London — The White House is becoming increasingly volatile and erratic in its pronouncements about the economy and trade as the internal contradictions between its policies become obvious.
President Donald Trump and his advisers have blamed the Federal Reserve and a range of foreign governments including China and Germany for the evident slowdown in the economy, especially manufacturing, saying that:
U.S. interest rates are too high.
The U.S. dollar is too strong.
Foreign governments are manipulating their currencies to obtain an unfair competitive advantage.
Past trade deals were one-sided.
In all, China, Germany, Japan, South Korea and a host of other countries have been blamed for trade and financial policies that harm the United States, according to the administration.
But more than two years into a bold effort to remake U.S. international policy by using tariffs to increase leverage in trade negotiations, the trade deficit is still growing at an annual rate of 15%.
There is no evidence the U.S. currency is significantly overvalued or that currency misalignment is contributing to the deficit.
The U.S. dollar exchange rate against a trade-weighted basket of other currencies is close to its long-run average, once adjusted for differential inflation rates.
Instead, the deficit stems from the fact that the United States spends more on investment in new buildings, equipment and software than it saves out of national income, borrowing the difference from foreigners.
The deficit is increasing rapidly because the U.S. economy is growing faster than the economies of its major trading partners.
As a result of differential growth rates, domestic demand for imports is growing more quickly than demand for U.S. exports in overseas markets.
The administration’s tariff and sanctions policies have made the deficit worse by contributing to a sharp slowdown in growth in China and the rest of Asia and Europe, which is slowing demand for U.S. exports.
U.S. exports of goods and services fell 1.5% in the three months between April and June compared with the same period a year earlier, the fastest decline for almost three years.
The last time U.S. exports declined was during the mid-cycle slowdown of 2015/16 and before that the recession of 2008/09.
TRADE WAR OF ATTRITION
The export slowdown is rebounding on the United States, contributing to a slowdown in the domestic economy, especially the more trade-exposed manufacturing sector, and in turn curbing import growth.
The continent-sized U.S. economy is much less open to international trade than most other major economies in terms of the share of imports and exports in gross domestic product.
But the influence of trade on domestic growth is evident in the nearly synchronised acceleration and deceleration of exports and imports in the past 25 years.
The Trump administration is waging a war of attrition against China and other trading partners, and one of the consequences has been to hit domestic growth.
By turning the entire U.S. economy into a weapon to achieve trade, diplomatic and security objectives, the administration has ensured domestic firms would be hit in the resulting conflict.
Experience over the last quarter century suggests the only reliable way to narrow the trade deficit is to push the U.S. economy into a recession, so the administration should be careful what it wishes for.
BLAMING THE FED
The White House has blamed the Federal Reserve for raising interest rates too aggressively and causing the economy to slow and is exerting maximum political pressure for significant interest rate reductions.
But it is not obvious the Fed has contributed much to the slowdown or that it can do much to reverse the deceleration if the administration keeps escalating the trade wars.
The economy’s deceleration has been contemporaneous with the imposition of successive rounds of tariffs rather than changes in interest rates.
Bond and equity prices, too, have reacted more to the steady ratcheting up of the trade war rather than interest rate policy.
The Fed cannot narrow the trade deficit, even if it cut interest rates aggressively, since the deficit is rooted in the savings-investment gap and differential growth rates between the United States and the rest of the world.
If the Fed cut rates, the principal monetary transmission channel would be through stimulating interest-sensitive business and housing investment, which would worsen the deficit.
In theory, the Fed could cut interest rates and resume its bond buying programme, with the aim, directly or indirectly, of weakening the exchange rate and boosting exports and well as helping import-competing firms.
But the exchange rate would only weaken if other central banks did not match the Fed’s interest rate reductions and bond buying, which is unlikely.
Given most major U.S. trading partners are experiencing an even more severe slowdown, it is improbable they would refrain from cutting interest rates or willingly let their own currencies appreciate and lose competitiveness.
If the other major central banks all cut interest rates and resumed bond buying, the U.S. currency would most likely appreciate rather depreciate.
The U.S. economy tends to be more responsive to monetary stimulus than the euro zone, Japan, China and other major trading partners.
So if U.S. interest rates were cut, and it had the intended effect of boosting equity valuations and stimulating domestic investment, the most likely outcome would be to strengthen the dollar and widen the trade gap.
The bottom line is that the White House’s economic policies are inconsistent. The administration cannot have strong growth, a rising equity market and a narrowing trade deficit while waging a trade war of attrition.
- John Kemp, Reuters