One of Donald Trump’s most important trade advisors, Peter Navarro, defended the American president’s trade policies some time ago in an article in the Financial Times, making at least one very strong point that went unnoticed in continental Europe.
Navarro writes:
“At the heart of this crisis is a trade deficit in goods that has ballooned to more than $1 trillion annually. The economic models of free trade that predict chronic trade imbalances will always be eliminated through price adjustments via exchange rates are dead wrong.”
The fact that he refers only to goods markets and only to the trade deficit is misleading, because services are also valuable commodities in this world. However, this is a minor sin; he should have referred to the current account deficit, which also amounted to more than a trillion dollars last year for the United States and includes the services balance. However, he is absolutely right about economic models and the role of financial markets.
The monetary system is crucial
Since the beginnings of free trade theory more than 200 years ago, statements about the benefits of international trade have always been subject to the proviso that the international monetary system ensures that no country has permanently high surpluses or deficits. Without this proviso, all statements about the advantages of free trade for all parties involved are utter nonsense. Consequently, almost everything that has been said in Germany over the past twenty years about free trade and the rules-based trading system is also utter nonsense. This applies to roughly 99 per cent of all German economists, led by institutions such as the Council of Economic Experts and economic research institutes. The renowned Kiel Institute for the World Economy has been particularly prominent in this regard.
Navarro is also absolutely right in his assertion that there have been no exchange rate adjustments that could have prevented persistent imbalances. But why is that? It really has nothing to do with the theory or models of economists. He should take a seat on the Amtrak train with his president and travel from Washington to New York (where he could also experience American high technology from the 19th century). From Penn Station, you then have to go to the southern tip of Manhattan, where you will find the solution. There is a famous street called Wall Street, and in what feels like every office on that street, he would meet the guys (and girls) who are responsible for the fact that for 55 years there has been no rule in this world to ensure that trade is not only free but also fair.
Truly intelligent economists knew immediately after the Second World War that the financial markets should never be allowed to determine currency exchange rates. The guys and girls there have zero understanding of economic interrelationships and speculate until they achieve a result that has nothing to do with balancing current accounts (as demonstrated here and in my recent book).
But because trading currencies to balance trade positions is so profitable, Wall Street has blocked every attempt by the American or any other administration to do anything about currency speculation. There was even a German government that was smart enough to want to talk about it in international negotiations. Most recently, Nicolas Sarkozy tried to put the monetary order on the G20 agenda, also in vain, because the greatest American presidents always quickly became very small when such talks even mentioned that Wall Street profits might be at stake. That is why, dear Mr Navarro, the financial markets have a life of their own and even strike fear into the heart of the greatest of all presidents when they become just a little nervous.
Devaluation is better than a tariff frenzy
Peter Navarro should also explain to the president at some point that there is no need to be disappointed by the markets when presidential policies are inconsistent. Anyone who wants to get rid of their current account deficit should, as James Baker did in the 1980s with the Plaza Accord, bet on a devaluation of the US dollar, because that kills two birds with one stone and no one can complain that they are being treated unfairly. This would eliminate the need for tinkering with bilateral trade balances, which are meaningless anyway, and bilateral sanctions.
However, if the president emphasises at every opportunity that he wants a strong dollar and at the same time wants to devalue it, he will remain incomprehensible. When they take effect, tariff increases are nothing more than a real devaluation. American consumers will have to pay more if they continue to buy foreign goods. That is the loss of purchasing power that is to be achieved vis-à-vis foreign goods. Export subsidies for American exporters could also be introduced, which would make the analogy almost perfect. The tariff frenzy combined with the attempt to maintain a strong dollar is certainly more than confusing.
Devaluing the US dollar is no problem at all. The president can talk down the dollar once he admits that real devaluation is needed, or he can instruct the central bank to weaken the dollar by buying foreign currency. The markets will then expect a devaluation, and it will happen because all speculators will reduce their dollar holdings. The US can do this in agreement with its partners but also on its own by buying foreign currencies with its own currency (of which it has unlimited quantities). This is perfectly legitimate; the Swiss central bank did this for decades to counter an unjustified appreciation of the franc.
The other financial markets are also not a problem
If Trump were to consistently pursue devaluation, he would not have to worry about the other capital markets. Stock markets love devaluation because it benefits their own companies. And the markets for government bonds would have no reason to go crazy. A devaluation aimed at reducing the current account deficit promises lower government deficits in the future. Why should the ‘markets’ get upset about that? But even if there is a bit of turbulence, as there was last week, that is not a problem. Where are investors who do not trust Trump supposed to go? There is simply no alternative. The American state is and remains the only debtor that offers sufficient investment opportunities for the masses of savers. If in doubt, the Fed can always step in and smooth out any excessive fluctuations.
Even if the Chinese government decided to significantly reduce its huge holdings of American government bonds, this would play right into Trump’s hands. China would then have to allow an even stronger appreciation of its own currency, which it certainly does not want. China has American bonds in its portfolio because it weakened its own currency in the past, so it bought dollars.
Overall, it’s simple: Trump has a good point about the American current account deficit, but he and his advisers are getting carried away with bilateral measures that are not effective. A deficit with the rest of the world should be addressed globally. However, the rest of the world, especially the Germans with their huge current account surplus, have either failed to understand international trade or do not want to understand it. In this situation, the appropriate means of eliminating the US deficit is to actively go for a devaluation of the US dollar. If the dollar depreciates by 20 to 30 per cent, the American overvaluation will be eliminated, and all market participants will have a clear picture of what will happen. If there is still some minor turbulence on the stock and government bond markets, this will not be a problem and can be smoothed by the central banks at any time.