Buy American

Buy American sounds good & it feels real good to say it. But wait, is there trouble lurking? If I have concern with the American Recovery and Reinvestment Act, it is trade protectionism.

It's difficult to come by an economist who thinks this is a smart thing to do. Harvard economics professor Greg Mankiw surveyed economists and found that 93% believe that tariffs and import quotas usually reduce general economic welfare.

Yes, it may protect a few steelworker jobs, and garner some higher prices for their goods sold for US infrastructure projects--of course, costing taxpayers even more.

But it's not the extra cost I'm concerned about. You have to look no further than Peoria, IL to discover that Caterpillar employees may be harshly effected...when foreigners retaliate for US protectionist policies. This provision may put far more workers out of jobs than it preserves for those in a couple industries.


In early February, 100 business groups and companies, such as the U.S. Chamber of Commerce, General Electric, Caterpillar and other major construction, defense and high-tech companies wrote a letter to Senate leaders.

They warned that a far-reaching Buy American rule will harm American workers and companies across the entire U.S. economy, undermine U.S. global engagement, and result in mirror-image trade restrictions abroad that would put at risk huge amounts of American exports.

I am very concerned that this Buy American clause will totally backfire on the US. There is a chance it could undo whatever stimulus comes from the $787 billion package.

I was very pleased to see that our Chinese trading partner will not adopt a "buy Chinese" products policy to stimulate its economy. That would be imposing trade protectionism, says Vice-Commerce Minister Jiang Zengwei. Domestic and foreign products will be treated on equal footing as long as there is demand.


Fortunately in the final version of this bill, the Buy American clause was watered down:

• The Buy American policy must not violate U.S. obligations under existing international trade agreements.
• The rule doesn't apply if American goods aren't available in sufficient quantities.
• Nor does it apply if the cost of the overall project will increase by more than 25%.

That's not how it was received overseas, however. Robert Zoellick, president of the World Bank, says it is crucial to avoid the protectionist policies of the 1930s. The Buy American provision is very dangerous, he said.

The Times of London says the symbolism of the clause is ugly. The Administration must give a stronger message domestically and to America's allies that it knows trade barriers destroy wealth and will impede recovery.

Czech Finance Minister Miroslav Kalousek denounced protectionism. At a press conference he said, It is our duty to explain, at the cost of our popularity, that this is the road to hell, that we need our neighbors more than ever before. We have to prevent populists from going on with the Buy Czech, Buy American, Buy French campaigns.


Let's learn a little from history. The Smoot-Hawley Tariff Act was signed into law in 1930. It that raised U.S. tariffs on over 20,000 imported goods to record levels.


After it was passed, many countries retaliated with their own increased tariffs on U.S. goods. American exports and imports plunged by more than half. In the opinion of leading economists, the Smoot-Hawley Act was a catalyst for the severe reduction in U.S.-European trade from its high in 1929 to its depressed levels of 1932 that accompanied the start of the Great Depression.

As a result of the Smoot-Hawley Tariff and other countries' responses to it, the world moved towards multilateral trading agreements that would prevent a similar situation from unfolding. This led to the Bretton Woods Agreement, in 1944.

US trade restriction was a hot topic at the 2009 World Economic Forum in Davos, Switzerland. Watch the following new video from Newsy.com to see what I mean.




More recently the Group of Seven leading industrialized nations vowed not to resort to protectionist measures as they seek to turn their economies around. In a published statement they said, The G-7 remains committed to avoiding protectionist measures, which would only exacerbate the downturn, to refraining from raising new barriers. This is fabulous news.

The G-7 nations are comprised of Canada, France, Germany, Italy, Japan, the U.K. and the United States.

Baltic Dry Index

People don't book freighters unless they have cargo to move.

The Baltic Dry Index (BDI) is calculated each day by the Baltic Exchange in London. The index assesses the price of moving raw materials like coal, iron ore and grain by sea.

The index measures the demand for shipping versus the supply of dry bulk carriers, reports Wikipedia.

The supply of cargo ships is generally both tight and inelastic — it takes two years to build a new ship, and ships are too expensive to take out of circulation the way airlines park unneeded jets in the California desert.

Marginal changes in demand quickly move the index. So the index indirectly measures global supply and demand for the commodities shipped aboard dry bulk carriers.

Dry bulk consists of materials used to produce concrete, electricity, steel and food. This index is an efficient economic indicator of future economic growth and production.

The BDI is a leading economic indicator because it predicts future economic activity.

Here's some good news. The Baltic Dry Index reveals a nice rebound in demand over the past month.


Economists have illustrated the rather close correlation of the BDI with stock market performance. If it is an efficient, leading indicator of future economic activity...then we could be seeing early signs of recovery from this recession.

That would support the view of economist Brian Wesbury (see my L U V article) of a V-shaped recession with recovery later this year.

Oil: Peace Dividend?

There is very good news from around the world. Our enemies are struggling due to dropping oil and gas prices. In Iran, Venezuela & Russia, the hold of the dictator is weakening as, one after the other, they face the consequences of dropping oil prices.

A few weeks ago, political analyst Dick Morris offered the following insights.

In Iran, the sanctions imposed by the United Nations, the aggressive efforts of the U.S. government, and the actions of states like California, Florida, and Missouri to ban pension investments in companies that do business with Iran are having a big effect.

Unable to expand its oil production for a lack of foreign investment, Iran faces the need to slash its budget drastically as energy revenues, the source of 85% of its income, crash. Iranian President Ahmadinejad is announcing harsh austerity measures.


