The Trade Warrior

Donald Trump's Attack on German Prosperity

U.S. President Donald Trump seems intent on launching a trade war. He is ignoring appeals to common sense coming from Europe and Asia, but one country stands to lose more than any other: Germany.

By DER SPIEGEL Staff

  U.S. President Donald Trump appears intent on launching a trade war. One of...



Green appears to be the color of the season. At the Geneva International Motor Show, Ford last week presented a limited-edition Mustang Bullitt in "Dark Highland Green" The M8 Gran Coupé from BMW showed up in lustrous "Salève Vert." And Porsche's new 911 looks a bit like a lacquered tree frog. Green like springtime. The color of hope.

Starting last Thursday, automobile manufacturers once again began presenting their newest attractions. But this year, the executives are having a more difficult time than usual in exuding confidence. It's not that their bottom lines are in bad shape; on the contrary. It's not that they are weighed down by the ongoing diesel scandal; they've more or less become used to that. Rather, their collective mood was crushed by just a few words pecked out on the screen of the mobile phone of the most powerful man in the world.

On March 3, U.S. President Donald Trump announced on Twitter that he would be slapping a punitive tariff on automobiles "which freely pour into the U.S.," as he complained. Prior to that, Trump had announced that he intended to introduce a 25-percent import tariff on steel and 10 percent on aluminum -- and signed the corresponding executive order last Thursday. It was a move that threw a significant share of the automobile and metal industries into turmoil.

If Trump also fulfills his threat against foreign carmakers, it would be a painful blow to German producers, particularly Porsche. The VW subsidiary is heavily dependent on sales in the United States, with every fourth vehicle sold in America. Were tariffs introduced, Porsche would likely be forced to raise its prices and risk taking a hit on sales.

Suddenly, automobile executives find themselves facing a challenge that they've only ever read about in history books: the dangers of protectionism of the kind that can lead to a global trade war. "For decades, we grew up with the certainty that free trade and free markets increase prosperity," says Matthias Müller, CEO of Volkswagen. "Suddenly, this certainty is being questioned."

'We Can Also Do Stupid'

Trump caused a bit of a ruckus with similar comments a year ago, shortly after his inauguration. In response, a delegation of German business leaders under the leadership of Chancellor Angela Merkel traveled to Washington to pay their respects to the new White House resident and make sure he understood that BMW, for example, produces more vehicles in the United States than it exports to the country from elsewhere. And it quickly seemed as though the threat had passed. Now, however, it has become clear that the mission wasn't successful after all. Trump is now ready to pull the trigger and appeals to logic are a waste of breath.

Europeans, Asians and quite a few Americans as well are now facing the stunning realization that the U.S. president adheres to a ludicrous set of beliefs. "Trade wars are good, and easy to win," Trump wrote on Twitter to a dumbfounded public. In the face of such voodoo economics, even the old Wall Street trope "greed is good" hardly seems objectionable.

The EU chose not to sit on its hands. In response to Trump's tariff plans, European Commission President Jean-Claude Juncker threatened retaliation, saying "we can also do stupid." His list of products that could be slapped with tariffs includes jeans, cosmetics, motorcycles, orange juice, whiskey and corn. The collective value of the products adds up to around 2.8 billion euros, with the tariff potentially being as high as 25 percent.

What will happen next? And what exactly might China's weekend threat to "defend the interests of our country and our people" mean in concrete terms? The country could, for example, cease importing soy beans from the United States, which would be a tough blow to farmers there. Or they could suspend exports of rare earths, elements that are vital in the production of many high-tech devices. It wasn't that long ago that China struck fear into the hearts of buyers by imposing a similar ban.

The concern is that once the cycle of tariffs and reciprocal tariffs gets started, it is almost impossible to stop. Small skirmishes can quickly grow into a global trade war.

The looming conflict is a sign of the turning point at which the global economy finds itself. Recently, the economy in most corners of the globe has been healthy, with the world experiencing a rare phase of synchronous growth. But it looks as though that phase is now coming to an end.

Interest rates are rising and sovereign debt is growing, the result of which is that governments are beginning to lose their flexibility and it is likely that some countries will soon face difficulties borrowing money on the open market. Increasing financial market instability shows that insecurity is on the rise. And in this situation, protectionist policies pursued by populists and nationalists harm economic growth and endanger international prosperity.

'Everything Would Start Teetering'

It is something on which a majority of economists actually agree: tariff barriers slow growth, put jobs at risk and drive up inflation. Once a trade war is triggered, there is no winner, although Munich-based economist Gabriel Felbermayr says that Germany has the most to lose.

