By Cormac Lucey
For most of the first year of his rule, Donald Trump’s bark was worse than his bite. Yet, over the past few months, the US president has started to show his pearly whites. He introduced $1.5 trillion of tax cuts — without any balancing spending cuts — at a stage of the recovery cycle when the American economy hardly needs additional stimuli.
The second Trump threat is the imposition of tariffs on imports of steel and aluminium. Initially these tariffs had exempted America’s allies but, beginning on June 1, the administration imposed a 25% tariff on imports of steel and a 10% tariff on aluminium on the EU, Canada and Mexico. The danger here is that those affected will retaliate, prompting additional American tariffs, escalating matters into a fully fledged trade war.
This is hard to imagine, yet we — in the words of that old Chinese curse — live in interesting times. The 1930s were also interesting times. There have been some worrying echoes over the past decade: sudden stock market falls; a global financial crisis; a massive rise in unemployment; and populist political revolts. The 1930s ended with the world sliding into a savage global war. A fully fledged trade war marked its beginning.
Willis Hawley, a congressman from Oregon, and Reed Smoot, a senator from Utah, sponsored the Tariff Act of 1930, which increased nearly 900 American import duties. There were then, just as today, wider forces at play.The original aim of the act, introduced by the US president Herbert Hoover, was to help agriculture, which had suffered badly in the early 1920s. There was little logic behind this, as American farmers faced little competition from imports. Expert opinion was solidly opposed to the Hawley-Smoot act.
The American economist Frank Fetter organised a petition against it, signed by more than a thousand of his colleagues. “Economic faculties that within a few years were to be split wide open on monetary policy, deficit finance and the problem of big business were practically at one in their belief that the bill was an iniquitous piece of legislation,” said Thomas Lamont, a partner at JP Morgan, in June 1930.
“I almost went down on my knees to beg Herbert Hoover to veto the asinine Hawley-Smoot tariff,” he added.“That act intensified nationalism all over the world.” It intensified nationalism by triggering a two-thirds collapse in world trade.
Ireland would face particular dangers from a global trade war as our economy — whether measured by GDP or adjusted GNI — is the second-most open in the developed world. It comes in after Luxembourg, which is so small that most of its economic activity necessarily involves either an export or an import. The EU’s decision to retaliate against US tariffs on metals with new tariffs on American whiskey has raised the risk of Trumpian counter-measures against Irish whiskey.
Compared with Ireland, the US is not so much a country as a largely self-reliant continent. In threatening a trade war, Trump may be acting crazily but not stupidly. America is considerably less dependent on trade than its European or Chinese rivals.
Trump is also justified in targeting European and Chinese trade surpluses as well as Chinese intellectual property theft. The imbalances in world trade have sky-rocketed since the abandonment of the gold standard in the early 1970s.
A Deutsche Bank report from last September, Long Term Asset Return Study: The Next Financial Crisis, concluded: “We think the final break with precious metal currency systems from the early 1970s (after centuries of adhering to such regimes) and to a fiat currency world has encouraged budget deficits, rising debts, huge credit creation, ultra-loose monetary policy, global build-up of imbalances, financial deregulation and more unstable markets.”
Under the gold standard system, trade deficit countries needed to boost exports quickly and scale back imports if they wished to avoid running out of the precious metal. Since abandoning the system, America has been able to run persistent trade deficits — to consume persistently more than it produces. If one country is running a trade deficit, it follows in logic that another country or countries must be running surpluses. Step forward mercantilist China and Germany.
The creation of the euro has allowed still greater economic imbalances to build up, as it destroyed the natural pressure valve of a free-floating currency regime. If Germany still had its own national currency, its rate of exchange would rise until its trade surplus was reduced to more tolerable levels.
A current account deficit above 4% of GDP or a persistently large surplus of more than 6% are among the warning signs in the European Commission’s scoreboard of about 30 economic indicators. Germany’s trade surplus exceeds 8% of GDP, while Ireland’s, at €45bn, exceeds 15% of GDP.
We are uniquely exposed to the dangers of a trade war; the question is whether we will get one. A recent BNP Paribas report envisages two possible escalation scenarios. The first is a multilateral trade war, between the US and the rest of the world. The second is a bilateral trade conflict, between the US and China. In both cases it envisages “a prolonged period of tension”. Crucially, it sees full-blown trade wars “as low-probability, high-impact scenarios”.
Trump was likely upping the ante in advance of this week’s G7 summit and the autumn’s US mid-term elections. Forcing progress can be presented as a victory to his voters. That’s my hope, at any rate.
Published in The Sunday Times (Ireland) edition June 10th 2018