Trump’s return to Mercantilism

Newly elected US President Donald Trump has made much of the US’s trade deficits, which has been a persistent characteristic of the US economy pretty much since the collapse of the gold standard  in 1971. Trump’s solution is state intervention through tariffs and tolls.

According to Trump, Canada is good as the trade balance with the US is roughly flat, while China is bad as they run large surpluses versus the US. Trump wants to address this by reducing imports by slapping tariffs on Chinese products. This counter-intuitive way of thinking has gained a foothold economic discourse, as if the purpose of working was to produce and not to consume. True, production must always come before consumption (a point lost on mainstream Keynesian economists), but the end purpose of man’s toil has always been consumption. Reducing imports, though reducing the trade deficit, will obviously not make a country rich. The US consumer is benefiting from cheap Chinese imports and if the Chinese chose to spend tax money on subsidizing export industries, that only adds to the benefit the US consumer enjoys. Import tariffs, as favoured by Mr. Trump, will serve to make foreign produced products more expensive for the American consumer, thereby lowering their standard of living. The problem for many Western economies running large trade deficits is not the trade deficit per se, it is that they continuously consume more than they produce. This will not be addressed by tariffs but by restoring interest rates to a level commensurate with supply and demand in the money market. Bringing consumption in balance with production will address the trade balance. But it is important to note that bilateral trade deficits/ surpluses with individual countries do not matter. Division of labour makes everyone better off.

Similarly, targeting the foreign exchange markets do nothing to address the underlying problems. Mr. Trump has spent a lot of energy accusing China of manipulating, i.e. undervaluing, their currency. This relies on the perverse notion that a weaker US Dollar is to the advantage of Americans. An American worker is obviously not working for dollars, but for what these dollars allow him to consume. Decreasing the value of of the pay check of American workers is hardly a road to prosperity. In addition, a policy of depreciating the US Dollar will discourage foreign investment in the US economy, reducing the amount of physical capital and thereby productivity and wages.

It is clear that a weak currency can provide a temporary boost to GDP, as we are witnessing in post-Brexit Britain. In the short term view of a politician hoping for re-election, the interim high may well outweigh the long-term downsides. But with a weaker currency, the UK consumer has been impoverished. The same is true for tariffs. What these policies have in common is that they interfere with the markets efficient allocation of resources and the division of labour, thereby serving to impoverish all citizens, domestic as well as foreign.

Trump’s concern about trade deficits is not wrong as such. No country can run continuous deficits – or surpluses for that matter. And the solution is actually straightforward. Under a classic gold standard, running a trade deficit leads to gold outflow as foreigners redeem currency for gold, and therefore to a reduced money supply – less gold means that the central bank will have to reduce the amount of outstanding money. Lower money supply leads to falling prices and eventually to a trade surplus as domestic production becomes cheaper relative to foreign production. This is David Hume’s price-specie flow, and means that if an economy consumes more than it produces in one period (and runs a trade deficit), it will produce more than it consumes in other periods (and run a trade surplus). Under a gold standard, consumption in an economy is therefore in the long run constrained by domestic production.

But alas, Trump is not advocating a return to sound money. As Murray Rothbard pointed out, whereas ‘genuine free traders look at free markets and trade, domestic or international, from the point of view of the consumer (that is, all of us), the mercantilist, of the 16th century or today, looks at trade from the point of view of the power elite, big business in league with the government’. Trump is foolishly heading down a mercantilist route tried unsuccessfully by many rulers before him. What he fails to understand is that trade is not a strife but always mutually beneficial.

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