This Entire Piece Is Wrong on Trade

When "Buy American" or Populism Goes Too Far

I found this article linked at Ace of Spades. I generally like the snark at Ace of Spades. They also can be pretty good at rants, and at connecting dots. It’s a good place to mine a lot of articles on the news of the day. Ace has linked to my blog on occasion.

Buck Throckmartin writes there, and he and I amicably disagree about a couple of things, but he comments here occasionally.

The article talks about the Faustian bargain America made on free trade. The problem is that it is written by an attorney, not an economist or a businessperson. Attorneys know how to argue and build arguments to support their case. The supporting arguments in this case are true, but are not correlated very much to what free trade is. Hence, the Faustian bargain sounds intelligent, but it is incorrect.

For those that don’t know, Faust bargained his soul with Satan and lost.

Trump rails against free trade, and populists who follow Trump rail against it. That has paved the way for tariff policy. Yesterday, the dollar volume the US has collected on tariffs since Trump instituted them was trumpeted. To be clear, there were tariffs being charged by the US prior to Trump taking office, so the number is probably inflated.

I am a huge fan of Treasury Secretary Scott Bessent. He is the best Treasury Secretary we have had since Bob Rubin. Bessent was one of the best macrotraders in the entire world and truly understands markets, flows, and the underlying plumbing that underpins the entire system. You couldn’t ask for a more qualified person to take the helm at Treasury.

I generally like Trump too, but he has excesses. Tariffs can go too far. They are not a panacea. What they are is a negotiating ploy. Ideally, there would be no tariffs on any goods or services by any country. In reality, that’s not true, so games are played.

There are strategic reasons, especially when it comes to defense, not to have free trade. Why? What’s the opportunity cost?

In order for you and I to see eye to eye, we have to agree on a few principles. The first is that unfettered free trade is generally a very good thing to have in our lives. It lifts all boats.

Why?

Because we all have limited resources. Because of that, we have to make choices. We could produce everything we needed to sustain life inside the US, but it would be prohibitively expensive to do so. Not because of regulations, laws, and all the artificial constructs, but because we have limited resources. There is only so much labor. There is only so much material.

Hence, it is better for us to trade with international partners and reallocate our resources to something else that is of higher value.

You see the same in your life. You could make all your clothes and produce all your food yourself. But, it’s better to trade currency for those things so you can do something else that is more high value.

Free trade also spurs innovation. Because we have trade, an innovator has access to all kinds of materials and knowledge they wouldn’t have had access to, and it allows them to build stuff to solve our problems.

I also think there are limits to free trade. When it comes to the security and defense of the country, the opportunity cost for free trade is higher than producing the same good/service at home.

The problem is we can’t see into the future. Often, items that will be used in the defense of our country start out as a game. Drones are a great example. It is impossible to produce a drone from start to finish in the US using only US materials and labor.

The other facet about trade is that many industries have supply chains that are very hard to move once established. Once established, human labor attains a learning curve effect, and there is a lot of indigenous knowledge around the supply and manufacturing of the product that is hard to replicate or move.

We are also discovering that the pairing of software and hardware inside a good has network effects. Tesla is a good example of that, but there are others, like drones or medical equipment. Hence, having that sort of manufacturing inside the US is a good idea.

The problem is, humans have to forecast much of this, and we are imperfect. Humans actually do a pretty poor job of looking into the future and seeing it perfectly, or even close to perfectly.

In today’s world, everything is being lumped into black or white. There is no nuance. It’s either bad or good. Instead of being objective, the world has become extremely subjective.

If we don’t agree there, stop reading and go on to something else.

Economist Thomas Sowell summed up the above perfectly in two ways. First, the study of economics is not about money or supply and demand; it’s about trade-offs and opportunity costs of those trade-offs. Second, when you take pictures with a camera lens, there are constraints that you have to handle when you use that lens. Using that lens should teach you about trade-offs and opportunity costs.

The article I linked to spends a lot of time talking about the trade deficit. The trade deficit is one of the dumbest economic numbers. Why? Because it forces the assumption that trade is a zero-sum game, and if you are in deficit, something should be done to make it equal. The trade deficit ignores opportunity costs and the reallocation of resources into higher value production.

Trade is not a zero-sum game. Not in the least.

The article says that the US pays for the deficit by selling debt and by selling US real estate. That is so wrongheaded, I do not know where to start.

Other countries have purchased real estate here, not because of free trade. They purchased it for strategic reasons, or they think they can get a higher return on investment by buying US real estate than allocating the assets used to purchase the US real estate somewhere else.

I am uncomfortable having China own a bunch of real estate next to military bases. China didn’t purchase that real estate because of any trade surplus with the US. I think it is a good idea to limit Chinese purchases of US real estate, or any foreign country.

But, realize that policy has an opportunity cost.

Limiting the number of buyers will decrease the price because demand will be lowered.

US debt is another issue. When we trade with another country, often that country purchases U.S. Treasury notes because they are trading with us using US currency. Much of the world’s trade is done with the US dollar, even when the US isn’t involved in the transaction. That’s great for the value of the US dollar.

Having other countries in the market to purchase our debt because of free trade lowers the costs to US taxpayers to finance that debt. Without free trade, the interest rate charged on US debt would be higher than it is already.

The author further cites, incorrectly, I might add, that it is a terrible thing for foreigners to own equity in US companies. What’s the opportunity cost? Decreased value of the company. That means decreased pay for employees of that company. Decreased opportunities for the growth of that company. He’s just wrong, and his clumsy assertion shows a clear misunderstanding of how a company operates and how markets operate.

The massive theft of intellectual property from the US to other countries is not because of free trade and foreign ownership of US equities. It’s because of ethics. In my opinion, the Chinese and other communist countries are highly unethical. They cheat. They steal. They lie. But, I bet the Chinese don’t think they are unethical at all.

What about the EU? The EU has all kinds of protectionist policies that go above and beyond tariffs that stop US companies from competing. So does Canada.

Is the US the only ethical country on the globe? Certainly not.

Our enemies or potential enemies have stolen intellectual property from us for decades.

For sure, the Chinese are stealing. So are other countries. The Chinese are nasty about it and erect trade barriers so US companies cannot compete. There are things that the US decided not to produce inside our country that are produced in China that probably should be produced here, because now we see the opportunity costs of not doing that are higher than the threats that come with not being able to produce.

Erecting a total trade barrier with China would have a greater opportunity cost to the US than having trade. That doesn’t mean free trade on everything. Does it matter if your shoes and clothing are made in China? Probably not. But it might matter where electronics for defense products are made.

Stealing, cheating, and lying are all opportunity costs and are hard to calculate. How much of it would you be willing to tolerate if you could get a better return on assets by making something else? Which goods or services would you put a barrier around?

Putting limits on holdings is putting a price ceiling on them. In many cases, having a price ceiling is strategic. In others, it is a failure to recognize the true opportunity cost of the ceiling. You are accepting a lot of dead weight loss in return for false security.

Too many people are putting elegant but fallible arguments around the 1970s phrase designed to save US automakers, “Buy American”. The US Automakers didn’t make as good a product as foreign car manufacturers and, in general, still do not to this day. These elegant but fallible arguments lead to good bite-sized talking points for social media and television, but result in very poor policy for our country.