Greg Kaza (“Economic Liberty and American Manufacturing,” Views, January) is to be congratulated for seizing hold of two important realities: that the late 1990’s saw a financial bubble of historic proportions, the origins and implications of which are poorly understood; and that incomes for the median- and lower-wage earner, when adjusted for inflation, have seen little progress over the last three decades. 

Wage stagnation is something that, frankly, puzzles academic economists.  At the risk of appearing obsessed, I suspect that the impact of the extraordinary immigration over the last 30 years, unmentioned by Kaza, will ultimately prove greater than is currently believed.  (At the moment, academic economists generally accept only that it has affected the incomes of the unskilled, albeit substantially.)  The extraordinary strength of the American dollar, not mentioned directly by Kaza, has also made American exports more expensive and foreign imports cheaper.  It is hardly surprising that the auto industry has suffered—and, more generally, manufacturing wages with it.

But why has the U.S. dollar been so strong?  Markets do overshoot, sometimes for years.  But I have a horrible feeling that Kaza is right to point to the LTCM bailout—coupled, since his article appeared, with the Enron fiasco—as evidence that something is fatally wrong in the system.  Conspiracy theorists on Wall Street believe that authorities and key financial actors have colluded to manipulate markets for public ends—and, quite possibly, private gain.  Paranoids, as we all know, do have enemies.  And, in this case, even if they don’t, the economic hiccup which Kaza and I both believe may follow the excesses of the 1990’s will make them sound credible.  I suspect that we may well see the equivalent of the witch-hunting Nye hearings, advancing government at the expense of free markets, in this decade.

Ironically—and here I suspect I may differ from the official Chronicles line—the real culprit is not the market but the authorities.  Why do we have a Federal Reserve anyway?  But that, of course, was the story of the Depression, the nightmare from which we only awoke in time to repeat as farce.

        —Peter Brimelow
Connecticut Berkshires

The observations of Greg Kaza concerning the sorry state of blue-collar American workers due to the decline of manufacturing need to be heeded by conservatives.  There are now more government workers in the United States than manufacturing workers—and that’s not even counting the legion of suppliers to government and those who draw welfare.

This growth in parasites at the expense of productive workers has been financed by borrowing abroad and selling our physical and financial assets to foreigners—a “buy now, pay later” proposition.

Kaza attributes the demise of American manufacturing to the explosive growth of the money supply and the demand abroad for dollars and dollar-denominated assets.  While he may be on to something, it is not clear that he has identified the root causes—that both the decline of American manufacturing and the explosion of the dollar supply may be consequences of more fundamental structural problems.

Why have changes in exchange rates not offset the effect of the excessive supply of dollars in order to balance U.S. exports with U.S. imports?  Eliminating the U.S. trade deficit of over a third of a trillion dollars per year would be the single most important way to resuscitate the manufacturing sector.

Why do foreigners prefer to buy U.S. assets instead of U.S. manufactured goods?  Why do U.S. manufacturers prefer to make goods abroad rather than here?  The answers lie in the inefficiencies of our federal tax code, the sorry state of American public education, and the failure of U.S. foreign policy to defend real American interests.

The federal government taxes income saved for investment, then corporate income, then dividends and capital gains from that income—and then taxes the composite upon death.  Even though the typical Organization for Economic Co-operation and Development (OECD) country has higher average rates on personal incomes, it has lower composite marginal rates on investment income.  So foreigners have a higher propensity to save and invest, and Americans have a higher propensity to consume.  Also, nearly all OECD countries other than the United States abate their principal corporate tax, the VAT (value-added tax) on exports and levy it on imports.  These ad valorem taxes have, in effect, replaced ad valorem tariffs.  “Free trade” has been a one-way street to the poorhouse for U.S. manufacturers and their workers.  

