By Bernie 04/02/18

 

Decline and Fall of World Trade

It was Friday afternoon in the coin store. Mary, the staunch Republican, had just come in. I was sitting in an easy chair (one that Mark, the owner, kindly provides) and reading the Wall Street Journal and meditating on what a sorry mess we are in. I remarked that the U.S. trade deficit had reached $57 Billion last month, the highest since 2007.

Mary:  That’s outrageous. Something must be done.

Me:  And unlike 2007, this deficit is despite U.S. petroleum exports, which it did not have in 2007. Leaving out oil, this is the biggest deficit in history. And it is mostly with China.

Mary:  Just so I understand, you are saying that China and others are sending goods in here in excess over what we are sending out to the tune of $57 billion in one month. That is hard to comprehend. But I guess I shouldn’t be surprised. Practically everything I see in the stores these days says “Made in China” on it.

Me:  So what’s to be done, or should anything be done?

Mary:  Of course, something should be done. It is a tremendous drain of our wealth and resources into a country that hates us.

Me:  But you just said that the stores are full of Chinese goods. Are you sure that it is us who are hemorrhaging wealth? Why isn’t it China?

Mary:  I meant we are hemorrhaging dollars.

Me:  Are dollars wealth?

Mary:  They can buy real things. That is, they are convertible to wealth. So I would say, yes, they are wealth.

Me:  And when our government prints dollars, are those new dollars wealth?

Mary:  That’s right.

Me:  And when a counterfeiter prints dollars, is he creating wealth, too?

Mary:  That’s right.

Me:  And more wealth is better, right?

Mary:  That’s right. But what’s the point of this discussion? Where are you going? Are you trying to trap me?

Me:  So to summarize, we can create wealth without doing any work, by just slapping green ink on little pieces of paper, or the electronic equivalent. What a wonderful world we live in. Provided, of course, that we have access to the printing press. Things get a little sticky if you happen to be one of those unfortunate souls who doesn’t.

Mary:  I fail to see where you are going with this pointless line of talk.

Me:  So why don’t we have the government just print up $2,000 every month for every person in America. Then everyone will be wealthier and happier.

Mary:  It would be a guaranteed income program. In fact, Bill Gates, or someone like him, has just proposed such a program.

Me:  I’m glad to see my mind moving in such august circles. Heck, why stop at $2,000? Since more wealth is better, let’s print $1 million for each person. Then we can all be millionaires.

Mary:  You are laughing at me, aren’t you?

Me:  Not at all. I’m just taking your argument to its logical conclusion. If a little wealth is good, then more is even better, right? Also, we can get the Chinese to make stuff for us to buy with those millions. The Chinese won’t mind. They love to produce goods for nothing. Of course, we will have to build a million new Walmarts to hold all that stuff. And we’ll have to build a million new container ships to transport it. And we’ll need a million new landfills for when all that stuff is dumped soon after it is purchased. That might pose an environmental problem. Look, I’m just trying to think ahead.

Mary:  Now I know you are mocking me.

Me:  Please forgive me. Listen, you are not the first one who believed that paper money is wealth. In fact, it may be one of the most widely held delusions of all time.

Mary:  Are you saying I’m delusional?  I’ve had enough (turns to leave).

Me:  Hold on. Please, stay a little longer. I’m completely serious now. Indeed, the trade deficit is a serious matter. It is also very tricky. It’s hard to learn the truth about it.

Mary:  I don’t see why it should be that hard to grasp.

Me:  It is especially hard for good Republicans to grasp.

Mary:  Just because I’m Republican doesn’t mean I’m stupid. You are insulting me again.

Me:  No, it’s not that. Republicans tend to be a bit nationalistic. They tend to subscribe to the notion that their country is always right.

Mary:  Are you saying that patriotism is wrong?

Me:  No, not at all. Love of country is good. It binds a people together and makes them into a nation. But worship of the nation or state is another matter. Then the state becomes God and is above right or wrong. That is nationalism and can be very destructive. Some people think that the United States is idealistically upholding democratic values and free and open markets. They think that other countries are cynically exploiting our good intentions.

Mary:  I don’t worship the state, but that’s exactly what I think.

