Some Ruminations on Trade Flows, Trade Costs and Trends

One of the persistently challenges I consistently face in trying to model US import and export flows is the sensitivity of the results to the inclusion of time trends. Time trends are bothersome because they are, in one sense, a measure of our ignorance. That’s a worry as we consider the feasibility of global rebalancing [0] [1] [2] [3].


One can whittle away at the role of time trends by including in the standard formulation a supply factor, so that for instance US imports depend on US income, the US dollar real exchange rate, and foreign export supply capacity. (How to proxy that latter variable is a vexed question). But in addition, we know that trade costs have varied over time (see the posts on de-globalization: [4] [5]).


Here are two graphs that highlight the potential importance of trade costs. The first graphs US log US durables and nondurables ex.-oil minus log GDP against the average tariff rate for US, Japan and European Union. Notice that as tariff costs decline, the trade intensity of GDP increases.


ttct1.gif

Figure 1: Tariff factor (1+t) for US, Japan, EU, interpolated (blue line, left scale), log nondurables good imports ex.-oil minus log US GDP (red line, right scale), and log durables good imports to log US GDP (green line, right scale), flows in Ch.2005$. NBER defined recession dates shaded gray; assumes last recession ended 09Q2. Source: Yi (2003), BEA, 2010Q1 2nd GDP release, NBER and author’s calculations.

The graph is merely suggestive, as it doesn’t include other trade costs, including transportation, and implicit costs (legal, administrative, logistical, communication). What this graph suggest is that goods imports might not trend in the same way going forward as over the past decade and a half (remember, some of these imports are incorporated into exports).


One message I don’t want people to take from this is that it would be a good idea to increase trade costs (via explicit or implicit protectionism) to reduce imports. That’s because the US is going to need to export, going forward, in order for the world economy to rebalance. Effective exporting requires in part ability to import the low cost components. But in addition, we need open export markets to be able to export. That leads to the obvious question of what the corresponding graph looks for exports. Here it is:


ttct2.gif

Figure 2: Tariff factor (1+t) for US, Japan, EU, interpolated (blue line, left scale), log nondurables good exports minus log Rest-of-World GDP (red line, right scale), and log durables good exports to log Rest-of-World GDP (green line, right scale), trade flows in Ch.2005$. NBER defined recession dates shaded gray; assumes last recession ended 09Q2. Source: Yi (2003), BEA, 2010Q1 2nd GDP release, Federal Reserve, NBER and author’s calculations.


For more on income and price elasticities, and accounting (or at least trying to account) for supply factors as well as trade costs, see this paper.


By the way, some of these trade costs are not policy driven. Oil prices, for instance, are an important component of transportation costs; and movements in that price (in the paper, I use the relative price of oil as a proxy for transport costs) are largely outside of the hands of US policy-makers (“drill, baby, drill” enthusiasts notwithstanding). [6] [7]

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32 thoughts on “Some Ruminations on Trade Flows, Trade Costs and Trends

  1. RicardoZ

    By the way, some of these trade costs are not policy driven. Oil prices, for instance, are an important component of transportation costs; and movements in that price (in the paper, I use the relative price of oil as a proxy for transport costs) are largely outside of the hands of US policy-makers (“drill, baby, drill” enthusiasts notwithstanding).
    That’s a pretty big “notwithstanding.” :-)
    Thanks for recognizing that imports and exports are actually linked and not independent economic sectors that have no influence on one another. Sometimes the balance-of-trade obsessive-compulsives speak as if we can have one without the other considering that Smoot-Hawley caused the Great Depression (http://tomrustici.angelfire.com/ Buy the book! You will learn things you have never even heard!)

  2. Steven Kopits

    Although the US government can influence short term oil prices (should it choose), it is unlikely to be able to influence prices fundamentally.
    However, government policy can have material impacts on volumes. For example, were total production in the GoM curtailed, such consumption would likely be shifted to imports. The annual value of GoM production is about $45 bn, somewhat more than the trade deficit of $40 bn for April. Thus, the cost of foregoing ‘drill, baby, drill’ is likely a material deterioration in the country’s trade balance.

  3. Lord

    Changing the corporate income tax to a vat tax would have almost the same effect with fewer complications.

