Before the turn-of-the-year, President-elect Trump announced Stephen Miran’s nomination to chair his Council of Economic Advisers. It is impossible to know how influential Miran or anyone else will be in determining the policies of the new administration. The traditional form and processes of the US government will almost certainly be subordinated to Trump’s personal relationships and whims. But we can still interrogate Stephen Miran’s published views to get a sense of the sort of advice Trump might receive.
Miran wrote a piece for Hudson Bay Capital, A User’s Guide to Restructuring the Global Trading System, discussing some of the policies the incoming Trump administration might adopt. The piece does not represent the views of Hudson Bay Capital and has no formal status with the incoming administration. Miran himself says the essay is ‘not policy advocacy,’ just an exploration of things a second Trump administration could do. But it does spell out what Miran sees as the problem that needs to be solved and how the various policy instruments at the disposal of the US government might be deployed to address it. Miran’s views will give a fig leaf of intellectual respectability to those policies and help rationalise things that Trump was probably going to do anyway.
The whole argument proceeds on the basis of a false premise, underscoring the fact that Trump’s trade policy agenda is a solution in search of a problem. The central claim is that the US dollar faces an over-valuation problem due to reserve asset demand and this explains the trade and current account imbalances that are further claimed to be bad for the US. This is much the same argument advanced by Michael Pettis, another cheerleader for the US using tariff protection to address supposed imbalances in the trade and investment relationship with China and the adverse consequences that are assumed to flow from those imbalances.
The issue mostly hinges on whether you think the US dollar exchange rate efficiently discounts reserve asset and other demand, or whether this demand is a disequilibrating influence on the global economy. That in turn requires some sort of market failure argument to justify why the US dollar exchange rate is over-valued. The market failure argument that Pettis, Miran and others rely on is distortionary and interventionist policies in China, although Miran sees the reserve asset demand for US dollars as a more general problem, not just a China problem. Tariffs are then seen as a mechanism for either offsetting the effects of foreign economic policies or getting other countries to change them.
Where this argument fails is that the US dollar exchange rate is already largely performing this function through the relative price of US dollar-denominated assets. The beauty of floating exchange rates is that they efficiently discount all policies, regardless of whether we think those policies are good or bad. The US dollar exchange rate would, for example, also discount the implications of EU protectionism. That is one of the reasons why EU protectionism is more of a problem for the EU than it is for the US. China’s economic policies are first and foremost a problem for China, as its recent economic performance suggests.
Miran acknowledges the problem of currency offset for the policy of raising tariffs with respect to China. Indeed, he notes that during the first Trump administration ‘the dollar rose by almost the same amount as the effective tariff rate.’ But he argues for tariffs as a mechanism to transfer revenue to the US from China. This is consistent with the idea of a return to a 19th century revenue tariff as a way of financing the US government. Miran discusses the implications of varying amounts of currency offset. Ultimately, the incidence of any given tariff is an empirical question, just like any other tax. But just like any other tax, there is a welfare loss associated with tariffs. The implications for dynamic efficiency are potentially much larger, in particular, the welfare losses associated with increased economic policy uncertainty.
Miran maintains that reserve asset demand in particular is likely to be price inelastic, but even if we generalise this to safe asset demand more broadly, it is not clear that this is a problem or leads to the US dollar exchange rate being inefficiently priced. Miran acknowledges that foreign purchases of US dollar assets lower US borrowing costs, but only ‘modestly.’
Bad macro takes have consequences
Even if we buy into the argument about the US dollar being structurally over-valued, the proposed remedies are fraught with risks that Miran readily acknowledges. The three options canvassed in his paper are tariffs, capital controls and a multilateral agreement such as a Plaza/Louvre-style multilateral agreement, already being dubbed the ‘Mar-a-Lago Accord.’
Miran is very aware of the inflationary risks around tariffs, the problems of trade diversion, currency offset and policy uncertainty. His advice therefore is that the US should tread carefully. He suggests a staged approach starting with tariffs before proceeding to deal with the currency. The idea is that tariffs or the threat of tariffs might address the problem without going down the route of unilateral or multilateral approaches to addressing the exchange rate.
A popular view in financial markets is that tariff increases will be staggered or scaled to bring other countries to the negotiating table. This is thought to be the more benign scenario. But any resulting negotiations and agreements are not going to change the fundamentals driving global trade and investment. Miran claims the ‘phase one’ trade deal with China was a success when it was clearly a failure on its own terms.
Scaled tariff increases are in many ways far worse than the imposition of a permanent, one-off across-the-board tariff increase, even a very large one. Markets can discount and divert around a known tariff. A floating tariff schedule subject to ongoing policy-induced uncertainty would be far more damaging to the global economy because it would be impossible to adjust to, but that is what Miran and others are proposing and many people in financial markets are mistakenly buying into it.
Miran readily concedes that the ‘volatility risks are material’ and that the ‘path by which the Trump Administration can reconfigure the global trading and financial systems to America’s benefit… is narrow, and will require careful planning, precise execution, and attention to steps to minimise adverse consequences.’ In reality, however, the path is non-existent. Because Miran’s proposed policy options proceed on the basis of a problem that is imagined rather than real, the proposed remedies will only serve to add more distortions, frictions and volatility in the world economy. Markets will do their best to adjust to and offset these policies, but that adjustment process will be needlessly costly and a drag on both the US and world economy. Even a well-functioning government would struggle to manage policies such as these and the second Trump administration is likely to be even more dysfunctional than the first.
In the first Trump administration, the biggest problem faced by Chinese negotiators was figuring out who to talk to and what the US even wanted. Trump lurched from demands for more Chinese purchases of US goods to threats of decoupling. The US government will likely just cycle through Miran’s list of options in an incoherent fashion. The staged approached to tariffs is something other countries could just sit out while letting the US domestic political process fight over the distributional implications of a rising tariff burden.
Other countries are also likely to retaliate and take offsetting policy measures. That’s why they are call trade wars. In the case of China, a large one-off devaluation would be an obvious response. Even just accommodating market demands for depreciation through the existing exchange rate mechanism would serve much the same purpose, putting the US on the wrong side of a fight with global capital markets.
Miran is also co-author of a piece for the Manhattan Institute on restructuring the Fed, including making Federal Reserve Board Governors serve at the will of the President. While his proposals are designed to balance Fed independence and accountability, the Trump administration might take a more selective view of those recommendations if it comes to view the Fed as an obstacle to its attempted restructuring of the global trading system.
Miran says he is not engaged in policy advocacy and his note can also be read as cautionary. He states very clearly that ‘there is the risk of material adverse consequences for financial markets and the economy.’ Hopefully, that advice will be front and centre of what the CEA tells Trump. The real danger is that the administration thinks these risks can be managed in ways that will advantage the US. In providing an intellectual justification for policies the Trump administration is likely to pursue anyway. Miran makes them more not less likely. It is worth noting the first Trump administration launched its 2018 trade war when USD-JPY was below 110. There is no level of the US dollar exchange rate that will dissuade Trump from using tariffs.
Bad macro takes have consequences and now we are going to have to live through them.