The boomerang of trade

Anyone up for a free lunch? Two United States Senators are. A new bill, from Tammy Baldwin (a Democrat from Wisconsin) and Josh Hawley (a Republican from Missouri), would mandate the country’s central bank to zero out the current account. In effect, the Federal Reserve would often have to ensure that exports equaled imports; that the amount that the US sells to other countries equals the amount that it buys from them. Congress has already charged the Fed with creating jobs and cutting prices.

The Fed is powerful but not omnipotent: It cannot satisfy all three mandates. Suppose, for example, that the world economy slows down. US exports would fall, pulling down US income and spending. Under the trade policies that the US now has, this need not be a calamity, because the exchange rate can adjust: The demand for the US dollar would tumble, so its exchange rate would weaken. A euro could buy more bucks than before. This would lower the euro price of US exports, so Europeans would buy more autos from Detroit. US income would rise again. The auto exports would offset the loss in US exports that was due to stagnation of the world economy.

But under the new Senate bill, the global slowdown could imperil the Yanks, because the bill effectively requires the Fed to set the exchange rate at the level where exports equal imports. As the US began selling more cars to the Spanish, its balance of trade would rise; that is, exports would increase relative to imports. But the Senate bill wouldn’t permit this for long.  It would require the Fed to strengthen the dollar, in terms of euros, so that the balance of trade would go back to zero, where exports equal imports. This would have a nasty consequence: To boost the euro value of the dollar, the Fed would reduce the supply of bucks. This would leave Americans with fewer dollars to spend, so spending would drop. US production would fall again, on top of the reduction that was due to the global slowdown. In short, the commandment to zero out the current account would make matters worse, at least in the short run.

Beat the heat

“No problem!” the senators might say. “We’ll just rewrite the bill to permit trade surpluses and prohibit trade deficits!” Suppose that they do. Now consider a global boom. World income would ascend, raising world demand for American exports. If the US economy is already running on all cylinders, then it won’t be able to produce much more for long. Workers will demand pay for overtime, which will raise production costs and prices. Inflation will rear its dastardly head.

If exchange rates can change easily, then the overheating of the Yankee economy will be temporary. The global boom increases the demand for the US dollar, so it would buy more euros than before. The euro price of auto exports from Detroit would go up, so the Spanish would buy fewer Chevys. In general, the reduction in US exports that was due to the stronger dollar would offset the rise that was due to the global boom. US output would drop back to the level that it could sustain, and US prices would no longer rise.

But the Senate bill would give us a different story. As the dollar strengthened under the global  boom, the Fed would perforce weaken it again by creating more bucks. Americans would try to spend them, heating the economy even more. Inflation could get out of hand.

One implication of the Senate bill for Kazakhstan is that the Fed would determine the tenge’s exchange rate.  The National Bank of Kazakhstan would no longer be free to stimulate the Kazakhstani economy by increasing the number of tenge that trade for a dollar.  The boomerang of trade could harvest a few unwary heads in Nur-Sultan and Almaty.--Leon Taylor, tayloralmaty@gmail.com

  

Reference

David J. Lynch. Senators pursue foreign investor tax, saying goal is competitive U.S. dollar. The Washington Post. July 31, 2019. Online.