The False Promise of the "Mar-a-Lago Accord"

'American disease' and the trade war endgame

Putin has Ukraine, and Xi has Taiwan. Without playing down the worrisome nature of Trump’s rhetoric toward Greenland and Canada, meanwhile, the real object of his revanchism is nevertheless the Bretton Woods II system of finance and trade. The reserve currency status of the US dollar defines today’s world, spanning global trade, investment, and security. It undergirds both domestic populism and overseas revanchism. Even if a range of opinions is acceptable on the exact optimal magnitude of the twin trade and savings deficits, liberalism will wither post-Trump without a canonical policy channel to manage them other than Trump's destructive tariffs. Fortunately, liberalism does offer solutions, yet if it does not recognize them as such, it will neither receive credit, nor implement them urgently enough.

The essential tradeoff the US makes as the reserve currency issuer is expensive exports in exchange for easy external financing, both of which are inextricably linked to dollar valuation. One way to think about this relationship is that the supply of dollars foreigners earn through their trade surplus must equal the demand for overseas dollars by the US (i.e. its current account deficit, or savings deficit). Imbalances between supply and demand cause price fluctuations. One basic formula accounts for the movement of money from a domestic perspective:

Exports – Imports = Saving – Investment

The left- and right-hand sides of balance of payments identity make up the trade and savings balance, respectively. The extensive imports of the US allow it to save less. While reasoning from identities is a fallacy, this equation does restrict the scope of possible actions to four variables.

Issuers of American assets—such as the government and Wall Street—are enormous beneficiaries of the current world order, so to what end is the government now seeking to disrupt that very order? Never mind the means and associated moral questions, which have attracted so much debate. What does Trump even hope to accomplish? In a November document entitled “A User’s Guide to Restructuring the Global Trading System,” Stephen Miran, then senior strategist at Hudson Bay Capital Management and now chair of the Council of Economic Advisors, proposed a concurrent solution to both the trade and the debt, which has been taken as a roadmap to Trump’s second-term trade and currency policies. In short, it seeks to reduce investment by refinancing a portion of the debt, leading to devaluation of the dollar. If indeed a true reflection of Trump’s thinking, this would probably be the most sophisticated policy initiative undertaken in either term of his administration, yet it should be taken as the first, not the last word on global imbalances.

Chain reaction

This story starts in 1985, in what was apparently one of Trump’s most transformative early political experiences. The US and Japan, along with France, West Germany, and the UK signed the Plaza Accord to depreciate the US dollar in light of a growing American trade deficit. The resulting surge in the yen (along with continued stimulatory policies on Japan’s part) resulted in a market crash. A subsequent timid response in light of the earlier international pressure caused a “lost decade” from which the Japanese economy never truly recovered. (China in particular views the episode as a cautionary tale about succumbing to American economic coercion.) Although Japan’s trade surplus has long been resolved, it never truly developed an internal economy to replace hardware exports; its “digital deficit” of software imports may soon exceed energy imports. For all the handwringing about the American comparative disadvantage in hardware, Asia’s complementary disadvantage in software is equally severe and consequential.

Back to the present. A number of central banks have been accumulating Treasury debt for reserves, which is what gives the dollar its special status today. By buying dollars on the market using their local currency, they inflate the value of the dollar, while preventing their own currencies from appreciating. The resulting overvaluation contributes to the trade deficit. These are not profit-driven transactions: these central banks could alternatively earn better returns through sovereign wealth funds rather than Treasury holdings, which would funnel money directly into the "real economy"—i.e. productive enterprise which could eventually contribute to America’s exports. At the same time, asking those countries to make that move directly would probably not be a good idea, given the state of national debt.

Thus, the multilateral currency proposal is to leverage security guarantees to “persuade” central banks to move into extreme long-term bonds, such as 100-year "century" bonds, while simultaneously selling some portion of their shorter-term holdings to appreciate their currencies. By doing so, they take on more meaningful credit risk (duration risk, if you’re following along the report), even while reducing the total quantity of their investment in the US. The specific countries with large reserves are (in order) China, Japan, India, Taiwan, Saudi Arabia, Korea, and Singapore. Excluding China, which will not cooperate with an American trade agenda, and oil exporters, most of the counterparts for a putative currency agreement would be East Asian. 

