Sean Rushton: Monetary Reform Would Rebalance Trade

Excerpt from the Wall Street Journal:
Contrary to claims coming from some trade hawks, America’s large and persistent trade deficit is not caused primarily by bad trade deals. The U.S. dollar’s status as the global reserve currency is at least as responsible as any free-trade agreement or unfair practices. High demand for dollars has tilted the playing field against American exporters and workers. Those arguing against tariffs—including Republicans courting blue-collar voters in the industrial Midwest—should be leading the charge for international monetary reform.

Before World War I the international gold standard amounted to an independent, relatively stable and universally accepted global currency. That system broke down during the interwar years. Then, at the Bretton Woods conference after World War II, the victorious Allies decided that the U.S. dollar, backed by gold, would be the international reserve currency to which exchange rates would be fixed. But this “gold exchange standard” was fatally flawed: The world’s need for dollar reserves soon outstripped America’s gold supply.In the 1950s and ’60s, the U.S. ran big trade deficits with its Cold War allies Japan and Germany, as they rebuilt their manufacturing bases and stockpiled dollars.
By the early 1970s, American policy makers were fed up. They severed the dollar’s link to gold and allowed the greenback’s value to float relative to other currencies, in the hope that it would depreciate and smoothly reduce the trade deficit.The opposite happened. No longer bound by fixed exchange rates and dollar convertibility, the U.S. government’s fiscal discipline broke down. Federal debt as a percentage of gross domestic product, which had been falling since the end of World War II, soon began rising steadily. As a matter of national income accounting, Johns Hopkins economist Steve Hanke has explained, a rising fiscal deficit means a rising trade deficit. The nearby chart shows how the U.S. trade balance dropped sharply into negative territory.
In the bedlam of floating exchange rates, demand for dollars soared. Many nations abhorred having their currencies—and thus their economies—jerked up and down because of decisions made by central bankers in the U.S. and other large economies. To defend against crises, especially at times of major U.S. monetary easing or depreciation, foreign governments stockpiled dollars. In 1973 the world held $500 billion in foreign-exchange reserves (in 2017 dollars); last year it was $11 trillion, a 22-fold increase. About two-thirds of total reserves are now denominated in dollars. Because of high global demand, the dollar’s international position is always stronger and U.S. interest rates are lower than they would be otherwise. This, in turn, means that America’s budget and trade deficits swell in tandem, while U.S. exports are costlier and imports are cheaper, regardless of trade practices.

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