Having based his budget on $50-$60 oil, he now must recast it for at a $40 per barrel level. He boasts of cash reserves of $23 billion, but that sum won’t last long unless he makes major cuts. (Do the math: a shortfall of $25/barrel per day x 4 million barrels a day x 365 days = $36.5 billion, more than he’s got on hand).

The question for Ahmadinejad and for the Ayatollah who stands behind him is: Can their regime survive economic collapse? Unable to buy social peace by handouts and subsidies, will the top blow off in a country that hates this regime--predominantly very young people & only 40% Farci?

Chavez, in Venezuela is not in any better shape. Because of corruption and incompetence, Venezuelan oil production has dropped from over 3 million barrels per day when Chavez took over to about 1.7 million today. As long as oil prices were quadrupling, it didn’t matter, but when they crashed, a harsh wind of reality blew in the door.


Chavez was losing popularity before the oil price dropped. He lost a constitutional referendum to give himself lifetime tenure and he just lost his municipal elections in the largest cities and states in the nation. After knocking out most of the major opposition candidates on phony charges of corruption, he managed to hang on to the governorships of the small, rural provinces, but he lost the cities – even the poor areas of the cities voted against him.

Putin’s Russia, which so recently threw its weight around by invading Georgia, faces perhaps the biggest hit of all to its economy. Producing 10 million barrels per day, Russia will be hit the hardest by the collapse of prices. (Again, do the math: Assume Russia budgeted at $60 oil prices and the price drops to $40. $20/barrel x 10 million barrels per day x 365 = a $73 billion annual shortfall).


With a GDP of only about $1.4 trillion, Russia faces the loss of about 5% of its economy. And Russian oil production has dropped by one million barrels per day for each of the past two years. With prices at rock bottom and nationalization an ever-present threat, who is going to invest in increasing Russian production?

This week we learned that a seven-year economic boom in Russia fueled by cheap credit and soaring commodity prices has come to an abrupt end, plunging the country into the worst financial crisis since its 1998 debt default.

Russia's economy is expected to contract by at least 2% in 2009 after growing at an average rate of 7% in recent years.

This vast nation with 142 million people owes its past success, and its current woes, to this decade's wild ride in commodities. Its economy depends on revenue from oil, natural gas and metals.

The commodities collapse is starting to hurt ordinary Russians. The unemployment rate jumped to 8.1% last month, with 6.1 million Russians currently out of work.

In these oil-producing nations the ruler buys social peace with oil money. The pressure to stay in power will be so intense that these leaders will force production as high as they can to offset the shortfall. The result is that there will be constant deflationary pressure on oil prices--and a potential "peace dividend" to freedom-loving countries because these rulers will not have the means nor perhaps the inclination to make war at this time.

Fear of Fear

In the beginning, economics was closely linked with psychology. My friend Phil likes Adam Smith, who described psychological principles of human behavior in The Theory of Moral Sentiments.

From those humble beginnings we now have the field of behavioral economics. It applies scientific research into people's cognitive and emotional factors to better understand economic decisions by consumers, borrowers & investors, and how they affect market prices, returns and the allocation of resources.

At the highest levels in government, behavioral engineering was applied during the Great Depression. President Herbert Hoover said that prosperity was just around the corner even as the economy continued to deteriorate.


Later in Franklin Delano Roosevelt's inaugural address he said that the only thing we have to fear is fear itself.


That same type of psychology is not being used today. The president has used jargon that risks making it worse.

In Elkhart, Indiana, President Obama warned that if we don't act immediately, our nation will sink into a crisis that, at some point, we may be unable to reverse.


During his first press conference he referred to potentially negative spiral that becomes much more difficult for us to get out of.

I understand that he needed to motivate Congress to act quickly on a stimulus package. But such rhetoric is also dangerous, and undermines one of the root causes of our recession--a slowdown in the velocity of money, which I've discussed before.

As people spend less, and save more, it makes it difficult for our economy to grow. This started last September following the difficulties with Fannie Mae & the meltdown of Lehman Brothers.

At that time President Bush came on TV...and he also frightened Americans. Our entire economy is in danger, he said. Without immediate action by Congress, America could slip into a financial panic, and a distressing scenario would unfold. Ultimately, our country could experience a long and painful recession.

Business cycles are often a product of human nature. The Administration needs to be more adept at recognizing & applying these psychological principles. Otherwise the R-word (let's hope not the D-word) becomes self-fulfilling prophecy...and actually prolongs the pain.

There are three main emotional motivators of stock markets and business behavior:

• Greed
• Herd instinct
• Fear

These in turn psychologically effect bull markets, business cycles & bear markets.

The ordinary Joe still has to eat...buy clothes...purchase a car. The president should not be afraid to tell them to spend. That's what President Bush recommended after 9/11.

We are far, far from a depression. Have you seen a food line lately? How about a woman selling apples on your local street corner?



There was a reason this positive outlook was emphasized when Bing Crosby, and the Andrews Sisters, sang:

You've got to accentuate the positive
Eliminate the negative
Latch on to the affirmative
Don't mess with Mister In-Between

You've got to spread joy up to the maximum
Bring gloom down to the minimum
Have faith or pandemonium
Liable to walk upon the scene

Today President Obama signed the American Recovery and Reinvestment Act.

In his Denver address he said, Today does not mark the end of our economic troubles. Nor does it constitute all of what we must do to turn our economy around. But it does mark the beginning of the end -- the beginning of what we need to do to create jobs for Americans scrambling in the wake of layoffs; to provide relief for families worried they won't be able to pay next month's bills; and to set our economy on a firmer foundation, paving the way to long-term growth and prosperity.

Let's hope he has turned over a new leaf--to Latch on to the Affirmative.