The most interesting feature of this proposition may be a Fed swap line to help compensate for the loss of liquidity. This effectively moves credit risk from the government to the Fed, but since the central bank can print money, it can technically never go bankrupt (more on this below), and it may be a value-creating trade. The real losers from such an arrangement then would be multilateral financing institutions like the IMF, which could otherwise swoop in after a crisis with punitive lending, now made obsolete through direct liquidity.

While noting the tradeoff between exports and investment noted above, the document also notes the unprecedented role of the dollar as a tool of global surveillance and sanctions as a result of its safe haven status. Thus, “the defense umbrella and our trade deficits are linked, through the currency,” a connection which justifies threats to revoke that security umbrella. This is not a power the US seeks to relinquish, despite its withdrawal from European security. Incidentally, recent proposed stablecoin legislation would expand that global surveillance apparatus to new heights (confounding all crypto narratives), despite the resulting possible further appreciation of the dollar. Instead, the US hopes to use its payments dominance as a bargaining chip in negotiations with partners, as well as a tool to marginally stall BRICS efforts to create alternative payment infrastructure. Real military blockades require more than just interrupting payment channels, but it is a useful capability to hold in reserve.

Thus, the full chain of proposed trades is from the security guarantee to currency revaluation to debt restructuring to an alternative liquidity source, all the way to the implicit disempowerment of the classic Washington institutions of neoliberalism—which incidentally played a major role in the post-war establishment of the dollar as a reserve currency in the first place. The logic of several of these links can be challenged. For instance, linking security guarantees with highly specific domestic policies of partners tends to undermine those very security guarantees. Trump has indeed gotten Europe to spend more on defense, but not necessarily on American suppliers. Much has already been written on this point, so it may be more productive to focus more on the end of the chain.

Neglect of East Asia

There are several reasons why the US cannot afford a repeat of the last multilateral currency agreement. First, given that security assurances are an explicit part of the deal, partners might wonder exactly what kind of security is being offered if it will lead to a market implosion. Second, if the Fed is holding liabilities linked to these economies, the US will be responsible for their performance in a way it was not last time. To ensure that this restructuring involves not just destruction of export sectors, but also a rotation into alternatives, it will still need to replicate the tough love of multilateral financial institutions, even if not through lending. Simplistic ‘big bang’ reforms will not lead to good results. Finally, even if the US tariffs Chinese goods, other countries will not necessarily cooperate in full. De-industrialization by these countries into China would not serve American strategy.

Each of the East Asian countries, who will be expected to stand up to China, have their own issues which will not be resolved by their respective domestic politics alone. There is an opportunity for an outside disruptor to do genuine good, but it appears highly likely that the administration will try to take a DOGE approach to these complex topics, attempting to resolve global financial imbalances via a small team without area expertise.

Ground zero for the new policy approach, not to mention geopolitics for the next decade in general, will be Taiwan. It is already cooperating with the US to dismantle its semiconductor "silicon shield," with no apparent backup plan—yet there is no reason on its face why semiconductors are more strategic than, say, cybersecurity, where it is still a lagging player. Meanwhile, Taiwan’s housing affordability relative to local salaries is through the floor, and an uncontrolled currency appreciation could easily lead to an explosion just as in Japan. It has been excluded from international economic organizations, and might prove surprisingly receptive to semi-coercive economic advice.

Japan’s bottleneck, as hard as it might be for people almost anywhere else to believe, is persistently low asset prices, leading to complacent management (who also happen to reflect the country’s aging demographics). With government debt exceeding 263% of GDP, the central bank is not exactly in a position to be moving hundreds of billions of US dollars around; it had enough trouble just getting to a positive interest rate. Japan’s real pressure point might be openness to foreign acquisitions, which should be equally attractive for American investors, and would also produce the desired currency effects.

