The US continues to withdraw from the rules-based system of global trade that it helped build over the last several decades. The imposition of tariffs on aluminium and steel imports on national security grounds reflects an increasingly unilateral US approach to trade policy.
The direct effect of these tariffs is unlikely to be significant. But conduct like this weakens the foundations of the international trading system. If other countries respond with legal actions in World Trade Organisation tribunals, and judgments are made against the US, the risk of an existential crisis for the WTO rises.
President Donald Trump seems to be reverting to his long-standing instincts on trade. Consistent with his 1987 full-page ad in The New York Times blaming Japan (and US fecklessness) for the trade deficit, Trump tweeted in March that ‘trade wars are good and easy to win’ and that the European Union treats the US ‘very badly on trade’, although the weighted average tariff into the US is almost exactly the same as the EU.
The probable flashpoint is the imposition of deeper trade and economic sanctions on China for intellectual property theft and a lack of reciprocity in its domestic markets. There are legitimate issues to be addressed, and recent developments in China suggest that these problems are becoming more acute. In response, the EU, Australia and others, in addition to the US, are being tougher on Chinese trade and investment.
The US has anchored the global economic system over the last several decades by acting as the reserve currency issuer. Demand for the dollar means the US benefits from lower interest rates and seigniorage revenue, as well as reduced market discipline on its policies. However, it faces a higher exchange rate than otherwise, which constrains its export growth. Indeed, running a trade deficit is something required of reserve currency issuers.
But there is a risk that the unilateralist US approach to trade will be reflected in a reduced willingness to support the reserve currency system where it conflicts with domestic goals. There is precedent; the US unilaterally ended the convertibility of the dollar into gold in 1971. As John Connally, then US Treasury secretary, said, ‘The dollar is our currency, but it’s your problem.’ Steven Mnuchin, Trump’s Treasury secretary, may not be as blunt but made ambivalent comments in January on the strength of the dollar. And while Larry Kudlow, the head of the president’s National Economic Council, argued for a strong dollar, it is not clear that Trump agrees, particularly as Washington’s fiscal stimulus plans collide with his demand for a lower trade deficit.
If the US is less committed to playing this role, the dollar becomes less attractive to hold – and is less compelling as a haven. Barry Eichengreen, the economic historian, notes that reserve currency status partly reflects geopolitical realities. It is possible that the ‘America first’ agenda on trade and other global issues is one source of current dollar weakness. Although the dollar’s share in global central bank reserves has been relatively stable, and while it dominates the settlement of international transactions, concerns about the commitment to a strong dollar could accelerate the transition to a multi-reserve currency system. This would be a tumultuous process.
An increasingly ‘Trumpian’ administration raises other institutional risks, such as pressure on the independence of the Federal Reserve as interest rates gradually rise. It is not difficult to imagine Trump directly challenging Fed norms. Markets cannot rule out a weakening of Fed independence, with lower interest rates and higher rates of inflation than otherwise.
David Skilling is Director of the Landfall Strategy Group, a Singapore-based economic advisory firm.