A User’s Guide to Restructuring the Global Trading System on Superphysics

Executive Summary

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For decades, President Trump has wanted to:

reform the global trading system
put American industry on fairer ground vis-à-vis the rest of the world

The root of the economic imbalances lies in persistent dollar overvaluation.

Introduction

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I expect the Trump Administration to overhaul the international trade and financial systems.

Theoretical Underpinnings

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The Triffin World

The deep unhappiness with the prevailing economic order is rooted in:

persistent overvaluation of the dollar
asymmetric trade conditions.

Such overvaluation:

Theoretical Underpinnings

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In Triffin world, the reserve asset producer must run persistent current account deficits as the flip side of exporting reserve assets.

USTs become exported products which fuel the global trade system.

The Core Tradeoff

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The persistent, price-inelastic demand for reserve assets gives the US the burden of an overvalued currency with only the gain of:

modestly cheaper borrowing.
geopolitical advantages of achieving core national security aims at minimal cost via financial extraterritoriality.

This overvaluation erodes the competitiveness of our export sector.

Tariffs

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President Trump used successfully and extensively in 2018-2019 in trade negotiations with China.

Tariffs

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While the macroeconomic data appear consistent with the currency offset theory, academics studying goodslevel microdata take a harsher view of this experience.

Cavallo, Gopinath, Neiman and Jang (2021) study detailed microdata of goods imported by retailers.

Incidence, Revenue, and Trade Flows

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Like inflation, the question of who bears the burden of the tariff will depend on what prices adjust.

But there are more nuances.

In a world of perfect currency offset, the effective price of imported goods doesn’t change, but since the exporter’s currency weakens, its real wealth and purchasing power decline.

How Likely is Currency Offset to Occur?

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The economic and market consequences of tariffs hinge on the extent to which they are matched by offsetting changes in currencies, so it is important to consider the likelihood that currencies do adjust. In the U.S.-China trade war of 2018-2019, currency offset was effective. However, there were several crosscurrents at the time that make the comparison cloudy.

Currencies

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Currency Policy and Risks

In the Triffin world, the demand for reserve assets causes persistent deviations from the equilibria in currency markets that would balance trade.

Graduated Scales, Leverage and Security

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The last trade war saw gradations of tariff rates for different types of Chinese imports.

Scott Bessent, a Trump advisor and potential Treasury Secretary, has proposed putting countries into different groups based on:

Feasibility

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Most importantly, a multilateral approach to dollar adjustment will only work if our trading partners have dollars to sell.

In contrast to the period of the Plaza Accord, most currency reserves these days reside in the hands of our Middle Eastern and Asian trading partners, not our European ones.

Reserve Accumulation

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Another unilateral approach to strengthening foreign currencies is to mimic the approach taken by some of our trading partners and accumulate foreign exchange reserves. By taking dollars and selling them in the market for other nations’ currencies, government can create additional demand for other currencies and increase their value. In terms of implementation, there are two meaningful avenues for doing so: the first is Treasury’s own assets, particularly its Exchange Stabilization Fund.

Market and Volatility Considerations

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Tariffs Then Dollars or Investments

A second Trump term is likely to be even more forceful than the first when it comes to reconfiguring the international trading and financial systems. With President Trump unable to run for another term, he can focus on his legacy and achieving some of his core goals of reindustrialization, manufacturing revitalization, and improved international competitiveness.

Conclusion

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The next Trump term presents potential for sweeping change in the international economic system and possible accompanying volatility. It is important for investors to understand the tools that might be employed for such purposes, as well as the means by which government may attempt to avoid unwelcome consequences. This essay attempts to provide a user’s guide: a survey of some tools, their economic and market consequences, and steps that can be taken to mitigate unwanted side effects.