Unlock the White House Watch newsletter for free
Your guide to what the 2024 US election means for Washington and the world
It’s only around 96 hours until Donald Trump’s inauguration day, and still the excitingly random tales about his prospective trade policy keep coming. This week’s was a Bloomberg story quoting his advisers contemplating a plan of gradually increasing import tariffs by between 2 and 5 per cent a month, presumably slowly turning the thumbscrew to extort concessions from trading partners.
It’s not the worst idea that’s been floated — using coercive tariffs to annex Greenland and the Panama Canal is comfortably ahead — but it’s still a bad one. It features a problem we’re likely to see recurring: trade policies that fail to account for the global macroeconomy and specifically the currency markets having lives of their own.
A standard side-effect of import taxes is to appreciate the exchange rate, thus undoing some or all of their effects. (To be fair, this is understood by some of Trump’s more economics-adjacent advisers, certainly by Scott Bessent, his nominee as Treasury secretary.) Thus, the tariff plans run directly counter to Trump’s intermittent desire to manage the dollar lower for competitive reasons and to close the trade deficit. Last week, the Chinese renminbi hit a 16-month low against the dollar, apparently reacting to tariff talk.
If anything, gradualism will worsen the tariff effect. Currency markets are forward-looking. It’s quite possible Trump will get the currency offset when his policy is announced but before the effect of the tariffs themselves.
In any case, the hope that the administration can sustainably manage the dollar lower is improbable. The standard reference is usually to the 1985 Plaza Accord, which sought to weaken the US currency. But not only does Plaza routinely get more credit than is due, the necessary macroeconomic adjustments will almost certainly be absent.
The mythology of Plaza — and the subsequent 1987 Louvre Accord to stabilise the dollar — often overstates its importance. As economics textbooks would predict, the dollar had rocketed higher in the early 1980s because of Ronald Reagan’s loose fiscal and the Fed’s tight monetary policy. But by 1985 it had clearly overshot and was already starting to fall. The Plaza announcement essentially gave it an extra push downwards.
Bessent contends that the 1980s and 1990s saw fiscal and monetary co-ordination to manage currencies. This is, shall we say, exceedingly hard to see in the data. The US promised to tighten fiscal policy at Plaza to help soften the dollar, but its tendency to run chronic deficits did not change.
The situation is in any case different now. President Joe Biden’s spending plus relatively high US interest rates have again led to appreciation, but the dollar is not hugely overvalued as it was in 1985. The IMF prudently gives a wide range to its estimates of fair value for exchange rates to avoid being dragged into currency disputes, but the midpoint of that spread has the dollar overvalued by 5.8 per cent relative to its estimated real equilibrium rate, not a dramatic misalignment.
Relative to 1985, the dollar has also been quite stable. Managing it would mean pushing from a standing start, not helping it on its way. The US bullying China into appreciating the renminbi might produce a one-off shift, but perhaps with dangerous consequences for financial stability. In recent years China has had to intervene in markets to strengthen as well as weaken its currency, last week being one example. It’s certainly not persistently holding it down for competitive reasons as in the 2000s.
Currencies are not trained spaniels which overcome their natural exuberance and obey ministers who shout “Down!” or “Stay!” They react to economic fundamentals much more than to official exhortations, or even official foreign exchange market intervention.
In this context, even without tariffs, Trump (with a Republican Congress) is highly unlikely to become the first fiscally conservative Republican president since Dwight Eisenhower and deliver a tighter-fiscal-looser-monetary policy mix. He wants to extend expiring tax cuts from his first administration and add more.
The non-partisan Tax Foundation research organisation says that, even factoring in tariff revenue from a massive 20 per cent tariff on all imports plus a hike of 50 per cent on those from China, these cuts will cost around $3tn over 10 years — that’s just over 10 per cent of one year’s GDP.
Supposedly offsetting or even outweighing those cuts is a streamlining programme by the Doge (Department of Government Efficiency) project co-run by Elon Musk. But if you expect feasible and sustainable spending control from a rabble of ignorant tech bros crashing round the federal bureaucracy, I’ve got a cryptocurrency-financed artificial intelligence-designed bridge from Mar-a-Lago to Greenland to sell you.
Musk’s men are less likely to engineer a smoothly purring Rolls-Royce of a federal government than build a rusty Cybertruck with a flat battery. Before Doge has even started, Musk has already cut its annual target savings in half, from a delusional $2tn to having a “good shot” at a merely quixotic $1tn.
Successfully steering a currency’s value through the maelstrom of the modern foreign exchange markets is fiendishly hard. Two of Trump’s signature policies — tariffs and tax cuts — are pushing in the opposite direction. If the currency slides under Trump it will more likely be reflecting weakening confidence in US institutions and growth prospects. That will not be a Plaza Accord for our times. It will be evidence of the wrong-headed trade and macroeconomic policy for which investors and governments around the world are bracing.
Source link