Korea, considering its previous experience with the IMF during the 1998 Asian financial crisis, will be less willing to take advice on internal matters. It is also in the midst of domestic political turmoil, which is due in part to its rapprochement with Japan, which happened to be Biden’s main foreign policy accomplishment in East Asia. It is worth making a quick note about their role in the changing global landscape, although for a somewhat different reason. They are a dark horse when it comes to the Ukraine war, particularly now with the involvement of North Korea. Korea has a rapidly growing defense industry, which it has so far resisted using too directly. This point goes a bit beyond economic restructuring, since defense is an export industry, but compelling Korean defense sales to Europe could help assuage concerns that hectoring of allies on defense spending is about mercantilism. This would be a way to help Ukraine without impacting the US military budget, which seems to be of great concern to MAGA.

In the 1960s and 1970s, Dutch gas exports became so successful that currency appreciation precluded development of other export or internal sectors, in what is now called “Dutch disease.” Note that in the savings and investment identity equation we began with, exports correspond negatively with investments. It might be clearer to put the factors contributing to currency appreciation on the left, and those contributing to depreciation on the right, as follows:

Exports + Investment = Saving + Imports

Here it is clearer that exports and investment “compete” for appreciation, which can be called a crowding out effect. East Asia’s failure in internal diversification appears to be due to institutional rather than price mechanisms: its financial systems are incapable of funneling sufficient funding where it is needed—often in riskier, newer, and smaller ventures. In these cases, it is more fair to say counterfactually that additional domestic investment would cause appreciation, which their respective governing systems have prevented. (Singapore, in contrast, has a well-functioning financial system; imbalances there might be attributed to its savings policies.) For countries with Dutch disease, imports will not appear organically until large-scale structural rotations can take place, whether the original cause involved currency pricing or other factors.

Housing supply is capital supply

The question naturally arises then, if that much effort is being made to develop plans to resolve these issues all over Asia, why not at home? Refinancing the national debt is indeed an effort in that direction, but it alone hardly addresses the malaise which has inspired both the rise of the populist right as well as the specific plan in question, in which asset growth outpaces the rest of the economy. Government debt makes up one aspect of that asset growth, but the household sector is easily just as important.

Throwing some numbers around, the US has some $13 trillion in outstanding mortgage debt, of which a significant portion is sold to foreign investors as a safe-haven asset. Housing cost created by artificial scarcity such as zoning regulations thus drives up the dollar, thereby crowding out exports. Understanding of the harmful effects of housing costs has become more mainstream over the years, but excess money spent on housing also creates a whole other less-understood class of opportunity costs as well. Compare that $13 trillion figure to the $7 trillion in foreign reserves in Treasury assets being identified here as the problem, for which the proposal is to dither around with the term structure on a portion of it. That adds to up to more money than I have in my bank account, or that my bank has in its account, but the entire project looks a little underwhelming in this light, particularly when compared to the amount of disruption it requires.

The real impact of housing is however much larger. The same principle applies whether or not the debt is eventually sold overseas, since the point involves savings on a net basis. If that money does not need to be raised from American investors, those investors could instead invest in other American assets, displacing foreign investors without creating credit risk, or else potentially creating new productive capacity, or maybe buying up Treasury debt. They could furthermore invest it overseas, directly depreciating the dollar.

Less intuitively perhaps, those points all also apply to the equity portion of the home as well, which after all belong to another kind of American investor. Money spent on housing is fundamentally diverted away from other uses, like the stock market. Furthermore, all those considerations still do not account for the impact of housing supply on inflation, transmitted through labor costs. It is particularly worth noting certain risk scenarios in which a supply-side shock could reverberate through housing, like what occurred after COVID. The Fed was forced to raise rates in response, which was in part how we got to the present situation, in which interest expenses exceed defense spending.

In fact, it is real interest rates which define the limits of fiscal sustainability in the first place, and even more broadly form the fundamental constraint in any effort to depreciate the dollar while ensuring debt sustainability. Interest rates in turn are defined not only by the creditworthiness of the government, but also by the balance of capital supply and demand in the whole economy. Higher demand for credit causes rate hikes in order to attract more savers, which appreciates the currency and makes exports more expensive.

