Perhaps the answer to the panic now playing out on world markets, in corporate boardrooms, shipping firms, ports, trading desks, pension managers’ offices and for you and me, looking at our online share portfolios in horror, is a 41-page document titled “A User’s Guide to Restructuring the Global Trading System”.
Authored by economist Stephen Miran, chair of Trump’s council of economic advisers, it argues that the root of the world’s economic imbalances lies “in persistent dollar overvaluation that prevents the balancing of international trade”.
“This overvaluation,” he writes, “has weighed heavily on the American manufacturing sector while benefiting financialised sectors of the economy”.
As global GDP grows, he argues, “it becomes increasingly burdensome for the US to finance the provision of reserve assets and the defence umbrella, as the manufacturing and tradeable sectors bear the brunt of the costs”.
It’s a dense 41-page document that hinges on what economists call the Triffin dilemma. This, explains ETM Analytics CEO George Glynos “is that in order for you to enjoy the benefits of a reserve currency [like the US dollar], you have to export that currency to the world. In other words, you need to make it completely available for everyone to access, and the only way you’re going to do that is if you proliferate the globe with dollars, and the only way you’re going to do that is if you run a big trade deficit.”
Except if you’re running a big trade deficit, by which you’re importing more goods than you export, then by definition you’re consuming more than you’re producing. And if you’re consuming more than you’re producing, you can only finance the difference between the two through debt.
“So that’s the dilemma,” says Glynos. “If you want the benefits of a reserve currency you’ve got to accept that your debt levels within that country are going to rise – but because you have the reserve currency, your currency also tends to rise because it’s seen as a hedge against any difficulties whatsoever. Why? Because you can just print more of it. But it comes at a cost, and this administration has decided that the cost is too much to bear and so they are wanting to rework the global trade order.”
Okay. So, start a trade war by applying higher tariffs?
Perhaps.
“What they’re trying to do is get their cake and eat it because Trump doesn’t want to let go of the benefits of having a reserve currency, and for the most part he won’t because dollars still make up 80%-90% of global trade. But now he’s trying to force some rebalance,” says Glynos.
The $9.2-trillion question
While Miran’s document says that “sweeping tariffs and a shift away from strong dollar policy can have some of the broadest ramifications of any policies in decades”, he acknowledges that “potential for unwelcome economic and market volatility is substantial”.
He also says: “There is a path by which these policies can be implemented without material adverse consequences, but it is narrow and will require currency offset for tariffs and either gradualism or co-ordination with allies or the Federal Reserve on the dollar”. Neither of these has yet happened, given the shocking nature of last week’s announcements, not to mention the mathematics used to calculate “reciprocal” tariffs.
Already, world markets have lost trillions of dollars of value. On Monday, Hong Kong’s Hang Seng closed over 13% weaker, its worst one day fall this century, while the S&P 500’s 4% fall at the open pushed it into bear market status – though by the close it had rallied to end only 0.2% down.
“What Trump is doing is almost game theory: you smash these guys with tariffs, and they smash you back and eventually you adjust until you get to the right level,” says 36ONE Asset Management CEO Cy Jacobs.
What is the right level though? And is the end game not only a weaker dollar, but also a refinancing of America’s huge debt bill at a reduced cost?
This is what analysts are trying to wrap their heads around: whether, far from being inflationary, a global recession prompted by a trade war will be deflationary, and part of another grand plan to cut US borrowing costs.
As Jacobs says: “There’s $9.2-trillion of debt requiring refinance in the next 12 months, so if you’re refinancing that at 3% instead of 4.5% that makes an unbelievable difference. I’m not saying the US 10-year [bond] can get down to 3%, but it has so far reacted from about 4.75% to 3.91%. And if you take 0.8 percentage points off $9.2-trillion, it’s a number.”
But what about the collateral damage being wrought in the process?
“It’s massive,” says Jacobs, “but [Trump] is absolutely serious. If anything, what we’re going to create is a US recession and possibly a global recession – and that’s what the 10-year is telling you, and that’s going to lead to lower interest rates. So you’ll have higher tariffs but very low interest rates. In a global recession no-one is going to spend.”
So is that really what Trump’s administration wants? Maybe.
“The only real way to stop the train now (I think) is political pushback from large swings in the polls; the stock market reaction we all expected to be the guardrail was just wishful thinking,” says one fixed income strategist, who spoke to Currency on condition of anonymity.
But, she says, “I think their assumptions only work in a world where the US gets to bully everyone else into submission and there are no reactions to the US actions, which in my view makes the logic fail. Also, if the dollar weakens due to a lack of confidence in the dollar itself and a result of capital outflows, it starts to become very dangerous territory … and the US [starts] to look and act more like an emerging market than a developed one.”
Already, China has warned it will “fight to the end” should the US go ahead with its threat of a further 50% tariff hike.
Economies of scale
Glynos, who like everyone else is trying to figure how these myriad moving parts fit together in the end, says: “You could say it’s a noble idea to try and re-domesticate productivity – in other words get people to reinvest in America to produce – but it doesn’t happen that easily.”
The past two decades in particular have seen China build up “enormous” economies of scale in production. Take shipping, as one example. Trump wants to bring back shipbuilding in America; at the moment, China produces 50% of the world’s ships while the US manufactures about 0.5%.
Except, unfortunately, America’s shipping industry – among many others – has been “obliterated” over time. “Trying to kickstart a shipbuilding industry you need skills, you need capital, you need the resources, all of it. And that’s not to say that America, even with these tariffs and costs would be able to compete with China because China just has such economies of scale,” says Glynos.
And as many wags on various social media have already pointed out: millions of Americans are not eagerly lining up to work 18-hour days for $50 weekly wages to sew the nation’s jeans again, either.
In a recent interview, US commerce secretary Howard Lutnick, in extolling the virtues of bringing back manufacturing hubs, went on to say that robotics would do the work – which calls into question the number of jobs that will really be created from these tariffs.
Asked about this, Glynos says: “You haven’t brought the jobs back, but you’ve become less dependent on others, and I think that’s another part of what’s happening at the moment that bothers America.”
That notion makes more sense if you apply it to the production of CPUs – computer chips – where Taiwan is the undisputed master. “China wants to take (Taiwan) over and you begin to realise that America is feeling vulnerable relative to China,” he argues. “They’re wanting to become less dependent on other countries around the world so they don’t ever get held to ransom.”
Still, few countries will just hang around waiting for Trump’s next move.
Glynos points to China’s decision recently to launch a digital version of the renminbi. The trading partners that have access to it are all the economies of the Association of Southeast Asian Nations, as well as the Middle East. In other words, “they are now wanting to kickstart their own currency to go up against America. This is the sort of thing that America was trying to avoid, but by going down this route they’re encouraging China to do exactly that.”
In a nutshell, we are living through an extraordinary economic experiment. Put on your goggles and protective gear.
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