There is No "Free Trade"--There Is Only the Darwinian Game of Trade

Rising income and wealth inequality is causally linked to globalization and the expansion of Darwinian trade and capital flows.

Stripped of lofty-sounding abstractions such as comparative advantage, trade boils down to four Darwinian goals:

1. Find foreign markets to absorb excess production, i.e. where excess production can be dumped.

2. Extract foreign resources at low prices.

3. Deny geopolitical rivals access to these resources.

4. Open foreign markets to domestic capital and credit so domestic capital can buy up all the productive assets and resources, a dynamic I explained last week in Forget "Free Trade"--It's All About Capital Flows.

All the blather about "free trade" is window dressing and propaganda. Nobody believes in risking completely free trade; to do so would be to open the doors to foreign domination of key resources, assets and markets.

Trade is all about securing advantages in a Darwinian struggle to achieve or maintain dominance. As I pointed out back in 2005, the savings accrued by consumers due to opening trade with China were estimated at $100 billion over 27 years (1978 to 2005), while corporate profits expanded by trillions of dollars.

China Trade Surplus: Gusher Profits for U.S. Corporations (August 13, 2005)

In other words, consumers got a nickel of savings while corporations banked a dollar of pure profit as sticker prices barely budged while input costs plummeted. Corporations pocketed the difference, not consumers.

As longtime correspondent Chad D. noted in response to my essay on capital flows, restricting trade may be one of the few ways smaller nations have to avoid their resources and assets being swallowed up by mobile capital flowing out of nations with virtually unlimited credit (the US, the EU, China and Japan).

Protecting fragile domestic industries with tariffs has a long history, including in the US, but the real action isn't in tariffs: it's in the bureaucratic tools to limit trade and the soft and hard power plays that secure cheap resources while denying access to those resources to geopolitical rivals.

The bureaucratic means of restricting imports have been raised to an art in Japan and other export-dependent nations: there may not be any visible tariffs, just bureaucratic sinkholes that tie up imports in red tape.

Then there's currency manipulation, for example, China's peg to the US dollar.What's the "free market" price of Chinese goods in the US? Nobody knows because the peg protects China from its own currency being too strong or too weak to benefit its export-dependent economy.

Those bleating about "free trade" are simply pushing a Darwinian strategy that benefits them above everyone else. US corporate profits have quadrupled since China entered the WTO; is this mere coincidence? No: global corporations arbitraged labor, credit, taxes, environmental/regulatory and currency inputs to dramatically lower their costs (and the quality of the goods they sold credit-dependent consumers) and thus boost profits four-fold in a mere 15 years while tossing the hapless consumers a few nickels of "lower prices always" (and lower quality always, too).

The Neoliberal Agenda trumpets "free trade" because "free trade" is a cover for "free capital flows." Once capital is free to flow from central-bank fueled global corporations, no domestic bidder can outbid foreign mobile capital, as those closest to the central bank credit spigots can borrow essentially unlimited sums at near-zero rates--an unmatched advantage when it comes to snapping up resources and assets.

If we ask cui bono, to whose benefit?, we find the consumer has received shoddy goods and paltry discounts from "free trade," while corporations, banks and financiers have benefited enormously.

Rising income and wealth inequality is causally linked to globalization and the expansion of Darwinian trade and capital flows: the winners are few and the losers are many. Tariffs will not solve the larger problems of reduced employment, stagnant wages and rising income inequality. To make a dent in those issues, we'll need to tackle central bank and central-state policies that have pushed financial speculation to supremacy over the productive economy.

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Forget "Free Trade"--It's All About Capital Flows

In a world dominated by mobile capital, mobile capital is the comparative advantage.

Defenders and critics of "free trade" and globalization tend to present the issue as either/or: it's inherently good or bad. In the real world, it's not that simple. The confusion starts with defining free trade (and by extension, globalization).

In the classical definition of free trade espoused by 18th century British economist David Ricardo, trade is generally thought of as goods being shipped from one nation to another to take advantage of what Ricardo termed comparative advantage: nations would benefit by exporting whatever they produced efficiently and importing what they did not produce efficiently. While Ricardo’s concept of free trade is intuitively appealing because it is win-win for importer and exporter, it doesn’t describe the consequences of the mobility of capital. Capital--cash, credit, tools and the intangible capital of expertise--moves freely around the globe seeking the highest possible return, pursuing the prime directive of capital: expand or die.

