A Trade Strategy for the 21st Century

The Washington Post recently asked a very good question: “If Not the Trans-Pacific Partnership, Then What?”   Since the problematic TPP is clearly not a gold standard that can define trade policies for the 21st century, what principles should?

Forty years of trade deficits, lost jobs, and closed factories make it clear that America’s current trade policies do not work in a world where exchange rates, driven by capital flows rather than trade in real goods and services, are rarely the rates required to balance trade. This note provides an outline for a new U.S. approach to foreign trade policy, anchored to balanced trade, that is suitable for the realities of today’s globalized, financialized world.

1. Balanced Trade: 

America’s nearly unbroken string of trade deficits since the 1970s has been driven by two major factors: the failure of international markets to maintain the dollar at a trade balancing equilibrium exchange rate, and foreign country currency manipulation. America’s foreign trade policy for the 21st century should start by restoring balanced trade with the following currency-related actions:

• Implement a Market Access Charge (MAC)  that would bring the dollar back to its trade-balancing equilibrium exchange rate and keep it there – regardless of what other countries may do. 

• Implement a Countervailing Currency Interventions (CCI)  policy to discourage and counteract any resurgence of currency manipulation by trading partners. 

• Establish quantifiable triggers for all currency-related actions so that they come into effect automatically. 

2. Fair Trade: 

Other countries hurt American exports, domestic production, corporate profitability and family incomes with their unfair trade practices. America needs to restore fair trade with the following actions:

• Fully enforce adherence to obligations in existing trade agreements. 

• Implement policies such as those in the Trade Facilitation and Trade Enforcement Act of 2015 that enforce payment of penalties levied in accordance with America’s countervailing, antidumping, and other trade remedy laws.

• Revise existing rules, preferably in collaboration with other countries, where current rules fail to prevent unfair trade. 

3. Growing Trade: 

Once America has assured that its international trade is and will remain balanced, expand trade through multilateral and bilateral agreements such as a revised TPP. Such agreements should:

• Have benefits that clearly exceed their costs -- including the costs borne by adversely affected workers and industries.

• Assure that the benefits of expanded trade are distributed in an equitable manner, taking into account costs to groups hurt by expanded international competition. 

• Provide an enforceable framework of rules consistent with contemporary realities to assure that trade under such agreements is fair and balanced. 

4. Strategic Trade and Domestic Development:

Along with these actions on the international front, America should implement domestic policies that will help all Americans gain the greatest possible benefits from the opportunities provided by trade that is balanced, fair and growing.  Such policies should accomplish the following:

• Develop America’s manufacturing capacity in strategically important areas through industrial policies that build up the R&D capacity and diffusion mechanisms needed to assure that U.S. manufacturing can develop internationally-competitive capacity in high value added and advanced manufactured goods. 

• Develop America’s “industrial commons.” Grow the network of researchers, suppliers, producers, investors, workers, and markets throughout America who provide the essential basis for America’s international competitiveness. 

• Restore and Expand America’s Infrastructure. Today’s crumbling, inadequate infrastructure, especially in transportation, but also in areas such as utilities ranging from safe drinking water to high-speed internet, take a daily toll on America. 

• Improve the American systems of education and health to assure that all Americans have an opportunity to realize their full potential, both for personal development, and to assure that America has a healthy, well-trained workforce that is second to none. 

• Improve America’s social safety net. Special attention should be given to assisting workers most adversely affected by increased competition from abroad to prepare for, find and take new jobs that are well paying. 

• Preserve America’s right to maintain its rule of law for the well-being of all American people. Protect them from decisions of private international tribunals that could over-rule our nation’s laws, thereby creating possible environmental damage, health hazards, monopolistic competition, and national security weakness. 

• Preserve America’s right to retain natural and man-made resources for the future of America – including, for example, production technology and other forms of intellectual property developed in America.

Conclusion

Trade that is balanced, fair, and growing on the basis of rules that are suitable to the realities of the 21st century should form the core of America’s international trade policy for the future. Externally-focused measures to accomplish this should be supported by domestic policies focused on preparing America to compete successfully in global trade and improve the quality of life for all Americans.

Rev. 9/19/2016

Trade Barriers Do Not Cause Trade Deficits -- Except When Currency Markets Fail

The tariff and non-tariff barriers imposed by China, Japan, and many other countries have been blamed repeatedly by many Americans for causing America’s trade deficits, lost jobs, and closed factories.  Their argument holds that, were it not for such trade barriers, America could export more of its goods and services to these countries, thereby helping balance its external trade.

However, trade barriers such as import duties, lengthy inspections, idiosyncratic technical requirements, licensing restrictions, and even bans do not actually cause trade deficits – unless currency markets fail.

In line with the classical trade theories of economists such as Ricardo and Hume, exchange rate markets will automatically assure that trade remains balanced, regardless of changes in factors such as inflation, productivity, and, yes, trade barriers.  However, forty years of trade deficits provide clear evidence that classical trade theory no longer works to balance U.S. trade.