  4. RicardoZ

    Comments by Professor Robert Mundell speaking in Hong Kong:
    Its wrong for the U.S. to force China to destabilize the renminbi, I myself dont think its a good idea, Mundell said. He called the Chinese move political.
    The yuan has traded at about 6.83 per dollar since July 2008, a policy that the central bank indicated is no longer necessary after the Chinese economy cemented its recovery.
    Mundell said the yuan-dollar peg gave Asian exporting nations more confidence in their trade positions by tying together two of their biggest customers. It also served as an anchor for the exporting countries monetary policies, he said.
    China could tackle its balance-of-payments surplus and build-up in foreign-exchange reserves while maintaining a fixed exchange rate, the economist added, saying that the tools could include boosting wages and consumer spending and easing the way for more imports.
    I realize that many who were schooled by mainstream economics professors do not understand the concept of a monetary anchor. Consider a small Asian country trading with both the US and China. With the yuan and dollar “anchored” the monetary authorities of the country can essentially out-source their monetary policy and not worry about windfall losses (or gains) from currency differences. The country can focus on production and exports and imports.

  5. 2slugbaits

    RicardoZ: “With the yuan and dollar “anchored” the monetary authorities of the country can essentially out-source their monetary policy and not worry…”
    I see. You mean the way Greece and Spain and Ireland “outsourced” their monetary policy to the Germans. Howz that work’n out?

  6. ppcm

    “With the yuan and dollar “anchored” the monetary authorities of the country can essentially out-source their monetary policy and not worry..”
    Could the negative effect of out-sourced expansive monetary policies be alleviated through growth constraints on domestic banks balance sheets,and a tax on capital borrowed from abroad?

  7. RicardoZ

    2slugbaits wrote:
    RicardoZ: “With the yuan and dollar “anchored” the monetary authorities of the country can essentially out-source their monetary policy and not worry…”
    I see. You mean the way Greece and Spain and Ireland “outsourced” their monetary policy to the Germans. Howz that work’n out?
    Actually contrary to the latest popular fallacy the fact that Greece and Spain are on the euro is working out better than if they were on their own currencies (think Zimbabwe). Had Greece and Spain still been on their respective currencies they would have first devalued before addressing the real problems of national sovereignty and default. Because their currency, the euro, is out of their control, they have to deal with real economic problems rather than with white-washed monetary procrastination and stalling tactics.
    I really appreciate you making this comment because if you begin to understand the postive nature of Greece being on the euro rather than the drachma, you may begin to see the light of why a currency anchored to gold is even more positive. Check out the writings of Robert Mundell on monetary issues.

  8. RicardoZ

    ppcm,
    Help me a little. I agree that there can be negative effects by outsourcing monetary policy (though Panama is in great shape using the US$). But to answer your question I need to know what negative effects are you talking about?

  9. ppcm

    Ricardo
    The negative effects have a track record:
    The misallocation of funds through the financial intermediaries.The havoc in the banking system is the footprint.
    If Panama has a good track record,I found Hong Kong to be the antithesis. The HK dollar is pegged on the usd and so is the monetary policy that means US procyclical monetary policies have always driven HK in real estates bubles.

  10. kharris

    RicardoZ said considering that Smoot-Hawley caused the Great Depression
    Wikipedia says:
    The SmootHawley Tariff or HawleySmoot Tariff (P.L. 71-361, officially named, the Tariff Act of 1930)[1] was an act signed into law on June 17, 1930, that raised U.S. tariffs on over 20,000 imported goods to record levels.
    and
    The main goal (of Smoot Hawley) was to protect American jobs and farmers from foreign competition, especially after the global economy entered the first stages of the Great Depression in late 1929.
    Oh, and before Wikipedia said it, so did JK Galbraith. And people living at the time knew it to be true, because they were already in an economic downturn when they read about the bill in the paper, before it was passed.
    Hmmm, who to believe?
    Now, as to whether things would have been worse for Greece outside of the EMU, that’s simply a matter of speculation. RicardoZ’s argument, as he stated it, is that remaining on the drachma would have been worse because Greece would have devalued. That argument, as stated, seems to assume devaluation is necessarily bad, or that devaluation is the issue itself, rather than general welfare. Either way, it sounds more like dogma than reality. In any event, we’ll never know what would have happened if Greece had held onto the drachma, which makes it pretty easy to just declare that one knows and argue from that. Easy, but not impressive.
    And, oh, by the way, the euro is down about 15% against the US$, 8% against sterling, 17% against the yen so far this year, so what’s this about how Greece would have devalued?