"There is no other country in the world that would be hit as hard."

Felbermayr, 41, heads up the Center for International Economics at the Center for Economic Studies (CES). The shaved-headed economics professor, originally from Austria, has examined just how devastating Trump's economic policies could be for the German economy. Every fourth job in the country, he says, is dependent on exports. And in five key sectors -- automobiles, machinery, electrical engineering, pharmaceuticals and precision instruments -- fully three-quarters of all exports go to the United States. "If the U.S. were to cut itself off, it would threaten the German business model," Felbermayr says. "Everything would start teetering."

What can be done? What might constitute an adequate response to the provocations from across the Atlantic? On that question, opinions among economists are more divergent.

Felbermayr suggests showing a bit of severity. If there is no international reaction to his tariffs on steel and aluminum, the CES economist believes, then Trump will try to apply the same strategy in other sectors. "A clear signal must be sent that not everything will simply be accepted." Felbermayr says that is important "because quite a bit more could be on the way."

Michael Burda, an economist at Berlin's Humboldt University, has a different take. "I would advise the European Commission to adopt a conciliatory tone." Burda was born in New Orleans in 1959 and earned his Ph.D. at Harvard. He warns that a "tit for tat" approach could escalate the situation: "Then we would sink into protectionism."

So, should Berlin and Brussels back down? Or should America's trading partners take a hardline approach? The health of the global economy depends on the answer chosen, as does the future of many German companies.

Senden, a town near Ulm in southern Germany, is home to the headquarters of ESTA, a leader in the production of dust filter and ventilation systems. The family owned company, founded in 1972, builds machines that extract shavings, dust and warm air from workshops and factory floors. The company employs around 200 people in Senden and delivers its products to 30 countries around the world, with a large share of its sales sent to America. Two years ago, ESTA founded a subsidiary in North Carolina.

Not long later, Trump was elected president and ESTA CEO Peter Kulitz was one of the few who was able to find something positive to say. Kulitz thought at the time that Trump had proven himself as a businessman and that he would surely shift quickly out of campaign mode and into governing mode.

A Destructive Spiral

Kulitz now holds a different view. "I have become disillusioned by Trump's astounding mercurialness," he says. He is concerned about the coming trade conflict and is worried that it could set off a destructive spiral. Thus far, his company hasn't had to pay much in the way of customs on the machines it exports. But if Trump were to introduce substantial tariffs on his company's finished products, the extraction systems would necessarily become more expensive in the U.S., a horror scenario for Kulitz given the tough competition in the American market.

German exporters have a lot to lose in the U.S. The value of goods sent by companies in Germany to the U.S. has almost quintupled since 1990, with almost 10 percent of all products exported heading over the Atlantic. More than 1.5 million jobs are directly or indirectly dependent on business with America.

The export of automobiles alone makes up around a quarter of all German exports to the United States. German carmakers send around 500,000 vehicles a year to the U.S., but they produce far more than that -- around 800,000 -- in the United States for sale in America or third countries.

BMW alone has created around 10,000 jobs in Spartanburg, South Carolina, with an additional $600 million investment in the works. Last year, BMW CEO Harald Krüger pointed out to the U.S. president how involved his company was in the United States. Trump responded at the time by complimenting Krüger for the job he was doing. But what are such statements worth when he launches a new attack just a few months later?

"If our export model is restricted," Krüger recently said, then BMW will have to "take a different approach" in the future. In other words, his patience is not unlimited.

BMW is already making preparations for a possible trade war, having boosted its staff of tax and customs experts. Furthermore, the Munich-based company is in constant contact with U.S. Senator Lindsay Graham, the Republican from South Carolina. Graham has publicly positioned himself in opposition to Trump's punitive tariff plan.

Furthermore, the company is exploring a step that had been unthinkable just a short time ago.

Currently, the BMW X5 is produced exclusively in the Spartanburg plant, but that privilege could be withdrawn in favor of producing some of the SUVs in China. That would give the company an important foothold in the growing Asian market for SUVs should China respond to the United States with tariffs of its own. In other words, the U.S. would become a victim of its own protectionism.

Dangerous Side Effects

The introduction of tariffs in the steel industry could likely produce unforeseen consequences.

German heavy industry isn't particularly concerned about the direct consequences of a 25 percent tariff on steel exports to America. Such exports aren't terribly vital to companies like ThyssenKrupp and Salzgitter.

