Trump tariffs may do more harm than good

Currency misalignment is the single most important driver of growing US trade deficits

During the 2016 presidential campaign, Donald Trump cited my research prominently when making the case that unfair trade with China had grievously hurt workers in the US.

It wasn’t the first time my research had been referenced during a political campaign; Hillary Clinton cited it in a similar manner in 2007. But it was the first time my data informed a subsequent executive branch policy that I view with dismay: namely, the Trump administration’s heavyhanded approach to trade, which has involved imposing $250 billion worth of tariffs on Chinese goods.

The president’s tariff approach ignores a more significant problem — the currency misalignment of the dollar and the Chinese yuan — and so could end up doing more harm than good.

Trump’s presidential campaign sought to channel the anger of many Americans over unfair trade. But rhetoric doesn’t always equal insight, and the president’s approach ignores two key facts.

First, trade deals on their own don’t have much potential to help America’s workers. Contemporary trade agreements may be nominally concerned with rules and tariffs, but their primary outcome has been to tilt the playing field in favour of foreign investors, which merely continues a cycle of outsourced production.

Tinkering at the margins, as evidenced by recent rewrites of the US-South Korea Free Trade Agreement and the North American Free Trade Agreement, alters mostly just the optics of trade policy. But it’s unlikely to have a meaningful impact.

The second fact is that currency misalignment is the single most important driver of growing US trade deficits. From 1997 to 2014, China purchased $4 trillion in US Treasury bills and other assets to bid up the value of the dollar relative to the Chinese yuan. This has made China’s currency artificially cheap, creating what is effectively a huge subsidy for Chinese exports to the US. It also imposes a de facto tax on all US exports to China.

China is not the only country doing this. Between 2006 and 2013, central banks in roughly 20 nations including China financed virtually all of America’s trade deficit. Growing US trade deficits with these countries now account for most of the 5 million manufacturing jobs — and nearly 90,000 factories — lost in the US in the past two decades.

Trade with China alone has eliminated 3.4 million jobs in the US since 2001, affecting every state and congressional district. The hardest-hit industry was not toys or apparel, but computers and electronic parts — long thought to be a source of America’s competitive advantage. It lost 1.2 million jobs.

Growing trade with low-wage countries like China has decimated the earnings of 100 million non-college educated workers in the US — two-thirds of the workforce. And job losses have devastated entire regions of America’s industrial heartland, especially in the upper Midwest. Not surprisingly, this includes some of the once reliably Democratic states that President Trump carried in the last election.

Significantly overvalued

Although China is no longer officially manipulating the value of its currency, the dollar remains significantly overvalued — in part because China is sitting on more than $3 trillion in foreign assets. The dollar is now overvalued by at least 25-30 per cent against not just the Chinese yuan but also the Japanese yen and the euro.

Notably, the dollar has risen further since Trump was elected, which further encumbers domestic manufacturers.

Unfortunately, currency misalignment can’t be fixed by updating trade deals. It’s a global problem driven largely by continuing foreign demand for US securities and financial assets. Since 2014, private foreign investment in American financial assets has increased the dollar’s real, trade-weighted value by 20 per cent. The dollar must be realigned against not just the Chinese yuan but also against the currencies of countries that have been running chronic trade surpluses for many years.

What’s required is the political will to stand up to powerful actors like Walmart and Apple that benefit from continued currency misalignment.

The president should apply leverage on America’s trading partners — a fee on incoming foreign capital, tariff threats or coordinated currency intervention — to realign the dollar.

Congress could try to force the president’s hand, threatening to impose significant taxes on capital inflows to reduce demand for US financial assets. But the authority to negotiate on currency rests in the hands of the executive.

And until Trump grasps the severity of the dollar problem, making a “great deal” on trade agreements will matter little for US manufacturers.