TradeFlow21 managing partner Steven Towns recently reviewed Trade Myths: Globalization has left trade balances behind, a profound book weighing in at all of 75 pages with an additional ten pages of charts that bust the same myths already exposed in prose. The author, Dr. Enzio von Pfeil, is a Hong Kong-based investment adviser and fund manager. A regular in the financial media in Asia, he is a former chief regional economist at leading London-based investment banks in Hong Kong. Enzio has long studied matters related to trade, and fortunately for those looking for perspective not readily found in the mainstream media, particularly in the U.S., he has penned Trade Myths. Of the five trade myths he discusses, in each instance, Enzio explains how misguided and anachronistic beliefs about trade could lead to an impaired U.S. economy with a simultaneous jump in interest rates having widespread repercussions. The book review begins below followed by Q&A.

The first myth is that “imports kill jobs.” Enzio readily dismisses this as self-serving for politicians wanting to avoid inconvenient truths. In short, politicians (the key subjects of Enzio’s work), rather blame outside forces for their constituencies’ economic troubles, rather than acknowledge failing policies in areas such as education, and matters such as burdensome taxation.  Enzio questions how the U.S. can be expected to increase its headline trade surplus as it employs fewer people in manufacturing. And, it turns out that as imports rise, so does employment, primarily in services. Yet, if all so-called “unfair” imports were banned, America’s multinational corporations (MNCs) would suffer heavy blows since their foreign-made products could not be imported back into the U.S.; and most imports would have to be substituted by local production, resulting in higher costs, in turn pushing up inflation and thus forcing interest rates higher, which would reduce investment and slow job creation (if not resulting in massive job losses), while the higher cost of capital would sink the housing and capital markets.

The second myth is that “exchange rates drive trade,” which is again self-serving for politicians. The argument that if other countries’ exchange rates were stronger, America would not have a deficit, does not hold water, explains Enzio, since a devalued U.S. dollar brings trouble of the kind explained above.  In fact, it’s comparative advantage, not exchange rates that really drive trade.

The third myth is that “trade balances are a national matter.” While being a convenient line for politicians, it is a risk infected one. Given the interconnectedness of the global economy, viewing trade balances nationally is purely mercantilist thinking and potentially subjects MNCs to host government protectionist retaliation. Alarmingly, a tit-for-tat trade war could lead to actual war. Disturbingly however, it turns out that a closer examination of trade data shows MNCs are responsible for very little of the U.S. headline $700 billion-plus trade deficit. More importantly, when factoring in the value of MNC’s foreign affiliates’ purchases and production, the U.S. has an enormous $2.7 trillion surplus! Enzio explains that America’s highly successful MNCs are the root cause of the “bad” trade deficit, not “bad foreigners.” Among his other keen observations is that when backing out the domestic activity of MNCs in China, the latter runs a global trade deficit of $1.7 trillion compared to a headline surplus of $260 billion!

The fourth myth is that “America’s trade deficit is ‘bad.’” This follows myth number three and in short, reiterating what was said about myth number one should politicians ban MNCs from operating abroad, the outcome is likely to be an “economic 9/11.” Two keys to this myth are that non-U.S. MNCs are more than ready to take market share from U.S. MNCs; and it doesn’t necessarily require a ban on U.S. MNCs operating broad, since U.S. politicians angering a host country such as China could result in the same dire consequences. Enzio wonders just how disaffected U.S. MNCs would respond in terms of their political contributions.

The fifth and final myth is that “foreigners finance America.” Once again, he regards this as a political ploy (whether deliberate or naively inadvertent) playing on vulnerability and blaming foreigners for ills. Should foreigners be banned from holding government debt or if they dumped their holdings, the outcome could mirror the fallout from the sub-prime crisis. However, taking a step back, Enzio enlightens readers on two fronts. The first being one must review just who the foreigners that own U.S. debt are and what percentage of the whole it comprises. Interestingly and also surprisingly, Enzio explains that news reports are misleading, since foreigners as a whole owned 25% of Treasuries outstanding in 2006, but of that an increasing amount is held by private investors (such as hedge funds and also MNCs) as opposed to institutions or governments, thus lessening the impact if there were ever any dumping. Data suggests a very strong correlation since 1970 between the growth of FDI and the “foreign” ownership of Treasuries. The other point here is that even if foreign holders were to dump Treasuries, there is no other market that offers the depth, liquidity, and sophistication of the U.S. Enzio notes that the size of the U.S. bond market is greater than the EU, UK, Japan, and Switzerland’s combined.

