30 September 2024

In an earlier article “Election 2024: What They’re Not Telling Us #1”, I suggested the two Presidential candidates were engaged in a “conspiracy of silence” regarding key policy issues. Last time, I indicated American fiscal policy is on an unsustainable course, but both party leaders have evaded the topic, let alone suggested a remedy.

Now, I turn attention to international trade policy. In his first term, former President Trump imposed wide-ranging tariffs on numerous countries and products, and threatened similar actions against countries with whom America had large trade deficits. In addition, his administration renegotiated long-standing bilateral trade deals, e.g. replacing NAFTA with the USMCA (a new trading arrangement between the USA, Mexico, and Canada). Likewise, the USA withdrew from the multi-lateral Transpacific Partnership (TPP), which seeks to expand trade with Asian partners. China became the key target to Trump’s more aggressive approach.

These measures represented a sharp break with the norms of the post-WWII international regime. Through its previous adherence to the WTO’s multilateral trading values of nondiscrimination and reciprocity and reducing barriers to world trade, the USA succeeded in boosting growth, jobs, and prosperity, while helping to massively reduce global poverty.

If elected, Mr. Trump has proposed even more aggressive action, including a 20% tariff on virtually all imported goods. At one point, the idea was floated to replace the Federal government’s individual income tax revenues with customs levies, which would require tariffs of up to 40%. The stated aim of these policies is to protect/expand manufacturing jobs lost to foreign competition. These proposals could add 4-8% to US inflation.

On the other hand, VP Harris has not provided many details of her trade strategy (true of many topics). However, while President Biden has trumpeted American’s recommitment to multilateral trade norms, he has maintained the Trump-era tariffs on China and did not rejoin the TPP.

The Biden administration’s “managed trade” approach aims to remain assertive with countries imposing barriers restricting US exports, along with nations with whom America has strategic disputes, e.g. China and Russia. On the other hand, the Biden Administration’s CHIPs Act indicates a willingness to protect and promote key strategic sectors, e.g. semi-conductors. Similar restrictions on subsidised Chinese electric vehicles aims to protect US manufacturers in a sector vital to American’s climate commitments. I anticipate Ms. Harris would follow a similar policy agenda.

Which approach is more likely to boost jobs and economic propsperity and control inflation? What will be the impact on America’s large world-wide trade deficit, bilateral imbalances with individual countries, and expanding US international indebtedness? What are the implication for the US dollar, and it’s role in the global economy? All are unaddressed questions during this bruising campaign.

Tariffs: Rearranging the Deck Chairs

Despite the imposition of tariffs on American imports since 2017, the US trade deficit has actually widened from $735 billion in 2016 to over $1 trillion annually during each of the past 4 years. To be blunt, tariffs will never reduce America’s overall trade gap. The shortfall illustrates the inability of US productive capacity to meet America’s seemingly insatiable spending habits. In other words, Americans save too little, spend too much, and produce too little. The main culprit is the ballooning US government budget deficit. Only macro-policies aimed at tightening fiscal policy, boosting household savings, and supply-side reforms boosting investment and domestic productive capacity will bring the external sector into balance. I don’t hear either candidate talking about any of this.

What tariffs can accomplish is to rearrange the deck chairs, e.g. shift trade patterns with individual countries. To be sure, the imposition of levies on Chinese goods has reduced the bilateral shortfall (Chart above). However, American’s did not stop purchasing foreign products. They simply bought more products from Mexico, Vietnam, Canada, Korea, Taiwan, etc. (Chart below). Indeed, there is evidence Chinese products may simply have been re-exported to the USA via these third parties.

Foreign Debt and US Dollar Credibility

Just as the US budget deficit has resulted in a surge in government debt, America’s persistent external current account gap has resulted in a significant buildup of international indebtedness since 2017 (Chart above). The following Chart illustrates America’s unenviable position compared to international partners.

The US net international investment position (NIIP) stands in deficit of 80% of GDP, having doubled since 2015. By comparison, often fragile countries/currencies like Brazil, Hungary, Spain, Portugal, and Mexico have negative NIIPs of 50% of GDP. With the exception of the United Kingdom, other G7 countries enjoy positive external investment positions (assets exceed liabilities).

So far, the US dollar has remained immune to America’s bulging foreign debt build-up. However, international concern about recent US trade policies and America’s unattended twin deficits are likely to have contributed to the decline in the US dollar’s share of global central banks’ international reserves (Chart above), as well as greater gold holdings by monetary authourities (next Chart).

US Dollar: Still Attractive?

Why has the US dollar remained so resilent, despite America’s twin deficits and rising foreign debt? While the US current account deficit has remained persistently near 3% of GDP per year, America has been able to attract foreign capital inflows to finance the external shortfall. The Chart below indicates the huge appetite foreign portfolio investors have had for US portfolio assets (bonds and equities) recently.

The inflows reflect America’s stronger post-Covid economic recovery, along with relatively attractive US bond yields, as the Federal Reserve raised interest rates more than other central banks. The US dollar, however, may become more vulnerable if these factors change, especially as the Presidential candidates do not appear likely to address the twin deficits in the near term. With the Fed’s attention shifting from inflation to supporting slower economic growth, US interest rates are likely to decline more quickly than elsewhere. Moreover, the next President is likely to prefer a weaker currency to help boost jobs and GDP. Therefore, the US dollar, which is significantly overvalued, may depreciate meaningfully in the next 12-36 months (next Chart).

Saving Globalisation: What’s Not Being Discussed

Despite the current furor about tariffs and protectionism, most Americans (especially mainstream, Republican-leaning voters) would acknowledge the nation has benefited from increased foreign trade. However, regaining support for globalisation requires recognition of its shortcomings, and implementation of policies aimed at addressing its failures. Everyone has benefited from the low prices and variety of imported goods. But, the benefits of globalisation have not been sufficiently widespread, which has contributed to a rise in income and wealth inequality (Chart above).

To be sure, foreign competition has led to hardship for certain sectors and American communities in the US rust belt; magnifying the political importance of states such as Pennsylvania, Michigan, Wisconsin, etc. Indeed, 6 million manufacturing jobs have been lost during the past 50 years.

However, it’s wrong to suggest foreign competition is the primary culprit. Indeed, manufacturing jobs have declined in all advanced economies in recent decades (Chart above). However, service sector employment has surged: nearly 100 million jobs have been added in this sector since the 1970’s. This is a desirable transition, as the USA (and other developed economies) expand in areas in which they have a competitive advantage. Indeed, the US unemployment rate has decline from 6% to 4% in recent decades. By the way, a similarly successful transition occurred — from agriculture to industry — in the 19th century.

Protectionism impedes this inevitable (and desirable) transition. A better policy approach must involve three features. First of all, reduce foreign barriers limiting highly-competitive US service sector exports — such impediments are far greater than on manufactured goods. Secondly, in order to remedy the adverse impact on US industries and communites exposed to competition, America must invest in education and life-long training to prepare workers for the jobs of the future. Along with services, manufacturing jobs in high valued-added sectors, e.g. technology, pharma, health care, and climate/alternative energy, will be an important part of the future US job mix. Third, adverse distributional impacts of international competition is better addressed through a progressive tax system (perhaps including wealth taxation), rather than through trade protectionism.

Unfortunately, I hear little discussion of these issues at present. On balance, however, Donald Trump’s remedy is likely to have more adverse growth and inflationary consequences than a continuation of the Biden/Harris “managed trade” approach.