Capital that fails to expand will stagnate or shrink. If the contraction continues unchecked, the capital eventually vanishes.

The mobility of capital radically alters the simplistic 18th century view of free trade. In today's world, trade can not be coherently measured as goods moving between nations, because capital from the importing nation owns the productive assets in the exporting nation. If Apple owns a factory (or joint venture) in China and collects virtually all the profits from the iGadgets produced there, this reality cannot be captured by the models of simple trade described by Ricardo.

In today's globalized version of "free trade," mobile capital can arbitrage labor, currencies, interest rates, regulatory burdens and political favors by shifting between nations and assets. Trying to account for trade in the 18th century manner of goods shipped between nations is nonsensical when components come from a number of nations and profits flow not to the nation of origin but to the owners of capital.

This was recently described in a Foreign Affairs article, (Mis)leading Indicators:

If trade numbers more accurately accounted for how products are made, it is possible that the United States would not have any trade deficit at all with China.The problem, in short, is that trade figures are currently calculated based on the assumption that each product has a single country of origin and that the declared value of that product goes to that country.

Thus, every time an iPhone or an iPad rolls off the factory floors of Foxconn (Apple's main contractor in China) and travels to the port of Long Beach, California, it is counted as an import from China, since that is where it undergoes its final "substantial transformation," which is the criterion the WTO uses to determine which goods to assign to which countries.

Every iPhone that Apple sells in the United States adds roughly $200 to the U.S.-Chinese trade deficit, according to the calculations of three economists who looked at the issue in 2010. That means that by 2013, Apple's U.S. iPhone sales alone were adding $6-$8 billion to the trade deficit with China every year, if not more.

A more reasonable standard, of course, would recognize that iPhones and iPads do not have a single country of origin. More than a dozen companies from at least five countries supply parts for them. Infineon Technologies, in Germany, makes the wireless chip; Toshiba, in Japan, manufactures the touchscreen; and Broadcom, in the United States, makes the Bluetooth chips that let the devices connect to wireless headsets or keyboards.

Analysts differ over how much of the final price of an iPhone or an iPad should be assigned to what country, but no one disputes that the largest slice should go not to China but to the United States. That intellectual property, along with the marketing, is the largest source of the iPhone's value.

Taking these facts into account would leave China, the supposed country of origin, with a paltry piece of the pie. Analysts estimate that as little as $10 of the value of every iPhone or iPad actually ends up in the Chinese economy, in the form of income paid directly to Foxconn or other contractors.

In a world dominated by mobile capital, mobile capital is the comparative advantage. Mobile capital can borrow billions of dollars (or equivalent) in one nation at low rates of interest and then use that money to outbid domestic capital for assets in another nation with few sources of credit.

Mobile capital can overwhelm the local political system, buying favors and cutting deals, all with cash borrowed at near-zero interest rates. Mobile capital can buy up and exploit resources and cheap labor until the resource is depleted or competition cuts profit margins. At that point, mobile capital closes the factories, fires the employees and moves on.

Where is the "free trade" in a world in which the comparative advantage is held by mobile capital? And what gives mobile capital its essentially unlimited leverage? Central banks issuing trillions of dollars in nearly-free money to banks and other financial institutions that funnel the free cash to corporations and financiers, who can then roam the world snapping up assets and arbitraging global imbalances with nearly-free money.

There's nothing remotely "free" about trade based not on Ricardo's simple concept of comparative advantage but on capital flows unleashed by central bank liquidity.

The gains reaped by mobile capital flow to those who control mobile capital: global corporations, financiers and banks. No wonder labor's share of the economy is stagnating across the globe while corporate profits reach unprecedented heights.

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The Death of Buy and Hold: We're All Traders Now

The percentage of household assets invested in stocks fell from almost 40% in 1969 to a mere 13% in 1982, after thirteen years of grinding losses.

