Trade Wars and GDP Growth

Bojidar Marinov

Podcast: Axe to the Root

“What does the GDP growth of the last one quarter tell us about the economy, from a Biblical perspective?”

Assigned Reading:
Regime Uncertainty, Robert Higgs (Published in The Independent Review, Volume 1, Number 4, of Spring 1997)


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Welcome to Episode 78 of Axe to the Root Podcast, part of the War Room Productions, I am Bo Marinov, and for the next 30 minutes we will be covering an area of life that is normally not considered to be “part of the gospel.” At least according to modern pastors and theologians, who just love to separate the world and the life and society of man into two areas: “this is the gospel,” and “this is not the gospel.” Of course, there is a reason for their dividing the world into “gospel” and “not gospel,” and it is the good old motive of power and power-mongering. But we will leave that to another episode. Suffice to say here, from the position of the Bible – and from the position of Christian Reconstruction – there is nothing that is outside the scope of the Gospel. All of life is covenantal, which means, all of life is ethical-judicial. All of life is subject to issues of good and evil, and therefore all of life falls under the judgment of God. Christ started his Great Commission with the words, “All authority has been given to Me,” and charged the disciples to teach the nations all He has commanded them. And all His commandments are given in the whole Bible, and they cover every aspect, and every area of life. And the description of the Gospel in 1 Cor. 15 ends with all things being subjected to Him. And “all things” means “all things,” not just the few religious topics pastors and theologians like to babble about.

Including the economy. The economy of a nation is also subject to the Gospel and is part of the Gospel; it is part of that all that He has commanded us. Economic decisions – whether individual or corporate or national – are ethical, they are either good or evil, and they are therefore subject to the Law of God. And, mark this, individuals and nations are either blessed or cursed for their economic decisions, according to whether the decisions were good or evil. Issues like forms of property, wages and profits, investments and consumption, economic growth, money, money supply, and banking, stock markets, government interference, taxes and regulations, government control over the job market, etc., are part of that all authority given to Christ. To exclude these from our Biblical, Gospel-centered analysis of our society today will mean to truncate the Gospel and to limit the power and authority of Jesus Christ in the world today; and with this, to allow areas of free reign for idols and false ideologies – and injustice. These need to be addressed from a Biblical, covenantal perspective, and we as Christians need to call for repentance and redemption in all these areas just like we call for repentance and redemption in the personal life of men. (Besides, what does personal repentance of an economist, or a businessman, or a government employee look like in his professional endeavors?)

What I want to talk about this week is GDP growth and trade wars. I was asked to cover this issue some time ago, but I didn’t get to it until now, and in fact, now is a very good time given the news of the last several weeks. First, of course, we have the great news of two quarters of high – and rather unexpected – GDP growth: 4.1% for the second quarter of 2018, and 3.5% for the third quarter of 2018. (Keep in mind that this is extrapolated for a whole year, it is not for the specific quarter. Thus, the second quarter’s real growth is a little over 1%, and the third quarter’s is a little less then 0.9%.) Now, Donald Trump is using this for his self-propaganda, claiming that there has never been growth above 2% with the previous administration. That is not true. Obama had three quarters better than that: 4.7% in the 4th quarter of 2011, and then 5.1% and 4.9% in the 2nd and 3rd quarters of 2014, two consecutive quarters of extraordinarily high GDP growth. (Again, remember, this is all extrapolated, not absolute.) Obama also had six quarters of above 3% growth, and they were quite consistently spread. On real annual basis, out of 8 years in office, Obama had 4 years of above 2% growth, 3 years of about 1.6% growth, and one year of negative growth, -2.8%, but that was his first year, arguably a left over from the previous administration. I say this not as some sort of eulogy for Obama or a defense of him; just keep it in mind before you get swayed by the current propaganda coming from the White House. Figures don’t lie, but don’t let liars figure it for you.