A recent report by the Federal Reserve Bank of Dallas compared the average literacy rate of U.S. border cities with Mexican border cities.  For the United States as a whole, literacy rates average 75 to 77 percent; for Texas, 75 percent; and for Mexican border cities, 95 percent.  Do manufacturers move plants to Mexico just for lower labor rates, or to get workers who can read and follow instructions?  We cannot even educate an adequate supply of engineers to run our shrunken manufacturing sector.

When foreign debts and the loss of American values yield their inevitable consequences, will we still be able to claim that “United We Stand”?  The financial bubble that Mr. Kaza observes distorts values, and the creation of values is, at its root, a manifestation of America’s loss of fundamental values.

        —David Hartman
Austin, TX

Greg Kaza correctly reveals how the “traumatic changes” in the U.S. auto and steel industries have been ignored by media pundits and neoconservatives, despite huge job losses.  Unfortunately, instead of addressing the cause of those tragedies, Kaza played a “trivia game,” asking how often Clinton and Reagan mentioned those industries while in office.  He concludes by painting Reagan as more concerned with those industries.

Neither former president deserves credit in this regard, least of all Reagan, who took his marching orders from globalists in his “Kitchen Cabinet” and from Trade Representative William Brock and Commerce Secretary Malcolm Baldridge.

In the 34 years from 1946 to 1980, the U.S. trade deficit averaged less than one billion dollars per year.  During Reagan’s eight years, the trade deficit ballooned to nearly $100 billion a year.  Nearly half of that deficit was with Japan, and over half was in autos and steel.  Eight months after leaving office, Reagan went to Japan to collect his two-million-dollar fee for services rendered and had the gall to say that it was for two 20-minute speeches.

When Reagan took office, the federal debt was $909.1 billion.  When he left office, that debt had soared to $2.6 trillion, an increase of $1.7 billion, or 186 percent.  In just eight years, Reagan piled up more debt than was accumulated in the previous 192-year history of our nation.

Every credible economist knows that production (i.e., the labor of real people) is the origin of all income, wealth, real-capital formation, tax revenue, and the ripple multiplier effect.  Based on a conservative 5-to-1 multiplier effect ratio and a 40-percent marginal tax rate, had the goods represented by Reagan’s trade deficits been produced in America, they would have generated over four trillion dollars in added national income (equal to $40,000 per household) and $1.6 trillion in added tax revenue to offset 94 percent of the federal debt increase during the Reagan years.

This makes no allowance for lower welfare and unemployment-benefit costs, had the growth rate of GDP?under Reagan (a mere 3.13 percent) been comparable to the 4.56 percent growth rate in the preceding 21 years, nor for a 1.2 percent drop in hourly wages compared with rising wages in the preceding 21 years.

The failure of the media to expose destructive U.S. trade policies and deficits stems from an apparent delusion that the U.S. government has nothing to do with U.S. product costs.  So U.S. industries and their executives, particularly in auto and steel, have been unfairly criticized for alleged shortcomings.

The truth is that, as a result of millions of federal, state, and local tax and regulatory laws, government is responsible for over 80 percent of U.S. product costs.  Since all domestic taxes and the cost of regulatory laws wind up in the costs of production, they are essentially tariffs on our own products.

An honest government would protect every American company against any competitor, including foreign producers, not burdened with the same, or comparable, mandated costs.  Even Adam Smith proposed tariffs on imports to equalize costs imposed by domestic governments.  But that is not the guiding principle of U.S. trade policies.

Instead, U.S. companies have been the victims of outrageously immoral and unconstitutional trade policies that encourage imports made under conditions that violate our own laws by levying tariffs of just two percent—hardly a level playing field.

Kaza remarks that Fed Chairman Paul Volcker “cleaned up” the double-digit inflation of the 1970’s.  Volcker opted for interest rates as high as 20 percent on mortgages and a “high dollar.”  But that is not what brought inflation down.  Rising inflation in the 1970’s was largely due to oil prices that soared from about $1.75 a barrel to nearly $40.  Inflation rates came down as prices fell under $20 a barrel as a result of a global oversupply and major conservation programs, including better automobile efficiency.