The conventional wisdom of financial advisors--to save money and invest it in stocks and bonds "for the long haul"--a "buy and hold" strategy that has functioned as the default setting of financial planning for the past 60 years--may well be disastrously wrong for the next decade.

This "buy and hold" strategy is based on a very large and unspoken assumption: that every asset bubble that pops will be replaced by an even bigger (and therefore more profitable) bubble if we just wait a few years.

The last time this conventional wisdom came into serious question was in the stagflationary 1970s, when stocks and bonds, when adjusted for inflation, lost over 40% of their value. The decade was punctuated by numerous rallies, but each one petered out.

The only way to profit in this sort of market is to trade, i.e. buy the lows and sells the highs. Buy and hold is a disastrously wrongheaded strategy when the underpinnings of the status quo are eroding.

The 36-year bull market in bonds is drawing to a close, as yields are rising even if official inflation is moribund. Buying and holding bonds will guarantee steadily increasing losses as existing bonds lose value as rates rise.

Stocks have risen solely on the back of central bank stimulus, which is now being reduced/ended. In my view, the political blowback of soaring income inequality due to central banks rewarding capital at the expense of labor will place limits on future central bank largesse.

These long-term reversals of trend make everyone a trader, whether they like it or not: buying and holding might work for real-world assets if inflation really gathers steam, but if markets gyrate in the winds of uncertainty, every asset might rise and fall or simply stagnate.

Being a trader simply means selling an asset when it has topped out relative to other asset classes, and shifting the proceeds into assets that have been crushed and are beginning an up-cycle. It sounds so absurdly simple: buy low, sell high. But it's not that easy to accomplish in the real world.

It takes discipline to buy when others are selling (the low point of any asset cycle) and to sell when when everyone else is confident (and greedy for even more gains).

As a general rule, letting others take the risks required to skim the last 10% of gains is a prudent strategy: take profits when they arise, and don't assume uptrends of the sort we've enjoyed for the past 9 years will last.

As a trader as well as an investor, I've learned the hard way that the barriers to successful trading are largely psychological/emotional: we are all too easily swayed by the emotions of greed, fear and group-think.

Buying and holding is a relatively painless strategy in a rising tide that raises all boats. But when markets gyrate up and down, only those able and willing to trade--to take a modest profit and then buy another asset and then sell that when profits arise--will actually prosper in terms of increasing the purchasing power of their holdings.

The final and perhaps most difficult piece of trading is to gain the ability to recognize a decision to buy an asset isn't working as planned, and to sell the asset for a loss. Nothing is more difficult for humans than admitting to ourselves that we were wrong and a decision isn't playing out as planned.

Taking a loss is remarkably difficult as well. Modern psychology informs us that the sting of losses is far more potent than the euphoria of reaping gains, and mastery of trading requires the trader to "make all things equal," to use the Taoist phrase: losses and gains are treated equally.

Like the football quarterback, we can't dwell on the interception we just threw; we must clear our minds for the next successful throw/completion.

This discipline takes much practice, and most participants in the markets are ill-prepared to acquire the necessary discipline.

Here's another metaphor: sailing in calm seas and light, steady breezes makes sailing seem easy to the beginner. But when the seas roughen and the wind gusts unpredictably, it doesn't seem so easy any more.

Everyone who buys or owns any asset from now on --currency, cash, real estate, cryptocurrency tokens, stocks, bonds, options, farmland, copper futures, oil wells, everything--is a trader. Those who don't understand this may suffer potentially catastrophic losses.

From now on, everything is a trade that might have to be sold to avoid losses.

"Buy and hold" is based on the belief that each popped bubble will be replaced by an even bigger bubble. As I've discussed before, there are solid reasons to suspect that there won't be a fourth bubble after this one finally pops: three bubbles and you're out.

It's instructive to refer to a chart of the percentage of household assets invested in the stock market. Buy the dip and buy and hold worked consistently from 1950 until 1969, when the wheels fell off the stock market. (The wheels fell off the bond market a few years later.)

Households kept putting more and more of their assets into the "can't lose" stock market until the stagflationary losses of the 1970s destroyed their stock portfolios and their belief in buy and hold.

The percentage of household assets invested in stocks fell from almost 40% in 1969 to a mere 13% in 1982, after thirteen years of grinding losses--a process punctuated by numerous sharp rallies, each of which faded.