The side effects, though, could be much more dangerous: The U.S. duties could divert the flow of goods in the steel trade. The global steel market has been imbalanced for years, with producers manufacturing 1.6 billion tons of crude steel each year against an annual demand of just 900 million tons. China is primarily to blame for this lopsidedness. Inexpensive energy and low wages enable the country's steel producers to sell their products cheaply around the world. If the U.S. were to make moves to protect its domestic steel producers, even more cheap steel would flow into the European Union than is already the case. Were that to happen, says Wolfgang Eder, head of the Austrian steel concern Voestalpine, "Europe would threaten to become the world's garbage pail."

Last Tuesday, industry representatives joined executives from ThyssenKrupp, ArcelorMittal and the steel plant Georgsmarienhütte for a visit to Matthias Machnig, state secretary in the Economics Ministry. Machnig is something like the trade commissioner for Merkel's caretaker government. The steel lobbyists had drafted a position paper in which they warned that EU steel imports could spike by 40 percent within just a few months. "This would immediately lead to a renewed escalation of the import crisis in Europe," they warned.

The steel representatives are also calling on the EU to file a complaint with the World Trade Organization (WTO) against the measures introduced by Washington, even though they are also aware that such a move isn't likely to be successful. It can take years until the appeals process is exhausted and the U.S. is also blocking appointments to the WTO's Appellate Body, essentially sabotaging its ability to function. As a result, it may soon no longer be in a position to make rulings at all.

Machnig views the talk of punitive tariffs from Washington as an attack on world economic peace and says that such a thing cannot be taken lying down. "It is prudent for the EU to be discussing reactions," he says. "We don't want a trade war, but if the U.S. takes measures, there has to be a joint European response." At the recent conference of EU trade ministers in Sofia, Bulgaria, at which Machnig represented the German government, an atmosphere of fierce determination prevailed.

Should American tariffs become a reality, the EU, said Machnig, "needs to take appropriate measures."

Trump's Worst Proclivities

Machnig has made frequent trips to Washington and he knows those involved in economic policymaking well. "A battle is raging in the White House between competing schools of thought," he says, pitting free-trade advocates against those preferring protectionism.

Unfortunately, those responsible for trade in the Trump administration happen to be among the most prominent proponents of protectionism: Commerce Secretary Wilbur Ross and U.S. Trade Representative George Lighthizer.

More moderate voices in Washington, by contrast, are currently on the retreat. Trump's senior economic advisor, Gary Cohn, for example, indicated last Tuesday that he was stepping down.

And Speaker of the House Paul Ryan, an enthusiastic Trump supporter thus far, urged Trump last week to "reconsider the idea of broad tariffs to avoid unintended negative consequences to the U.S. economy and its workers." Beyond those two, there aren't many left who might be able to tame Trump's worst proclivities.

The trade war that Trump has now announced was far from a complete surprise. For decades, Trump has been a vocal critic of U.S. trade policies that he believes benefit everybody except the United States. He is convinced that China, Canada, Mexico and the European Union intentionally hurt the U.S. by profiting to a greater degree from international trade agreements.

Arms crossed, Trump sat in the Cabinet Room of the White House on Thursday and said, "The WTO has been a disaster for this country." The heads of the biggest steel and aluminum companies in the U.S. had taken seats around him, including representatives of US Steel, Nucor and United Aluminum, and they all nodded their heads. Trump said the WTO was good for China and others, but not for the U.S. He then uttered his threat of punitive tariffs.

The fact that Trump has chosen this particular moment to make his announcement is no coincidence. His government is currently in the middle of negotiations to make changes to the North American Free Trade Agreement (NAFTA), the free trade agreement with neighboring Canada and Mexico, which are both steel suppliers to the U.S. Several days ago, negotiators for the three countries met in Mexico City to explore whether and how improvements could be made to NAFTA.

So far, the parties have failed to come to an agreement, with Mexico and Canada refusing to renegotiate the entire deal. Trump has said that if the U.S. can reach an agreement with them, that Mexico and Canada would be excluded from the tariffs.

A Zero-Sum Game

Domestically, the president is hoping that the threat of a trade war will give his party a boost as mid-term elections approach in early November. So long as he can position himself as a man of the 1950s and 1960s, the era when the steel and aluminum industry in the U.S. flourished, he can be assured of support from Rust Belt voters. "IF YOU DON'T HAVE STEEL," Trump tweeted, "YOU DON'T HAVE A COUNTRY!" He has repeatedly described U.S. trade policy a "disgrace."

It's the complaint of a man who feels he is surrounded by resentful and mean-spirited competitors who are all out to enrich themselves to his disadvantage. Trump views politics as a zero-sum game. When others get more, he gets less -- that's his dogma. Behind this is a fear of winding up the loser. America "has been ripped off by virtually every country in the world," he complains.

