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Dubai Ports rejection helped US economic growth

By Howard Richman and Raymond Richman
web posted March 5, 2007

When Congress killed the Dubai Ports deal one year ago, they were worried that our security would be endangered if we let an Arab company run five of our sea terminals.  In a last-ditch attempt to salvage the deal, the Bush administration, Jack Kemp, and Larry Kudlow switched from security to economic arguments.  A year later, it is possible to evaluate those economic arguments.

Bush Administration: Discouraging financial investment hurts the U.S.

Last March, the Bush administration argued that scuttling the Dubai Ports deal would send a negative message to foreign investors who would withdraw their investments and hurt the U.S. economy.  The Bush administration was fudging the difference between two kinds of investment, "direct investment" and "financial investment." The former contributes to economic growth; the latter does nothing but change the name of the owner on a piece of paper. Dubai was buying the existing management contracts already owned by a foreign company, P&O Navigation, in New York/New Jersey, Philadelphia, Baltimore, New Orleans and Miami.

"Direct" investment is illustrated by BMW building an assembly plant in South Carolina; financial investment is illustrated by Daimler-Benz buying Chrysler or by foreigners purchasing US stocks and bonds or putting money into dollar-denominated savings accounts in foreign banks that the foreign banks in turn place tax-free into US financial institutions. 

The Bush administration was correct if they meant that the Dubai Ports deal rejection would discourage some foreign financial investment.  According to the Bank for International Settlements, OPEC nations reduced their dollar-denominated bank deposits and increased their euro- and yen- bank deposits starting soon after the Ports rejection.  This weakened the U.S. dollar, versus the euro.  However, the effect upon the United States economy was entirely beneficial.

U.S. dollar strengthDoesn't the Bush administration know that we are experiencing a trade deficit in goods and services (5.76% of GDP in both 2005 and 2006) because the dollar is too strong right now?  The dollar needs to weaken so that American goods become cheaper to foreigners and foreign goods become more expensive to Americans.  The chart of Dollar Strength and US Exports shows the relationship between the dollar's purchase price in terms of other currencies and U.S. exports of goods and services as a percentage of GDP.  It shows that after the dollar strengthened, exports fell, and that after the dollar weakened, exports rose.   

The strengthening of the dollar from 1996 through 2002 was very bad for American manufacturing investment.  American manufacturing companies couldn't make much profit, so they weren't willing to invest very much to build new factories or to make their old factories more efficient.  It wasn't until 2005 that manufacturing investment started to turn around in response to the weakening dollar. 

Fixed investment in manufacturingAlthough the dollar fell by 11% versus the euro in 2006, it actually strengthened by 1% against the Japanese yen and only weakened by about 3% versus the Chinese yuan.  The Chinese government keeps its currency pegged about 40% higher than it should be against the dollar and avoids a black market by buying up all of the excess dollars. Then they indirectly lend those dollars through financial investments to American consumers who use them to buy… more Chinese goods. We call this strategy "dollar mercantilism." 

The Japanese were the first dollar mercantilists.  They've been buying dollars and investing them in the United States for decades in order to bid up the world price of the dollar and thus the price of American goods in world markets and at the same time to bid down the Japanese yen and thus the price of Japanese goods in world markets.   Their manufacturing companies have made big profits which they invest to produce better cars and computer goods, while our manufacturing companies have laid off employees and slowed their investment.

So far the Chinese and Japanese governments have each collected approximately $1 trillion of U.S. financial investments over the years (that's about 7.5% of our GDP each) in order to keep their currencies weak versus the dollar.  Many of the other Pacific Rim countries also accumulate dollars and India and Brazil just joined the pack. 

Sooner or later, our government is going to have to figure out that the dollar is too strong, not too weak.  If it weren't for the Dubai Ports deal chasing away some OPEC financial investment, the dollar would have strengthened in 2006 and that strengthening would have slowed the growth in our exports and nipped in the bud the turn-around of our manufacturing investment. 

Jack Kemp: Foreign investment in the U.S. brings democratic capitalism to the world

Last year when the Dubai Ports deal was being debated, Jack Kemp argued strongly for the deal.  Noting that he was on the Board of Directors of many U.S. corporations that do business overseas, he argued that increasing world economic integration brings "democratic capitalism" to the world.  However one of the main effects of the financial investments being sent to the United States is that China has been growing by about 10% per year, while the U.S. economy has only been growing by about 3%. 

Doesn't Kemp realize that China has a communist government?  In order to do business in China, American companies accept the Chinese government as a partner.  The Chinese government has been, and continues to be a totalitarian regime.  For all we know, their experiment with limited free markets will suffer the same fate as Lenin's New Economic Plan (NEP) did when Stalin came to power. It was Lenin who said that capitalist greed would produce the rope needed to strangle capitalism.

Sooner or later Jack Kemp and the corporations on whose board he sits will need to recognize that they may be strengthening totalitarianism, not democratic capitalism, when they build factories in China.

Larry Kudlow:  If you're a protectionist, you're anti-growth

Writing on the National Review Online website, Larry Kudlow endorsed Jack Kemp's position.  According to Kudlow, those supporting the Dubai Ports deal were pro-economic growth, while those opposing the deal were "xenophobic protectionists like my old friend Patrick Buchanan."   According to Kudlow's radical version of the free-trade ideology, not only is the free flow of goods across borders good, but the free flow of financial capital across borders is good as well, even though it produces trade deficits.