President Richard Nixon famously observed, "We're all Keynesians now," indicating the triumph of Keynesian policies within the political system. Perhaps in a few years someone will mutter "we're all traders now," and that utterance will mark the passing of buy and hold as the status quo's "can't fail" strategy.


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Should Facebook, Google and Twitter Be Public Utilities?

This opaque corporate censorship amounts to a private-sector Stasi, pursuing an Orwellian world of profits reaped from the censorship and suppression of dissent

My longtime friend GFB recently suggested I revisit my position on RussiaGate, the investigation into Russian interference in the 2016 US election.

I have been dismissive of the investigation because the idea that a pinprick of Facebook advertising ($100,000) could influence the sprawling ocean of public opinion struck me as preposterous.

But GFB suggested I look a bit deeper and consider the consequences of the Russian interference, however modest it might have been; and I have taken his sage advice and reconsidered.

I've reached the conclusion that Facebook, Google and Twitter should be operated as public utilities, not as for-profit corporations beholden solely to their shareholders and managers.

Here is my thinking:

1. As GFB so insightfully observed, Facebook says it sells advertising, as this is uncontroversial. But what Facebook is actually selling is data on its users. This enables enterprises to deliver adverts to highly specific audiences (surfers between the ages of 18 and 34 with an interest in traveling overseas, etc.), campaigns that are known only to the advertiser and Facebook, not to the targeted users. But it also enabled the Russian crew to target audiences most likely to be receptive to divisive, inflammatory content.

2. If we follow this dynamic to its conclusion, we realize that these for-profit corporations are threats to democracy, or incompatible with democracy, if you prefer that wording, as they directly enable the relatively affordable and easy sowing of intentionally divisive content.

A recent wired.com article, Inside the Two Years that Shook Facebook--and the World, describes Facebook CEO Mark Zuckerberg's realization that the technology he'd assumed was both incredibly profitable and helpful could be used as a force for exploitation and propaganda.

3. In response, the social media/online advertising quasi-monopolies--Facebook, Google and Twitter-- have all pursued censorship as their "solution" to "fake news."

But as we all know, censorship isn't quite as easy as the corporate technocrats reckoned; algorithms designed to sort out "fake news" inevitably end up axing legitimate content, particularly legitimate dissent, which often shares certain traits with what's conveniently labeled "fake news," that is, anything that veers from supporting the conventional status quo.

As the failure of the quick-and-dirty algorithms has became painfully visible, the for-profit quasi-monopolies have hired humans to sort the wheat of legitimate "news" (and what exactly defines legitimate news?) from the chaff of "fake news," and discovered to their dismay that the people they hired are biased against various dissenting views.

4. This opaque corporate censorship amounts to a private-sector Stasi, pursuing an Orwellian world of profits reaped from the censorship and suppression of dissent, all in the name of "getting rid of bad players."

5. Democracy depends on the free and open distribution of a wide spectrum of opinion, and an electorate which is skeptical enough to decide for themselves what's inflammatory nonsense and what contains kernels of truth that deserve further inquiry. The dominance of corporations seeking to maximize profits via selling user data invites the sort of private censorship we are now witnessing--a trend that is poisonous to a free press and democracy.

6. This is the intrinsic conflict between a free, accountable-to-the-public press that serves democracy and a handful of quasi-monopolies that are only accountable to shareholders and management, both of which expect the corporation to maximize profits by any means available, as maximizing shareholder/insiders wealth is the corporation's sole raison d'etre (reason to exist).

The social media/search/online advertising quasi-monopolies have transformed the Web into an unaccountable for-profit machine that harvests data from users, and this data-selling is just as open to abuse and exploitation as it is to conventional marketing of goods and services.

In a frantic rush to protect their profits and market dominance and avoid government regulation, these social media/online advertising giants are rushing to impose a private-sector Stasi of censorship and suppression of dissent--in effect, undermining the foundation of democracy in their pursuit of monopolistic profits.

7. The solution isn't an opaque, unaccountable private-sector Stasi--it's the transformation of these social media and search platforms into public utilities that do not collect any data on their users.