  11. don

    “One message I don’t want people to take from this is that it would be a good idea to increase trade costs (via explicit or implicit protectionism) to reduce imports. That’s because the US is going to need to export, going forward, in order for the world economy to rebalance.”
    The problem is outsized U.S. imports and arrested-development of U.S. exports. A good part of the imbalance can be laid to foreign currency manipulation, including the yen carry-trade induced by assurances that authorities in Japan will not allow dramatic yen appreciation. Virtually all Asian currencies are undervalued and the foreign reserves of these countries are massive. Their model of export-led growth is broken, but it seems it will not be repaired without very substantial pressure being brought to bear. This may sound like mere unenlightened ‘protectionism’ coming from the likes of me, but witness Krugman’s support of Charles Schumer’s legislation.
    Smoot-Hawley was remarkably unenlightened policy for a strong export surplus country to adopt, but we are now an import deficit country, to the tune of losses in domestic AD that are historically high and unusustainable.

  12. RicardoZ

    kharris,
    You fall into the same trap many fall into when attempting to analyze a historical event. Legislation does not start when a bill is signed. It ends when the bill is signed. If you follow the progress of Smoot-Hawley from 1928-30 you can see the impact of the bill on the economy. But you also need to go back even farther to WWI and then the Fordney-McCumber tariff in 1922 to totally understand. You also need to understand why the US was the only country in the world to have a “Roaring 20s.” Then you need to understand how Smoot-Hawley destroyed the agricultural export market causing the banking crisis or the 1930s. Finally, if you see how all of these interact you can see how Smoot-Hawley actually brought Hitler to power and was one of many causes of WWII.
    Don’t accept the shallow analysis of those like Galbraith who are more interested in justifying a position than performing good economic analysis.

  13. RicardoZ

    ppcm wrote:
    The misallocation of funds through the financial intermediaries. The havoc in the banking system is the footprint.
    If Panama has a good track record,I found Hong Kong to be the antithesis. The HK dollar is pegged on the usd and so is the monetary policy that means US procyclical monetary policies have always driven HK in real estates bubles.
    You are correct. When you outsource monetary policy you have to be prepared to assume the monetary errors of the source of your monetary policy. But in a situation where your primary trading partner is the source of your monetary policy your monetary problems such as real estate bubbles simply follow those of your trading partner.
    This is similar to the fact that monetary errors that caused our recent real estate/credit crisis created problems in both New York and California. Should California develop its own currency because the FED screws up our economy? For me the answer is no. California being able to use the same unit of trade with New York is more important, and Hong Kong (or China or Panama) using virtually the same currency as the US is more beneficial also more beneficial to trade.
    The EU monetary union has simplified trade between the members, but the currency cannot correct the political foolishness of socialist central planning.

  14. 2slugbaits

    RicardoZ: “Actually contrary to the latest popular fallacy the fact that Greece and Spain are on the euro is working out better than if they were on their own currencies (think Zimbabwe).”
    Hmmm…so a country is either on the gold standard or they immediately slide into Zimbabwe or the Weimar like hyperinflation. No middle ground. And it’s funny that you haven’t bothered to think about the extent to which being on the euro contributed to the PIIGS getting where they are today.

  15. don

    “Actually contrary to the latest popular fallacy the fact that Greece and Spain are on the euro is working out better than if they were on their own currencies (think Zimbabwe).”
    My guess is Argentina and the dollar board may be a better place to look for a good example.

  16. ppcm

    Ricardo
    Thanks for your comment,but I am still left with gaps in thoughts.
    Shall we conclude:
    The financial sectors are thinking as determinists,that is they have no thinking of their own?
    The states are of the same fabric,they are submissive to the “independant monetatary policies” be they domestic or outsourced?
    On SmootHawley Tariff
    I thought the debate was still open as no one can ascertain wether the tariifs were preceeding the depression or merely factoring despaired attempts?

  17. RicardoZ

    Don,
    Thanks, Argentina today is another good example. They do not even pretend that monetary policy is independent from the government’s needs.

