True or False?

1.       Tariffs protect our nation from unfair trade practices?
2.        Federal Reserve Board and its leadership (Board Chair) have power to hurt the economy?
3.       President has power to ban American businesses from doing business in a foreign land?


We could test other questions as true or false, but let’s stick with these three. Each of the three questions could be answered correctly both true and false. There is a bit of truth and falseness in each question.


Number one is almost always false. Tariffs were designed to protect important industries at home that were at a competitive disadvantage from foreign producers. Steel is an example. Producing steel at home is considered a core industry to a manufacturing and construction powerhouse nation. Importing steel is viewed as weak and dangerous; our nation would be vulnerable to predatory pricing from those nations wishing to weaken us. Friend or Foe? World community or competitors?


But tariffs produce unintended consequences. They raise prices on goods that are basic to many products and cause inflationary prices for derivative goods. Protected producers may become less motivated to improve their product. Innovation is stifled. The pace of inventing new and better products slows. Competitive advantage stalls. We all suffer.


Tariffs may be important for the short term to create a protective window of time in which a producer of national strategic importance figures out how to compete better and naturally in the long run. Then there’s the boomerang effect: tariffs can cause a nation to boycott their competitor nation and invent their own native industry that becomes better than the foreign provider. This is what happened in colonial America when Britain taxed the settlers on their goods. Americans responded by building their own ships, wagons, and many replacement goods. In turn that developed the American economy faster and stronger. It turned out to be a motivator.


In recent decades free trade has become the natural order throughout the globe. Trading goods and services at market rates that compete openly allows the market to determine the best price and terms. Trading partners then have the funds to buy and sell other goods in a broader pattern of goods. Those producers with the best products at the best prices win business. Those that have inferior products or higher prices lose. Both quality and price is relative, however. That is why quality is a competitive advantage. Price is not always the arbiter.


International trade is complex. Value of currencies is only one difficult component to manage. Shipping, damage during shipping, international regulations and a host of other complexities shroud foreign commerce in layers of mystery. The results are good if the end price and exchange of valued products fit the use of the buyer and seller. Both trading partners win.


Number two is false. The Federal Reserve sets objectives for performance of the economy. Setting interest rates is the mechanism used to do this. Banking regulations have effects on the economy’s performance, too, but interest rates are primary. Raising interest rates dampens economic activity. It makes borrowing money more costly and forces borrowers to plan carefully to afford the risk of why they are borrowing in the first place. Cheap borrowing motivates business risk takers to expand their businesses. In turn this produces more jobs, more goods and more competition. The economy runs bigger and faster. If demand or quality is poor, the economic results are negative and go bust.

So, increasing interest rates slow the economy, while lowering rates speeds up the economy.

Currently, the economy is moving quickly, but there are weak spots. Interest rates do not need to be lower at this time to spur the economy; besides, interest rates are near historic lows. Risk takers do not need lower interest rates to make good decisions in borrowing funds. Blaming the Federal Reserve (and its chairman) is inappropriate for the current condition of the economy. Our economy is in danger of being overheated and out of balance. It does not need lower interest rates at this time.

If the Federal Reserve were to bow to political pressure, that would be a manipulation of the levers of power and do damage to the economy. This is the design reason behind the Federal Reserve's autonomy. No one controls the Fed.


Number three is false in the main. The president does not have the unilateral power to ban American business from foreign markets. Mechanisms could be imposed to have the same effect, but it would take a concerted effort by regulators, Federal Reserve, and Congress to make it happen. The components are so complex that the court system would likely be tested to determine constitutionality of the legislation or policies attempting to curb international trade.


That’s my Economics 101, 102 and 201 and 302 lessons for the day.


August 26, 2019