This GDP growth coincided with another economic news, namely, Trump’s trade war against China, Canada, the European Union, and pretty much the whole world, in fact, over tariffs, and specifically over tariffs on steel. From previous episodes of Axe to the Root, you know my view on these tariffs: they are nothing more than another example of corruption, boosting the profits of crony capitalists not by increasing productivity, but by robbing the public. Domestic steel producers in the US held 75% of the market anyway; the only thing they did after the tariffs were introduced was to increase their prices and make their customers pay more. This increased cost for their customers created problems for companies who are traditional exporters – who now lost their export base – and for domestic companies that sell to the domestic market, so now the US consumers will have to pay higher prices. It also made US companies buy lots of inventory from China in anticipation of the tariffs, which diverted resources from investing in productivity. (More about this later.) In addition, China declared their own tariffs in response, which made a number of American businesses lose their export contracts – especially agricultural producers in the Midwest. Which, of course, created better opportunities for agricultural producers in Mexico and Brazil, who are now having a heck of a year moving into markets lost by American agricultural producers. To which the Trump administration responded with declaring a $12 billion bailout for farmers – which, however, is absolutely insufficient to cover the long-term cost of lost markets. (And in the trade with agricultural products, it sometimes takes decades to get established in the market – ask the Texas ranchers about.) There are also certain conditions to the bailout which leave the smaller producers out. Not to mention the irony that, for example, the two largest pork-producers in the country that qualify for the bailouts – Smithfield Foods and JBS – are Chinese and Brazilian-owned, respectively. And they are not the only foreign-owned firms that would profit from the bailout – under the rules of the $1.2 billion initial purchase of foods, there is no way to tell inventories bought from Mexican or Canadian farmers from those bought from US farmers. The confusion the Trump administration created is so perfect that it is worthy of being mentioned in Joseph Heller’s Catch-22. Previous presidents have also had their moments, but we haven’t seen such ineptness and chaos since Jimmy Carter.

Then there is the curious case of the actions of the Chinese businesses and government. The Chinese government did put up an air of retaliating against Trump’s tariffs with their own tariffs. Now, American companies responded to the tariffs with increased imports before the tariffs hit, to stock their inventories with cheaper steel and other materials. But there was no corresponding action on the Chinese side: at least not as active as expected. Chinese importers did not rush to buy US goods in anticipation of the increased Chinese tariffs. It was almost as if the Chinese businesses were told by their government to hold on until second notice. That second notice came just this last week: the Chinese government announced that they would lower the tariffs for all imports by 20-30%. On the surface, it looks like the Chinese government has surrendered and has done Trump’s bidding to lower their tariffs. In reality, however, a few important details paint a different picture. First, the Chinese did it only after American exporters lost their markets in China, and after American importers rushed to buy to stock up their inventories. This both opened the Chinese market for non-US producers and gave the Chinese economy a significant short-term financial injection. Second, the lowered tariffs apply to all imports, and not only to those from the US. Which means, the Chinese government practically told the whole world that they have an open door to complete against American producers on Chinese soil. And, third, the lower tariffs come at a time when the Chinese government is in the process of further de-regulating its manufacturing. Lower costs plus lower regulation will make it even more attractive for American companies to outsource to China; the resulting prices will be low enough to cancel the effect of the US tariffs, and so the Chinese will continue having good positions on the US markets. In short, the Chinese government played the game of, “We will do what you want us to do, technically, but we will do it in a way that will hurt you more than it hurts us.”

Or, to make it even clearer, the Chinese government seems to have learned the lesson of the last 150 years of European history: The best way to win a trade war is to lose it. Or, even better, to lose it at the right moment, when your opponent is worked up to fight it to the end. Meanwhile, the Trump administration is operating on obsolete feudal ideologies of two centuries ago.