Such a broad formulation is surely inaccurate, though it does contain a kernel of truth. When it comes to imported automobiles, for example, the Americans only demand a 2.5 percent tariff. The Europeans, meanwhile, levy a 10 percent tariff on all vehicles imported from the U.S. That deal has been in place since the Uruguay Round of multilateral trade talks and was agreed to in 1994. So, is Trump right?

If you compare the tariff profiles of the U.S. and the EU, no clear picture emerges. There are a number of products for which the Americans apply very low tariffs, including dairy products and cars. In other areas, like oil products or textiles, however, the Americans apply higher tariffs.
But if you look at industrial goods across the board, the tariff levels are similar. The U.S. levies 3.2 percent on average, whereas the Europeans apply tariffs of 3.9 percent. Such a difference is insignificant, says Rolf Langhammer, an economist with the Kiel Institute for the World Economy, "because even a small shift in the exchange rate can offset it."

Trump's allegation that Germany is flooding the world with goods without importing enough from others also seems questionable upon closer inspection. There may be a gap in the exchange of goods, but in the trade of services, there is equilibrium. And digital services don't even make an appearance in the trade balance. Yet this is precisely the domain of American high-tech companies like Google or Facebook.

"We're touching an elephant while wearing a blindfold," says economist Langhammer, complaining about the lack of clarity provided by official statistics. Only a small part of the services sector shows up, but the bigger picture cannot be discerned.

Trump isn't particularly interested in such details, instead preferring to see massive criticism as affirmation. Trump knows that his friends within the Republican Party oppose the tariffs, but he also knows that he is most effective when he whips up his followers against the Washington establishment and stands against elites in both parties. Among the constituencies offering the greatest support for Trump's policies right now are members of the steelworker's union, who tended to vote for the Democrats in the past. That, too, is something Trump is counting on in the run-up to the mid-terms in November.

More Damage than Advantages

One would think that the Americans might have learned their lesson. History is peppered with examples of protectionist initiatives -- and they show that protectionism generally does more damage than not.

The Smoot-Hawley Act of 1930, named after two politicians from Utah and Oregon, respectively, slapped huge tariffs of up to 60 percent on around 20,000 foreign goods, with the intention of protecting American agricultural products. More than 1,000 economists signed a petition against the law, but economic nationalism won out. And the consequences were disastrous, with foreign governments also increasing their tariffs. In the following years, the volume of U.S. foreign trade fell by two-thirds.

Many decades later, in March 2002, then-U.S. President George W. Bush imposed tariffs of up to 30 percent on steel. Other countries responded with retaliatory measures. Again, costs far outweighed the benefits and the president lifted the tariffs only 20 months after introducing them.

Bush's successor Barack Obama also imposed an import tax of 35 percent on tires imported from China. The move did create around 1,200 new jobs in the U.S. tire industry, but each new job came at the extremely high price of around $900,000 per job, a study by the Washington think tank Peterson Institute found.

Trump, in other words, is by no means the first American president who has sought to deploy these instruments. But no other president has behaved so immoderately or been as unpredictable in both their words and actions.

The international community is alarmed, perhaps China most of all. The People's Republic has been the world's largest trading nation for the past five years, exporting goods valued at more than $2 trillion a year and importing roughly the same amount. A global trade war would hit the country hard: Around 18 percent of China's exports go to the U.S.

During his presidential campaign, there was no other country that Trump attacked as frequently as China. He accused Beijing of stealing American jobs, manipulating its currency and, yes, "raping" the U.S., calling it "the greatest theft in the history of the world." If he won the election, he said, he would slap Chinese products with punitive tariffs as high as 45 percent.

Trump won the election and Beijing began gathering its troops for a trade war, using the state media to present its weapons: the world's largest market for cars, the fastest growing aviation sector, millions of Apple, Starbucks and McDonald's customers and even the 330,000 Chinese students studying at American universities.

But the world trade battle was initially delayed. Trump invited Chinese President Xi Jinping to Florida and then he himself flew to Beijing and appeared to have been impressed by his host. He said he didn't blame Beijing for the gaping hole in the trade balance between the U.S. and China. "After all, who can blame a country for taking advantage of another country for the benefit of its own citizens?"

Washington is now starting another attack, even if Trump has only mentioned China in passing. The weekend before last, Xi's top economic adviser, Liu He, made a special trip to Washington in an effort to assuage tensions. The Chinese press has also shown more reserve than it did a year ago, a sign of the degree of concern in Beijing with Trump's political course.

