Many people who have supported Donald Trump and cheered on the first 10 days of executive orders are deeply squeamish about the sudden trade war. Trump has imposed tariffs on Canada, Mexico, and China and suddenly, long before there has been any action on taxes and before deregulation in the United States has taken effect. Even people who are concerned about issues of international trade and U.S. manufacturing worry that all of this is too much, too soon.
The claim has been that Mexico and Canada have been insufficiently vigilant in stopping illicit drug traffic and immigration, while the complaints against China’s trade practices go back decades. Trump has moved with a level of ferocity against prevailing trade practices that no one really expected. Financial markets have not welcomed this news, and even fans and defenders of the actions otherwise are having a hard time swallowing the trade war.
The concern is a legitimate one. If a trade war tanks the fragile economy and hits prices in ways Americans simply cannot afford right now, everything else about the Trump agenda is thereby put at risk.
For this reason, there is every reason to feel relief that the president of Mexico, Claudia Sheinbaum, has made enough concessions on border control to delay the imposition of tariffs. Just before the tariffs were to go into effect, Canada promised to do the same. The war is averted for now.
Mark my words: this is far from over. One way or another, many nations in the world are going to face much higher tariffs with the United States. All of this is quite scary for anyone doing business across borders.
How to sort out the complications here? We need not plunge back into the old debate over free trade and protectionism. That issue goes back hundreds of years in political economy. Both concepts represent ideal types that are not directly relevant to the current situation. To add to the complications, there is more going on here besides just immigration and drugs or even the status of intellectual property.
The real issue concerns U.S. manufacturing and how the status of the dollar in the world economy—the main source of liquidity for the world—has rendered the postwar trading order inconsistent with America’s ambitions for a manufacturing revival. The bottom line is revealed in the trade deficit figures that show some half a century of unsettled account deficits. That is the part that drives Donald Trump crazy because he sees it all as money owed to the United States.
Free-trade economists look at this and say that it simply does not matter. This is nothing but other countries sending capital to the United States in exchange for which they get pieces of paper. What looks like a deficit is nothing but an accounting fiction, a habit of tallying up imports and exports that dates from an earlier era that simply has no relevance anymore.
Is that true? The trouble is that this persistent trade deficit coincides with a huge loss of manufacturing industries and jobs in the United States. This is simply undeniable (though many still deny it). We’ve seen this inexorable trend since the 1970s to lose industry after industry (dozens in all) to foreign competition.
This is not simply because other nations make better stuff. Instead, it traces to the math of international exchange. Because the United States is the world’s dominant currency, labor and resource costs will always be lower in foreign nations. The readjustment promised in classical economic theory never happens, leaving the United States forever vulnerable to ruthless competition in any industry that depends on labor inputs.
Why is this? It all comes back to the fateful decision of Richard Nixon in 1971 to leave the gold standard and impose a world dollar standard rooted in paper money alone. Ever since then, the U.S. dollar has served as liquidity for the world. Central banks around the globe have accumulated U.S. debt in central banks and banking systems and deployed those as assets on which to build manufacturing chains, easily beating even the most robust domestic industries with only the general exception of oil and finance.
This situation is clearly untenable, as any trade theorist from David Hume to Gottfried Haberler has repeatedly explained. In the days of the gold standard, national currencies were different names for the same base currency that shipped around the world as a means of settling accounts. Price levels and currency valuations adjust according to the flow of goods, making it impossible for one country, much less all countries to continually outcompete another country in all industries over many decades.
The technical name for this process in the past was the specie-flow mechanism. This is what made free trade consistent with the prosperity and economic prospects of all nations. The trouble is that this mechanism broke in 1971. At the same time, taxes and regulations grew and grew, raising costs for American producers to intolerable levels.
Over the course of decades, it became obvious that accounts would never be settled. The United States was forced to sit by and watch the destruction of its supply chains, manufacturing infrastructure, and a trained workforce. This was celebrated as some kind of triumph of free trade but it had almost nothing in common with the trade regimes of the past.
“The standard free trade argument against the Donald’s tariff blunderbuss is pretty much bogus, as well. America’s industrial economy has been massively hollowed out by continuous giant trade deficits since 1975 and these deficits are the measure of good jobs and middle class incomes that have been off-shored. … The fact is, in the last 18 years there has been zero growth in industrial output, even as real GDP has purportedly expanded by 40 percent. That juxtaposition is hardly an indication of blooming health in the industrial economy. More specifically, actual manufacturing output is -6 percent lower today than it was in Q4 2007 on the eve of the Great Recession, even as U.S. real PCE for goods has grown by +61 percent during the same period. That is, if you produce 6 percent less goods and consume 61 percent more goods, why then you absolutely do have a ‘hollowing out’ problem.”
