Submitted by Azizonomics [21]
Global Trade Fragility
Yesterday I got my new iPad.
Yeah, I bought one like millions of other suckers. Apple can take my dollars and recycle them buying treasury bills and so partially fund, at least for a short while, America’s unsustainable debt position [22].
But really, I bought one to enjoy the twilight of the miraculous system of global trade. An iPad is the cumulative culmination of millions of hours of work, as well as resources and manufacturing processes across the globe. It incorporates tellurium, indium, cobalt, gallium, and manganese mined in Africa. Neodymium mined in China. Plastics forged out of Saudi Crude. Aluminium mined in Brazil. Memory manufactured in Korea, semiconductors forged in Germany, glass made in the United States. And gallons and gallons of oil to ship all the resources and components around the world, ’til they are finally assembled in China, and shipped once again around the world to the consumer. And of course, that manufacturing process stands upon the shoulders of centuries of scientific research, and years of product development, testing, and marketing. It is a huge mesh of processes.
The iPad is an extreme example of the miracle of civilisation There are less extreme ones. Take, for example, the hamburger. Hamburgers did not exist until the age of regional trade, and refrigeration. The ingredients in a hamburger were not in season at the same time. Cows were not slaughtered at the time when lettuce was harvested. Lettuce was not harvested at the same time tomatoes or onions were typically harvested. For thousands of years previous to this we ate seasonal concoctions, like turkey, yams and cranberries at thanksgiving, as well as smoked and cured foods all year round. In modernity, we have been able to use modern technology to bring about any combination of produce: from greenhouses, to air freighting, to refrigeration, and so.
[23]
I look at the global trade system — which we here in the West rely upon for goods, resources, consumption, etc — and I see something akin to the problem with the financial system in 2006. We abandoned robust and aged local systems, local knowledge, artisanship, etc, in favour of a huge interconnected mesh of trade where all counter-parties are interdependent, and where one failure can break the entire system.
This is a beautiful age. We have truly allowed our imaginations to run wild.
But is it sustainable?
My favourite economist [24] (yes, I am joking) notes:
The world economy was, to an extent never seen before, truly global. It was linked together by new technologies that made it possible to ship products cheaply from one side of the globe to the other, to communicate virtually instantaneously over huge distances. But it was also, more importantly, linked together by the almost universal, if sometimes grudging, acceptance of a common economic ideology: the belief that free markets, with secure property rights, were the only way to achieve economic progress; and in particular that a nation hoping to make its way forward needed to welcome foreign trade and foreign investors with open arms. And this shared ideology did indeed lead to unprecedented transfers of Western capital and technology to emerging economies – transfers facilitated by the fact that everyone knew that any country that strayed from the path would be punished by financial crisis, and would soon be obliged to accept the harsh austerity prescribed by teams of Western technocrats.
The year, of course, was 1913.
So a truly global trade system has come crashing down before, and we bounced back pretty well from that. But it was a painful time. That particular collapse seems to have arisen from the complex and internecine system of warfare pacts binding great powers to the whims of smaller ones. When small powers went to war, the great powers were dragged in alongside. It was a hyper-fragile system where one small breakdown could trigger a much larger one, just like the problem that led to the present system of financial derivatives. If one counter-party fails, the whole system can be brought down.
Great powers are once again aligning themselves around smaller allies. China and Pakistan and perhaps Russia seem willing to back Iran [25], while the United States is reluctantly backing Israel. One spark in the middle east could set the world alight and effect an immediate and devastating breakdown in global trade.
But there is a new factor at play today: the service economy [26]. While nations in 1913 were freely trading, and while the concept of Ricardian equivalence was widely known, no nation took interdependence to quite the extreme that so many nations have today. And many nations have taken this idea so far that without imported goods and energy, their internal economies might completely collapse, or at very best struggle with the adjustment from supranational back to local.
Here’s the situation in the United States:
[27]
And for the United States, this hasn’t been a two-way street. America is importing a lot more than she is exporting. In other words, America is now dependent on international trade.
Here’s the United States’ current account balance as a percentage of GDP, (in other words exports – imports as a percentage of GDP):
[28]
Simply international trade has become too big to fail.
The problem is, we know from history that the system of international trade can fail, and as we move deeper into the ’10s, there are a number of obvious threats emerging. The boneheaded answer from certain tenured professors and high-flying MBA [29]s might be that the incentives to keeping the international trade system wide open (and cheap) are enough to force countries to co-operate. Tell that to Binyamin Netanyahu, who seems increasingly fixated on striking Iran, and forcing Iran to retaliate with a closure of the Strait of Hormuz. Tell that to Mitt Romney who seems ever-more intent on starting a trade war with China that (very simply) the United States cannot win, because while the United States is dependent on real, physical Chinese goods, China is “dependent” [30] on America’s endless stream of paper money. In other words not very dependent at all given that China already has a $3+ trillion hoard. Tell that to Barack Obama who — instead of pushing for the United States to mine its own deposits of rare earth minerals has run squealing to the WTO complaining of Chinese price manipulation.
This post is not a prediction. I am not necessarily predicting a breakdown in the global trade system, although there are surely many obvious dangers as well as hidden black swans. I am merely forecasting that the world is extremely fragile to one, and that the consequences to certain countries with a negative current account balance [31] could be, shall we say, painful.
Governments are advised to go out of their way to make sure that back-up systems in terms of medium-to-long-term food supply, fuel supply and medicine supply are in place so that the consequences of a breakdown in the system of global trade can be minimised.
This is an example of a process that the philosopher Nassim Taleb has called robustification.
Nations ignore figures like Taleb — surely the Nietzsche of our homogenised and manufactured age — at their peril.