A User's Guide to Restructuring the Global Trading System

Executive Summary

• President Trump's longstanding focus on reforming the global trading system to benefit American industry.
• Persistent overvaluation of the US dollar contributes to economic imbalances.
• Discusses tools for reshaping global trade and financial policy, focusing on tariffs and currency policy.
• Tariffs can be revenue-generating if offset by currency adjustments, affecting the tariffed nation's purchasing power.
• Currency policy adjustments offer different tradeoffs and need careful handling.
• Financial market consequences and sequencing of policy tools are explored.

Chapter 1: Introduction

• American dissatisfaction with international trade and financial systems has increased.
• Trump's re-election signals potential for overhauling these systems.
• Trump administration might raise tariffs significantly and alter dollar policy.
• Overvaluation of the dollar burdens American manufacturing and benefits financial sectors.
• The essay aims to analyze potential policies and their consequences, not advocate for them.

Chapter 2: Theoretical Underpinnings

The Roots of Economic Discontent Lie in the Dollar

• Overvalued dollar impacts competitiveness of U.S. exports and burdens manufacturing.
• Historical job losses due to trade, particularly with China, are significant.
• Security concerns with China and Russia necessitate a robust manufacturing sector.
• Dollar overvaluation contributes to trade imbalances and is tied to reserve currency status.

The Triffin World

• Demand for USD and USTs due to reserve status leads to currency overvaluation.
• Triffin dilemma: reserve currency status leads to deficits and currency overvaluation.
• The U.S. struggles with these burdens as its GDP share shrinks relative to global growth.

Economic Consequences

1. Cheaper Borrowing: U.S. benefits from lower yields due to reserve demand.
2. Richer Currency: Reserve demand raises the dollar, affecting trade balance.
3. Financial Extraterritoriality: USD reserve status allows U.S. to exert global financial control.

Reshaping the Global System

• Unilateral and multilateral approaches to reform.
• Tariffs and currency policies aim to boost American manufacturing competitiveness.
• Policies to maintain dollar reserve status while improving burden sharing.

Chapter 3: Tariffs

Tariffs and Currency Offset

• Tariffs can be noninflationary if offset by currency adjustments.
• 2018-2019 tariffs largely offset by currency depreciation, minimal inflation observed.

Inflation

• Tariffs impact on inflation depends on currency offset.
• Studies show mixed results on passthrough of tariffs to consumer prices.

Incidence, Revenue, and Trade Flows

• Currency offset affects who bears the tariff burden.
• Perfect offset leads to revenue generation without inflation, but can affect exports.

Tariff Implementation

• Graduated approach to tariff implementation to minimize market volatility.
• Tariff rates can vary based on trade and security criteria, aiming for better terms.

Chapter 4: Currencies

Currency Policy and Risks

• Adjustments to dollar value impact attractiveness of dollar assets.
• Risks include potential outflows from Treasury markets and higher long yields.

Multilateral Currency Approaches

• Multilateral agreements, like the proposed Mar-a-Lago Accord, could adjust currency levels.
• Coordination with trading partners can help manage financial consequences.

Unilateral Currency Approaches

• Trump administration could use IEEPA to influence currency values unilaterally.
• Reserve accumulation by selling dollars to buy foreign currency.
• Risks include financial market volatility and impacts on U.S. debt markets.

Chapter 5: Market and Volatility Considerations

• Trump's second term likely to focus on tariffs before currency policy.
• Tariffs as negotiating tools for better trade terms.
• Gradual and cautious approach to policy changes to minimize market disruptions.

Chapter 6: Conclusion

• Trump's potential policies could reshape the global trading system.
• Importance of planning and execution to minimize adverse consequences.
• Tariffs likely precede currency adjustments.
• Potential for dollar strength before any depreciation occurs.

References

• Extensive references to studies and economic theories discussed in the essay.

Disclosures

• Author's views do not represent Hudson Bay Capital's policies.
• Information is for educational purposes and not investment advice.