Me:  But that won’t lead to a clear understanding of the trade deficit. This is one deficit where it took two to tango. You also won’t understand what happened when the whole thing blows up.

Mary:  If by blowing up you mean the trade deficit ends and China stops exploiting us, then the sooner the better.

Me:  Be careful what you wish for. International trade will collapse except for a few barter deals. That will mean the collapse of the economies that depend on it. And guess which country depends on it most?

Mary:  The U.S.?

Me:  Yep. Can you imagine the chaos here when that $60 Billion a month in foreign products fails to show up? Also, who will buy our government’s bonds? Who will lend it money so that it can continue to pay the Social Security, Medicare, disability recipients, NASA contractors, etc?

Mary:  But right now, the volume of trade is hitting records. Trade hardly looks like it is about to collapse.

Me:  That should be a warning. When trade or anything overflows its natural boundaries, it’s time to pay attention. The insidious thing about paper money is that things always look brightest right before collapse. It’s blue skies all day long.

Mary:  that reminds me of a song by Irving Berlin:

            Blue skies smiling at me,

            Nothing but blue skies do I see.

            Bluebirds singing a song,

            Nothing but bluebirds all day long.

            Never saw the sun shining so bright,

            Never saw things going so right...

 

Me:  Yes, that song came out in the summer of 1929, just before the crash in October. You might say it was the swan song of the roaring 20’s.

 

Mary:  The gods must have been laughing when that one came out.

 

Me:  Yes, the gods punish hubris, don’t they? Or were they warning us? There were probably thoughtful people who saw its cock-eyed optimism as a cue to get out of the market.

 

Mary:  I don’t understand why the trade dollars come back to our shores.

 

Me:  The Chinese exporters don’t want dollars. The dollar is the international trading medium, but the Chinese companies who sell to us pay their workers in yuan. So they sell the dollars they get for yuan. Now, there is one outfit in China that has an open bid on dollars 24 hours a day, seven days a week.

 

Mary:  Who?

 

Me:  The People’s Bank of China (PBOC), China’s central bank. They create yuan out of nothing and buy up all the dollars that flow in. If they didn’t, the dollar would fall relative to the yuan and pretty soon the dollar wouldn’t buy anything in China. That would end our trade deficit.

 

Mary:  I told you they were the villains in this movie.

 

Me:  Yes, that is the first factor that is driving the trade deficit – Chinese money printing. So the free market is overturned by inflationism on the part of the Chinese. The trade deficit could not exist without the Chinese making money out of nothing. By the way, all those counterfeit yuan set off a huge capital goods boom in China. They brought on over-capacity in steel, rubber, cement, aluminum, etc.  That means there are millions of workers working in factories that are losing money because they can’t sell their goods at a profit. The government is pumping up credit, making loans to those companies so they can keep going. That over-extension of capital will eventually destroy the Chinese economy.

 

Mary:  So you admit the Chinese are to blame.

 

Me:  Remember, I said it takes two to tango. Yes, they are half the story, but they are not all of it. There is another counterfeiter out there. And the only thing worse than one counterfeiter is two counterfeiters. Our printing the trade dollars in the first place is the other half.  But back to the dollars coming back here. What does the PBOC do with the dollars it vacuumed up from the export companies?

 

Mary:  Holds them?

 

Me:  No, it wants interest on those dollars. It wants to put them to work. So it buys U.S. government securities and it buys U.S. mortgage-backed securities. That drives interest rates down over here. So everyone can afford a home in the U.S. and the U.S. government doesn’t worry about budget deficits. It can borrow as much as it wants without worrying about high interest rates or crowding out private borrowers in the U.S. It is boom time in the U.S., as well as in China. Bottom line, China is loaning us the money to buy its products. To be precise, it is not so much that we are printing money as that we are creating fictitious credit to buy Chinese goods. Read my story “How the Hog Ate the Cabbage” to understand how fictitious credit works. The important thing is that whether its new dollars or new loans, it allows us to buy goods without paying goods back. So all this credit from China creates a spending boom over here.

 

Mary:  On the surface, it looks like a good deal for us.

