- The New Rules with Alan Pentz
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- A Time for Choosing
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I’ve written multiple times in the past about the need to reform our global economic system and about the fact that Trump’s win in the 2024 election will accelerate that transition.
But the question one month into his Presidency is: what is Trump’s vision for the world we are heading to? I’m confused as are many others. So far mostly we’ve heard about tariffs. 25% on Canada and Mexico. Even more on Columbia. Maybe the EU’s next? And China gets 10%.
It appears that the only ones that will stick for now are the 10% tariffs on Chinese goods. Was Trump threatening Mexico and Canada to make the blow of Chinese tariffs seem smaller? Possibly.
What are the goals we hope to achieve with these tariffs? Are they meant to raise money for tax cuts? That’s likely, although exchanging lower corporate taxes for a tax on all American consumers doesn’t seem like a great trade (pun intended).
There’s also a lot of ways in which tariffs can be offset, especially those at the relatively low level of 10%. China devalues its currency. Some exporters eat part of the tariff. China finds new ways to ship goods through third countries, etc.
The Real Choice
In the end, tariffs on just China or implemented bilaterally won’t be as effective as they could be. The point is not to balance trade between the US and China; it should be to balance trade across the global system. We should expect to have trade deficits with some countries that export things we don’t want to make as long as we have corresponding surpluses with other countries.
The issue is that too many countries including the second, third, and fourth largest economies in the world, have distorted the system to favor their own exports and to reduce their imports. That arrangement requires the US to run ever larger deficits or face wide spread unemployment.
That system cannot continue indefinitely and the core question at the heart of today’s geopolitics is how that system will change. I see two options that have a realistic chance of success confronting Trump.
Option One: Rebalance the System
The first path is to lead an international coalition focused on rebalancing the system. It would make the most sense for the US to partner with the other key deficit or balanced countries that happen to be close allies in the Anglosphere: Canada, the UK, and Australia.
We could unite those countries behind an agenda calling for the implementation of a new economic system that would force the rebalancing of trade. There have been various proposals for how to do this.
You could adopt an updated Bretton Woods type system that would attempt to keep currencies in a range of relative value to each other forcing up the price of goods from countries trying to over produce for exports. This would involve the use of capital controls to prevent the current appreciation of the dollar against other currencies.
Another option is one of the proposals that John Maynard Keynes made during the Bretton Wood’s negotiations for the post World War Two economic order. He envisioned a global central bank using a currency called Bancor to encourage the balancing of trade. This seems way too “global new order” for the US. We want to control the system.
I won’t get too deep on the pros and cons of those policies today. That’s a totally separate piece in and of itself. Suffice it to say that there are multiple ways we could choose from to rebalance the system. The issue with each of these is that they require cooperation from the participants.
Germany, Japan, and South Korea would not appreciate this approach. It would force deep readjustments in their economies. Those adjustments could be destabilizing. China would be apoplectic. There’s some slim possibility we could provide a reasonable adjustment path to our allies but my guess is we don’t have the stomach to force these adjustments on countries we need to help us face down the Chinese.
There’s a possibility that China tries to break off Japan, South Korea, or even Germany by offering some concessions on trade. Those countries would be foolish to take it. As soon as they were dependent on China, they would renege on any concession.
The chances of this happening are maximized if the US goes it alone and imposes tariffs or capital controls itself without building an international coalition. Why wouldn’t our allies, including Germany, Japan, Australia, etc. seek a deal with China? With the US offering not all that much, it would make sense for them to at least try to play the US off of China.
It seems the EU has finally realized how dangerous their relationship with China has been. We shouldn’t make continuing the alliance with the US feel like a worse deal.
The US is the world’s most important country but we should not try to go it alone in a world where China accounts for a third or more of world production. We do not have the people and resources to make up for all of that. Although we are a Pacific power, we are almost 7,000 away from China. We must rely on alliances to project power and keep global production humming.
The Option Two: Focus on China
More realistically, I think we need to agree to accommodate our surplus production allies in order to form a united front against China. In this scenario what we are really worried about is our competition with China. National security hawks will favor this and I think it’s where Wall Street and other financial and tech elites land.
Europe and Japan in particular buy a lot of US financial assets. That helps keep the cost of treasury debt lower and price of stocks higher. A full readjustment would mean a pretty big drop in those asset prices so Wall Street isn’t going to be interested.
Tech and the largest hyperscalers in particular (Apple, Meta, Google, Amazon, etc.) sell a lot of services to Europe and to a lesser extent allied Asia. They don’t want anything to threaten that revenue. While our goods deficit with Europe is much higher than our services surplus, that surplus is concentrated into those hyperscaler companies.
If you have hawks, Wall St, and tech all on the same side, that side probably wins. While I would ideally want the first strategy, I understand the trade offs and can live with the second. However, I’m not sure we’re pursuing either.
Do We Have a Strategy?
The first month of the new Administration has been a mixed bag to say the least. Several key economic advisors were good picks and Trump has put trade at the center of the agenda.
The concerning part is that the trade strategy seems focused on bilateral measures. The threat of tariffs is overused and brought out in minor disagreements like the one with Colombia.
While there might be a case to browbeat Mexico and demand they break more firmly with China, I don’t understand what the Canadian tariff threats are about. What goal are we trying to accomplish there? I worry that Trump doesn’t differentiate much between the EU and China. Let’s not push them onto the same side.
Most worrying is the idea of some grand bargain with China. Is all this noise just a prelude to some Trump/Xi summit where they hammer out a deal? That really scares me.
China won’t honor any commitments. We know this and have seen it repeatedly including in the aftermath of Trump’s first term China deal. China is focused on gaining total dominance in all key advanced manufacturing and technology areas and gutting every other country’s capacity to compete. There is no accommodation with Xi and the CCP as long as that remains the goal.
My hope is that some of this rhetoric is just about shaking people up and getting them used to the idea that a time for choosing has come. After a few rounds of tariff threats and the push back they create, we might settle down and get serious about a more long term strategy. I hope.
Keep learning,
Alan
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