Sunday, February 26, 2017

Martin Feldstein Insults Your Intelligence in Defending the Border Adjustment Plan

Martin Feldstein published an Op-Ed in the WSJ this evening entitled "The Illusory Flaws of ‘Border Adjustment’". [If the link doesn't work for you, I suggest you Google the title of the article which should get you in.]  Mr. Feldstein is an esteemed economist, much more recognized that little Gepetto me, but in this case, Mr. Feldstein is way off base.  

Actually, he goes further - he calls you stupid for disagreeing with him:

"Why then do American importers and retailers object to the border-adjustment tax? One reason may be that they do not understand how the rise of the dollar would keep the selling prices of imported goods unchanged. Alternatively, they may not trust the economic analysis, worrying that the dollar would rise only partially or slowly, leaving them worse off. To them, border adjustment looks like an unnecessary risk with no potential upside. But there is a real benefit: The border-adjustment tax would produce enough revenue to make cutting the corporate tax politically feasible." [Emphasis added]

I, personally, do not like to be called stupid in writing.  It is condescending and arrogant. And all the more galling because the author of the insult is wrong.

We hear the insults but rarely if ever do we hear any acknowledgement of the obvious - this tax is going to KILL companies, in particular small businesses.  Kevin Brady was asked the following question yesterday in an interview at CPAC: "I wanted to ask you about the fact that, according to a U.S. Census Report, 97% of importers are small business[es]. Are you concerned that there could be job losses that hurt small businesses due to this tax?"  And Mr. Brady responded:  "No, I don't, because [of] the way we are designing this tax and phasing it in to address those issues." Yup, he's not concerned, and neither is Mr. Feldstein.  He's excited about the $120 Billion raised by the tax, as you will see in reading his article.  As previously related in this space, small businesses imported $643 Billion in 2014.  Multiply that by 20% and you get the full proceeds from the tax.

Transition or no transition, it's a small business tax.  Small business pays the entire bill. Feldstein and Brady are detached from reality.

Feldstein starts by recounting the pablum that the rising dollar (up 25%!) will reduce costs for importers sufficient to make everything balance.  No price increases to you, the consumer.  And if you don't agree with him, as he makes clear above, you just don't understand.  He does, you don't.  

So here's my retort:

FIRST, the direction of the market cannot be predicted with confidence.  Duh.  Feldstein is predicting the direction of the market when he makes a pretty darned specific call that the dollar will rise 25%.  His formula says so, and if you doubt this, you are a worrier.  See above.

We cannot afford to bet our economy on somebody's "hunch".  It is also true that economists have CONCEDED that exchange rates follow a random walk.  This has a name: The Exchange Rate Disconnect Puzzle. It's a thing. Feldstein knows about it.  Why he wants to sell this bill of goods is a question worth asking.  

And to the extent he has the direction of the dollar move right, his claim suggests that the move is "permanent".  And I ask you - what other market move can you name that was "permanent"? Would you bet real money that a shift in the market value of an asset would never reverse, ever? Other than inflation, which is an inapplicable concept in this case, I cannot cite any similar market situation. To suggest, imply, hint or even think that a move like this would last forever is asinine. That's the right word for it.  No apologies to Mr. Feldstein.

SECOND, Feldstein blandly overlooks the calamitous impact of a sudden rise in the U.S. dollar by 25%. No worries about tanking the export market for U.S. companies, and he sniffs at the cost of the BAT-induced reduction in the value of American assets overseas, noting that it is "only" 3% of household net worth.  This is how economists say they don't want to think about the details. Many (most?) of these assets are owned by corporations which may have borrowed against the assets in another currency (dollars?). The sharp loss of capital from this massive number (Trillions of dollars) will not only rock many unsuspecting companies but may trigger a major financial crisis in the Third World where there are a lot of dollar-denominated loans in place. Contagion?  Feldstein doesn't acknowledge the risk.  

And no question about how we're compensated for taking this massive risk.  Oh yeah, all the money they are going to vacuum out of small business importers.  Until we all croak.

THIRD, Feldstein ignores that U.S. companies typically buy in dollars, not foreign-currency. We don't have forex departments and make life simple by matching the buy and sell currencies.  So there is no "automatic" savings. Feldstein points to the oil market for reassurance.  He makes the point that when the dollar rises, oil prices typically fall.  But anyone who watches oil prices knows this phenomenon is not reliable.

In any event, this response (also provided to me by Brady's tax counsel at Ways and Means in December) fails to take into account that oil doesn't care which hole in the ground it comes out of, about 90 million barrels are produced daily and hundreds of millions of barrels are traded in exchanges all over the world every day (spot market and futures).  On the other hand, our products are produced in small quantities, are available from only one source (us), and perhaps shockingly, there is no spot market or futures market for our products.  So you can't hedge.

Feldstein isn't saying so directly, but he wants us to hedge.  His argument has the necessary implication that we must buy futures contracts to capture gains from dollar appreciation (rather than relying on getting lower prices from our factories). Thus, he advocates for a system that forces small businesses to gamble. As a government policy. This is so reckless and delusional it hardly merits a reply.

FOURTH, Feldstein seems to be detached from the reality of how products are made. Every physical product has inputs that are local and other inputs that are imported.  Only pure service businesses have only local costs. Yeah, I know you're thinking of hookers but I am sure economists are thinking of lawyers.  In any event, if you buy a product overseas, some aspect of that product came from elsewhere and would likely rise in price as the dollar rises in price. Local content will actually fall in cost (cheaper hookers, I mean lawyers, in dollar terms). The net of the two effects is what importers like our company will face when the dollar screams upward. I have written about this in the past.  After speaking to many factories, we think our costs will RISE if the dollar goes up by 25%.  Feldstein says everything is going to be fine, trust him, and if we disagree, we just don't understand.

In this case, I am pretty sure I do understand.  It's a darned shame that Feldstein will stoop so low to push the defective idea of his former protege Auerbach and his crony Holtz-Eakin.  His arguments are flimsy and he will lose this argument.


  1. Good analysis. I own a (small) importing business also, and you are exactly right about what will happen. Best case, costs go up for the american consumer. Worst case, recession (depression?) here and worldwide.

  2. Second that. I also own a small importing business. And I'm with you Verne on the effects.

    Richard, you said "Yeah, I know you're thinking of hookers but I am sure economists are thinking of lawyers". The difference between the two?

    1. I think I'll let the economists spell that out.

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