 

Me:  Yes, until you look below the surface and realize that it is completely unsound and dishonest. That it is driving both China and the U.S. toward collapse.  Do you remember the difference between a good economist and a bad one?

 

Mary:  What is it?

 

Me:  The bad ones look at only the visible results of an action. The good ones look at both visible and invisible effects. Anyone who says our trade deficit is a good thing is in the former category.

 

Mary:  What I don’t understand is why China would do this. Their wealth is flowing out and they are getting in return securities (that is, IOU’s) that they can probably never cash out of.

 

Me:  Yes, it’s like borrowing the money from your Hong Kong tailor to buy his suits. It is not a sound business for him. He will go broke if you don’t pay. The U.S. will never pay China. Not in real wealth.

 

Mary:  So why? Why are they doing it?

 

Me:  Because certain elites in China are getting fabulously wealthy at the expense of their own workers. Remember the first rule of counterfeit money:  He who gets it first wins. He who gets it last loses. When dollars flow into China, they go in as reserve assets. Another term for this is “high-powered money.” It’s just as if they were printed at the Chinese border. The exporters, which in many cases is the Chinese government, get a huge purchasing power advantage over everyone in the rest of the country – everyone not hooked into the export machinery. So China in general is being impoverished, but a few are getting rich.

 

By the way, the same thing is happening here. The workers in the Midwest are losing their jobs and descending into poverty and despair. But the coastal elites have never done better.

 

Mary:  So the elites in both countries benefit at the expense of workers in both countries.

 

Me:  Yes, it’s a big joke on all working people, a joke the elite laugh about amongst themselves, but are too polite to share with the workers.

 

Mary:  So I guess we need punitive tariffs on all goods coming here. We have to stop this.

 

Me:  I wish that would stop it. But it won’t. I’ll explain in a minute. What you have to do is stop printing paper money. That is the cancer eating away at every vital organ of society in both the West and the East. Honest trade can only occur when there is honest money.

 

Mary:  Maybe it means going back to the gold standard. Then when anyone shipped goods in, they would have to ship gold or other goods back. Then trade would always balance. It would be wealth in only with wealth back out.

 

Me:  That’s a great idea, but I can give an example where even the gold standard did not result in fair and honest international trade. The capacity for humans to do evil is the real problem. The gold standard only works when there is a high level of honesty and moral restraint. The best systems are only as good as the people running them.

 

Mary:  I’m interested. Tell me more.

 

Me:  This story is about Spain from 1500 to 1700. When it conquered Mexico and South America around 1515, it began a program of looting and pillage against the Indians almost unprecedented in history. Furthermore, it made the Indians that it didn’t murder work as slaves in the mines. So Spain was getting free gold and silver and bringing it back to Spain. What do you suppose it did with it?  Remember gold and silver were money in those days.

 

Mary:  I suspect it bought products from all over Europe.

 

Me:  Yes, and what happened to Spain’s domestic production?

 

Mary:  Don’t know.

 

Me:  Well, prices rose in Spain because of the highly charged monetary environment. They were low in the surrounding countries because there was less money. Prices are always highest near the point of money creation. Spain was, in effect, creating money out of nothing. It’s kind of like the U.S. printing money today.

 

Mary:  So prices are lowest far away from the source of money creation.

 

Me:  Yes, and they are highest close to the source of money creation.

 

Mary:  Goods were cheapest outside Spain. So foreign goods were flowing into Spain and gold and silver were going out. Just like our dollars leaving the U.S. today.

 

Me:  You are exactly right. The goods flowed into Spain from outside; the gold and silver money flowed out. Remember, goods always go to the place where the price is highest.

 

Mary:  So Spain was getting cheap goods from Germany, Italy, Austria, France, etc. Also from the Muslim countries.

 

Me:  Yes, those goods were driving Spain’s domestic producers out of business because they had a higher cost of production than the foreign producers.

 

Mary:  It sounds just like today. Foreign producers are driving our manufacturers out of business.

 

Me:  Yes, and there is a very succinct way to describe this phenomenon:  Industry is destroyed at the source of money creation.  Very few know this timeless law. The bad economists never mention it.

 

Mary:  How did Spain end up?

