Rebuilding America's Job Market

Despite the fact that headline employment data shows what appears to be a healthy economy, millions of work-deprived Americans who have fallen off the Bureau of Labor Statistics radar screen would suggest otherwise.  One of the greatest declines in America's "job creation machines" has been in manufacturing.  Here is a graph showing what has happened to the number of manufacturing jobs in the United States since 1939:

We have to go all the way back to World War II to find manufacturing job levels that are the same as they are today.

Here is a graph showing the percentage of non-farm employees that are involved in the manufacturing sector:

Right now, only 8.5 percent of non-farm workers in the United States are involved in the manufacturing sector, down from nearly 26 percent in 1970 and 13.2 percent in 2000.  Since the Great Recession began, the number of workers in manufacturing has dropped from 13.746 million in December 2007 to its current level of 12.296 million, a loss of 1.45 million jobs.  Even worse, since China acceded to the World Trade Organization in December 11, 2001, the United States has lost 3.415 manufacturing jobs.

Here are some additional statistics from the Economic Policy Institute about America's beleaguered manufacturing sector.  Between 1998 and 2013, nearly one-third of U.S. manufacturing jobs disappeared along with over 80,000 manufacturing establishments.  While manufacturing made up 12.1 percent of GDP in 2014, its footprint in the American economy is far larger; in addition to the 12 million or so workers directly employed in manufacturing, an additional 17.4 million workers are supported indirectly by the manufacturing sector.  In other words, manufacturing directly or indirectly supports more than 29.6 million jobs or 21.3 percent of all U.S. employment (2014 data).  As well, manufacturing is responsible for $208 billion worth of business research and development or nearly two-thirds of all U.S. business spending on R&D.  In addition, when the services that manufacturing businesses purchase are factored into the equation, the value of gross output from this one sector amounted to $6.2 trillion or roughly 35 percent of GDP

Here is a graphic showing the current United States goods trade balance, a relatively accurate proxy for the manufacturing trade balance since manufacturing constituted 86.9 percent of total U.S. trade in goods and 94.3 percent of total trade in non-oil goods (2015 data):

Note the rather dramatic increase in the goods trade deficit after the much-touted (by Bill Clinton, no less) WTO trade deal with China.   In May 2016, exports of goods were $119.8 billion and imports of goods was $182.1 billion, resulting in a goods trade deficit of $62.3 billion, slightly larger than the goods trade deficit for all of 1991!

It's pretty obvious that the manufacturing sector was and still could be a significant job creator for the United States economy, however, there is one key factor that has interfered with this mechanism.  In a Policy Memo by Robert Scott at the Economic Policy Institute, the author outlines the root causes of the problem.  Globalization has created an extremely competitive trade environment and all nations, particularly those in Asia, are looking for an edge to give them increased market shares.  Through the use of currency manipulation, these nations have affected the value of their currencies to make their domestically produced goods less expensive and, by comparison, American-made goods more expensive.  In this case, currency manipulation acts like a form of tax or tariff on imported goods, making domestically produced goods look more attractive to local consumers and exported goods more attractive to outside consumers.  Nations that run large and consistent trade surpluses with the United States (i.e. the United States runs trade deficits with these nations) tend to be currency manipulators.  Governments can manipulate currencies by buying foreign assets denominated in the currencies of other nations (i.e. U.S. Treasuries) which increases the demand for that currency relative to their own currency.  China and roughly 20 other Asian nations have purchased trillions of dollars worth of U.S.-denominated assets over the past 15 years (again since China joined the WTO in 2000) and this has resulted in this:

  

To give you a sense of how big the problem has become, back in 2000, China held only $60.3 billion in U.S. Treasuries and Japan held $317.7 billion.  By 2005, four short years after China joined the WTO, their holdings of Treasuries had grown to $310 billion, five times what they held in 2000.  Can anyone say "currency manipulation"?

While Donald Trump is correct in announcing that China's currency manipulation is responsible for the massive trade deficit, his claims that countervailing duties will clean up the problem with trade deficits will not really help American workers.  Increasing tariffs on imported goods will achieve only one thing; raising the cost of goods that the United States imports.  Any new job creation in competing industries would be limited because of the negative effect of tariffs on domestic prices.   The biggest part of the problem for American workers is the excessive demand for the United States dollar which has been driven up to excessively high values; in the past two years alone private capital flows in China and Europe have driven the dollar up by an additional 15 percent.  This will have a medium- and long-term negative impact on U.S. trade deficits and the creation of domestic manufacturing jobs.  How can we tell when the dollar is fairly valued?  The author of the memo suggests that the dollar will be fairly valued when the United States experiences neither a trade surplus nor a trade deficit.  This balance would be accomplished when the U.S. dollar falls by between 25 and 30 percent on average and by more when measured against the currencies of China, Germany and Japan, for instance, the value of the dollar would have to fall by 37 percent against China's yuan renminbi and 50 percent against Japan's yen.  If trade balance were achieved, there would be a significant increase in the demand for United States-manufactured goods which would ultimately result in the rebuilding of the lost manufacturing sector jobs.

