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Trade war and the US dollar

Part I

After US President Nixon decoupled the dollar from the gold standard fixed at $36 to an ounce of gold agreed upon in the Bretton Woods Agreement, the dollar has steadily increased alongside with the price of gold to $1,200 per ounce. Despite that, the US refuses to back up its currency with gold.

To avert financial pandemonium in the international monetary system, the IMF allowed the issuance of SDR or special drawing rights. This refers to a type of monetary reserve currency created in 1969 to supplement the existing money reserves of member-countries, principally the US dollar. This was created in response to concerns about the limitations of gold and dollars as the sole means of settling international accounts, and to augment international liquidity by supplementing the standard reserve currencies.

Equivocally, the US Federal Reserve Board had to abolish the interest rate on all commercial transactions, which means that usury was now legal. Most countries followed, otherwise they would find themselves economically isolated. This, they have to do to attract investment to an already wobbly economy. Calibrated inflation was the trick to keep alive the business, though only the traders/exporters benefited from it, and not the consumers. Without the central banks injecting more money, it would be difficult to increase interest rates.

Arguably, the value of the US currency is based on the fictitious strength of its GDP. From the 70s, US production of manufactured goods was at 55 percent of the world’s total. Today, it represents only 1/6 of the total production output. Besides, US decision to abandon the gold standard was prompted by the spiraling budget deficit caused by its involvement in the Vietnam War. Today, the US has an accumulated debt of $21.48 trillion, which many believe could result in default payment.

The runaway appreciation/revaluation of the dollar initially brought a smile to many American traders and consumers because they were able to import more for a much less dollar. The optimists saw the China export as heaven-sent. They could not believe China could produce that vast quantity of goods at much cheaper prices they could not imagine. The pessimists however were alarmed, saying that the entry of these products could eventually kill the American manufacturing industry.

Nonetheless, the US trade war against China is based on three premises: First, on Trump’s “America First” policy. Second, on the huge US trade deficit against China. Third, that China allegedly violated US intellectual property rights. The first is rather absurd. Strictly speaking “America First” policy is out of place in today’s conduct of economic relations, more so under our era of globalization.

This gives no room for compromise. States practicing a jingoistic economic policy only accept that which is most favorable to it, while forcing other countries to subsume their interest to what the dominant state wants. It is for this why Trump’s “America First” policy is look upon as ludicrous because there is no way he can enforce that unless his purpose is to provoke war.

The second issue is unique because it is not really based on trade deficit but on the overvaluation of the dollar against other currencies. This has become most apparent in countries which the US has extensive trade relations. While it was intentionally done to allow the US buy more goods for a few dollars, the same goods and services must seek its own level when brought to its jurisdiction.

A simple illustration is the importation of goods made from abroad. They are cheap insofar as they their value remains in China. But once these goods enter the US market, their price will have to be adjusted in accordance to the value of the dollar. These products will have to pay the regular customs duties to protect its industries and workers from the unfair trade practice of dumping.

The US has no choice but to continue its importation to sustain the needs of its people. Even if they can be produced locally, it would still be much costlier for them. But neither by imposing tariff on selected countries where it suffers trade deficit bring about solution because price differential has nothing to do with it, but on the excessive valuation of the dollar which is no longer anchored on the gold standard.

To impose excessive tariff as a form of protection would only drive importers to choose countries that impose no or lower tariff. Besides, it is difficult for the WTO now to agree to the US policy of reviving protectionism by imposing tariff barriers as it would be inconsistent with globalization when its main objective is for the complete reduction, if not elimination of tariff. Moreover, member-countries strictly adhere to the universal principle in free trade of “most favored nation clause”- that a status or level of treatment accorded by one state to another in international trade should apply to other countries in terms of tariff and quotas.

One must bear in mind that exporters are sellers, and such enjoy the upper hand. Given this situation, other countries can easily fill the vacuum that will be left by US importers. Even if the US decides to lift the tariff, the imbalance will persist because US importers will continue to take advantage of the high value of the dollar instead of seeking to revive local production and manufacturing.

In other words, tariff cannot resolve the trade deficit. Either the US has to produce their own products at a cheaper price based on the old Adam Smith economic principle of “comparative advantage” or to take the drastic approach of devaluating its currency to allow other countries to import more US goods to reduce the huge trade deficit. Imposing protective tariff will only exacerbate the situation.

On the third premise that allegedly China violated US intellectual property rights, frankly speaking, is has nothing to do with the huge trade deficit the US has with China. If the US believes its intellectual property rights are being violated, either through piracy or illegal copying of its trade secrets, the solution is to bring a case against China, and allow the international arbitration court to decide; that if found guilty, penalty can be imposed to recover the losses it may have suffered.

Besides, if the US is truly insecure that its patented products will be violated, the better solution is to stop consigning production in China. China cannot be kept on guessing which of the US patented intellectual property right or trade secret was violated.

Rather, US companies persist in taking the risk because the return of investment is something they could not shy away. Besides, no other country could supply them of the essential materials and parts for their technology-based products, and skills of manpower needed for such specialized production activities.

 

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Topics: Bretton Woods Agreement , America First , US Federal Reserve Board , China

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