 

Me:  Its domestic production was destroyed. If you read “Don Quixote,” published in 1605, you get the impression that it had only shepherds and innkeepers left by that time. And it became a third rate power. England defeated its Spanish Armada in 1589 and it never came back. I’ve read somewhere that it wasn’t even producing its own ships by 1589. Can you imagine a country that depended so much on its maritime power not making its own ships?

 

Mary:  Well, how many ships does the U.S. produce now? How many U.S. flagship vessels are sailing now?

 

Me:  Good point. Remember:  Industry is destroyed at the source of money creation. 

 

Mary:  So our terrible trade deficit is actually a monetary phenomenon.

Me:  Yes, it is caused by paper money, money created capriciously, with no wealth backing it; money conjured out of nothing. Spain’s robbery of the Indians backfired. And our robbery of Asian coolies will backfire on us.

 

Mary:  Back to the elites in China enslaving their own workers, I’ll bet there were Indian warlords turning their own people over to the Spaniards.

 

Me:  I wouldn’t be surprised. It happened in Africa. As I said, the capacity for humans to do evil seems almost unlimited. And it pays no respect to race. Here is another slogan:  “What is wrong for individuals to do cannot be right when nations do it.”  The key thing in Spain’s case is that it was getting the gold without working for it. It is theft when an individual does this. It was still theft when Spain did it. And it had terrible ramifications down the road.

 

Mary:  By the way, I keep hearing about currency wars and trade wars breaking out. Do those have anything to do with what we have been talking about?

 

Me:  Yes. A currency war occurs when nations try to obtain a trade advantage by debasing their currency, i.e., inflating it. Do you know how you win a currency war?

 

Mary:  No.

 

Me:  The way you win a trade war or currency war is by shooting yourself first. If you ever want to see the lunacy of paper money, just watch the trade policies of nations when they are in the grips of it. The way you win is to destroy your currency worse than everyone else. Impoverish your own people faster than the other countries impoverish theirs. If you do that, then you can send goods to other countries without their sending goods to you and competing with your industries. Never mind that your people are starving because no goods are coming in and all your goods are going out.  By the way, that actually happened in the Soviet Union in the 1930’s. Stalin was exporting the wheat crop and starving his own people. It is no accident that currency and trade wars lead to shooting wars. After the industrial companies that often control the government have gotten what they want, they find that they can’t import goods because their currency is worthless. At that point, they propose using force to get raw materials – usually from weak, semi-agrarian countries. That’s what Japan, Italy, and Germany did in the 1930’s following the currency war of that period.

 

Mary:  So a currency war is a kind of race to the bottom where countries kind of walk over an economic cliff all at once, like a bunch of lemmings. By the way, what’s the difference between a currency war and a trade war?

 

Me:  The currency war always comes first. One country will debase its currency so it can sell more goods. But then the other countries debase their currencies. Then the first one debases again, and this insanity continues until they all realize they aren’t getting anywhere. That’s when the trade war starts. Country A puts a big tariff on certain goods coming into it. So the other countries retaliate by putting tariffs on country A’s goods. They go back and forth until trade has collapsed. At that point, people in each country are in such terrible desperation and poverty that they elect some guy with blood in his eye who promises to use force. That’s when the shooting war begins.

 

Mary:  Wow. This is insanity. And all because of paper money.

 

Me:  You are really catching on. That’s why I said that tariffs won’t work. They just lead to retaliatory tariffs. And these kinds of problems seem to be a recurring theme throughout our history. Leaders across a broad spectrum seem hell bent on destroying the institutions they have been entrusted with. Now all the bulwarks of society are crumbling in disarray.  From education to sports, from religion to art, from families to entertainment, from philosophy to law, you see a tendency toward nihilism. But I must get back to my story. Here is one more example of the insane consequences of paper money. You know what GDP is, right?

 

Mary:  Yes, it is Gross Domestic Product. It is supposed to measure the final sales in a country.

 

Me:  Yes, and since sales represent production or product, it measures the amount of product a country has in one year. For example, an increase in inventories is counted as an addition to GDP, even though it is unsold product. It still adds to the product of the nation. So how is international trade counted? In other words, if the U.S. imports 10,000 automobiles from Korea, how is that counted in GDP?