And to all this we need to add a last but very important element of the picture: the financial markets. I know, quite a few Christians eye the stock market with suspicion: is it real, and does it really have anything to do with the economy? I am not going to cover this issue here. But there is a curious thing happening there: starting in January this year, the stock market has been in constant turmoil, after experiencing a relatively stable growth for several years. The Dow Jones almost hit 27,000 in January this year, and then collapsed by over 10%. It tried again in September, and collapsed again. However you want to interpret this, one thing is sure: investors are running from investments and are liquidating their inventories the moment the prices go above certain level. As a stock market specialist said recently, “Stocks do not lie. They reveal people’s psychology.” Something is happening, and it is not good.

But there is still the objection: no matter what we say about the Trump administration, the GDP has been rising by more than 3.5% on an annual basis for two consecutive quarters. How do you explain that? And what does it mean that the GDP is growing by so much? And what we supposed to make of the stock market signals? And how are we supposed to understand all this within a covenantal frame of interpretation? Let’s look at it.

What is GDP, or Gross Domestic Product?

GDP is the aggregate market value of all goods and services produced in certain territory over the course of a certain period, usually a year. Remember Robinson Crusoe from our earlier episode of Axe to the Root titled “The Nature of Economic Growth.” The amount of berries Robinson gathers every day is his GDP for the day. (Given that Robinson doesn’t import any value from other places, and all of this value is produced by him.) If Robinson spends half of the day making a pole and the other half gathering berries, then his GDP will be the sum of the work put in the pole plus the amount of berries he gathered for half day. If we move to more realistic examples, the things get a little bit more complicated. If you are a shoemaker, and you are making 500 pairs of shoes a year, your annual GDP will be the market value of these shoes, but discounted by the cost of the materials you bought from other people. Those other materials were already existing value, so your GDP will be only the value you created above the sum of the value you “imported.” A nation’s GDP, then, will equal the market value of the final goods and services provided, not including intermediary or imported materials and services. It is what total value we as a nation produce over one year. It will include all the consumer goods we produce. It will also include all the services we produce. It will include all the investments in machinery and organization of production that increase productivity per capita. It will include all the scientific and technological research and discoveries. It will include entertainment and art. It will include all the government services – although, admittedly, given that all these services can be provided at much lower prices and higher quality at the free market, they will be highly overrated in calculating the GDP. It will, however, exclude all the imports, and it will exclude all the intermediate materials used to produce final goods. And it will exclude financial investments: stocks and bonds are only transfer of deeds, not production, and the money paid for stocks count as “product” only when the company uses it to make investments.

There are several ways of calculating GDP, and all of them should lead to the same figures, except that there are always errors in calculation. I will omit mentioning all of them, and I will only focus on the simplest – and according to the US Bureau of Economic Analysis, the most reliable – methodology. It is called the Expenditure Approach, and it takes in account the final uses of all goods and services. The formula is this:

GDP = Consumption + Investment + Government spending + Export – Import

It should be quite clear: our total product is equal to what we spend on consumer goods plus what companies spend on investment in productivity plus what the government spends (someone must produce it for the government to buy it), plus what people abroad spend on our goods (exports), and from all this, we need to subtract what we spend on other nations’ imports (because they were not produced here in the US).

What is GDP good for, what does it reveal and what doesn’t it reveal? And is it reliable as an economic indicator? It is reliable, as far as its purpose goes. But it is also limited, and often does not give the information people think it does. For one, it does reveal the total production of a territory over a certain period. When we say that the GDP of the industrial area Beaumont-Greater Houston-Corpus Christi equals that of Russia, that speaks volumes about the economy of Russia (140 million population) vs. the economy of South East Texas (10 million population). When we take the product and divide it by the population, we can calculate the mean productivity of an area; which goes under the name “GDP per capita.” Although, our number may differ from the real productivity, given that we don’t know how many hours of productive work has the average worker worked. (A modern, highly productive plant may have been idle for most of the year and will show low productivity, while workers in some backward place may have been forced to work 16 hours a day in primitive conditions, and may show higher productivity.)