The remainder of Trade Myths includes an explanation of the drivers of trade flows, the history of the economics behind trade, and Enzio’s suggestions for how to remediate the discussion of trade. His first suggestion concerns myth number three or specifically, antiquated (mercantilist/nationalist) trade balance accounting, and how it needs to be modernized. His second suggestion involves tax solutions for helping the working class. And adding to that, his third suggestion relates to the necessity of improving the quality of the U.S. workforce by way of better vocational and pre-college education. In closing, while Enzio duly noted that political self-interest can prevail during economic downturns, this reader was compelled to reflect on an earlier quoted passage from the late Professor Daniel Boorstin, which Enzio recaps in stating: [America's] politicians/leadership recognizing the U.S. itself is the largest stakeholder in the globalized economy will be the necessary first step in the process of transforming mindsets about America’s trade balances and trade policies.

Q&A:

ST: What are your thoughts on the latest “currency manipulation” talk out of Washington, especially since the situation seems to be worsening with growing bipartisan support in both Congress and Senate?

Enzio: This cheap talk has to be seen against the backdrop of mid-term elections in America. It also has to be seen against the backdrop of Congressional “stimulus” packages which have resulted in 10% unemployment rates – and in 20% unemployment rates for males who are 30 – 55 years old. Another backdrop is that charade of the Treasury report on currency manipulation. Everyone bandies around the “glories” of purchasing power parity; I, for one, have severe methodological problems with this bit of nationalistic chauvinism. It is interesting that the one country whose currency has fallen the most uses this, the U.S. You never hear serious intellectual debate coming from Germany, Japan or Switzerland about how “overvalued” their currencies are – yet, they keep generating huge and growing trade surpluses.

ST: Although it’s mostly “cheap talk” at this point, there’s a palpable escalation of angst in the U.S., meantime while there seems to be firm resolution in China (re. a desired gradual appreciation of the yuan). Do you think another Smoot-Hawley type tariff and a subsequent devastating impact is a possibility?

Enzio: Absolutely not. I don’t think that Congress would be that short-sighted. But I can see its members chasing the WTO with all sorts of law suits, depending upon which constituencies these Reps and Senators are representing.

ST: Changing directions then, tell me, is trade balance accounting consistent among the U.S. trading partners, and what, if anything, is being done to modernize the accounting?

Enzio: Yes, everyone uses the same, 16th century framework. Thus, all trade balances are measured in terms of national borders. This was logical in the 16th century, when there were very few MNCs and when mercantilism was common practice.

ST: Okay, so let’s assume that politicians accept your suggestions and everyone now recognizes that the U.S. has a massive trade “surplus” when factoring in activity of U.S. MNCs’ overseas affiliates. In your opinion, what then is a healthy amount or range of debt-to-GDP? Does or should this vary much across borders, given idiosyncrasies within countries (Japan comes to mind)?

Enzio: It is not as much the ratio per se as it is who is financing that deficit. If the foreigner really is financing that deficit, then the country that is borrowing the money is vulnerable to the foreigner pulling their funds out. But a second point also is relevant: what is the currency of the fiscal deficit? If it is a small currency, then the foreigner, in fact, can pull out. But in the case of the USA, the dollar is the world’s dominant currency, so that reduces the leverage of the foreigner. Furthermore, if American politicians accepted that their own MNCs are very much “at fault” for America’s geographical trade deficit, their whole mindset would change from: “how can we punish ‘bad’ China, to: how can we re-invigorate our own competitiveness?”

ST: For my last question, I want to get your thoughts on if we recognize the massive trade surplus in the U.S. and correspondingly the huge deficit in China when backing out MNC activity, does this change the ongoing U.S.-China trade and currency arguments?

Enzio: Absolutely. Were MNCs’ balances to be included in such “global” trade balances between China and America, then Americans would be asking their very own politicians just why American MNCs are producing more and more abroad instead of back home in the United States. Answer: the politicians have, in their quest to get re-elected, made many expensive promises. That means that taxes and regulations have increased, courtesy of politicians’ desire to get re-elected. The upshot is that the U.S. (like Europe and Japan) have “priced themselves out of the market” in terms of costs and regulations. As a second fusillade primarily against U.S. politicians: instead of focusing on what could make America more competitive – namely, pre-college vocational training – those very politicians who rail against “bad and dangerous” China have a mendacious record when it comes to vocational education policy in America.

Thus, were my points regarding America’s global trade surplus and China’s global trade deficit to be heeded, then this rubbish about exchange rates “really” affecting trade flows would wilt in the face of much more important competitive considerations, e.g. domestic tax as well as regulatory regimes, along with (vocational) education policy. Laconically, you cannot import a car repair; you need a qualified local to repair that Mercedes that you have imported from Germany. Were exchange rates really as important as some politicians claim, then why do Germany, Japan and Switzerland – whose currencies have appreciated fourfold against the dollar since 1970/71 – all have trade surpluses (as I mentioned in your first question)?