 

Mary:  Don’t know.

 

Me:  It is subtracted from our GDP. In other words, we get real wealth injected into our country and we give Korea nothing but IOU’s that we will never pay off. That is counted as a debit to our GDP. Meanwhile, Korea counts it as a credit to its GDP, even though it is poorer by 10,000 automobiles. It is completely backwards.

 

Mary:  I guess it gets back to the question raised earlier about what is wealth – the dollar or the cars. I said that we were losing dollars and that was a loss to us. You said that since we can now print dollars ad infinitum, we have to look at real stuff in analyzing who benefits.

 

Me:  Yes, you have to do a real wealth analysis or you will get absurd results. You will get hopelessly confused. GDP only counts as economic activity the number of dollars spent. It doesn’t count the real wealth. When those dollars were convertible into gold, there was a basis for using them to measure GDP and other aggregates. But not now.

 

Mary:  So if a woman quits some meaningless job in the government and stays home with her kids and bakes bread and makes meals and cans food, the GDP of the country goes down.

 

Me:  That’s right. The actual GDP may have gone up, because she might not have been producing anything useful in her government job. But it only counts dollars, and since they now have little to do with real wealth, a misleading picture results. We will need to do real wealth analysis when we discuss the collapse of world trade.

 

Mary:  OK, let me understand. You are not against vibrant and robust international trade. You are merely saying it has to be balanced and honest.

 

Me:  In fact, we should want robust international trade. It raises everyone’s standard of living. But it has to be honest. It can’t be based on exploitation of labor. That negates the whole purpose of international trade, which is to give workers a higher standard of living by letting them concentrate their talents on making goods they are best at. When labor becomes more efficient, the workers should be allowed to keep some of it. Let’s face it, some nations are better at making certain things. It is called comparative advantage. Some nations are good at growing corn, some are good at making watches, and some are good at making automobiles. It adds much value if each can concentrate on its strengths and then trade to get the other things it needs. This brings great benefits to everyone. Some have said that the benefits are so great that it’s worth having paper money to accompany it. But paper money in the end destroys all trade. It poisons the well, so this is false logic. But the proponents of paper money will use any argument, no matter how specious.

 

Mary:  But what if you were making goods that other nations don’t want? That’s what they were saying about our Midwest, our so-called rust belt.

 

Me:  The markets have a remedy for companies making products no longer in demand. It is called bankruptcy. Then resources and labor are reallocated to areas where there is demand, either domestic or foreign. With all of America’s advantages:  natural resources, an educated, industrious people, superior transportation, political freedom, flexible capital markets, it is preposterous that the whole heartland of the country would just shut down. No, this disaster is a result of paper money and fictitious credit. Our country can’t sell because we can just print money and buy the goods free from the Chinese and others. It’s Spain all over again. Remember, industry…

 

Mary:  Yes, I know, “Industry is destroyed at the source of money creation.”

Me:  Very good!  You and I could go far together.

 

Mary:  No, thanks.  How did the historical gold standard augment comparative advantage and lead to more world trade?

 

Me:  the reason gold emerged for international trade is the same reason silver emerged for domestic trade. Smith wants fish. He has corn. Jones the fisherman doesn’t want corn, he wants bread. So they can’t trade. But then silver comes along as a medium of exchange. Then Smith can give Jones three pieces of silver for his fish and Jones can use those pieces to buy bread. Everyone is happy. It’s the same for world trade.

 

In the Middle Ages, people in Europe were crazy about silk and pepper and cinnamon from Asia. But the people in Asia didn’t care much about the products made in Europe, so it was no deal. But the people in Asia would take gold and silver, so that solved the problem. Also, the gold was very transportable and compact.

 

So let’s fast-forward to the 1870’s. An American cotton grower might sell cotton to a textile mill in Manchester, England. But the grower might not want the cloth the textile mill made, or might not want the quantity of cloth it would take to square the deal. But since dollars and British pounds were both convertible to gold, the trade was easy. The grower would take pounds for which he could get gold, any day. Then he shipped the gold to America and turned it back into dollars and paid his workers. International trade was easy, balanced, and honest.  I hope I’m not wasting your time on such elementary stuff.