One thing that GDP can’t reveal is the living standard of the average person in the nation. Of course, under normal circumstances, there is a high correlation between living standards and GDP per capita. But remember, GDP includes government services and expenses. If a nation has high productivity but its government uses all this high productivity to produce expensive weapons and stockpile them (or drop them on other nations), then the living standards of the nation, measured in produced goods and services, must be discounted by the product which goes into building those weapons. Yes, I know, the workers who produce them may still be paid, but the market will have fewer consumer goods for the money they may have.

And still another thing that GDP can’t reveal – and this is the most important of all for the purposes of this episode – is whether the nation is long-term oriented in its economic activities, or is short-term oriented. GDP is an aggregate, and it is neutral in relation to the question of whether the product of the nation was focused on consumption, or on investments. Why is this important?

To answer this question, the listeners of Axe to the Root need to go back to Episode 7, “The Nature of Economic Growth.” In it, we saw the example of the simplest possible economy, Robinson Crusoe on an uninhabited island. The most important question Robinson faces is whether he wants to continue with this subsistence economy, or whether he wants to grow it. But for him to grow it, he needs to forgo present consumption and spend some of his resources (time and food, or even go hungry for a day) to create tools that will increase his productivity: a 15ft pole, traps for goats, an enclosure for the goats, a frame for drying fruits, etc., etc. His time and resources can’t be spent simultaneously on producing food and on producing tools; he needs to decide how much consumption he is willing to forgo, otherwise he will have no economic growth. However, from the perspective of GDP, we won’t be able to tell if Robinson has worked on productivity or on consumption; his activities on any single day will be marked as the same GDP whether he was busy making the 15ft pole or foraging for berries.

And why is this important? Because, only by knowing what Robinson put his efforts into the previous day – consumption or investments – we will be able to predict what his GDP will be the next day. Obviously, if he put his efforts into foraging, he may have gone to bed full and happy, his next day’s GDP will be the same as the previous day’s. But if he put his efforts into investing in productivity, he may have gone to bed hungry and unhappy, but his next day’s GDP will be higher. And we don’t just want to measure the GDP of yesterday. We want to know what it tells us about tomorrow.

So, what does the growth of the GDP of the United States in the last two quarters tell us about tomorrow? A few days ago, Bob Bryan, analyst at Business Insider, put up an article which breaks down the GDP growth for the last quarter into different categories, in order to find out what it tells us about the future. And here’s what he discovered.

First, he points out that, indeed, the US GDP grew at a faster pace than expected: 3.5% instead of 3.3%, on an annual basis. That in addition to the previous quarter when it grew by 4.1%. But, as I mentioned above, the GDP numbers are a neutral aggregate; they don’t tell us what has grown and what hasn’t. Inside this 3.5%, there are some not so good facts about the direction our economy is taking.

The most obvious thing in it is that trade was the greatest drag on the economy in the last one quarter. Remember, when calculating GDP, exports are a plus, but imports are a minus. So when a country has a negative trade balance, this will affect the GDP: the GDP will be lower by the difference between imports and exports. Remember how Donald Trump constantly proclaims that his purpose is to make the world by American-made goods, and correct the trade deficit between America and the world? Well, in the last one quarter, that deficit actually became even worse, with the gaps between imports and exports widening even more. The reason, as we said earlier, was that US companies, in anticipation of the tariffs, rushed to fill their inventories with still cheaper materials. Such rush was not observed on the Chinese side, or on the side of any of America’s trading partners, whether the European Union or Canada or Mexico or Brazil or anyone else. For all practical purposes, Trump’s tariffs gave the world a significant financial injection in US dollars. If those economies were thinking of investing in new production facilities, this is a good time for it, while the American economy is simply piling up inventories. (And inventories are not investments, they are simply future consumption.)

The trade deficit was so gigantic that it actually dragged the GDP down by 1.8 percentage points. To give you an idea of what that means, it means that if the trade balance had remained neutral (at zero), we would have had a GDP growth of whopping 5.3% percent on an annual basis – something that hasn’t happened in the US for over 20 years! Apparently, whatever gains Trump thinks the US economy will get from his tariffs, will be simply making up for the deficit created by those same tariffs within the last six months.

