The week began with the meeting in Buenos Aires of the Central Bank Governors and Finance Ministers of the Group of Twenty (G20). This group includes the bulk of the world’s leading economies. The chair of the G20 rotates each year – this year it is Argentina. The areas of G20 focus are effectively determined by global events and by a troika of the previous, current and next chair. This year that includes Germany (chair in 2017), Argentina and Japan (chair next year).
While the state of the world economy, the digital economy and cryptocurrencies were high on the agenda for Buenos Aires, the bulk of attention was on trade. The G20 says it is committed to free trade but as far as the US is concerned it should be fairer.
It started with a tweet…
In recent weeks the Trump administration outlined plans to impose import tariffs of 10% on aluminium and 25% on steel from March 23rd. This has led to an increased focus on trade tensions with fears that this could trigger a trade war.
A recent tweet from President Trump stated, “Trade wars are good, and easy to win.” Having fought the election partly on a protectionist agenda, the President now plans to put this into effect via tariffs. This fits his mantra on keeping to his promises and alongside deregulation and tax cuts is portrayed by him as being positive for the US. In recent weeks, also, Trade Ambassador Robert Lighthizer has also outlined the President’s 33-page Trade Policy Agenda. Its main messages included reform of the global trading system, more efficient markets and ensuring a fair outcome for US firms. Indeed this latter point is key.
At the heart of the issue is the persistent US trade and current account deficit. Meanwhile, a number of countries run persistent current account surpluses. China is one, but this has been reduced significantly, reaching 1.4% of GDP last year according to IMF data. Germany’s surplus, in turn has risen, reaching 8.1% of GDP. This is huge. To put this in perspective, ahead of the global financial crisis a number of countries were singled out for running large surpluses: above 3% of GDP. This was seen then as the threshold for an unsustainable surplus. Often overlooked now, such macro imbalances were then seen as a trigger for the financial crisis.
Trade surpluses: issues beset by complexity
President Trump’s view on trade seems to accord closely with that of one of his advisers. The economist Peter Navarro heads up the White House Trade Council and has in recent years criticised Germany and China. In the Navarro view of the world – and Trump’s thinking seems to echo this – the reason is a mercantilist approach to trade. This approach can involve a surplus country protecting import-competing domestic industries and subsidising export ones. It also involves having a cheap or actively managed currency policy.
The issue of current account surpluses is a complex one. Take Germany, which ran a current account deficit in the 1990s and has seen its surplus soar since the introduction of the euro in 1999. In Germany’s defence of its surplus and the notion that it is not doing anything wrong are: German wage growth has been restrained, boosting competitiveness; it has a high domestic savings and investment rate, the latter allowing German goods to be of higher quality; and also emerging economies like China are at that stage of development where German exports are in demand.
Yet, against Germany is the belief that it has not boosted demand enough to import more, and also that were it not for the euro, and if the DM still existed, its currency would be considerably stronger. Indeed, when one looks at the euro area overall, it is running a large current account surplus in excess of 2.6% of GDP. There are many possible solutions, including boosting demand to import more and allowing one’s currency to appreciate. The latter is not a policy aim, as the European Central Bank seeks to boost inflation from its present 1.2% and towards its close to 2% target.
A weak currency has also been seen as an argument against China. China’s current account surplus has decelerated significantly over the last decade. That, however, appears not to have changed thinking at the top of the US administration.
Strong dollar policy has weak traction
This approach also helps explain Trump and his Treasury Secretary’s Mnuchin’s approach to make the dollar competitive. Unlike previous administrations they do not favour a strong dollar policy. I think they are right – and certainly if one looks at the UK, which like the US has a large trade deficit, I would side with two economists who have recently written on this subject: John Mills and Roger Bootle, who state that the pound needs to be more competitive. A competitive currency is a necessary, but not sufficient, condition to help rebalance an economy towards exports.
Of course, there is a quality component, too, that should not be overlooked. Switzerland, for instance, enjoys a large current account surplus, despite a strong currency. And part of Germany’s and China’s export success will owe to their high rates of investment. The UK and the US, meanwhile, have low rates of investment although when it comes to innovation they do well.
So it is a complex area, but the thinking at the White House suggests the trade angle will be exploited via tariffs. What happens next? Countries that are threatened seem likely to exploit two options: a multilateral approach via the WTO to get the US to back down; or sorting out a deal with the US.
Thus, the immediate, or first round effects, of such a trade approach are likely to be low. It is the second round, or subsequent effects – which depend upon the follow-up policies – that worry the markets. For instance, the US could even escalate the issue, imposing further tariffs. Or, the US could make demands that were seen in a more positive light. One might be that the euro area spend more on its own defence spending. Another that the euro area boost demand through a more relaxed fiscal policy, as it has long been a valid criticism from the US that the euro area’s fiscal policy has been too tight.
A positive impact for the dealmaker in chief?
For their policy to be a success, Navarro and Trump would like countries to do deals with the US that open up their markets to US exports – and also to see domestic US steel and aluminium producers substitute for the now more expensive imports. But this positive “substitution” effect for the US would likely be dwarfed by a negative “income” effect and is the reason why most economists would be wary that this trade policy would work.
As tariffs are a tax on imports, this will hurt US consumers as the tax is passed on into higher prices, and also as it penalises US industries that import aluminium and steel. Basically, the net effect would be deflationary and not help growth. Also, if countries were to retaliate through a tit-for-tat policy, imposing their own tariffs on US goods, then this second round effect would dampen global trade and exacerbate the impact on growth globally and thus likely worry equity markets.
For the moment, markets seem to think that this issue will be resolved. If it is not then it will be export-oriented economies, and specific, vulnerable sectors that are most at risk initially followed by a more general negative impact on markets. Of course, if this trade issue is resolved by the US backing down and in turn other countries seeking to allay the fears of the US, then the impact could prove positive for markets. Global economic imbalances are best addressed by policy measures to boost demand and by currency appreciation in the surplus countries, and by competitive exchange rates in the deficit ones. Trade wars are not the answer.