 

Mary:  Actually, I did not know this.

 

Me:  Our public schools at work. When all currencies were convertible to gold, a company could trade without fear that it wouldn’t be paid for the goods shipped. It received the importing nation’s currency and knew it could immediately convert to gold. Also, gold was self-correcting. If Nation A sent more goods to Nation B than Nation B sent back, then gold would flow out of B and into A. Since gold was money in both countries, then B saw a contraction in its money supply and A saw an acceleration in its money supply. So B experienced deflation, which means less money to buy and sell inside the country. B has a recession. The party is over there.  People pull in their belts and they import fewer goods from A. That helps eliminate its trade deficit. Meanwhile, Nation A is getting more gold, so it’s party time there. That means more demand for foreign products. Also, its goods stay home because domestic prices rise.  This lowers demand for its products from B. That also helps eliminate its trade surplus with B.

 

Mary:  So how will this end? You have convinced me that it will lead to the collapse of world trade. But how?

 

Me:  Before we discuss that, we should review. Can you think of anything?

 

Mary:  Tariffs won’t work; they lead to trade wars. The trade deficit is a consequence of paper money. Trade can only balance when we get back to honest money – money convertible to gold. You can’t have free or fair trade when someone is able to print money and use it to buy goods on the international market without paying for them in offsetting wealth.

 

Me:  That trade deficits are destroying China is easily seen, but that they are destroying America is less obvious. They are bad in the way that welfare is bad for the people receiving it. It destroys in subtle ways by destroying their will and ability to work, their self-reliance, dignity, and self-respect.

 

Mary:  OK, how will this end? Is there any way out without a giant collapse in trade?

 

Me:  I don’t think so. Resources are too skewed out of any relationship with reality or sanity. If it was just financial flows, everyone could just cancel each other’s debts. But factories have been built, and distribution and transportation networks constructed, that have nothing to do with real world conditions. Consumption patterns are unsustainable.

 

Mary:  On that cheery note, proceed.

 

Me:  The first thing you have to understand is that the U.S. is consuming wealth without producing wealth to pay for it. We have discussed that and I think you agree now that it is a gargantuan and growing amount.

 

Mary:  So dollar denominated debts are building up around the world.

 

Me:  Yes. The U.S. before 1985 was the world’s largest creditor nation. Now it is the world’s largest debtor nation. How did this happen?

 

Mary:  You said it was the trade deficit.

 

Me:  Yes. So the question is:  How long will the other nations put up with this growing debt?

 

Mary:  They don’t have a choice. If China says tomorrow that it will not take dollars for its stuff, it won’t be able to sell it. Its factories shut down and millions of people are in the streets. It’s MAD (Mutually Assured Destruction).

 

Me:  That’s right. So there will have to be a crisis. A dollar crisis. The system will have to be collapsing before anyone repudiates the dollar. But I do think China and Russia are getting ready for just such a collapse.

 

Mary:  How do you know?

 

Me:  Because they are buying gold – massive amounts of it. In fact, the central banks around the world are accumulating gold. Do you remember back in the 1990’s, the central banks such as the Bank of England and the Swiss National Bank were selling? They had to have a pact that limited gold sales so the price didn’t fall too far. Not anymore. Can you think of any other reason they would be accumulating gold?

 

Mary:  Maybe they like its color. I guess they are getting ready for the day on which the dollar stops being the international reserve currency.

 

Me:  Exactly. So let’s trace step-by-step how the U.S. degenerated so badly. How did it get on that “long winding road to confetti,” to quote James Grant. How did it get to the point where its obligations are so far beyond its resources that it can never pay them off? Its domestic debts are so great it could never collect enough taxes and its foreign debts are so great that it could never create enough real wealth.

 

Mary:  So how does it get out of this predicament?

 

Me:  It has two choices. It either defaults on its debts, i.e., refuses to pay, or it depreciates the currency in which the debt is denominated to zero. The first is by the ice storm of deflation; the second by the inferno called inflation.

 

Mary:  So what you are really talking about is national bankruptcy.