Building up inventories, as I mentioned earlier, is not investment. It doesn’t change the productivity of the economy. Whether the inventories are full or half full, won’t change the rate by which the economy produces goods and services. So, in the dichotomy between investment and consumption we talked before, building up inventories must be counted on the side of consumption. The money that the producers spent on inventories can’t be used for building new production facilities – at least not until sometime in the future when these inventories are used for the production of consumer goods and then sold to the buyers. The question, however, is this: will the buyers in the future have the larger quantities of money to buy these consumer goods? It is good that we are preparing to produce more consumer goods. But what if the market runs out of purchasing power to buy them?

This question is very relevant to the situation, given another insight from Bob Bryan’s article, namely, that almost all of the GDP growth in the last quarter, and in the quarter before it, came from increased consumption. Or, as economists call it, “strong consumer confidence.” But “consumer confidence” is nothing more than the propensity of the consumers to spend more than save, an in fact, to be willing to go deeper into consumer debt. This fact is really startling, and should worry us immensely if we care about the future of America: almost all of the GDP growth of the US for the last quarter came from increased consumption, not from investments or trade. You may want to call it “consumer confidence,” but let’s call for it what it is: it is consuming the capital base our economy has built up so far. Purchases of consumer goods and services made a total contribution of 4.7 percentage points to that growth of 3.5%. That is an enormous increase. Where did the money for it come from?

Part of it, of course, came from Trump’s tax plan which went into effect in January this year. In general, it reduced the total tax revenues from income taxes by $2.5 to 3 billion a month. Apparently, all this money went into consumption; or, to be precise, into buying “durable consumer goods,” like TVs, furniture, clothing, etc. – the spending on such goods jumped by almost 7% (on an annual basis, again). People got their tax money back, and guess what they did: they didn’t invest it; they bought stuff. But this $2.5 to 3 billion a month can’t account for all of the increased consumption. Where did the rest of the money come from?

From the stock market.

Remember what I said earlier about the stock market this last year? The Dow Jones hit a record high of almost 27,000 in January and then collapsed by 10%. Then it climbed up again in October and collapsed again. This is not small money that is at play here and it can’t be easily dismissed; we are talking about a total market cap of trillions of dollars. What reality do the movements of these trillions of dollars reveal to us?

Stock prices go down under one simple condition: there are more sellers than there are bidders. That is, those who are holding that stock want to get rid of it. They believe it is overpriced, and they want to get the money for the stock. Either they don’t believe the stock is going to perform well in the future (remember, a stock price is entirely calculated on the basis of subjectively expected future dividends), or they value current consumption more than the future dividends. In general, when the stock market is going up, that means that more people forgo current consumption and seek future dividends. When the stock market is going down, that means that people prefer to spend the money right away; or that, at the most, they put their money in short-term debt instruments, which are all tied to either private consumption or government spending, not to long-term equity. I mentioned “consumer confidence” above; let me give you the other name for “consumer confidence”: investor’s pessimism.

This is the reason why the stock market has been on such unpredictable roller coaster for the last one year: because millions of people who normally save some of their money by buying stock (which has been the reason for the rising stock prices: rising demand), have now decided to rather spend their money on consumer goods instead. Why they do it is of no big significance: whether they do it because they don’t believe the stock market will perform, or because they just want to buy new things, is of no consequence. The result is the same: higher consumption, lower investment.

(And, keep in mind, some at least may do it because they know and expect that prices of consumer goods will go up with the new tariffs. Trump’s tariffs will hit not only companies, but individual consumers as well.)

So we have enormously increased consumption for the last two quarters which made the bulk of the increase in GDP. It is not that we are producing more; we are consuming more of what has been produced. You can’t expect consumption to grow the economy; if it could grow the economy, then starving Ethiopians should be able to grow their economy by just eating more. If it is absurd to tell Ethiopians that they need to eat more in order to grow their economy, then it is also absurd to think that higher consumption is really economic growth.