  18. RicardoZ

    ppcm,
    Before I respond let me clear up some terms.
    I need a little more on financial sectors being determinists? Do you mean they react to monetary policy or they are controlled by monetary policy?
    By states do you mean states in the US or states and in independent countries?
    On Smoot-Hawley let me suggest a dissertation that you can buy on-line. http://tomrustici.angelfire.com/ This will give much more detail and lay out the path that led to Smoot-Hawley and then how Smoot-Hawley struck such a blow to the rest of the economy for years.

  19. Anonymous

    “If you follow the progress of Smoot-Hawley from 1928-30 you can see the impact of the bill on the economy.”
    Anticipation of the Act would have caused imports to rise immediately prior to its passage, as importers stocked up. This would increased the CA leakage. Was that the point made? Or did other countries react quickly upon seeing our pending legislation and beat us to the punch (thereby hurting U.S. exports)?
    But I still don’t think Smoot-Hawley is a good example for our current situation. More fitting as a lesson for China or Germany.

  20. RicardoZ

    Anonymous,
    I made an off-hand comment that Smoot-Hawley caused the Great Depression. It was that comment that started the discussion. You are right that Smoot-Hawley has nothing to do with our current situation.
    Concerning an increase in imports immediately prior to the passage of Smoot-Hawley you have to understand the economic climate. US trade policy had significantly locked out other countries from the US market even before Smoot-Hawley. When congress was debating the tariff countries all over the world either threatened or actually passed retaliatory tariffs connected directly to the passage of Smoot-Hawley. World trade was being destroyed by the US simply debating the tariff months before Hoover actually signed the bill.
    An open-minded study of Smoot-Hawley is fascinating because so many historians have gotten it so wrong.

  21. ReformerRay

    RicardoZ undermines his own argument by this sentence: ” US trade policy had significantly locked out other countries from the US market even before Smoot-Hawley”.
    The world economy survived U.S. protectionist policy for years before the Depression. After 1929, all nations struggled to bolster their economy.
    The collapse of the U.S. economy happened because of an financial bubble in excess of productivity increases in goods and services, both in the years preceding 1929 and in the years preceding 2008.

  22. RicardoZ

    ReformerRay,
    You need to do a lot more reading on international trade following WWI. The US had the “Roaring 20s” because after WWI taxes were reduced. The rest of the world (except Italy who also reduced taxes) began the depression right after the war. The world economy did not survive US protectionist policies. The world economy succumbed to them in 1929.
    There was not financial bubble. Friedman did not find one. Rothbard did not find one (thought he attempted to manufacture one). There was not a financial bubble before 1929. PE rations were withing normal range. Equity prices were high but not relatively higher than other periods that did not have recession.
    Rather than repeat the myths investigate the facts.
    2008 did have a bubble caused by congressional action on low income loans, regulators forcing lower lending standards, and GSEs taking on risk allowing lenders to put people into bad loans with no consequences. Essentially, market forces were short-circuited by government intervention through the regulators leading to a government induced economic melt-down.

  23. ReformerRay

    RichardoZ
    You need to do a lot more reading on Tariff rates in the U.S. before WW I. See the chart that Irwin repoduces on page 147 of his Free Trade under Fire. Tariffs on dutiable imports ranged from 40% to 50 percent during the period from 1861 to 1934 (except around WW I). How is it that high tariffs created so much problem around 1929 when they had been no problem for the preceding 3 decades?
    No financial bubble om 1929? If no bubble, how did the decline in stock prices caused so much trouble? Stock prices did go down, you will agree.
    RichardoZ would like to rewrite history to show that the private sector is not inclined to create bubbles and depressions. Can’t be done. Too much evidence supports the business cycle reality.

  24. ReformerRay

    A financial bubble occurs when financial assets value are increasing in excess of what would be justified by the real economy. We know we have had a financial bubble when the growth of financial values is obviously out of line with the real economy and financial values collapse. It is the collapse that identifies the bubble.
    We had a collapse of financial values after the stock market crash of 1929, therefore, we had a financial bubble before 1929.