 

Me:  That’s right, and it could come suddenly. To quote Ernest Hemingway when asked how one goes bankrupt:  “Slowly at first, then very fast.”

 

Mary:  So in order for this to have occurred, our government must have been grossly mismanaging its budget and the economy. That’s what happens when you elect Democrats to office.

 

Me:  It wasn’t just Democrats. But regardless, you are right. The economy was grossly mismanaged. The government has gotten so big it is consuming, commanding, or messing up over 50% of the economy. Either by theft or stupidity, it has severely damaged the ability of the private economy to generate jobs and products. It is paying tremendous subsidies to people who don’t work – pensioners, the unemployed, the sick, the disabled, the poor, veterans, etc. These groups consume wealth, but don’t produce. Someone has to supply wealth to them and it is not the government. All the government can do is take wealth from A and give it to B. Furthermore, the government is paying giant subsidies to companies that don’t produce wealth on a net basis. These companies, as well as individuals, become less and less efficient with time, once they are on the dole. That is, they demand more and bigger subsidies as time goes on. Again, the bigger subsidies must come from net wealth producers.

 

Mary:  I understand this, but I don’t see how it figures in the collapse of world trade.

 

Me:  I’m getting to that. By the way, our trade deficit is one of the reasons those subsidies got so big. As I said before, it is the insidious thing about paper money. It makes you think you are richer than you really are, so you spend and spend when you should be retrenching and would be if you could see things clearly. It’s like giving a deadbeat another loan. He thinks he is OK as long as he can get credit, so he keeps lying around, drinking beer and chasing women when he should be looking for a job. I have relatives in that category.

 

Mary:  Don’t we all.

Me:  Anyway, the Chinese goods came in here and kept prices down despite these massive spending programs by the government. And the government didn’t have to borrow from Americans, which would have been impossible. They don’t have enough savings to fund the government’s borrowing. But it could borrow from the Chinese. What a wonderful world! So the subsidies and idiotic government programs just grew and grew, compliments of the Chinese.

 

Mary:  OK, I see that. The trade deficit allowed us to consume way beyond our means. Furthermore, it allowed the government to subsidize non-work through deficit spending. It kept interest rates down over here.

 

Me:  Yes, to quote Kipling, it has been a time “when all men are paid for existing and no man must pay for his sins….”

 

Mary:  But how does that bring on a collapse in world trade?

 

Me:  Bear with me. So the net wealth producers in the U.S. have two problems. They are being taxed to pay for the net wealth destroyers, and they have to compete with cheap Chinese goods coming in, just like they did in Spain in the 1550’s. Also, those wealth producers are paying the inflation tax. When the government creates money and gives it to a non-producer, the producer had his claim on that wealth transferred away from him. This puts net wealth producers in the U.S. in a grave predicament. Most of them were operating on thin margins, perhaps 5%. So if someone like the government comes along and hijacks that 5% and gives it to a non-producer, then that company is underwater. It has more real wealth going out than is coming in. Remember, we are only talking about real wealth here. Dollars don’t matter because they no longer represent real wealth. You have to do wealth analysis to know who is bankrupt and who isn’t in a completely dishonest system like ours. People who are bankrupt, i.e., people who are net wealth destroyers, can be made to look solvent when you can just print money and give it to them.

 

Mary:  I get your point, but it is very hard for me to not see things in terms of dollars.

 

Me:  I understand. So let’s continue, and maybe things will clarify. Before I forget, The other way our net wealth producer, the one with the 5% margin, gets put under water is when a Chinese company comes in and sells its product for 5% less than he was selling his for. So both factors, our government’s inflation or taxes, or foreign bogus trade flows push that company over the edge and into the net wealth destroyer category.

 

Mary:  So just to be clear, a net wealth producer is one who produces a product that has less in it in materials, energy, labor, etc. than it commands on the market for those things. Adding all those things together, on the day of sale the company is able to get something greater than the material, labor, capital, etc. it put into the product.

