TARIFFS: THE $`S ELEPHANT IN THE ROOM / MACLEOD FINANCE

Tariffs: The $’s elephant in the room 

Trump’s tariffs will backfire spectacularly. It might not resolve the trade deficit, driving up prices. MAGA? Certainly not — it will undermine the dollar instead

ALASDAIR MACLEOD

The twin deficit syndrome

Unless there is an increase in personal savings, a budget deficit feeds into a trade deficit. 

The mechanism is simple to explain.

A budget deficit results in an injection of extra credit into the economy, mostly in the form of direct (welfare) and indirect (wages and other subsidies) support for consumer spending. 

This is in addition to the wages and other income consumers enjoy from their own activities. 

And unless consumers increase their savings to allow for the extra government credit over and above its revenue income, it will be spent on consumption.

We must now refer to Say’s law. Jean-Baptiste Say was an early French economist who understood that through our division of labour we produce goods and services to consume. 

In other words, we use our individual skills to maximise our income, so that we can buy the things we need and choose. 

And because everyone else does the same, we all have access to goods and services which it would be silly for us to produce ourselves.

The relevance to twin deficits is simple. 

Because we all produce to consume, without 

the extra credit injection of a government deficit there will be a balance on our national trade. 

Undoubtedly, there will still be imports and exports, but because collectively we have to pay for our imports, we can only do that by exporting. 

Assuming there is no change in our savings rate, that there will be a balance on our trade must be true.

Now enters a government whose spending is greater than its revenue. 

It creates extra demand in the economy for goods over and above that of consumption without that extra demand. 

Again, we assume there is no change in our savings habits. 

Therefore, this demand can only be accommodated through higher prices, or by goods and services provided from elsewhere. Imports now exceed exports.

Under President Trump, the government’s budget deficit is increasing. 

A week ago, we learned that fiscal Q1’s deficit came in at $602bn. 

That’s an annual rate of $2.4 trillion. 

Meanwhile, due to Trump’s tariffs and unprecedented uncertainties as he keeps on moving the goal posts, the deficit shows signs of declining. 

According to analysts at KPMG, “The US trade deficit narrowed by a stunning 39.0% in October to $29.4 billion, the third month in a row of improvement, yielding the smallest trade deficit since June 2009.”

So where is the excess spending going? 

The FRED chart shows that the savings rate has been declining in recent months, so consumers aren’t saving. 

Therefore, it can only go into higher prices for consumer goods.

The fact that this cost-push inflation does not yet appear in government statistics is explained by the Cantillon effect. 

In the early 1700s, Richard Cantillon observed that price inflation lagged the injection of extra money and credit into an economy, benefiting the first receivers, then the next and so on before the dilution of spending power was fully reflected in prices. 

Therefore, not only is the persistence of inflation above target so far explained, but with a spendthrift president in charge of the US economy, the purchasing power of the dollar faces further dilution, probably accelerating in the coming months.

Trump’s mistake is to assume that raising tariffs is the solution to the trade deficit. 

To the extent that the policy succeeds, the purchasing power of the currency is undermined, unless US citizens decide to materially increase their savings, i.e., stop spending. 

The trade deficit is actually the president’s own making.

His other major error, which is only one among others, is to believe that competition from abroad for consumers’ dollars is unfair, and that tariffs are necessary to protect US manufacturing. 

That merely removes US manufacturers’ incentive to innovate and compete, slipping behind foreign manufacturers in terms of technology, quality, and price for goods that consumers prefer. 

A protected US industry will simply fall further behind international standards.

Summary and conclusion

Rising US consumer prices will be a nasty shock for later this year, due to Trump’s capricious tariff policies. 

The US trade deficit diminishing in recent months probably indicates less international demand for dollars, further undermining its value.

These factors are in addition to all the other factors increasingly undermining the fiat dollar’s credibility, risking its eventual collapse.