  25. RicardoZ

    ReformerRay,
    You are not going to get it if you are a noe-trick-pony. WWI pushed the world into a debt crisis unprecedented in history. The only way or a nation to reduce its debt is to engage in international trade. Most of the debt was owed to the US so to pay back the debt the rest of the world had to provide the US with goods in exchange for paying down this debt. The US response was to pass the Fordney-McCumber tariff to protect and maintain the US export levels of WWI. The rest of the world was at was during WWI so what the US was essentially trying to do is lock the world into a war economy, no production only consumption. Well the rest of the world was in ruins; there was no ability to consume.
    The US then entered into a series of loans to its debtors. They were essentially offering credit cards to pay off credit cards. The international debt crisis worsened through the 1920. All during this time the US agriculture market was suffering because the rest of the world was returning from killing to feeding people. Congress took the mercantilist route and held tariffs high.
    In 1928 the politics of agricultural price in the US became heated. Politicians began to talk protection. As long as there were more against tariffs that for them the markets continued to hum right along. First the House of Representatives fell in favor of Smoot-Hawley, but the Senate was still a majority against. In 1928 the senitment in the Senate began to change. In the fall of that year the sentiment in the Senate tipped toward support and the bottom fell out of the markets.
    Treasury Secretary Andrew Mellon made statements to indicate that the administration would be opposed to Smoot and within two weeks after the crash the markets began to recover, but Hoover in his foolish way paniced and called in all of the industrial giants and made them pledge to keep wages and prices high and not allow them to adjust to slower growth.
    By year end 1929 the markets had regained much of their losses from October, but as 1930 began Smoot once again reared it head. The markets were up and down almost daily with news of the progress of Smoot. When the House and Senate passed the final bill it was the broadest and largest tariff in US history. The markets crashed once again in anticipation of world wide chaos.
    After Hoover signed the bill over the objection of almost every major economist in the country the markets and the economy began to drop and didn’t stop. Both imports and exports crashed, and the agricultural price decline, the driver of Smoot-Hawley, went into a massive depression. With agriculture crashing the rural banks began to fail because their whole business depended on agriculture, they could not draw from subsidiary banks because the politicians once again had created a banking system destined to fail in such an environment (not Canada did not have bank failures).
    I could go on but in truth Smoot-Hawley was do devastating that it brought down the world economies and created the Great Depression.

  26. RicardoZ

    ReformerRay,
    Even an aggregates guy like yourself should understand that you cannot have bubble unless it is supported by something. You either have to have a decline in another sector of the economy to supply the bubble or the monetary authorities must provide the supply of air.
    You must also resist the fallacy of post hoc ergo propter hoc reasoning. A collapse of values does not necessarily mean that previous values were too high. It could just mean that the government screwed up an economy they should have left alone.

  27. ReformerRay

    RichardoZ
    I agree with Lord Maynard Keynes that the punitative peace treaties after WW I was the major cause of economic problems after WW I.
    Your discription of the problems the U.S. created by attempting to fudge repayment sounds likely.
    These activities were not Smoot-Hawley though they set the forces in motion which led to Smoot-Hawley.
    My contention is that Smoot-Hawley was one of a series of mistakes but it was by no means a major reason for the collapse of the U.S. stock market. The U.S. economy hummed along from 1861-1914 with high tariffs. High tariffs created problems when maintained in the conditions that existed in 1929. Like today, the leaders of 1929 tried to continue past behavior without recognizing that the world had changed.
    My lesson to take away from the experience is to urge the U.S. to reject free trade and embrace equal trade as the desirable goal for all tradintg nations. We will not rebalance world trade until we accept a goal that requires it and the U.S. takes unilateral steps to move toward equal trade by increasing the cost of buying imports in the U.S. (But it must be done carefully, accepting current realities which point the way to do it).

  28. RicardoZ

    ReformerRay,
    Yes, the peace treaties after WWI did contribute to the problems in Germany but not the rest of the world. Other nations in Europe were actually to receive reparations, not pay them. Europe owed massive amounts to the US even though they won the war and they had no way to pay these debts especially since Germany could not pay its commitments.
    You say that the leaders in 1929 were guilty of continuing past behavior without recognizing that the world had changed. Isn’t that what you are doing by bringing up tariffs from 1861-1914? Do I need to remind you of changes in tax policy not only in the US but all over the world?
    You are correct that Smoot-Hawley was one of a series of problems contributing to the Great Depression but even other problems such as money supply issues and bank failures grew from Smoot-Hawley’s destruction of the agricultural export market. Even the mistakes of the Federal Reserve would not have been made if they had not faced unprecedented contraction due to the destruction of world trade.
    Equal trade is nonsense. Should a manufacturing export country trade equally with a raw materials export country? Equal trade is nothing but an euphenism for politically motivated bureaucratic mandate. Without free trade you cannot know real prices or demand. Interfering with free trade distorts any data a bureaucrat might use to make decisions even if he could resist the policial pressures.
    As Hayek said your “careful” imposition of central planning would lead you to a totalitarian solution that you really would not desire.