 

Me:  Yes. So for example, let’s suppose you were making ethanol from corn as a substitute for petroleum. If the petroleum that went into making the ethanol was greater than the petroleum the ethanol substituted for, then you would say that the ethanol was a net petroleum destroyer instead of a net petroleum saver. We have to do this kind of analysis, because when the government can just print money and give it to someone, you can’t tell what category he is in.  You must look in detail at the wealth he is consuming vs. the wealth he is producing.

 

Or another example:  Let’s suppose you are making electric cars to save on greenhouse gases. If the greenhouse gases that the coal-fired power plant that charges the electric car are greater than that produced by a gasoline car, then you would say that the electric car was a net producer of greenhouse gases instead of a net saver.

 

Mary:  So let’s get back to talking generally about how countries go bankrupt:  First, the government mismanages its finances and it starts paying all kinds of subsidies. This damages the private producers of wealth. But the government can only pay the subsidies by getting real wealth from private producers. This weakens the private producers.

 

Me:  Yes, when you subsidize something, you get more of it. When you tax something, you get less of it. So the net wealth destroyers grow and the net wealth producers get fewer. So the net wealth producers left must be taxed even more heavily. So more of them go bankrupt and become net wealth consumers. So it’s a spiral into perdition.

 

Mary:  So pretty soon the whole country is a net wealth consumer or destroyer. That’s when it must get wealth from outside. That’s when it starts running trade deficits.

 

Me:  No, there is one other place the country can go before it must get wealth from outside. It still has one option. It’s like a family that is bankrupt to the point where it can’t pay the heating bill…

 

Mary:  Oh, I know! It can burn the furniture.

 

Me:  Yes, countries can do this, in a sense. They can consume the country’s capital, i.e., unconsumed wealth still in the country. Remember, we are only talking about real wealth in this analysis. The government can consume the piled up savings of industrious parents and grandparents. So the family can burn the tea table passed down from Grandma.

 

Mary:  So what happens when all the accumulated capital is gone, or at least it is in hiding and the authorities can’t find it?

 

Me:  That’s where gold plays a role.

 

Mary:  I was just going to mention that.

 

Me:  You are catching on.

 

Mary:  So now the country is destroying or consuming more wealth than it is producing and it has consumed everything loose in the country. What next?

 

Me:  That’s when the trade deficits start.  They start pulling in wealth from foreign net wealth producers and savers. But the same process begins again, just as it did within the country. The foreign net wealth producers are weakened because they aren’t getting paid in real wealth. They are getting dollars, but they are not getting wealth back. They may even be foolish enough to think they are being paid, but in real terms, they are going behind. They will eventually either say “enough” or they will go bankrupt. China is in that spot. It either says “enough” or the whole country goes bankrupt paying subsidies of real wealth to the U.S.

 

Mary:  This looks very dangerous.

 

Me:  That it is. This giant welfare system of subsidies and benefits we are paying depends completely on the kindness of strangers. China, Arabia, Chile, Brazil, Russia, etc. – All those countries are in trouble. They are in trouble because of the tremendous wealth transfusions from them to us. At some point, they will stop taking dollars that cannot be redeemed for anything real. They might as well pick leaves off trees and store them as take dollars.

 

Mary:  I don’t want to be around on the day they stop taking dollars.

 

Me:  I guess I should give you the rest of that verse I just quoted from Kipling (this should really ruin your day):

 

As it will be in the future, it was at the birth of Man

There are only four things certain since Social Progress began.

That the Dog returns to his Vomit and the Sow returns to her Mire,

And the burnt Fool's bandaged finger goes wabbling back to the Fire;

And that after this is accomplished, and the brave new world begins

When all men are paid for existing and no man must pay for his sins,

As surely as Water will wet us, as surely as Fire will burn,

The Gods of the Copybook Headings with terror and slaughter return!

 

Mary:  Wow!

 

Me:  I would like to compliment you for staying here and listening to me pontificate.

 

Mary:  It wasn’t easy.

 

Me:  Churchill said:  “Most people, sometime in their lives, stumble across truth. Most jump up, brush themselves off, and hurry on about their business as if nothing had happened.”  You stumbled across truth today and stuck around to see what it was you stumbled over.

 

Mary:  Don’t expect me to do so the next time. This experience was painful. But I learned a few things.

 

Me:  I’m glad. Have a good day.