U.S. foreign debtDoesn't Kudlow realize that the growing US Foreign debt is a Sword of Damocles hanging over the US economy?  Other debt-ridden countries (like the Asian Tigers, Argentina, and Russia) have suffered severe currency crashes accompanied by high inflation and a huge cut in living standards.  Just what is so "pro growth" about letting our foreign debt grow until a huge economics contraction occurs?

Back in 1984, at the request of Treasury Secretary Don Regan, one of the original believers in the radical version of free-trade ideology, the United States enacted one of the most stupid tax loopholes of all time, the private-foreign-savings tax-loophole.  Before 1984, private foreign savers paid a 30% withholding tax on any interest earned in the United States.  After the loophole, they paid, zip, zero, nada, so long as their investments were purely financial, and not direct.  

It's not that Congress wasn't told that they were making a mistake.  At the April 11, 1984, hearing on the "Tax Treatment of Interest Paid to Foreign Persons" before the Committee on Ways and Means of the House of Representatives, Citizens for Tax Justice (Bob McIntyre), First Boston Corporation and Morgan Guaranty Trust, all warned that the version of the tax loophole that was eventually enacted would strengthen the dollar which would, in turn, increase U.S. trade deficits and cause the loss of U.S. manufacturing jobs. 

All of this was written up by Giuseppe Ammendola in his 1994 appropriately titled book, From Creditor to Debtor: the U.S. Pursuit of Foreign capital – The Case for the Repeal of the Withholding Tax. Striking the 1984 tax loophole [§871(h,i,k); §881(c,d,e)] from the Internal Revenue Service code would increase United States income tax collections from foreigners by about $22.5 billion in the first year.  

Then there's another foreign-savings tax-loophole that we should eliminate.  As a result of various treaties that we have with foreign governments, they get to invest in the United States tax free, and we get to invest in them tax free.  The only problem is that they have over $3,000 billion invested in the United States (according to the International Monetary Fund's COFER database), while our government only has about $38 billion invested in them. 

Sooner or later, Larry Kudlow and the other free-capital-movement ideologues are going to have to stop pretending that our growing foreign debt problem will go away if we just ignore it.  There are ways to address the problem without interfering with the advantages that accrue from free movement of goods across borders.  We can start by closing the foreign-savings tax-loopholes that are driving down American manufacturing employment and investment, driving up the U.S. foreign debt, and threatening a huge economics contraction. 

Bismarck: God Provides for Fools, Drunkards, and the United States

Otto von Bismarck once said, "God provides for fools, drunkards, and the United States of America."  Last year, OPEC provided the Dubai Ports deal whose rejection gave us a year of improving exports.  This year, it looks like we could get a similar gift from the Chinese.

In a recent issue of Business Week (March 5, 2007), financial analyst James C. Cooper reported that the Chinese are considering diverting $200 billion from their dollar accumulations in order to purchase euros in the coming year.  If the Chinese buy euros instead of dollars, they would have to let the yuan strengthen versus the dollar, which would be very good for U.S. exports, trade balance, and manufacturing investment.

However, James C. Cooper did not see this as a good development.  Instead, he worried that a drop in Chinese financial investment could cause U.S. interest rates to rise so much as to reduce  business borrowing for U.S. investment. 

Doesn't Cooper realize that U.S. interest rates are extremely low at present?  At the end of February, the interest rate on 6-month U.S. T-Bills was just 2.0% and the interest rate on 10-year T-Bills was just 1.5% after subtracting last year's 3.1% inflation.  It would be good for interest rates to rise enough to induce Americans to save.

Sooner or later, the American people are going to figure out just how foolish the advice is that is being given by the trade-deficit ostriches.  Their heads are so firmly planted into the ground that they say things that are totally disassociated from reality.  It is almost unbelievable that the Bush administration can claim that we need OPEC financial investment when our real problem is that the dollar is too strong, that Jack Kemp can argue that American corporations are spreading democratic capitalism when they are really building communist totalitarianism, that Larry Kudlow can claim that free movement of capital across borders is pro-growth when it is actually threatening the U.S. with a huge economics contraction. 

Sooner or later, the American people will begin to listen to the advice of those leaders, lobbyists, and economists who have been examining the problem like eagles.  Leaders like Pat Buchanan, Warren Buffett, and Byron Dorgan, lobbyists like William Hawkins, Alan Tonelson, and Bob McIntyre, and economists like Giuseppe Ammendola, Peter Morici, Robert Blecker, and Eamonn Fingleton.

Our foreign debt wasn't incurred in a day, and can't be eliminated in a day, but there are some very good gradual solutions available. We would start by eliminating our tax-loopholes that subsidize foreign financial investment.  Doing so would not only help balance the federal budget, but it would also weaken the dollar so that American manufacturing can continue its recovery.  ESR

Dr. Howard Richman is the executive director of a non-profit and an Internet economics teacher.  Raymond Richman is professor emeritus of public and international affairs at the University of Pittsburgh with a PhD in economics from the University of Chicago. They are currently writing a book about dollar mercantilism entitled The Savings of Nations.

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