Rhetorically, China has begun posing as a defender of free trade. "Pursuing protectionism is like locking oneself in a dark room," Xi said in 2017 speech at the World Economic Forum in Davos. "While wind and rain may be kept outside, that dark room will also block light and air."

But China itself engages in protectionist behavior, and Western companies have been complaining more strongly than ever of a lack of access to Chinese markets. In most industries, the Beijing government requires that companies enter into joint ventures with Chinese partners. In lucrative sectors, in particular, foreigners are often only allowed to bid for contracts on small projects, like the new Fuxing high-speed train, which is to be based on German and Japanese technology. German students also have a difficulty even just landing an internship at Chinese companies.

Countries and companies around the world are increasingly using those kinds of subtle barriers to trade around the world. And they, too, present a form of protectionism. Classic tariff policies, on the other hand, have become less important in recent decades -- with the percentages steadily sinking to a current average of just under 8 percent worldwide. That's around half of mid-1990s levels and one-third of that which was demanded in customs levies in 1947. Back then, tariffs averaged 22 percent.

And until Trump's recent Twitter tirades, it had appeared that such tariffs would remain in the past.

But are we about to see a redux?

Three Scenarios

Several scenarios are imagineable. The first is that Trump's statements will prove to be nothing more than talk. But even if that were to turn out to be the case, it's difficult to imagine that governments around the world would simply return to business as usual after such attacks.

The second is that the U.S. will isolate itself and Europe and Asia will pull closer together.

There are hints at such a development, such as the free trade agreement the EU reached with Japan last year. At the same time, however, it would be hard for the U.S. to completely extract itself from the global arena. It's too important for that. A quarter of all global commodity demand comes from the United States.

The third scenario is the bleak prospect of a trade war. It's a confrontation that would mark the end of an era -- the era of liberal global trade that has developed since World War II. And it would mark the start of a new, post-global order.

A great deal is at stake and the tension in Brussels are palpable. Indeed, a trade war with the U.S. is the last thing the internally divided EU needs right now.

On the 12th floor of the European Parliament building, Bernd Lange hunches over the list of all the possible retaliatory measures. Lange, a member of the European Parliament with the center-left Social Democratic Party (SPD), is chairman of the parliament's International Trade Committee. Last week, the committee met several times to discuss Trump's announcement.

Trade expert Lange looks at what are called the "tariff lines" in the document, the listing of products the EU could slap with tariffs. It includes several tariff lines for whiskey, depending on the variety, and could cost the U.S. around a half-billion euros.

Further entries would affect pleasure boats in categories both over and under 7.5 meters long (25 feet). And there are also two categories for motorcycles: those that are below 800 cubic centimeters and those which are more powerful. Lange takes an especially close look at this tariff line: He owns a BMW R 1200 RS.

The EU trade expert would actually prefer to see the list disappear back into the filing cabinet. But Lange hasn't yet given up hope of resolving the conflict. "We'll just have to see if we are forced to implement" these measures, he says.

Ultimately, that decision will be made in Washington rather than Brussels. Donald Trump has the smartphone in his hand.


By Frank Dohmen, Simon Hage, Alexander Jung, Peter Müller, Christian Reiermann, Christoph Scheuermann, Gerald Traufetter, Marco Wedig and Bernhard Zand


The Dollar’s Doldrums

Barry Eichengreen




BERKELEY – Donald Trump’s first year as US president has been, if nothing else, a bounteous source of surprises.

One of the big ones in the circles I frequent is dollar weakness. Between January 2017 and January 2018, the broad effective exchange rate of the dollar fell by 8%, wrong-footing many of the pundits. I include myself among the wrong-footed (others can decide whether I qualify as a pundit).

Tax cuts and interest-rate normalization, I expected, would shift the mix toward looser fiscal and tighter monetary policies, the combination that drove up the dollar in the Reagan-Volcker years. Tax changes encouraging US corporations to repatriate their profits would unleash a wave of capital inflows, pushing up the dollar still further. New tariffs that made imports more costly and that shifted demand toward domestic goods would require offsetting effects in a near-full-employment economy in order to shift demand back to foreign sources. The most plausible such offset was, of course, appreciation of the real exchange rate, which could occur only through inflation or, more plausibly, a stronger dollar.

The markets, in their wisdom, rejected this logic for more than a year. It is thus incumbent upon those who of us made such predictions to “mark our views to market,” as my Berkeley colleague Brad DeLong likes to say.

Economic commentators are better at rationalizing past exchange-rate movements than at forecasting future trends. So, when it comes to explanations for the dollar’s decline over the past year, we are confronted by an embarrassment of riches.