The transformation can start with regulations that restrict the data collection, monopoly and profiteering of these corporations.

The nation's moribund anti-trust laws might finally be applied to these social media/online advertising quasi-monopolies (and their quasi-monopoly media cousins), imposing transparency that reveals their dangerous dominance.

As these regulations limit their monopoly, data collection and thus their profitability, the market value of these quasi-monopolies will decline accordingly. Once their value has been reduced, a federal agency akin to PBS could buy them on the open market, strip out all data collection and maintain them as a free public utility that is worthy of the taxpayer subsidy because they are now an integral part of a free and transparent press.

The point here isn't that public ownership is perfect; the point here is that public ownership means these immensely powerful technologies are accountable to the citizenry, rather than to profit-maximizing private owners and managers. You can't have two masters, and the pathetic bleatings of billionaire technocrats about their "commitment" to democracy (while they spend millions lobbying Congress to protect their unaccountable New-Gilded-Age monopolies) cannot change this reality.

This may sound controversial, but if we really follow the internal logic of accountable-only-to- owners and insiders quasi-monopolies selling user data for immense profits and acting as unregulated censors of dissent, this is the only possible positive conclusion: transfer the ownership of these for-profit quasi-monopolies to the public, the sooner the better.

6. This week, GFB forwarded another article, What Would a 'healthy' Twitter Even Look Like? The answer is self-evident: a "healthy" Twitter, Facebook and Google would be publicly owned utilities that collected no data and sold no advertising other than general display ads visible to every user.

Now that the traditional media has been consolidated into a handful of self-serving corporations, these unaccountable quasi-monopolies should be broken into a hundred pieces by anti-trust laws.

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Never Mind Volatility: Systemic Risk Is Rising

So who's holding the hot potato of systemic risk now? Everyone.

One of the greatest con jobs of the past 9 years is the status quo's equivalence of risk and volatility: risk = volatility: so if volatility is low, then risk is low. Wrong: volatility once reflected specific short-term aspects of risk, but measures of volatility such as the VIX have been hijacked to generate the illusion that risk is low.

But even an unmanipulated VIX doesn't reflect the true measure of systemic risk, a topic Gordon Long and I discuss in our latest program, The Game of Risk Transfer.

The financial industry has reaped enormous "guaranteed" gains by betting against volatility. As volatility steadily declined over the past two years, billions of dollars were reaped by constantly betting that volatility would continue declining.

Other "guaranteed" trades have been corporate buybacks funded by cheap credit and passive index funds Central bank policies--near-zero interest rates and "we've got your back" asset purchases that made buying every dip a no-brainer trading strategy--have changed as banks attempt to dial back their stimulus and near-zero rates, and as a result volatility cannot continue declining in a nice straight line heading toward zero.

Higher interest rates have introduced a measure of uncertainty in another "guaranteed gains" trade--betting that interest rates would continue declining. All of these trades were "guaranteed" by central bank stimulus and intervention. In effect, price discovery has been reduced to betting that central banks will continue their current policies--'don't fight the Fed."

Now that central banks have to change course, certainty has morphed into uncertainty, and risk is rising, regardless of what the VIX index does on a daily basis.

Here is what a "guaranteed gains by buying the dip" market looks like: just bet that central banks will buy every dip and suppress volatility, and you're a genius.

Until the recent spot of bother that destroyed the short-volatility trade, betting on declining volatility "guaranteed gains":

Meanwhile, back in the real-world economy, wage earners' share of the economy continues stair-stepping down as every risk-asset bubble eventually pops:

Back in the good old days, corporate profits were the foundation of rising stock valuations. But corporate profits have stagnated while stocks have soared.

Gordon and I discuss the inconvenient reality that risk cannot be destroyed, it can only be transferred to others. So who's holding the hot potato of systemic risk now? the short answer: every participant holding risk assets, which now includes virtually every asset class.

Suppressing volatility does not mean risk has vanished; rather, it means that risk is increasing as accurate information on systemic risk is being suppressed. The global financial system is becoming increasingly fragile and thus more prone to collapse, and an artificially low measure of volatility doesn't change this reality.

My new book Money and Work Unchained is $9.95 for the Kindle ebook and $20 for the print edition.

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