“The root of the economic imbalances lies in persistent dollar overvaluation that prevents the balancing of international trade, and this overvaluation is driven by inelastic demand for reserve assets. As global GDP grows, it becomes increasingly burdensome for the United States to finance the provision of reserve assets and the defense umbrella, as the manufacturing and tradeable sectors bear the brunt of the costs.”
He notes that Trump has celebrated the high value of the U.S. dollar and sworn to uphold its status as the reserve currency of the world. And yet the converse of that situation is the undervaluing of all other currencies in the world, thus enabling a forever flood of cheap imports to the United States and the creation of trade deficits that simply never settle.
How do tariffs fit into this issue? Mira is not alone in seeing the use of tariffs as a tool in the revaluation of international currency exchange. He argues as follows:
“From a trade perspective, the dollar is persistently overvalued, in large part because dollar assets function as the world’s reserve currency. This overvaluation has weighed heavily on the American manufacturing sector while benefiting financialized sectors of the economy in manners that benefit wealthy Americans. And yet, President Trump has praised the reserve status of the dollar and threatened to punish countries that stop using the dollar for reserve purposes. I expect these tensions will be resolved by a suite of policies designed to increase burden sharing among trading and security partners: rather than attempting to end the use of the dollar as the global reserve currency, the Trump Administration can attempt to find ways to capture back some of the benefits other nations receive from our reserve provision. Reallocation of aggregate demand from other countries to America, an increase in revenue to the U.S. Treasury, or a combination thereof, can help America bear the increasing cost of providing reserve assets for a growing global economy. The Trump Administration is likely to increasingly intertwine trade policy with security policy, viewing the provision of reserve assets and a security umbrella as linked and approaching burden sharing for them together.”
In other words, the idea is to deploy tariffs as a kind of bandage to cover the problem that is actually rooted not in trade as such but mispriced currency. Will it work? I have strong doubts. In the end, tariffs work to tax U.S. consumers and producers. There can be no doubt about this.
It’s true that other nations can experience a diminution of trade flows to the United States but the U.S. has absolutely no means by which it can force any country to pay tariffs. Those are paid by importers, which is the same as U.S. businesses, and retaliations can and do seriously harm U.S. exporters.
In all this is a very dangerous game based on a highly speculative theory that tariffs can be used to revalue currency exchange relationships in a manner that will ultimately benefit U.S. manufacturing.
One way around all of this is for trade and production to take place exclusively within the United States, thus bypassing restrictions entirely. That could result in boosted manufacturing but this is a long-term effect. Meanwhile, as we’ve seen, the taxes called tariffs are paid immediately and can be severely harmful to U.S. output.
My apologies for marching through all these complications but I’ve found the debate to be frustrating. Neither side is dealing with the root of the problem, which traces to an unsound money regime. So far, the Trump administration has made no proposals to fix this problem at its root, and there is every reason to doubt that tariffs will accomplish the goal.
Trump celebrates the presidency of William McKinley and his tariff regime but there are two crucial differences between then and now. Back then, the United States was on a gold standard so international accounts settled according to the specie-flow mechanism. Another factor is that government was a mere 0.05 percent of the size of today’s and therefore labor and regulatory costs in the U.S. were also very low. The U.S. was a manufacturing paradise not because of tariffs but because of freedom.
The one clear path that the United States has right now to begin to repair its trade problems is simply to stop the debt creation and money printing. That path would deny other nations a trick they have had up their sleeves for many decades. It would not fix everything but it would at least start to plug the leakage. It offers more hope than tariffs alone. If such an approach were coupled with dramatic reductions in taxes on capital and income, the effect could be brilliant for U.S. producers.
All that said, I seriously doubt that Trump can be dissuaded from his firm commitment to using tariffs as a method of rebalancing world trade. It’s an untested experiment and, to my mind, the best hope we have here is that this approach results in as little damage as possible, while the deregulation and tax cuts can do magic otherwise. These structural changes cannot arrive soon enough in order to mitigation the deleterious effects of a trade war.
