The Free Trade Pipe Dream
Money has value only because we can buy something with it. For simplicity let’s say that one dollar is backed by one widget. For every widget that is manufactured one dollar is created. So that the ratio of goods to dollars in circulation is one to one. Now what happens when that dollar is not used to purchase goods made in America but instead purchases goods made in China. Setting the effect on domestic prices when a dollar is exchanged for yuan, suffice it to say that the dollar will start losing value.
The U.S. Dollar cannot buy Chinees products and vice versa. Anyone who holds a Dollar only has the power to buy goods made in America. Without producing goods in America, the dollar has no value. Money is only valuable because we can buy things with it. Arguably foreign currencies are weighed against each other based upon the production capacity of its domestic production. So, if for example, China produces twice as much wealth by production [widgets] than does the United States, we might say that the yuan is twice as valuable than the Dollar. If one is holding a dollar and wants to buy goods from China, they must first convert the Dollar to the yuan. In this example the exchange would be two dollars per yuan. The Chinese who already hold the yuan only pay a dollar for widgets produced in China while Americans pay two dollars.
The value of the dollar against the yuan can only be equal if the United States produces the same value in goods [number of widgets] as are being produced in China. If for example there is nothing for the Chinese to buy in America, they will not desire to hold the Dollar and its value to them will be zero. The same holds true for anyone who is holding the Dollar, whether they are Americans or foreigners. One might be tempted so say that even if there is zero production, the Dollar can still purchase services that are offered by Americans. This is true, but at this point it is an unnecessary complication, because the answer would require another very long explanation. The short answer is that the service industry does not produce wealth. Basically, service is the overhead of production that increased the cost of widgets without added value. So, the dollar cannot be backed by services which do not represent production of wealth. Not one widget is produced by lawyers, psychologists, or truck drivers for that matter.
Now let’s consider the case where production does not change, but the dollars that represent that production increases. This occurs when the government prints money and distributes it to banks who either invest in securities, bonds or make loans. In any event the money is placed in circulation. Assume that the increase in the number of dollars placed into circulation is twice that which was in circulation before the money supply was increased. Since the dollar’s value is backed by the number of widgets produced in America, and that relationship is a constant, then it follows that if the numbers of dollars doubles and the number of widgets remains constant, the dollar’s value is reduced by 50%. Each dollar is worth one-half, or fifty cents. For the moment we will not factor in the velocity of money, except to say that if one dollars is transferred to another for value and that dollar is notplaced into circulation again, the one dollar as a velocity of one, but if the new holder of the dollar spends it on something else than it is as if two dollars existed since the one dollar has been exchanged for two widgets, but the one dollar still only represents the value of one widget
When Trump places tariffs on foreign goods in order to protect domestic production, initially the cost of a widget produced in china will increase by the amount of the tariff. A short-cited viewpoint does notlook beyond phase one, see this tariff as a bad thing for the consumer, but in reality, in the long term the tariff will protect the value of the dollar. By reducing competition from China, Americans will begin to produce widgets and for every widget that is produced a dollar will be placed into circulation. When more dollars are placed into circulation demand for widgets will increase and so more widgets will have to be produced which in the end results in growing the economy.
Opposition to tariffs is largely because tariffs increase the cost of widgets to consumers. Pure economic theory would hold that when a country such as China can produce a widget more cheaply than can be produced in America, and Bobbles can be produced more cheaply in America than in China, then everyone worldwide should purchase widgets from China and Bobbles from the United States. In this way everyone saves money that can be spend on other products. But like global governance which is hoped to produce world peace, the idea that such an economic system can actually be achieved is a pipe dream. China has for many decades trafficked in a trade war by imposing high tariffs on imports from the United States. In effect China has for a long time now engaged in a protectionist policy that has impoverished the American economy, not only by restricting imports from America, but also by subsidizing production of widgets in China so that in the short term it will cost more to produce the widget than it will sell for, but in the long time, once China has destroyed competition from the United States it will be able to charge in Dollars whatever it wants for widgets. In the extreme, for the sake of simplicity; meanwhile, since no one is being paid to produce widgets in the United States, everyone is out of work. Whether it is widgets or something else the principle is the same. No production, no economy.
Frank J. Morelli