The most popular explanation for dollar weakness is that Trump, through incompetence or misdirection, failed to deliver what he promised. There was no across-the-board import tariff.

There was no abrogation of the North American Free Trade Agreement. There was no $1 trillion infrastructure package.

But there were, in fact, deep tax cuts. There were, in fact, interest-rate hikes by the Federal Reserve.

And there were, in fact, tax changes creating incentives for the repatriation of profits. Other things equal, these developments should have propped up the dollar. So there must be more to its weakening than just Trump’s failure to deliver.

Another popular explanation is that investors expected the real exchange rate to rise through inflation rather than currency appreciation. The dollar weakened, in this view, because the Fed fell behind the curve and risked losing control of the inflation process.

Conceivably, this interpretation could prove correct. But it is not correct yet. There was no surge in inflation between January 2017 and January 2018. Currently, the fear in the markets is not that the Fed is behind the inflation curve but that it will raise interest rates even faster than expected in order to preempt overheating. And if higher interest rates are good for one thing, they’re good for the dollar.

Beyond this, there are at least 17 other narratives to explain dollar weakness. Some are insightful. Others are entertaining. Most, however, overlook the most plausible explanation, which is Trump-related uncertainty.

Investors have no way to forecast the impact of policies, because policies thought to be headed one way suddenly veer in the opposite direction. A big infrastructure bill turns out to be small.

Withdrawal from the Trans-Pacific Partnership trade agreement turns into a possible decision to re-enter TPP. Steve Mnuchin, the Treasury secretary, seemingly abandons the United States’ strong-dollar policy but then re-embraces it. Uncertainty is the order of the day, every day.

And there’s nothing investors like less than uncertainty. This is especially true of investors in a currency whose strongest attraction is its safe-haven status. Investors traditionally flock to the dollar not simply because it is stable, but also because it tends to strengthen in a crisis, given that its issuer has impregnable defenses and possesses the deepest and most liquid financial markets in the world.

But now that issuer also has a president who is casting doubt on his country’s defense alliances and who is, consciously or not, encouraging his Russian counterpart, Vladimir Putin, to build, or at least boast of, new offensive weaponry. It has a president who has encouraged the idea of a government shutdown, fueling doubts about the liquidity of the market in US Treasury bonds.

More chaos in the White House would only depress the dollar further. Working in the other direction is the fact that some of the dollar-supportive measures that observers expected Trump to adopt, such as tariffs on steel imports, are now coming, like it or not. It may be indicative that on March 1, when Trump announced his steel and aluminum tariffs and the stock market tanked, the dollar strengthened. Uncertainty may continue to dominate, but it may also be that the dollar’s rise on March 1 was a harbinger of what is to come on foreign-exchange markets.


Barry Eichengreen is Professor of Economics at the University of California, Berkeley, and a former senior policy adviser at the International Monetary Fund. His latest book is Hall of Mirrors:The Great Depression, the Great Recession, and the Uses – and Misuses – of History.


Colombia’s Problem With Mexican Cartels

By Allison Fedirka

 

Colombia has long been known as the world’s top producer of cocaine, a reputation the government tried to rid the country of for years through a crackdown on drug cartels. It has made some progress, with high-profile rebel groups putting down their arms, promising to turn away from drug trafficking and signing peace deals. Frequent and intense counternarcotic operations carried out by Colombian security forces led to shortages of a precursor chemical necessary to make cocaine, missed production quotas and decreases in the quality of the cocaine being produced. But the crackdown laid the groundwork for a new security threat facing the country today: Mexican cartels.

Over time, the disintegration of Colombian drug trafficking groups essentially opened the door for powerful groups from Mexico that wanted to protect their supply chain. On March 13, Colombia’s justice minister expressed concern, on the sidelines of the United Nations’ Commission on Narcotic Drugs conference, about the presence of Mexican cartels in Colombia. He said that there are links between the cartels and Colombian organized crime groups, as well as dissidents from the Revolutionary Armed Forces, or FARC, rebel group, which signed a peace deal with the Colombian government in 2016.

In the 1980s-’90s, both countries had powerful cartels that, economically and militarily, were more or less on equal footing. This is no longer the case. When Colombia took down major cartels like Medellin in 1993 and Cali in 1998, much of the drug trafficking activity was taken over by the FARC, paramilitary auto-defense groups and budding cartels such as Norte del Valle. But the Colombian government has been dismantling these groups too. Norte del Valle has fragmented, the auto-defense groups demobilized by 2006, the FARC has demobilized, and another rebel group, the National Liberation Army, or ELN, is also engaging in talks. Many of these groups have not been eliminated completely but rather have splintered into smaller criminal groups commonly referred to as “bandas criminales” or bacrims. In the last quarter of 2017, the seizure of three large cocaine shipments showed no less than 22 different groups were involved. The operational capacity of individual bacrims is limited and a power vacuum has opened up in the black market. Even the largest group to emerge over the past several years, Clan del Golfo, has suffered internal divisions and failed to consolidate control over other groups.