To that growth in consumption we need to add the growth in another one of the components: government spending. Government spending grew by about 5% on an annual basis, and added about 0.7% to the GDP growth. Which is quite alarming: if the government lets us keep more of our tax money but increases spending, that can possible mean only one thing: that the government deficit spending is increasing. Our kids will have to pay in the future for our GDP growth today.

But what happened to investments? Didn’t they grow as well?

They didn’t. Investments remained flat. Although, when we break them down, we see another rather alarming picture. Investments in equipment and real estate dropped by 8% (again, annual basis). Which means that US companies have refrained from investing in higher productivity, or even from maintaining the old facilities. Perhaps because they are planning on closing them due to the increased cost of steel, as several automakers already announced. American families also refrained from investing in the real estate market – either because they can’t afford it, or because they find current consumption more attractive.

What increased by 8% to make up for the drop in investments was what the Bureau of Economic Analysis calls, “investments in intellectual property.” That is, Americans and American companies refrained from investing in real estate and production facilities, but they bought computer programs. Remember when Franklin Graham, while shilling for Trump, said that there was no pride in being a programmer, but the real pride was in being a factory worker? Well, the US market proved him wrong: Looks like the real value is in being a computer programmer, while we are going to be losing factory jobs. Franklin Graham’s nonsense aside, there is a good reason why Americans invest in software: It is not subject to tariffs. A software company can outsource to India, China, Bulgaria, Estonia, Zambia, and the product they get will come over the Internet, and can’t be taxed with tariffs. Thus, the price of software is closer to the real market price. To invest in building a new plant will take buying steel; and since steel is now taxed additionally, it will be overpriced on the market, and therefore the investment won’t make sense.

I think we covered all of it, right? Remember, GDP is the sum of the following components: Consumption, Investments, Government expenditures, and Trade (Exports minus Imports). In itself, GDP is just an aggregate, and it is neutral in relation to these components and what they tell us. We need to look at each one of them separately in order to know what is happening.

So let’s summarize what we see in all these components as applied to the GDP growth of the last quarter:

Consumption was the largest motor behind the GDP growth. Americans went out and bought as many things as they could, increasing their consumption by 12% (on an annual basis) compared to previous quarters, which added close to 5% to the GDP growth. People took their extra money from tax savings, and also took their money from selling their stocks, and put it into consumption.

Government spending was the only other component that increased.

Trade was negative: imports outweighed exports by such a gigantic margin that trade added the whooping negative 1.8% to the GDP growth, something that hadn’t happened for many decades in the US. (Ironically, it happened under a president who vowed to fix America’s trade deficit.)

Investments remained flat. But in that flat, there is a nuance. Investments in equipment went down by 8%. What balanced it was investments in intellectual products (mainly software) which went up by 8%. We have no increased investments in production facilities. The promised opening of new jobs might need to wait for a while.

And in addition to it, we have been involved in a trade war against the whole world, which jacked up the prices for many goods and materials that are essential for our economy, while losing foreign markets for US exporters who had spent decades in investments to win those markets. At the same time, our opponents seem to have learned the lesson to lose the trade war before we do, and thus drive down their own costs in the race for increased productivity.

In summary: Our GDP is up. But that’s not necessarily good for our economy. We may be in the position of the farmer who decided to eat more than usual, only to find out that he has eaten his last seeds.

The reading assigned for this week will be an article, not a book. But it is an important article which you don’t want to miss, if you want to understand the dichotomy consumption/investments and its importance for the economy. The article is by Robert Higgs, and it is titled, “Regime Uncertainty.” It was published in The Independent Review, Volume 1, Number 4, of Spring 1997. You can find the PDF online. It is 31 pages long, and, as most writings by Robert Higgs, it is worth every word.

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