I’ve been under the weather this week with a bad cold, so I’m a little out of it and not thinking as clearly as I should be. In other words, this is the ideal mental state for discussing Trump’s tariffs.
Many electrons have been inconvenienced over this topic, and most have been in vain. I’ve wondered all week whether I had anything meaningful to add. However, a few points that have emerged in discussions are worth highlighting.
Bill Mitchell has already written an insightful piece on the subject, making perhaps the most crucial observation:
The analysis has to be different when there is the possibility of nominal exchange rate movements coinciding with relative price level movements between nations.
What’s astonishing is how few commentaries, particularly those originating in the U.S., acknowledge that China operates with a different currency. We often see arguments like:
If a game costs $10 to make in China, upon arrival in the U.S., the publisher must pay a $5 tax to the U.S. government.
However, the game doesn’t cost $10 to make in China; it costs about 70 CNY.
To offset the tariffs, the exchange rate only needs to shift so that 70 CNY equates to 6.66 USD—a simple adjustment that China could facilitate by directing its sovereign wealth funds to be more generous when purchasing U.S. dollars. The result? China accumulates fewer U.S. dollars, reducing its savings and, consequently, reducing the issuance of U.S. Treasuries and interest payments flowing to China. Paradoxically, this could even shrink the dollar-denominated trade deficit, making Chinese goods appear even cheaper in U.S. markets—despite no actual reduction in the volume of imports.
There are, of course, many permutations here, but the basic idea remains the same. The intent of the US administration is to eliminate additional net foreign savings of USD.
Trump is resorting to tariffs because they are a tool granted to him by Congress, and Congress, due to the structure of the U.S. institutional arrangements, lacks the power to curtail his use of them. Any restrictive legislation passed would face a presidential veto. Such is the challenge of having a Head of State with an independent democratic mandate.
However, this approach fails to address the root cause of the issue: economies pursuing export-led growth manipulate financial flows to suppress productive activity in their target markets, creating space for their output. When U.S. dollars are exchanged for CNY, they fuel wages and production in China, while the corresponding U.S. dollar holdings in Chinese wealth funds flow into assets, prompting portfolio adjustments that ultimately end up in U.S. Treasuries—where the funds effectively disappear. The missing counterbalance? Federal spending should be directing dollars into domestic production and employment. Without such a mechanism, imports become an economic burden rather than a benefit to a good chunk of the population, and political responses like Trump’s tariffs become inevitable.
Much of this boils down to how GDP is calculated, adding exports and subtracting imports. In contrast, actual living standards are improved by imports and diminished by exports. This is a textbook example of Goodhart’s Law:
When a measure becomes a target, it ceases to be a good measure.
There are far more effective ways to address the impact of trade imbalances, but those in power have ignored them for years. And so, here we are—watching events unfold.
Indeed, we live in interesting times. Fittingly, we even blame the Chinese for that saying.
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