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Little recognized in all the hubbub over President Trump’s trade policies involving punitive import tariffs is an implicit new exchange rate policy imbedded in the trade policy. This appears truly a case of penny wise, pound foolish.
As he threatened during the 2016 campaign and thereafter, President Trump has aggressively upset the global trading system applecart, and threatens the U.S. economy now finally blossoming as an unintended consequence. As promised, he withdrew from the Trans-Pacific Partnership. And so the United States was left on the outside looking in when the other 11 participants in the negotiations went forward to complete a new agreement, and China circled to fill the political lacuna created by the U.S. absence.
The president continues to threaten to withdraw from the North American Free Trade Agreement, and he has begun raising targeted punitive tariffs on aluminum, steel, autos and auto parts, and a long list of other items. As expected, our trading partners have not taken kindly to the president’s trade lashings, and they have responded with new punitive tariffs of their own on carefully selected U.S. exports.
None of these events are occurring in an economic vacuum. U.S. tariffs imposed on U.S. imported goods are raising prices to American businesses and consumers. Many of those goods, notably steel and aluminum, are intermediate inputs U.S. businesses use to manufacture final products. It’s unlikely your neighbor recently bought themselves a nice slab of Canadian aluminum for Christmas. And so these new U.S. tariffs have made other U.S. companies less competitive worldwide.
At the same time, tariffs imposed abroad have made U.S. companies attempting to export less competitive. President Trump has often and rightly pointed to Harley-Davidson as a great American company manufacturing in the United States. The Europeans took note, and so when they imposed retaliatory tariffs their list included, guess what, Harley-Davidson motorcycles. To continue to compete in the European market, Harley-Davidson announced it is shifting overseas U.S. production destined for the European markets. Not good.
These are the well-publicized decisions and consequences, but the heretofore unremarked implicit exchange rate policy imbedded in the president’s trade policy will likely be even more painful. Sensibly, China, in response to recent and possible future trade actions on both sides, has shifted its monetary and exchange rate policies. For example, the Chinese central bank is encouraging banks to lend more to small businesses to cushion them from any economic effects arising out of the trade dispute. And China’s central bank also cut the reserves banks have to hold, thus further opening the credit spigot to support the Chinese economy.
These are classic actions a central bank adopts to provide economic support in the face of possible economic weakness, representing a carefully calibrated loosening of monetary policy. Notably, it comes as the Federal Reserve is executing an equally carefully calibrated reduction in monetary support for the U.S. economy. Consequently, the Chinese yuan is falling steadily against the dollar. As of June 25 the yuan had fallen nine straight days for a cumulative 3% decline with no apparent attempt by the central bank to slow the descent.
The decline in the yuan, or alternatively the rise in the dollar, means the price of Chinese imports into the United States is falling while the price of U.S. goods into China is rising. The good news is that this exchange rate movement offsets somewhat the harmful effects of the new U.S. and Chinese tariffs. The bad news is that these price effects are not targeted, but extend to all bilaterally traded goods and services.
The Chinese government has apparently decided the domestic economic risks of a trade war justify a pre-emptive domestic monetary policy response. The effect of this policy is to make U.S. companies less competitive viz-a-viz Chinese companies in the United States and in China. The Chinese monetary policy reaction is a direct consequence of President Trump’s new tariff-based trade policies. The exchange rate-related loss of U.S. competitiveness is indeed an imbedded consequence of these trade policies.