ST: Thank you for your time, Enzio.

1. Do your homework: learn something about your target country; no, you don’t have to learn Arabic, but do learn some greetings; and understand that the Middle East is not only what you see on CNN or the evening news (usually scenes of violence or of money in Dubai). Note that relationship building is especially important.
2. Be culturally sensitive: both the business week and business hours are different in the region, with SUN – THUR and later hours the norm; Friday is mosque day (communal prayer). Remember, the region has a long, rich history and people want to be treated as equals with the West. Also, be ready to drink a lot of tea. Don’t expect much, if any, alcohol.
3. Learn even a little about political issues: Arab/Israel (eventually your local business partners may inquire of your opinion); government sanctions (U.S. businesses face certain restrictions such as in Iran); and illicit payments (referring to bribery, which U.S. companies are prohibited by law from engaging in — and it’s not necessary to do business, says the Ambassador).
4. Patience needed: don’t present the image of being in a hurry, a rather common stereotype of Americans. Can’t expect to fill your order book right after leaving the airport; doing business begins with relationships.
5. Use the U.S. govt.: the Dept. of Commerce, embassies and consulates all have information and resources available to U.S. companies looking to do business overseas.
6. Think about security: while the Middle East is not the 24/7 violence portrayed on the news, recognize that like anywhere it is important to be aware of your surroundings; you can’t do business if you’re uncomfortable. Review State Dept. travel warnings; contact the consulate if you are planning an extended stay.
7. Find a local partner: “most important” step when targeting a market; may be an agent, representative, or a distributor; a local partner can also facilitate with any cultural sensitivities that may arise.
8. Consider intellectual property issues: as with any market you enter, ensure that you’re intellectual property rights are protected. Don’t assume protection if you’ve only registered in the U.S.
9. Beware of the “V” word: don’t make promises regarding immigration visas to the U.S.; issue may eventually arise with local business partners; U.S. concerned with security and immigration, but serious commercial implications if business lost to more “open” European markets, for instance.
10. Understand M.E. buyers’ criteria: quality is king, and there’s a willingness to pay, but it’s not everything (can’t charge too much premium); also looking for service and personal relationships. Preference to do business or at least interact with more senior ranking company representatives.
11. Be prepared to compete: true of any market, but there are some distinct advantages/disadvantages for U.S. exporters. The former include existence of free trade agreements in select regional economies. The latter is largely in light of European competitors (proximity and longevity).
12. Be realistic, be bold, and be patient (see #4), as you strive for success.

Along with his “12 Rules,” Ambassador Donnelly also mentioned the importance of foreign currency exchange rates. He advised that business counterparts in the Middle East are sophisticated with forex, and the fluctuations in the dollar can impact business since for example, euro-denominated goods or services may be priced more or less favorably. On that note, TradeFlow21 is continuously tracking economic and capital market developments, and we look forward to helping your company engage in business in the Middle East.

1)      demands the cessation of hostilities between Israel and its neighbors, including the creation of a sovereign Palestinian state as the only viable means of resolving the Palestinian question

2)      requires a U.S. policy that summarily rejects those in all quarters who use division and discord as a means of maintaining their “competitive advantage” in the region

3)      dictates that economic development, through investment and trade, be embraced as the preferred path to establishing a more stable, secure world for all

In his long-awaited speech on American-Muslim relations today in Cairo, President Obama responded, arguing that

1)      “America will not turn our backs on the legitimate Palestinian aspiration for dignity, opportunity and a state of their own”

2)      “as long as our relationship is defined by our differences, we will empower those who sow hatred rather than peace…conflict rather than cooperation…this cycle of suspicion and discord must end”

3)      “on economic development, we will create a new corps of business volunteers to partner with counterparts in Muslim-majority countries…I will host a summit on entrepreneurship this year to identify how we can deepen ties between business leaders, foundations and social entrepreneurs in the United States and Muslim communities around the world”

Thank you, Mr. President.  The partners of TradeFlow21 will join you in the cause to build a prosperous, secure Middle East through commerce and trade.  Let us now begin our work.

Necessity demands the cessation of hostilities between Israel and its neighbors, including the creation of a sovereign Palestinian state as the only viable means of resolving the Palestinian question.

Necessity now requires a U.S. policy that summarily rejects those in all quarters who use division and discord as a means of maintaining their “competitive advantage” in the region.

Necessity dictates that economic development, through investment and trade, be embraced as the preferred path to establishing a more stable, secure world for all.

For over 60 years, the Middle East, which is comprised of over 20 nations spanning Northern Africa in the west to Southern Asia in the east, has been defined by conflict and oil. This is a new era. Real GDP non-oil growth in the region, which is projected to expand by more than 3.5 percent this year, suggests that Middle Eastern nations are actively pursuing commercial diversification as they seek to become full partners and competitors in the global economy. It also presents tremendous export opportunities for companies who want access to an emerging market of 500 million consumers.

