Central to the Washington administration’s stated policy agenda is a concern for working Americans by creating jobs and raising their standard of living. This goal is intended to be achieved by developing US manufacturing. Taken in isolation, such a goal seems to deliver what many Americans want, which is why they gave a strong mandate to President Trump and the Republican Party at the election.
But if such plans are judged in relation to other stated economic objectives, the conclusions may differ substantially. And here I am referring to what seems to be priority zero for the US administration: balancing the trade deficit, as the imports of goods (not services where the US has a surplus!) substantially exceed exports. Such a deficit has been financed in the country’s balance of payments by the massive capital inflows provided by investors attracted by the American business environment and assets.
The US administration blames for the said situation overly permissive trade policy and the over-appreciation of the dollar. Let’s take them in turn.
Resetting trade policy by imposing tariffs “automatically” on all countries that have trade surpluses with the US is questionable, as long as they are not carefully calibrated to the specifics of each situation. Let’s take for example Botswana’s trade surplus caused by diamond exports to the US. Surely increased tariffs will not lead to diamond mines opening in the US because the US … has no diamonds. And the examples could go on, especially among consumer goods imports, which include a lot of cheap manual labor found mainly in Asia.
As for the dollar’s overvaluation, it can be considered as correct. As the Financial Times recently noted, this distortion in the valuation of the US currency may explain, among other things, why the poorest US state, Mississippi, has a per capita income similar to Germany and Britain and higher than Japan. The overvaluation of the US dollar has been a consequence of its privileged status in the global economy in recent decades as the main currency used in trade or as a reserve asset.
As the Financial Times points out, although the US economy accounts for 25% of the global economy, over 57% of the world’s reserves are denominated in dollars, 54% of the world’s export invoices are issued in dollars, 70% of bond issues are in dollars, 80% of foreign exchange involves the dollar. Such status for the US currency has come with lower financing costs for the US government, as well as a massive influence on the global financial system and trade flows.
Today’s American decision-makers, however, seem to see only the downsides of the dollar’s overvaluation, even though, in addition to the advantages listed above, there was another one that most Americans seem to ignore. An overvalued dollar has also made their purchasing power overvalued. In other words, living better than they should. The low prices of many commonly imported goods were due precisely to the fact that the population pocketed a currency estimated by some analysts to be 19% stronger than it should be.
This brings us to one of the main causes of the US trade deficit: private sector consumption. From this, we can draw an extremely politically sensitive conclusion that can never be spoken in public. A correction of the US external deficit implies a reduction in Americans’ consumption, in other words, a fall in living standards. And even if this objective is not explicitly mentioned, the envisaged economic measures and their consequences will lead exactly in that direction.
First, the increased customs duties will lead to a generalized increase in the prices of imported goods, and thus to higher inflation. Everywhere in the world, inflation erodes people’s purchasing power. Could wage growth beat inflation? Rapid wage growth in the US would destroy the economic rationale for relocating manufacturing from low-wage Asia to rising wage America.
Second, normally trade policy aimed at deficit reduction should have a positive impact on the dollar. But the chaotic way in which it has been conducted has caused investor confidence in the US and in US assets to suffer a dramatic fall. Under these conditions, the dollar has seen its value fall in recent weeks as a result of capital outflows from the US. A weaker dollar, so another ticked target for the US administration, right?
Except that a weaker dollar will combine with tariffs to make many imported goods more expensive. Thus, the depreciation of the dollar will also lead to lower consumption by Americans. The problem is that this adjustment in purchasing power will not have a similar impact on the entire population, with low-income earners being hit hardest. The risk is that the already existing social polarization in American society will become even greater.
Another theoretically correct step towards reducing the external deficit is to reduce the budget deficit. An important role in this exercise has the DOGE team, coordinated by Elon Musk, which in the last two months has had as its main objective to significantly reduce the number of workers in public agencies. It is a process that continues and will produce through unemployment, as well, a fall in the consumption of the Americans who are unemployed or still employed, but fearful of the prospect of untimely layoffs.
To conclude, the tariffs, the weaker dollar and the shrinking budget deficit will generate a domino effect that will lead to a reduction in the US trade deficit as planned. But what is not being said is that one of the dominoes is the very pocket of those so often cited: the working Americans.
Subscribe to receive notifications when new articles are published