Trump’s weak-dollar approach: Brace for exorbitant disruption

On the face of it, the chaotic action and frenetic pace of US President Donald Trump’s first 50 days in office lack cohesive thought and direction. Dig deeper and a picture emerges of a potential ‘framework’ or ‘grand design.’

Believers see two main reasons for a reset of the global trade order. The first is a deep-seated resentment that the United States has been subject to foreign subsidies, unfair trade practices and dumping of goods, and the second is a belief that the US has disproportionately shouldered the cost of the post-World War II security architecture for the rest of the world, particularly Europe and Japan. Consequently, the US has been running large trade deficits and its dollar has steadily strengthened in a trade-weighted sense for decades.

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One representation of the trade-weighted dollar (TWD) is an index put out by the St. Louis Fed that shows the Nominal Broad US dollar index rising 50% since its recent lows in 2008. The previous high for the TWD index was in 1985. That high point resulted in a major multilateral agreement to weaken the dollar called the Plaza Accord.

This Accord was an arrangement between the US and four other countries—Japan, UK, Germany and France—to take coordinated action to bring down the value of the dollar, which was estimated to be about 25% overvalued at that time. The accord worked well for the US, completely reversing the upswing of the dollar within two years.

Then, as now, supporters argued that it was necessary to intervene to reset the dollar, given its inexorable rise. The intellectual underpinnings of the recent thinking on this subject are laid out in a dense paper authored by Stephen Miran last year while he was at a hedge fund. Miran is President Trump’s chair of the Council of Economic Advisors, and the paper is unabashedly titled ‘A User’s Guide to Restructuring the Global Trading System’.

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Miran argues his case beginning with the following observation: “The root of the economic imbalances lies in persistent dollar overvaluation that prevents the balancing of international trade, and this overvaluation is driven by inelastic demand for reserve assets. As global GDP grows, it becomes increasingly burdensome for the United States to finance the provision of reserve assets and the defence umbrella, as the manufacturing and tradeable sectors bear the brunt of the costs.” He then goes on to catalogue some of the available tools for reshaping the trade system, the trade-offs that accompany the use of these tolls, and what he views as American policy options to minimize their side-effects.

Miran’s ambitious prescription for remaking the global trade order has been dubbed the ‘Mar-a-Lago Accord’ after Trump’s golf resort. Ironically, the setting for the Plaza Accord was the Plaza Hotel in New York, which was subsequently bought by Trump, who was a real-estate developer back then.

By his own admission, a policy map that includes sweeping tariffs and a shift away from a strong-dollar policy can have broad and deep ramifications. Miran believes that there is “narrow path” by which these policies can be implemented without causing material harm. This will require that tariffs be accompanied by a currency move.

Even then, economic and market volatility could be substantial. Miran concludes his argument thus: “Reallocation of aggregate demand from other countries to America, an increase in revenue to the US Treasury, or a combination thereof, can help America bear the increasing cost of providing reserve assets for a growing global economy. The Trump administration is likely to increasingly intertwine trade policy with security policy, viewing the provision of reserve assets and a security umbrella as linked and approaching burden sharing for them together.”

And so, that is the grand plan of the Mar-a-Lago Accord. Critics believe that it is deeply flawed because of its singular focus on traded goods (not services where the US enjoys a trade surplus) and the dollar, with the country’s trade balance as the main variable. Raghuram Rajan, professor of economics and a former central banker, argues that Miran has reversed economic relationships.

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The US budget deficit necessitates an insatiable appetite for Treasuries, and this is fulfilled by foreign countries via the balance of payments. He lays the blame squarely at the table of the US spending beyond its means, rather than blaming rapacious foreign countries for America’s debt burden. Rajan echoes the conventional view that the dollar’s position as a reserve currency confers on it what former French president Giscard d’Estaing called “privilège exorbitant.” Miran has tried to stand that proposition on its head and believes the reserve status to be an exorbitant burden that needs massive intervention to correct.

My sympathies lie with the conventional view. Trump’s mercantilism, cloaked in the academic garb of resetting the global trade order for America’s benefit, will turn out to be an ‘exorbitant disruption.’ If carried through fully, the inevitable consequences will be inflation and slow growth. US debt and its fiscal deficit will be in no better shape in four years from now. It will become self-evident then that the emperor has no clothes. One can only hope that too many American institutions are not irreparably damaged in the process.

P.S: “When downfall is imminent, one’s intellect tends to act against their own best interests.” From Chanakya Niti 16.5

The author is chairman, InKlude Labs. Read Narayan’s Mint columns at www.livemint.com/avisiblehand