In the meantime, Mexican cartels have tried to protect their business interests in Colombia and to take advantage of the fractured environment. Roughly five years ago, as FARC peace talks were starting, Mexican cartels began sending representatives to Colombia. They were assessing their prospects in the country following the peace deal and recruiting dissident FARC rebels and members of other criminal groups. They offered drug traffickers a way to continue their operations, despite the government crackdown.

Since then, Mexican cartels have transformed the cocaine industry in Colombia. Cartels like Sinaloa, Zetas and Jalisco New Generation have set up offices and oversee operations in at least 10 Colombian provinces: Antioquia, Cundinamarca, Norte de Santander, Valle del Cauca, Narino, Cauca, Meta, Guaviare, Vichada and Cordoba. Mexican cartels primarily finance local groups to carry out operations and make use of facilities that are already in place. Additionally, they buy and lease production land – primarily in Cauca, Putumayo, Catatumbo and Narino – that gives them further control over their supply chain. To enhance production and quality, the cartels have started hiring agriculture and engineering experts. Mexican cartels are also becoming increasingly involved in transportation, since Colombian groups can’t handle large-scale operations and can’t get major shipments to market.
 
 
Despite the crackdown, therefore, cocaine is making a comeback in Colombia. Colombian cocaine production has been on the rise since 2013, and based on indicators, this upward trend will continue in 2018. Between 2015 and 2016, production increased 35 percent to 710 tons and the cultivation area for coca, the plant from which cocaine is derived, increased by 18 percent to 188,000 hectares, according to the most recent U.S. Drug Enforcement Administration figures. Coca is cultivated in 183 municipalities throughout Colombia, though just 10 of these municipalities account for 49 percent of production. Production is also driven by high U.S. demand, which has also been rising since 2013. Cocaine from Colombia accounts for 92 percent of the cocaine that reaches the U.S., and the U.S. consumes 52-54 percent of Colombian cocaine exports. There are now well over 1.2 million users in the U.S., the highest number since 2007.

There are a number of ways Mexican cartels can increase their control in Colombia and most of these involve an increase in criminal violence in Colombia and other places like Central America. The car bomb that exploded in Ecuador in January just over the Colombian border – an area known to be a hub for coca cultivation and cocaine export – is just one example. Dissident FARC groups, backed by a Mexican cartel, orchestrated the attack in response to a series of drug seizures and arrests. Right now, there appears to be a large enough market to keep all these groups in business so that they don’t have to compete against one another. But there is no guarantee this will continue to be the case in the long term. Moreover, Colombian security forces are still working to eradicate these illicit activities and this may lead to clashes with criminal groups. While it’s unclear how exactly this will play out in the future, and how violent the clashes will be, the Colombian justice minister has reason to be concerned.


New Economic Experiment: Thank You Mr. Trump - And Mr. Kudlow

by: John M. Mason

 

- Larry Kudlow is now expected to step into the position in Mr. Trump's administration just vacated by Gary Cohn.

- Larry Kudlow is a supply-side economist and was part of the supply-siders in the Reagan administration.  He is very vocal in his support of the supply-sider Donald Trump.

- If Larry Kudlow becomes Trump's National Economic Council, we are sure to hear of the outcome of the economic experiment now being conducted between supply-side economics and demand-side economics.

 
Yes, Larry Kudlow is interested in stepping into the position of Director of the National Economic Council reporting to President Donald Trump just vacated by Gary Cohn.

According to the New York Times, Mr. Kudlow is now the favorite to take on this responsibility.
 
Funny thing, Mr. Kudlow just happened to have the lead opinion piece, co-authored with Heritage Foundation senior fellow Stephen Moore, supporting Trump economic policies, published in The Wall Street Journal on the very day that all the news was being released about his taking on this new role.
 
In this article, Mr. Kudlow and Mr. Moore attempt to make it clear that there are two concepts of how macroeconomic policies work and that the efforts of Mr. Trump and his administration create an environment where the difference between the two can be tested.
 
The two concepts are the demand-side approach the construction of macroeconomic policy and the supply-side approach.
 
Mr. Kudlow is from the supply-side approach and he first gained recognition in his support for supply-side policies when he was a member of the Reagan administration in the 1980s.
 