Crowding out is however not a morality tale, but a process driven by scarcity which can work in two directions. In contrast to Dutch Disease, on the deficit side, we might speak of “American disease”: inflated investment expenditure crowds out exports. This terminology identifies many of the same trends as the complaints about de-industrialization—which are legitimate, if slightly exaggerated—but without ever implying the validity of tariffs as a solution. It also emphasizes cost-cutting as a critical element of growth, which economists sometimes lump together. Whereas the old logic was that deficit spending increased inflation, the current situation is that inflation will need to come down in the real economy to promote growth, and ultimately to prevent runaway debt.

Having attributed the domestic trade deficit to an international savings imbalance, it might seem reasonable to assert that the burden of re-adjustment should be borne by the surplus side, which after all has the resources. At least, this is the position taken by Michael Pettis, who is probably the world’s highest-profile intellectual to support import tariffs on a reasoned basis (or perhaps the only one). Pettis has done a lot of work describing the institutional basis of China’s surplus, and for that reason, is gaining influence in the Trump administration. By nature, however, an imbalance requires two sides. Reducing demand for investment by increasing its efficiency is a central feature of Miran’s plan, yet other, more market-oriented methods exist to get to the same place.

Charity for your local factory

Any honest accounting of global imbalances must first acknowledge that they are truly difficult to unwind. The obvious choices are dollar depreciation, which increases debt servicing costs—or appreciation, which exacerbates the trade deficit. Any viable solution will need to tinker with the real economies of the US and its trading partners, involving amounts which easily reach the multiple trillions of dollars. It is for this reason that a half-baked attempt, even a genuine one, will not suffice.

It is debatable whether the present proposal qualifies. As much chatter has taken place over the trade deficit, the real heart of Trumponomics is still a transfer from domestic consumers to domestic producers, via higher prices to match those of foreign producers—but businesses are just as prone to aggressive cost-cutting through Chinese imports as consumers. (Tariffs also produce deadweight loss, and there is no guarantee that domestic production will fill in the gap, on any time scale, despite the higher price level). The concurrent proposals for giant corporate tax cuts, not to mention cuts in funding for the IRS, make a mockery of any notion of fiscal conservatism.

There is also a massive question about the credit implications of 100-year bonds, which would be highly illiquid. (Importantly, some sources describe them as zero-coupon bonds, which would only pay out at maturity, sometime around 2125. This language does not appear in the original report, which also considers perpetual bonds with regular coupon payments as a possible alternative.) In the interest of ‘steelmanning,’ this analysis has entirely glossed over the difficulty of establishing fair pricing, which would not only involve negotiations between the US and its counterparties, but also credit rating agencies.

It is worth noting that housing is not the only area of production which could potentially impact cost structure. The proposal also places some emphasis on energy (carbon-based, of course), but fossil fuels do not play the same role in the economy they did during the 1970s oil crisis. Miran further uses the possibility of deregulation to elide the question of whether tariffs promote exports, rather than just substituting for imports, claiming that deregulation could counteract resulting currency appreciation (Table 2, p. 17). But why deregulation in that case only? If we can assume a trillion-dollar bill into existence sitting on the sidewalk, why not two or three?

It may also be worth questioning whether rebuttals regarding global imbalances are really needed, under the assumption that Trump’s sloppy execution will refute itself. Unfortunately, however, the slogan of “no pain, no gain” is so powerful that affirming the consequent will continue to be associated with social status until some alternative narrative takes hold. There is no problem with trade deficits in principle, but they are linked to the national debt and will need to be addressed at some point. A reconstituted version of liberalism will need grounded answers on these topics of existential importance. If we wish for more capital to flow into the “real economy,” we must prevent crowding out from housing, a distortion from which a myriad of more abstract downstream features of the US-led monetary system—and its challenge from global competitors—also follow.

Featured image is "Marine One at Mar-a-Lago," Official White House Photo by Joyce N. Boghosian, 2019. Inverted.