  29. ReformerRay

    “Interfering with free trade distorts any data a bureaucrat might use to make decisions even if he could resist the policial pressures”.
    The three nations that have been long term exporters to the U.S. in excess of their imports – Japan, Germany, and China – practice interference with free trade with a vengance. In each country, trade policy and trade action is aimed at maintaining a trade surplus.
    Free trade is a beautiful ideal that can only be practiced within a country where import restrictions by states are not permitted (USA). Free trade within the U.S. was essential for the development of the U.S. economy 1861- 1914.
    My proposal leaves no room for bureaucratic decisions. The U.S. Congress is requested to pass a law which sets up a process of increasing tariff rates by 5 percentage points every 4 months, starting 4 months after the law is signed by the President with a rate of 10%, said rates to apply uniformly to all goods manufactured in the countries of China, Japan, Germany, Canada and Mexico that are imported into the U.S.
    The way imports have been restricted in the past is not the only possible system and certainly not the best possible system.
    Equal trade is an ideal, just like Free Trade is an ideal. The difference is, each country can control its own imports so as to work toward equal trade and benenfit from the reduction in a trade deficit, if they have one, regardless of what other nations do. With the free trade ideal, any nation that wants to live according to the free trade ideal will be impacted by what other nations do (large U.S. trade deficit). The equal trade ideal will not be possible for every country to acheive with every other country. Each country should move as close to the ideal as possible. My recommendation for the U.S. is to stop moving toward equal trade when the the total U.S. trade deficit in goods is equal to 23% of the goods imported into the U.S.
    You are the one hiding behind a theory (free trade) that is unworkable, as shown by recent history. A practical, realistic person would not expect ambitious countries like Japan and China and Germany to forego the opportunity to use exports in excess of imports to and from the U.S. to create wealth and power for their country.

  30. RicardoZ

    ReformerRay,
    Are you saying that all countries should increase tariffs by 5% every 4 months until their trade deficit is equal to 23% of imported goods? Should they reduce tariffs if their imported goods is less than 23%? Why 23%? Is this percentage just for the US or for everyone? As with all central planning your system would lead to all kinds of unintended consequences.
    Free trade is not something anyone can hide behind. It is a principle of allowing traders to trade without outside interference.

  31. ReformerRay

    As I said before. “outside interference” is rampant in the world trading system. The inevitability of “outside interference” is the reason free trade is a poor guide to practice in the real world.
    My recomendation is that every trade deficit nation should do whatever they can do to reduce their trade deficit to a reasonable figure. The 23% of goods trade deficit as a share of goods imported is for the U.S. only. That was the level the U.S. reported in 1997. 1997 was the end of four years of roughly stable U.S. trade deficit; 4 years when theU.S. actually increased the number of people employed in manufacturing.
    23% works for the U.S. because we have a trade surplus in services and some of our goods imports are necessary inputs into production.
    Unforseen consequences accompany every change. The question is not whether we can predict the future completly. The question is which course of action is likely to produce the best results for the U.S. – considering what we know now about what free trade has done to the U.S.
    My proposal wins hands down.

  32. RicardoZ

    When the central planners of the world screw up international trade this is not repaired by having US central planners screw it up worse.
    Let me suggest you read about Commadore Vanderbilt and how he became a shipping magnate even though Fulton and others received huge subsidies and special monopoly rights from the government. That will give you a better idea of how free trade wins over central planning error every time. We have not been close to free trade in the US since the “Progressives” took power at the turn of the 20th Century, and the more centralized the planning becomes the worse things get. With free trade everyone wins while central planning pickes winners and losers. Even if one side is centrally planned it loses to the free trader because the free trader does not have to trade unless the trade is a benefit. The central planners trade based on political not economic results leading to econommic losses.

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