But, Mr. Kudlow and Mr. Moore have written their article with one particular focus in mind and this focus has to do with the possible impact the Trump economic policies will have on inflation. And, it is this focus that is, to me, the foundation of the economic experiment that is now underway and that Mr. Kudlow, especially, wants to fight for.
 
The concern has arisen that with the US economy so near to full employment after over eight and one-half years of economic recovery along with the tax cuts just passed in December and the budget provisions just passed in the last month leading to a rapidly increasing governmental budget deficit, that higher rates of inflation are just around the corner.

For one thing, the bond markets have shown a substantial increase in inflationary expectations in the past six months or so. I have already written about the rise in inflationary expectations several times this year.
 
And, this is the key point in the economic experiment that Mr. Kudlow and Mr. Moore discuss.
 
The authors argue that if an analyst just works from a demand-side perspective they will expect that the policies of the Trump administration will produce greater amounts of inflation as unemployment goes lower and lower.
 
The “myth” supporting this belief they argue comes from work of New Zealand economist A. W. Phillips, the father of the Phillips Curve that purports to show that a trade-off persists between wages and unemployment:
“He (Phillips) was right that wages tend to rise as unemployment falls.”
However, Kudlow and Moore argue, “it wasn’t until the 1960s that economists Paul Samuelson and Robert Solow wrongly extended this theory by suggesting a linkage between unemployment and general inflation.”
 
They add, “That theory doesn’t comport with the facts, then and now.”
 
The important conclusion for the current argument, however, is that the Phillips Curve is assumed to show that unemployment can be reduced if policymakers can increase aggregate demand sufficiently to generate a little more inflation. This is what the popular presentations of the Phillips Curve are used for. And, an “empirical” construction of the Phillips Curve has been a major component of most econometric models of the economy used in the policy making of the federal government and the Federal Reserve System. This is demand-side economics.
 
Supply-side economics claims that economic policies should stimulate more production - more economic growth - so that more goods and services will be produced, leading to greater hiring of labor, and higher wages. Higher wages are possible because labor productivity increases in this model. And, inflation? Well, inflation might even decline should the supply of goods and services be large enough.

Kudlow and Moore claim: “In the Reagan tax-cut boom, which lasted through the 1990s, unemployment and inflation fell together as the dollar stabilized under treasury secretaries Donald Regan, James Baker and Robert Rubin.”
 
Where does inflation come from? It comes from excess money creation, Milton Friedman taught us that.
 
Mr. Kudlow and Mr. Moore conclude that there is no reason to expect inflationary pressures to rise within the current policy environment. The consumer tax cuts won’t produce inflation: “unlike stimulus spending, tax cuts don’t distort the economy with artificial demand.”
 
Furthermore, "Except for some of the child credits and a few fattened deductions, the $1.5 trillion cuts…was almost completely geared to reducing taxes on small and large businesses to boost incentives to invest and produce.”
 
Thus, we see the economic experiment right before our eyes. If inflation picks up and becomes a real problem, then the demand-siders win the argument. If inflation remains stagnant and economic growth picks up, then Mr. Kudlow and the supply-siders take home the prize.
 
The outcome of this “experiment” is very important for the Federal Reserve. Currently, Fed officials are signaling that they will raise their policy rate of interest at least three times this year, possibly four. One of the arguments being used to justify this path is that inflation seems to be rising and such increases are needed to keep the economy from getting overheated.
 
So, Fed policy is going to be dependent upon whether or not the supply-siders win.
 
But, there are two other issues that I think are important to keep in mind. First, are the tax cuts and other economic efforts of the Trump administration really supply-side cuts? A lot of the analysis that has been put out indicate that the Trump policies are not really that supply-side orientated. In addition, many analysts are arguing that the policies are skewed to help wealthier individuals, a group that might not be so interested in creating supply-side improvements.

The second issue has to do with financial engineering. Over the past fifty years or so, government policies have created an atmosphere where the benefits of governmental programs become incentives for businesses to use financial engineering to reap “unintended” benefits from programs meant to stimulate the economy.
 
Morgan Stanley analysts have already produced results that indicate that businesses will overwhelmingly put their policy benefits to use in the following three categories: stock buybacks and dividend increases, mergers and acquisitions, and bonuses and raises.
 
Well, we’ll see where things come out. Mr. Kudlow and Mr. Moore claim that the results of the Reagan tax-cuts created a boom where “unemployment and inflation fell.” Mr. Kudlow may be in a position to highlight such a result achieved during the Trump years - if such the supply-siders win the argument. Stay tuned!