Volcker’s tight-money policies exacerbated trade deficits, especially with Japan, as his “high dollar” caused imports to rise sharply while exports fell.  By the time Reagan left office, both the auto and steel industries were on the brink of bankruptcy.  In just two years, General Motors alone lost over $20 billion.

The trade and monetary policies of the Reagan years resulted in another two trillion dollars in trade deficits during the Bush and Clinton years, culminating in a $425-billion deficit in 2000, sending total trade deficits since Reagan took office to over three trillion dollars.  Concurrently, the federal debt soared to $5.95 trillion, forcing the current Bush administration to request raising the debt ceiling to $6.7 trillion, making a mockery of the silly notion that we would enjoy trillions of dollars in surpluses over the next decade.

The relationship of trade deficits to the federal debt can no longer be ignored.  Nor can the fact that over 20 million Americans have lost their jobs, their homes, their families, their health, and even their lives while the social fabric of our nation was being torn apart, creating the widest gap between “rich and poor” in our nation’s history.

Therein lies the tragic legacy of free-trade policies.  When President Bush and his aides tell us that free trade creates jobs, they are doing more than blowing smoke: They are lying.

        —Gus Stelzer
Mill Creek, WA

Mr. Kaza Replies:

Mr. Hartman is correct in raising the issue of “more fundamental structural problems” in the credit structure.  Mainstream economists focus on the growth of the money supply as the source of the financial bubble.  Consider the frequently cited Money of Zero Maturity (MZM), which grew at a 13-percent annual rate between 1995 and 2001, and at 14 percent post-LTCM.  But they overlook the full ramifications of non-commercial bank entities, including government-sponsored enterprises (GSEs), creating money and credit.  

Consider one example among many: hedge-fund speculation through repurchase agreements (or offshore “spread” and “carry trade” derivative plays) that expand institutional fund deposits and the money supply (beyond MZM growth).  This credit is recycled into U.S. financial markets.  Credit growth, in response to the demand for dollar-denominated financial instruments, is the key causal factor.  Foreign and domestic speculators prefer these instruments because they often deliver a greater rate of return.

The credit structure’s demand for an artificially strong dollar is in conflict with the manufacturing sector’s desire for a currency in equilibrium.

Much of this credit structure is centered, as Mr. Brimelow notes, in the government sector (Federal Reserve, GSEs such as Fannie Mae, Freddie Mac, and the Federal Home Loan Bank system) or among private banks whose insurance is backed by the full faith and credit of the U.S. government—i.e., the taxpayer.  

Deflation has also undoubtedly contributed to the climate facing manufacturers.  Japan, the world’s second-largest economy, is exporting its bad deflation (and cheaper exports), and domestic manufacturers, for only the third time since World War II, face a rare “rolling deflation” that appears, disappears, and reappears.  The Producer Price Index (PPI) has been negative for three of the last five years (1997, 1998, and 2001), and Consumer Price components such as “new cars” are negative while the index itself is slightly positive.  General Motors and U.S. Steel could raise prices in earlier periods of rolling deflation (1948-1954, 1959-1963) but have little pricing power today.

The current manufacturing decline began almost a year before the current recession; it is also more severe, according to the National Bureau of Economic Research, which reported on February 11: “Industrial Production.  A peak occurred in June 2000 and the index declined over the next 17 months by 7.1 percent, far surpassing the average decline in the earlier recessions of 4.6 percent.”  Consider the Eighth Federal Reserve District (St. Louis), which includes Illinois, Arkansas, and five other Midwestern and Southern states.  Manufacturing employment in all seven states has contracted during this recession (Arkansas’ decline, spurred by high tax rates on capital investment, is the greatest on a percentage basis), while government and service-sector employment has grown in every state except Missouri and Mississippi.

Mr. Stelzer misses my main point: My essay was meant not only to illustrate that President Clinton neglected manufacturing but to warn Republicans that Ronald Reagan was their last presidential nominee to win the industrial states of Michigan, Indiana, Wisconsin, Ohio, and Pennsylvania.