Arguably, America’s apex was at the end of the second world war. The 'Make America Great Again' slogan that adorned posters and baseball caps during Donald Trump’s 2016 presidential election campaign was in no small part a reference to that time. Even before Germany and Japan surrendered, America had crystallised the post-war economic world order in the Bretton-Woods agreement of 1944. This was the first attempt to formalise a framework for international trade and currency exchange and the financial might of the foremost industrial superpower was at its heart. American power was to effectively underwrite the western economic system to avoid the closed markets and trade warfare that had plunged it into a downward spiral in the 1930s and led to the rise of dictatorships and militarism.
Fast forward to the present day and there is a palpable fear President Trump is recklessly abandoning the international order that has underpinned global trade and prosperity for over seven decades. Headlines spawned by much of the world’s press during the recent G7 summit of leading economic powers (the US, Canada, Japan, the UK, Germany, France and Italy) expressed horror at Mr Trump’s bellicose attitude towards America’s allies. This response is, however, somewhat simplistic and overlooks the fact that inter-relationships between countries in the post-war economic system have shifted in the past. True, Mr Trump’s style and bluster may not be to many people’s taste, but the substance of his demands is more a re-setting of America’s role as lynchpin after 1945, rather than withdrawal into the isolationism of pre-1942.
The headline figure in Mr Trump’s sights is America’s colossal trade deficit. From the EU, the US imports $150bn (£112bn) more in goods than it exports; the deficit with Japan is nearly $70bn and $18bn with Canada. Outside the G7, the US has a $71bn deficit with its other major North Atlantic Free Trade Agreement (Nafta) partner, Mexico. The Trump administration’s greatest ire, however, is reserved for China – the 2017 trade deficit was $337bn.
Trade deficits
Running deficits is nothing new for the US – America and the world has benefitted from the privileged status the country is afforded by being able to print the global reserve currency, the US dollar, and issue highly trusted government securities, US Treasury notes. In a recent letter to the Financial Times, Istvan Dobozi, former lead economist at the World Bank, argued that “as long as the US consumes more than it produces, or invests more than it saves, the trade deficit is a macroeconomic necessity”. The rest of the world has in turn relied on US demand for goods and services to boost their own economies.
In the past, America has seen bolstering trade partners as very much in its strategic interest. Maintaining the Bretton-Woods system until it was no longer tenable saw the US erode what was after the second world war the most dominant economic position any country had ever had. Encouraging prosperity abroad was, however, the cost of preventing the spread of communism and containing the Soviet Union.
Bretton-Woods had established the US dollar as the global reserve currency, but with fixed exchange rates and a pegging of the dollar to the price of gold, US policymakers were on the horns of a dilemma, which was described by Belgian economist Robert Triffin: to provide US dollar liquidity to make the system workable, America had to run down its capital reserves in a way that would undermine confidence in the currency.
The Nixon Shock
Ultimately, the system was unworkable and President Nixon unilaterally broke away from Bretton-Woods in 1971. In a surprise move known as the 'Nixon Shock', the US reneged on its commitment to peg the dollar to gold at $35 an oz. Bretton-Woods was formally ditched in the Jamaica accord of 1976, when the new system of floating exchange rates was recognised.
In a sense, history is repeating itself now. President Trump isn’t turning his back on globalism; he’s looking to adjust a system that is largely dependent on the US, as the world’s biggest net consumer, so that it works better for the country’s long-term interests. Whereas in the 1960s and early 1970s, the focus was on America’s capital account, now the current account (especially the trade deficit) is drawing attention. As many economists point out, the trade deficit isn’t a problem per se, but the size and rate of expansion has ramifications for America’s power and influence. Expending its economic power helped America win the Cold War, but the (not entirely unreasonable) fear is that China is the big geopolitical winner from the current global economic system.
America funds the deficit in its current account by running a surplus in its capital account. Matthew Rooney, a former senior official in the US Department of State, points out that dollars used to buy foreign goods often flow back into the country as foreign direct investment (FDI). This is a good thing, and a trade deficit with this type of dynamic is good for US jobs, productivity and growth. Partners like Japan, which invests heavily in the US, can feel hard done by some of the US's approach to tariffs, but there is a reason America needs to examine its trade relationships comprehensively to re-set the global balance.
