The nominated CEA chair designate, Stephen Miran, has an exposition (h/t Politico)of how protectionism and a depreciating dollar can go together. As far as I can make out, it involves massive forex intervention, possibly sterilized, along with “user fees” on foreign held-UST’s…
Executive Summary
The desire to reform the global trading system and put American industry on fairer ground vis-à-vis the rest of the world has been a consistent theme for President Trump for decades. We may be on the cusp of generational change in the international trade and financial systems. 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. In this essay I attempt to catalogue some of the available tools for reshaping these systems, the tradeoffs that accompany the use of those tools, and policy options for minimizing side effects. This is not policy advocacy, but an attempt to understand the financial market consequences of potential significant changes in trade or financial policy. Tariffs provide revenue, and if offset by currency adjustments, present minimal inflationary or otherwise adverse side effects, consistent with the experience in 2018-2019. While currency offset can inhibit adjustments to trade flows, it suggests that tariffs are ultimately financed by the tariffed nation, whose real purchasing power and wealth decline, and that the revenue raised improves burden sharing for reserve asset provision. Tariffs will likely be implemented in a manner deeply intertwined with national security concerns, and I discuss a variety of possible implementation schemes. I also discuss optimal tariff rates in the context of the rest of the U.S. taxation system. Currency policy aimed at correcting the undervaluation of other nations’ currencies brings an entirely different set of tradeoffs and potential implications. Historically, the United States has pursued multilateral approaches to currency adjustments. While many analysts believe there are no tools available to unilaterally address currency misvaluation, that is not true. I describe some potential avenues for both multilateral and unilateral currency adjustment strategies, as well as means of mitigating unwanted side effects. Finally, I discuss a variety of financial market consequences of these policy tools, and possible sequencing.
Dr. Miran also mentions getting the Fed to “cap” interest rate increases. This is because of the recognition that interest rates are a key determinant of the dollar’s value, as I show in this post.
On restructuring the international financial system, count me dubious.
“Tariffs provide revenue, and if offset by currency adjustments, present minimal inflationary or otherwise adverse side effects…”
The currency adjustment necessary to prevent adverse inflationary effects (from tariffs) is dollar appreciation. The adjustment necessary to prevent the adverse effect on growth of supy-chain interruptions is depreciation. Miran, in the quote here, seems to have missed that fact. He needs to pick one.
But I’m getting ahead of myself. Back after I’ve read Miran’s masterpiece.
OK, first the elephant in the room, the room that is the global trading system; Miran’s modest title is: “A User’s Guide to Restructuring the Global Trading System” Isn’t China also working on restructuring the global trading system? And hasn’t China rounded up a number of other countries to support China’s version of restructuring? Isn’t China’s system likely to be inimical to U.S. interests?
If the U.S. rejiggers trade rules to Trump’s liking, at considerable cost to the rest ofthe world, is that likely to encourage support for Trump’s version of restructuring, or China’s? Isn’t the system Trump and Miran intend to tear down a system that we built? So we tell the world we want one thing and then, after they’ve rebuilt their economies to suit us, we change our minds. To suit Trump?
I think I may have to write this many times over the next four years: The easy stuff has all been done already. There is no easy way to balance the U.S. trade account or to balance the budget. If it were easy, somebody would have done it.
Trump’s pretended easy answer to narrow the U.S. trade gap. All we have to do is weaken the dollar, keep the Fed from responding by tightening monetary policy, prevent our trade partners from responding to protect their own economies, penalize overseas investors for funding the budget deficit, engage in some sort of underwear-gnome plan to prevent all of this from harming the real economy and avoid a giant financial shock.
Oh, I know. Tax cuts for the rich!
Off topic – the PBOC is reportedly discouraging investment funds from buying Chinese sovereign bonds:
https://www.reuters.com/markets/rates-bonds/china-cbank-calls-mutual-funds-flag-bond-investment-risks-sources-say-2025-01-03/
China’s 5-year is yielding 1 36%, down from 2.40% a year ago. The U.S. 5-year is at 4.42%; prior to the Covid era, Chinese yields had always been higher than U.S. yields:
https://en.macromicro.me/charts/18341/cn-10-year-yield-spread-between-cn-and-us–vs-cnh
The appetite for Chinese government debt is a symptom of the loss of value in housing, equities and commercial loans; it’s what happens in a balance-sheet recession. That part is easy to understand. The rush into government bonds is picking up now, perhaps because of Trump’s tariff threats, perhaps because the PBOC seems likely to increase liquidity provision:
https://www.bloomberg.com/news/articles/2025-01-04/china-s-pboc-vows-more-support-for-innovation-and-consumption
The PBOC’s effort to resist the drop in long-end yields is at odds with the its own easy-money policy. Bank officials are reportedly concerned that a bubble is forming. A bond bubble could set up yet another asset class for losses, further damaging balance sheets and confidence.
By the way, where is everybody?
I am also dubious https://stephenkirchner.substack.com/p/stephen-miran-on-restructuring-the
Pay-walled.
On topic – the U.S. vs the rest:
https://www.apricitas.io/p/americas-productivity-boom
I grabbed this post by Joseph Politano for the graphic showing the growth in U.S. labor productivity relative to other developed economies, but the text is at least as good as the graphic. The U.S. has increased labor productivity in the Covid era, while most other peer economies have not. Politano points out that this divergence is mostly because of productivity gains in services. He also notes, rightly, that recruiting the services sector to boost productivity is a really big deal, since the vast majority of U.S. workers are in the service sector.
Of course, U.S. gains in productivity depend to a very great extent on gains in output. The U.S. has enjoyed above-trend growth in jobs, which would normally mean slower productivity growth, but not this time. A tight labor market has been good for productivity growth especially in the service sector, where such gains are historically slow. That’s pretty remarkable.
When things work as described in Econ 101, productivity gains result in wage gains, and wage gains in the U.S. have been respectable lately, even adjusted for inflation.
I haven’t labeled this comment “off topic” and for good reason. Services are mostly “non-tradable”. Trump’s (and Miran’s) mistaken notions about tariffs and currencies are focused on the tradables sector. The U.S. is the wonder of the world in the Covid era mostly because of services. Trump’s “I have ideas” nonsense takes no account of the successes of the U.S. economy, in fact pretending that those successes are failure. That, alone, is a bad sign. Most of what U.S. residents consume is produced in the U.S., and ignoring that fact in service of a poorly-conceived trade agenda puts our prosperity at risk.
The U.S. outperformed the rest of the world in part because our government provided assistance on a massive scale. We are about to experience a factory production boom because our government subsidized reshoring of chip manufacture on a massive. We just fired the guy who did all of this. The guy we hired can’t admit the truth about the U.S. economy, because he got the job by lying about it.
This could be really bad, not because of Trump’s ideas, but because of his willful ignorance.
“The U.S. outperformed the rest of the world in part because our government provided assistance on a massive scale”. It is certainly true the U.S. has become more protectionist under both administrations JJust not sure that supports the view that protectionism is bad for economic welfare when comparable and far more open economies have faired worse.
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