Opus Vol.1 : On Trade Wars and Currency


Tariffs are the tool de jour for the Trump Administration to fight back against what it has been calling unequal arrangements in commerce with foreign entities. With tariffs come a wide range of consequences, both positive and punitive. Sure, a level pricing field for US made steel and aluminum were the intended consequences, but what will the repercussions be? To start, the most American of brands have been accosted. Levi’s Denim, Harley Davidson Hogs and Bourbon Whiskey are now under consideration, by the EU, to be taxed in hopes of balancing out the American actions. This is a pointed warning.


Such a bold move must be backed by substance. So, where does the US bargaining power come from, anyways? We have been a nation marked by serial consumption, on a net basis. In short this means that we buy more stuff than we produce. How the heck can that be sustained for the long haul? Well, it probably can’t, but there is one thing that isn’t being factored in. We supply the world with a reserve currency: The US Dollar. In effect, the only reason the jig isn’t up is that we keep stimulating other economies to produce goods for us by exporting Dollars. Not so easy to digest.


Since The Bretton Woods agreement in 1944, the dollar became the currency in which all others were to be converted if they wished to buy gold. This lasted a bit over 25 years as in 1971, after mounting foreign pressure to exchange Dollars for the soft yellow metal, the US withdrew from the system. Unable to make the promised payments of gold, The US defaulted to the fiat currency system. From then on, faith was what funded the Greenback. With a seemingly unlimited upside to the amount of faith came a seemingly unlimited supply of Dollars.


Another plus for the viability of the US Dollar as a reserve system was its resilient and diversified economy. Augmented by a stout military presence and an ever-reaching political influence, the US seemed like the best candidate for the job. With this kind of privilege could come abuses and using twenty-twenty hindsight, they are easy to make out. Under the previous monetary regime, Central Banks were unable to “print” money as the flow of gold dictated interest rates. This caused rightfully earned booms and equally justifiable busts, yet in the fiat system there have been few consequences for this stimulative action.


This brings us to the bargaining chips the US possesses. As noted above, we buy goods and services abroad in excess of what we sell. This doesn’t seem like a pro if we were to list them out, but it does speak to the interconnectedness of financial and trading markets and the reliance other counries have for us as consumers. Without our consumption bias, China would likely not grow near the clip in which they currently do. This means more worldwide unemployment, and this goes for a swath of emerging nations. Ditto to the Eurozone, England and Japan. By shipping our Dollars abroad, in exchange for things, we keep the economy churning at the current rate. Without dollars, the system would halt. So, our great strength turns out to be the spoils of war. Had we not won the Second World War, this privilege would likely not exist.


Rounding out the reasoning we return to the original propositions: Does the US have a leg to stand on in issuing tariffs? Are we really getting the raw end of the trade deal, or has our monetary clout more than made up for it? Both questions are difficult to quantify and surely produce subjective answers. For example, soon before the departure of gold as a monetary unit, the French Minister of Finance called the Bretton Woods system “America’s exorbitant privilege”. One can only imagine his updated opinion when just a few years later the World would abandon gold convertibility altogether and further empower the Dollar.


Being the main reserve currency of the World, the US Dollar is held by central banks, usually in the form of Treasury securities. Accounting for over half of central bank reserves, our Dollars are overwhelmingly used for international trade as they are trusted to be sound. When the World is in crisis, US Dollars, in company with the Japanese Yen, are in demand because less profound means of exchange may be more volatile and untrustworthy. This inflated demand alone increases the price of Treasury securities which is a de facto mechanism for lower borrowing costs. To boot, because government interest rates are the heart of markets, lower interest rates mean more lofty risk-asset valuation. This means a larger wealth effect stateside. So, when looking at the bigger picture, which includes the ability to run a current account deficit until the cows come home, is America worse off for these trade policies? Could it be that other countries need these protections to level the overall playing field?


Where does the incentive lay for countries like China? Well, when they sell goods to us, we give then Dollars. From there they have a few choices, but there are two strong ones. Sell Dollars or invest them in riskless Treasuries. To sell Dollars means to buy Yuan, which would strengthen the home currency and make exports more expensive for your industries. This scenario seems less than desirable. Next up, to buy Treasuries; This is more likely. This gives us higher Treasury prices (lower yields) which effectively helps our government borrow at lower than natural rates of interest-another plus. As a nation, we are a subsidized borrower. We get a discounted rate of interest with which we spend how we choose. So far, this is a pretty good deal.


Doubling back, the justification for the steel and aluminum tariffs are based on National Security. It is safe to say this sounds like a slick way to validate a personal agenda. The truth is that without the Dollar demand from other countries, the US might not be so strong. Markets are interconnected to a large degree and our competitive advantage is our willingness to be the World’s largest provider of reserve currency. Perhaps we are barking up the wrong tree and focusing on creating the wrong jobs. As seems to be the case, these tariffs are aimed at the Luddites who fear capitalisms inevitable creative destruction.


More recently, with Gary Cohn’s departure as Chief Economic Advisor to the President, many argue that the all adults have left the White House. While this may be the case, others, equally as prominent, have argued that the new policies are advantageous if a trade war does not break out. With the President tweeting “…trade wars are good, and easy to win.” on March 2nd, one must wonder where he gets his data and if he will share. As a reminder, this comes from an administration that is unleashing fiscal stimulus on the last legs of the business cycle in vein hopes to reinforce its image of growth in any climate. None of this sounds like it comes from the mouths of market historians.


As a student of business and economics, you may have many questions. First, are trade wars good? Coming from the leader of the European Central Bank, Mario Draghi, is this line: “If you put tariffs against your allies, one wonders who the enemies are.” So far, so bad. Now to the theoretical prod. For a man whose policies are all about winning, should he be so afraid to let our country compete on a global scale? You can answer that yourself. Next, are trade wars easy to win? Simply put, is there truly a winner when goodwill between trading partners is eroded and one nation emerges as more powerful? Again, the floor is yours. Call it a globalist proposition if that is what soothes you, but the cheap labor from overseas has created a situation where our quality of life has improved drastically over the years, and all on the backs of other countries. We may not be villains though; our demand has, in turn, given emerging economies opportunity to work, albeit in less than desirable circumstances than ours. From this vantage point, our unearned birthright is nothing to complain or start trade wars about.


Beyond all of this seems to be a hubris and arrogance that is less than desirable in nature. Evidence comes from the Presidents recent comments regarding his interaction with Justin Trudeau. In the exchange, Trump stated firmly that The US has runs a trade deficit with Canada. When Trudeau attempted to correct him, he would not accept. In fact, his statement was not correct and his inability or unwillingness to change his mind when facts are presented is troubling to his stance of tariffs. From what has been gathered, it seems a trade war may not be easy to win, especially when unlimited brute force comes up against fact and tact. We will certainly find out.


Come what may.