How can an end to currency manipulation be achieved?  Economists have have suggested two methods that the United States could use:

1.) intervene in the currency market by engaging in countervailing currency intervention (CCI) by purchasing large amounts of foreign assets denominated in the currencies of the trade surplus nations.

2.) impose an adjustable market access charge which would act as a tax or fee on all capital inflows.  This would result in a decrease in the demand for dollar-denominated assets and would push down the value of the U.S. dollar.

To keep these policies free of "political meddling", the author suggests that the two approaches could be implemented by the Department of the Treasury (or less appealingly, at least to me, by the Federal Reserve).  This would remove the ability of the president or Congress to interfere with the neutrality of the system.

While imposing countervailing duties or tariffs on nations that are taking part in currency manipulation seems like a great idea, it will do little to solve the problem of increasing demand for American exports.  The whole point of realigning the value of the U.S. dollar is two-pronged; it makes imported goods more expensive to American consumers and, most importantly, it makes American goods more competitively priced to foreign consumers.  It is that effect of reducing currency manipulation that will result in the resurrection of American manufacturing sector and putting millions of workers back into well-paying jobs.  Even a million new manufacturing jobs would help.

Russia 1998 - A Currency Devaluation and Sovereign Debt Default Case Study

Russia's collapsing currency and rapidly rising interest rates have been front page news in the media over the past month.  Here is a chart that shows what has happened to the yield on Russia's 10 year bonds:

The yield on ten year bonds is in excess of 16.5 percent compared to 10.2 percent during the last week in November 2014.  While these levels are high, they are nothing compared to what happened during the Russian crisis of 1998 and you will see.

Here is a chart showing what has happened to the value of the Russian ruble over the past month:

The ruble has fallen from 45 to the U.S. dollar during the last week of November 2014 to a low of 77.5 to the U.S. dollar in mid-December 2014.

While all of this is interesting to watch from outside of Russia, such dramatic moves in Russia's interest rates and currency exchange rates is not unprecedented.  

In 1998, Russia's economy experienced a currency crisis that resulted in a forced devaluation and a default on both public and private debt.  A study by Abigail Chiodo and Michael Owyang at the Federal Reserve Bank of St. Louis provides us with an interesting history of the 1998 Russian crisis and how it developed.

Let's look at the definition of a currency crisis.  A currency crisis is created when there is a speculative attack on a currency that occurs when currency traders decide to buy a country's currency by selling the currency of another country, for example, in Russia's case, currency traders have elected to sell rubles and buy other currencies such as the euro and U.S. dollar. A crisis can occur for several reasons:

1.) investors fear that the government will attempt to finance its debt and deficits through the printing.

2.) investors fear that the government will reduce its debt by devaluing its currency because the country either cannot afford to support the value of its currency or chooses not to support its currency.  If the government is unable to buy its own currency (i.e. prop it up) with its foreign reserves (i.e. by creating demand for its own currency), the value of the currency will drop.  This will result in the price of domestic goods and services becoming cheaper relative to foreign goods and services but will likely result in higher levels of inflation.

Let's look at Russia's public finances over the period from 1995 and 1998 giving us a sense of the magnitude of the problem in 1997 and 1998:

Government debt includes both domestic and foreign debt.  Note that interest payments on the debt reached a high of 43 percent of total government revenues in 1998. To put these numbers into perspective, according to the Central Bank of Russia, Russia's foreign debt in June 2014 was $731.204 billion U.S. dollars.

After the end of the Communist-era in the Soviet Union, Russia moved toward a free market economy.  In April 1996, Russian officials began to negotiate the payments for the debt that it had inherited from the USSR.  By 1997, it appeared that the Russian economy was on the mend with a better trade balance between both imports and imports as shown on this figure:

There was also a significant improvement in the nation's inflation rate as shown here:

Inflation had fallen from 131 percent in 1995 to 11 percent in 1997, a trend that reversed during the currency crisis.  