The reason is straightforward: Today’s global currency markets fail to determine exchange rates that will balance U.S. trade because exchange rates are now determined by international trade in capital, not by trade in goods and services.

In the 18th and 19th centuries, if a country imported more goods and services than it exported, it paid for the difference with gold (or silver), or it paid with paper money backed by a precious metal. If the trade deficit was relatively large, cross-border payments made to cover the deficit would gradually deplete the country’s reserves.

When the gold ran out, the country would print more paper money. If it printed more than the world wanted to hold, the value of the country’s currency would fall, making exports cheaper and imports more expensive. As exports increased and imports decreased, trade would more back into balance – regardless of trade barriers.

Any trade barriers present would simply reduce trading volumes, thus reducing the efficiency and benefits of trade. Trade deficits did not cause the deficits. Currency misalignments caused the deficits, and these misalignments would automatically be fixed by a well-functioning global currency market.

The Case of America Today

Why doesn’t the global exchange rate system work like this for America today?
The answer is very simple. The world has changed dramatically over the past 200-300 years, but American trade policy has not. The key changes in the global economy include:

1. A surge in the number of countries trading on a global rather than regional basis, their level of development, and their average wage rates.
2. A sharply higher ratio of international trade to global GDP.  Globally important financial markets developing in countries around the world.
3. Greatly increased integration of global financial markets, thanks largely to the explosion of computer and information technology.
4. The U.S. dollar’s rise to dominant reserve currency status during the 20th century.
5. The emergence of U.S. financial markets as a global safe haven.
6. The collapse of the gold standard between WWI and WWII, and of the Bretton Woods system in 1971-73.

Despite these dramatic changes, most of which were dominated by or closely linked to global capital flows, the international monetary policies of the United States have changed but little. Forty years of virtually continuous U.S. trade deficits since the collapse of the Bretton Woods system prove that policies adequate to deal with the realities of the 21st century have not yet been implemented.

 Sure, some measures have been introduced. For example, changes were made in the way the U.S. handled global currency market interventions to manage the value of the U.S. dollar during and after the Bretton Woods system. Also, the Omnibus Trade Act of 1988 included measures designed to fight currency manipulation, but these measures have failed to solve U.S. trade deficits.

During the recent Trade Promotion Authority (TPA) discussions, strong emphasis was placed by many in Congress on the importance of including an enforceable clause against currency manipulation in the TPP, but as Bergsten and Schott noted recently with respect to the commitments that ministers of finance made in their Joint Declaration on currency manipulation: “Are the commitments … enforceable through the dispute settlement procedures of the TPP? … The short answer is, no.”  If not enforceable, they will fail.

For decades, the Federal Reserve has used the Federal Funds Rate to keep the flow of domestic capital consistent with its goals for growth, inflation, and employment. Furthermore, the Humphrey-Hawkins Full Employment and Balanced Growth Act of 1978 gave the Fed an official mandate to assure that its monetary policies are consistent, not only with employment, growth and inflation targets, but also with "an improved trade balance" based on, “improvement in the international competitiveness of agriculture, business, and industry.”

Nevertheless, the Fed lacks any policy similar to its Fed Funds Rate that would allow it to moderate the massive inflows of foreign capital that drive the dollar’s overvaluation and America’s trade deficits.

In short, the U.S. has no meaningful international monetary policies designed to keep the dollar close to its trade-balancing equilibrium exchange rate – and thus no meaningful instruments to prevent trade deficits from sapping the economic and social vitality of our nation.

Policies for the 21st Century

America needs to implement a set of international monetary policies that will bring the value of the U.S. dollar back close to its trade-balancing equilibrium exchange rate and keep it there – regardless of how illegal or misguided the trade policies of other countries may be. This could easily be accomplished by passing a law mandating the introduction of three policies. Ranging from general to specific:

• Market Access Charge (MAC): When ordinary market forces such as the dollar’s reserve currency status and America’s status as a safe haven for investors cause the dollar’s overvaluation, impose a modest Market Access Charge (MAC) on all foreign capital inflows whenever the trade deficit exceeds one percent of GDP. By moderating inflows, the MAC would reduce upwards pressure on the dollar, allowing it to return to its trade-balancing equilibrium exchange rate.
• Countervailing Currency Intervention (CCI): When currency misalignments are clearly the result of official currency manipulation by specific countries, the U.S. Government would make countervailing purchases of an equal value of the offending country’s local currency.
    
• Currency-adjusted Countervailing Duties (CCD): In line with legislation proposed by Schumer and Brown, allow the U.S. Government to treat currencies manipulated by foreign governments as subsidies to their exporters and add a proportional currency surcharge to countervailing duties on specific imports from such countries.

These three simple measures would fill a gaping monetary policy hole in America’s current trade policy tool box, and they would help America become more internationally competitive in the 21st century.

John Hansen     Aug. 31, 2016

America Needs a Competitive Dollar - Now!