I don't like being in the position of saying Trump is right, but when it comes to trade, otherwise reasonable people often say things that are rather silly, which mean that Trump can be right. Matt O'Brien takes the silly route when he takes issue with the idea that our trade deficit in the last decade could have led to an economy-wide lost of jobs and also says that the story of the trade deficit and jobs is all history anyhow.

Before going to the woodshed, I'll give Matt credit for what he gets right. Matt acknowledges that the opening to China with its entry to the WTO had a devastating impact on millions of workers and their communities. For some reason, many economists and commentators feel a need to deny this fact. I suppose the flat earth society is larger than I imagined.

I will add one point to Matt's discussion of this issue. Matt notes that in principle, the gains to the winners from trade are larger than the losses to the losers. This means that we should be able to compensate the losers and make everyone better off.

Matt correctly points out that the compensation to the losers is invariably a joke. They don't get s**t, and then we call them names when they vote for Trump.

But there is an additional point on this compensation story that is worth throwing in. The claim that the gains exceed the losses and therefore we can have compensation to make everyone better off is only necessarily true if we have a costless compensation process.

In other words, if we can just vacuum up dollars from everyone who won and hand them out to the people who lost, then we can ensure that everyone is better off, but in the real world we don't actually have a costless process. In the real world we get money from the winners from things like income and sales taxes, which come with distortions. This means that for every dollar we collect in revenue, we are losing some amount of economic activity. 

Similarly, our compensation programs also carry costs. We don't have clearly identified losers whom we can just hand money to. We have things like trade adjustment assistance that we have to pay people to administer. And some people who apply may not qualify and others who qualify may not be accepted. 

Are the gains from trade large enough to cover the tax distortions and the cost of running our compensation programs and still leave everyone better off? Economic theory can't answer that one, we have to look at the actual taxes and the programs. Of course, if we don't even try to compensate the losers, like in the U.S., then we don't have to worry about this question.

Okay, on to the substance of my disagreements with Matt. He tells us:

"Yes, trade with China really has devastated some of our manufacturing communities for far longer than we thought possible. And yes, some of China's trade practices really have been unfair, from the way it used to manipulate its currency down to subsidize exports to the way its state-backed companies still “digest” technology from foreign firms to discourage imports. But up until 2008, when interest rates got as low as they could go, there's no reason to believe that China was costing us jobs overall. Nor is there to think that it is now. Interest rates are back above zero, and China has not only stopped pushing its currency down but has also spent a trillion dollars propping it up."

Starting with the first part of this, the story is that until the Fed hit the zero lower bound in 2008, there is no reason to think the trade deficit cost us jobs, because the Fed would have lowered interest rates further if it felt it was necessary to create jobs.

Here we need some serious thinking about the zero lower bound. The Fed continually lowered interest rates as the labor market failed to recover following the 2001 recession. It continued to shed jobs all through 2002 and most of the way through 2003. As a result the federal funds rate was pushed down to levels not seen since the early 1960s. It eventually bottomed out at 1.0 percent in the summer of 2003 and was kept at this level until the summer of 2004.

As fans of arithmetic everywhere know, 1.0 percent is larger than zero, so we could say the Fed was not at the zero lower bound. However, many folks at the time felt the Fed had gone as low as it could and that any further reductions would do more harm than good by creating alarm over the state of the economy. In fact, people thought things pretty much like this even following the collapse of the housing bubbles in 2008. The European Central Bank (ECB) pushed its overnight rate to 1.0 percent and left it there until 2011.

It has since lowered its rate further, but at the time plenty of good folks talked about the ECB being at the zero lower bound even though it was not actually at zero. (It's rate has since gone negative, thereby showing that zero was not actually the zero lower bound.) 

The point is that it was widely believed at the time that the Fed had done pretty much all it could to boost demand and we were still coming up short in the years 2002–2004. Eventually we did see the gap in demand filled. The housing bubble that grew up in this period led to a surge in residential construction and also a consumption boom driven by the housing wealth effect. This bubble driven demand did get us to something close to full employment in 2006–2007, but I'm not sure this helps Matt's case.

Now for the second part of Matt's comment, that this is all history, since China is now trying to raise rather than lower the value of its currency. First, if we envision China holding a normal amount of reserves given the size of its economy and trade (e.g. $1 trillion) rather than its actual holdings of more than $4 trillion (counting its sovereign wealth funds), there is no doubt its currency would have a much higher value than it does today.

Currency values, like interest rates, are affected by both flows and stocks. Everyone agrees that long-term interests in the United States are lower than they would otherwise be as a result of the fact that the Fed is holding more than $3 trillion in assets. It's the same story with China's reserve holdings and the value of the dollar.

But more importantly there is a clear course of action here. The United States could act together with China and agree on raising the value of its currency by 20 percent (or whatever target is chosen) over some clear time frame. This would reduce our trade deficit, especially if the dollar falls against other currencies as well. 

That would certainly change the mix of jobs in the economy, with more manufacturing jobs and fewer jobs in lower paying sectors like retail and restaurants. And, if we think that millions of prime-age (ages 25 to 54) didn't suddenly decide to retire very early, it could bring these people back into the labor market, thereby raising total employment.

In short, the story of problems with trade is not behind us. Trump is not wrong to be raising it as an issue, even if almost everything he says about trade may be wrong.