The world is waiting for President Obama to signal a new turn in U.S. – Middle East relations where strategic alliances are built principally on commerce and trade. The partners of TradeFlow21 welcome such a change as both vital and necessary.

The message from oil analysts and capital market participants is mixed. On one side, the picture is bleak, as unemployment and economic contraction loom, while so-called oil “fundamentals” are weak (weak demand and strong supply). These all suggest that the oil rally may have run its course for the time being. However, the bullish camp points to the now rhetorical “green shoots of recovery” theory, reports of stockpiling by China, short (seller) covering in futures markets,  and higher risk appetite among investors and traders — with all the aforementioned accompanied by a weakening dollar, which has an inverse relationship with oil and many other commodities.

Therefore, it truly is a mixed bag. For consumers and domestic U.S. manufacturers, an economic recovery at home and more broadly around the world has huge implications, but higher oil nibbles away at the purse and at margins, respectively. At the same time, as a weak dollar typically suggests a more favorable climate for U.S. exports, there is pressure on the input (or materials) side from rising commodities. Nevertheless, at current price levels, higher growth for higher oil is a bargain! For oil producers, higher oil is almost always welcome, although refining operations can cap the upside. Also, higher oil means more likelihood for investment and exploration, which eventually may lead to more revenues, and supply, but ultimately, perhaps somewhat of a damper on prices.

That being said, TradeFlow21 remains enthusiastic about the sustained growth prospects in the Middle East. In some cases, oil now accounts for a lower portion of GDP than in years past as Gulf economies seek economic diversification, but in terms of a source of foreign reserves, oil overwhelmingly remains the source of liquidity. In our opinion, the higher oil prices of late are not necessarily worrisome from the U.S. viewpoint. Reason being is that OPEC, and the Gulf producers in general, are sensitive. A recent guest on Bloomberg Radio made the point that the Gulf producers don’t want to be blamed for a prolonged global recession, and therefore, are willing to sacrifice near-term profits and even some budgetary shortfalls. Oil producing companies have a relatively low break-even price, perhaps as low as $30 or less, but oil producing nations that went on a spending spree in recent years tend to have budgets based on break-even oil in the $40-$60 range, with outliers such as Abu Dhabi in the low $30s and Bahrain in the $70s (Fitch Ratings). No doubt sovereign budgets have been, and will be further adjusted, but in order to sustain growth, significant amounts of money will continue to be spent within the region. For Connecticut manufacturers and exporters, the Gulf represents real opportunity (from everyday consumer products to building materials and beyond), and TradeFlow21 is here to help make the region more accessible to you.

But this is a new age where human intellect and industry are changing the landscape in terms both political and social.  Among the 20-plus countries that comprise the Middle East, most have already embraced global commerce as a primary means of engagement with the world community.  The recent economic boom among the Gulf nations in particular has also ushered in an era of commercial cooperation with Western partners, creating a more interdependent, integrated world.  It has also fostered a deeper understanding and respect for the region as the cradle of civilization for writing, philosophy, science, art, and faith.  In spite of current economic circumstances, TradeFlow21 will work tirelessly to promote investment and trade as the primary tools of engagement.  Let commerce do what conflict cannot do; create an environment where sovereign states, democratic or theocratic, and their people live in relative peace, prosperity, and security.  The killing must stop.  Peace must prevail, because humanity now demands it.

Next January, President-Elect Barack Obama will be severely tested on many fronts:  a two-theater war; dislocation of global markets; and a mounting environmental crisis that threatens to alter the face of the earth and the security of nations. He will be pressed for answers, not just explanations.

For many, the Middle East is the nexus of terror, provoking wars of intervention, and oil, which has created untold wealth for the region and pollution as a by-product of a fuel-addicted world. It is also a land of over 300 million people, where industry, entrepreneurship, and direct foreign investment have fed a development boom of unprecedented scale. Though Gulf states in particular have felt the effects of the current financial crisis, resulting in plummeting home prices in Dubai and the court-ordered closure of the Kuwait stock exchange, the Middle East’s influence in world markets is uncontested.

We urge the President-Elect to seize the moment and let trade flow freely into this intersection of the world, supplanting terror and war by transforming oil-dependent economies into highly diverse, fully integrated drivers of global growth and opportunity.

Let trade also rebalance a troubled region that for the past 60 years has employed a Cold War model with Israel as the sole arbiter of U.S. and Western interests.

Let trade transcend language, culture, and faith as democracies and theocracies find concord through commerce, with prosperity and security the dividends.