As well as FDI, the capital account includes loans made to the US. Countries purchasing its government securities and its currency are enabling America to consume more than it produces. So long as the dollar retains its status as global reserve currency, America should be able to borrow in dollars and print money to repay its debts. The end of dollar hegemony is not in plain sight but, with the rise of cryptocurrency technology and China playing a long game in establishing the renminbi, constantly expanding debts is hardly a sound strategy ad infinitum. Consideration also needs to be given to expanding productivity, growth and competitiveness; so borrowing represents speculation to accumulate, not just shopping on credit.
Protecting strategic industries
America’s superpower status also requires strategic industries to be protected. The world’s foremost military power needs to have its own steel industry. The metal tariffs (25 per cent on steel and 10 per cent on aluminium) imposed on European and Canadian allies are partly aimed at preventing Chinese producers from circumventing restrictions on them. It is true, American businesses will suffer from having to pay more for steel, but this is ultimately an issue of national security. Placing all its trade relationships on the table hopefully gives America an opportunity to make wins that help its companies in other areas.
Much of America’s borrowing is to fund its structural government deficit and some economists blame Federal dissaving for reducing the amount of domestic money available for efficient capital investment. The Trump administration has granted enormous tax cuts to help industry and is also planning a massive programme of infrastructure spending. Expansive fiscal policy will increase the US national debt, so would seem at odds with the agenda of improving America’s strategic position, yet it is also a tool to help companies’ profits and boost productivity. Fiscal policy cannot be looked at in isolation, it is not surprising that trade is also a focus.
Mr Trump is playing for high stakes. It is possible that a trade war could hurt the value of the dollar and, coupled with fiscal expansion, have an inflationary impact (US inflation figures ticked above the Fed’s target rate of 2 per cent this week). If accompanied by a recession, a stagflation scenario reminiscent of the 1970s could be in the offing. There is, however, a considerable prize to be had if Mr Trump succeeds in winning trade reforms. The key consideration with US debt is not its overall size, but how it compares to GDP. Removal of discrepancies the US faces in overseas trade can only be good for growth. Inevitably, there will still be bilateral current account deficits but, by enforcing global action on some of the worst protectionist practices China is guilty of, it is likely that the most strategically dangerous will be narrowed.
The manner in which Mr Trump has gone about trying to push allies to consider his trade agenda has drawn sharp criticism and some commentators have even questioned his understanding of international trade. Nobel Laureate economist Paul Krugman told the Financial Times that Trump appeared to be mistaking VAT in EU countries for a tariff and that he “appeared to be making trade policy with zero understanding of the most basic facts and concepts”. Whether or not Mr Trump was making such an error, the observation that EU red tape and policy hurts business is not without foundation and the stuttering eurozone could arguably benefit from supply-side reforms, like tax cuts in member states, of its own.
In the past, America saw its best interests lay in carrying the world economy, but it is perhaps only fair to expect allies to pull more of the weight. The EU drags its feet on economic reform partly because it can rely on the US consumer, but 70 years after the Marshall Plan it is time for the EU and its member states to take more of a lead and do their bit for global growth. Mr Trump thinks constantly carrying the can, and boosting its main rival China, is a bad deal for America. He’s right.
Next week's economics
By the time Investors Chronicle hits newsstands, we’ll know whether Federal Reserve chairman Jerome Powell has taken rising inflation as a signal to raise interest rates. Philip Smeaton, chief investment officer at Sanlam UK, thinks that tariff discussions have helped stoke inflationary fires. He says: “While the US president’s negotiation style has often been more bluster than action, it looks as though some tariffs will go live, and he doesn’t seem too concerned about the short-term effects if it has a lasting impact in the longer term. However, [Jerome] Powell will be keeping a watchful eye on the ongoing discussions and any further effects these may have on growth and inflation.”
In Europe, the major decision to digest will be whether Mario Draghi, President of the European Central Bank, gives a timetable for the end of quantitative easing on Thursday. Bloomberg writes that inflation data is supportive of a hawkish stance but not growth.
