ones. Not least because it is regional imbalances that are to blame for the current Euro-crisis, as well as being one of the principal reasons for why the current government's localism agenda will fail, as I noted here previously.

Nor do such imbalances evaporate spontaneously in a puff of smoke. They are currently corrected (partially at least) by national taxation and wealth transfers via state subsidies, transfer payments and government investment. So unless someone can come up with a mechanism to tax China and the Gulf States (amongst others) I don't see how one can compare intra-national trade inequalities and inter-national trade inequalities in this simplistic manner. Analogies only work if they are equivalent. This one clearly isn't.

My next concern is with this statement:

(ii) "In fact there is always a balancing item in the shape of an increase or decrease capital items, i.e. lending or investment. If this lending and investment is counted as ‘trade’ as it surely should, then the whole problem disappears in smoke!"

Except that lending and investment are not trade. If they were, we wouldn't ever need to worry about paying our way in the world, would we? We could import whatever we wanted and if it was more than what we produced, we could just borrow the difference? After all, as Terry Arthur pointed out himself: "What on earth is the point of working to give your hard-won production away?" Surely all we would need to do is to either borrow money, or just print more money and give it to foreign companies and workers in exchange for their goods (which is pretty much what we have been doing in recent years, and why we are in this current debt crisis)?

So am I the only one who can see the gaping flaw in this policy? Even Milton Friedman could occasionally spot the fallacy of a free lunch when one was offered.

Firstly, such a policy could not continue indefinitely as the country would eventually run out of money. It is bad enough that such a disastrous policy has been allowed to continue unchallenged and uncorrected for over a quarter of a century, and not only here in the UK. The USA is in similar dire straits as Warren Buffett has pointed out.

The problem is that these balancing items are not trade: they are long term or permanent debt. We export money to pay for imported goods, but that money has to be repatriated one way or another. So those foreign entities that receive it, then use it to purchase our goods (i.e. our exports). So far, so good. But if they don't want our goods then they buy our assets: corporate bonds, shares, gilts, property. Then they are entitled to rent on those assets in perpetuity. So now our labours are used not in exchange for the goods of foreign labourers, but to pay for the rent and interest that is due on the assets we no longer own. Brilliant!

Again Warren Buffett has discussed this himself and pointed out that this amounts to a form of 'intergenerational inequity'. Does that phrase sound familiar? The IEA is often using such arguments itself to rail against things like state pension provision, but at least such provision contains a quid pro quo for each generation. In exchange for paying for their parents' support in old age, so the current generation will also be equally rewarded in their due turn. There is, though, no quid pro quo for the generation that is left to pay the trade deficit of its predecessors.

I would have thought that the IEA in particular would have understood all this. After all it has been banging on about the UK debt mountain for long enough. So why does it fail to acknowledge that the biggest and most dangerous contribution to this mountain is a long term imbalance in trade? It is one of the biggest fallacies in economics that inward investment is good for an economy. Such investment is nothing more than accumulated debt. When overseas investor invest in the UK economy, they are not giving us their money for free. They are lending it to us. Sooner or later they will want it back with interest.

(iii) "So it would be absurdly stifling if all countries had to put themselves in a straitjacket of equating ‘exports’ and ‘imports’ (thus leaving out lending, borrowing and investment) year in and year out."

In which case why do so many people at the IEA advocate similar straitjacket policies for governments via balanced budgets?

It is true that demanding that exports and imports balance year in and year out would provide no flexibility to take account of the vagaries of the business cycle. But again Warren Buffett has discussed this as well and suggested a system of tradable import certificates (ICs) that would allow market mechanisms to regulate the trade balance. He suggested a time limit of 6 months on these ICs in order to counter excessive speculation, but if that time limit were extended to 3 or 4 years on a small minority of ICs they could be used to address the fluctuating demands of the business cycle.

(iv) "Savings and investment are synonymous - even hoarding money under the bed has the same result via deflation..."

Absolutely not! Savings and investment are not synonymous otherwise they would always have the same effective interest rate and there would be no such things as liquidity traps.

As for deflation: how can that be considered to be equivalent to investment? Deflation is actually equivalent to asset speculation but with cash as the asset. Hoarding money in this case is no more akin to investing than is commodity speculation by putting your money into gold when the price of gold is rising. Neither results in the growth of capital plant, machinery or national output and jobs. Just look at what happened during the Great Depression in the USA for a case in point.

Equally worryingly, parts of this article appears to be another example of a repetitious theme at the IEA when it comes to discussing economic policies. Whatever the question, the answer too often appears to be the same: it was all the fault of a flawed interest rate policy. So here is the BIG question. How can the same solution (i.e. interest rates) be used to control four or five independent economic indicators (M0 or M2 inflation, M4 debt, the trade balance, GDP growth and investment)? Or to put it another way: how can one interest rate be set to at least four different values at the same time?

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