In 1997, oil was selling at $23 per barrel, a rather high price given that prices during the 1980s had fallen as low as $10 per barrel.  At that time, oil revenues made up 45 percent of Russia's main commodity exports.  Moves by the IMF and the Paris Club that were negotiating with Russia kept the ruble trading between 5 and 6 rubles to the dollar.  At that time, analysts predicted that Russia's credit rating would improve and Russia's government was counting on 2 percent economic growth in 1998.  On the downside, real wages were only half of their level in 1991 and only about 40 percent of the workforce was being paid on time.  Tax collection was also a problem, resulting in a high public sector deficit.  One of the biggest problems that was glossed over during the negotiations was the value of the assets held by Russia.  One-quarter of Russia's assets were loans that the USSR had made to Cuba, Mongolia and Vietnam.  

Unfortunately, during late 1997, the Asian currency crisis caused a speculative attack on the ruble, resulting in this:

The Central Bank of Russia (CBR) was forced to defend the ruble, spending $6 billion of their foreign exchange reserves.  At the same time as the ruble was under attack, the price of oil and non-ferrous metals began to drop, reducing Russia's hard-currency earnings by two-thirds.  

By early May 1998, the Chair of the CBR, Sergei Dubinin, began to warn Russia's government that there would be a debt crisis within the next three years.  Reporting on the warnings were misinterpreted to mean that the CBR was considering a devaluation of the ruble.  This resulted in a significant decline in investors' perceptions of Russia's economic stability.  By May 18th, 1998, government bond yields had increased to 47 percent.  Investors and depositors became increasingly unwilling to purchase Russia's bonds because of concerns that they would not be repaid.  This resulted in a decrease in the amount of cash that commercial banks had to keep them afloat.  In response to the crisis, the CBR increased the lending rate to 50 percent and spent $1 billion of its already strained reserves to defend the ruble.

Oil prices continued to decline, hitting $11 per barrel resulting in a loss of $4 billion in revenue.  The oligarchs who were controlling Russia's oil and gas industry strongly suggested that the CBR devalue the ruble, a move which would have increased the ruble value of exported oil and gas.  In response, the CBR raised its lending rate to 150 percent as shown here:

Here's what happened to real short-term interest rates in Russia between January 1995 and August 1998:

The high short term rates dropped after Boris Yeltsin was elected in July 1996 but rose as the crisis developed, killing off any hope of a Russian economic miracle.

Despite these efforts, the knowledge that billions of dollars worth of corporate, bank and government debt were coming due in the fall of 1998, necessitated the intervention of the IMF.  The IMF approved additional assistance of $11.2 billion in July 1998, however, approximately $4 billion in capital had fled Russia between May and August of 1998, putting an additional strain on the economy.

On August 13, 1998, the Russian stock, bond and currency markets collapsed on fears that the government would default on its debt, devalue its currency or both.  The annual yield on ruble denominated bonds rose to more than 200 percent and the stock market dropped by 65 percent on very light volumes (it had fallen 39 percent in the month of May alone). 

On August 17, 1998, Russia's government floated its exchange rate, devalued the ruble, halted payments on ruble-denominated debt and declared a 90 day moratorium on payments by the banking system to foreign creditors, a devaluation and debt default double header.

As a result of the crisis, this is what happened to Russia's economic growth during the period from 1995 to 2001:

By 2000, the Russian economy was growing at 8.3 percent, much of which can be attributed to an increase in the price for oil.

At the time of the default, Russia announced a forced restructuring of its ruble debt obligations that were falling due at the end of 1999 with a face value of $45 billion at the exchange rate prior to the crisis.  Not only were there problems with Russia's debt, but Moscow-based private banks collapsed as well, forcing depositors to transfer their deposits to Sberbank, the state-owned savings bank.    

Right now, many are speculating that Russia's current crisis has been brought about by sanctions imposed over the Ukrainian issue and by falling oil prices since oil forms a key part of Russia's government revenues.  In Russia's 2014 budget, it called for total revenues of $409.6 billion and spending of $419.6 for a deficit of $10 billion or 0.4 percent of GDP ($2.5 trillion), a tiny fraction of the deficits run in most developed nations.  According to calculations by Forbes, assuming oil prices of $111.76 per barrel for crude oil (the year-end price in 2013) and natural gas prices of $66 per fuel oil equivalent barrel, Russia's annual oil and natural gas revenues for 2014 would be $662.3 billion or 25 percent of GDP.  If oil drops in price to $80 per barrel, Russia would see its oil and natural gas revenues decline by $120 billion.  Obviously, this would push up Russia's deficit for 2014.

What is being ignored is the interconnectedness of the world's economy.  As became apparent during the Asian crisis and the Great Depression, when one part of the world's economy suffers, the suffering has a strong tendency to spread to the most unexpected quarters.  In the current case, while low oil prices will have a strong impact on Russia's economy, they will also have an impact on any nation that relies heavily on oil revenues to achieve some semblance of fiscal balance and any nation that trades with Russia.