India is one of the countries that Trump has threatened in case it moves ahead with using currencies other than the US dollar for its international trade.
Is there any method to this madness? One place to look for an answer is a book written by Robert Lighthizer in 2023 that I came across in the weekly newsletter by investment firm Marcellus.
Lighthizer was the US trade representative during the first Trump administration. He outlines four principles for US trade policy.
First, the US should not let its geopolitical adversaries benefit from easy access to its huge domestic market.
Second, access to this US market should be used as leverage in trade negotiations.
Third, trade policy should be actively used as a tool to make the kind of US economy that its government wants.
Fourth, the US government should act unilaterally when needed rather than bother about the niceties of the multilateral trading system.
In his first stint in the White House, Trump had ratcheted up tariffs on Chinese goods in March 2018. These tariffs, in tandem with tighter monetary policy by the US Federal Reserve, had driven a powerful rally in the US dollar against other currencies, which lost ground to the greenback
The Indian rupee too declined in value against the US dollar, while the Reserve Bank of India used around $30 billion of its reserves to defend the local currency.
Neither was a catastrophic event, but what happened back then should be kept in mind in case the US uses tariffs more aggressively in the months ahead. The rupee has already depreciated against the US dollar in the second half of this year.
It is likely that higher tariffs will stoke goods inflation in the US, at least till domestic supply chains are built. The Federal Reserve may then have to increase interest rates to fight rising prices, which can, as in 2018, again put many currencies around the world under pressure as international capital is sucked into the US.
There is thus a good chance that the effect of higher tariffs will be neutralized to some extent by a stronger US dollar that makes imports relatively cheap, which in turn could trigger a US campaign against other countries for manipulating their currencies to protect their competitiveness.
In other words, US tariffs will have consequences not just for trade policy, but also affect how India manages its external financial account. It is a slippery slope.
The drama on trade, tariffs and currencies is usually played under a spotlight. It quickly becomes a talking point. What is less evident is the underlying issue of economic imbalances.
The US can reduce its aggregate trade deficit with the rest of the world only if it saves more, while China can reduce its structural trade surplus through higher domestic consumer demand. These two parallel shifts will involve changes in the underlying economic models, not something that can be done overnight.
It is also likely that the job for China is even more difficult than it is for the US, given that suppression of domestic consumer demand to maximize savings, investments and exports has been the pillar of the Chinese economic model for at least the past three decades.
The slow pace of adjustment could mean a battle of retaliatory tariff moves by the two largest economies in the world, which is not good news for other countries.
Trump also wants to protect the position of the US dollar as the global reserve currency even as he wishes to cut the size of the US trade deficit. This is an impossible balancing act.
The American economist Robert Triffin had pointed out way back in the 1950s that the US would have to maintain global liquidity by supplying dollars to the rest of the world via trade deficits, or when its payments to other countries was higher than what it earned from other countries.
In other words, US trade deficits were needed to ensure that the rest of the world had enough dollars for its international trade as well as foreign exchange reserves.
Triffin pointed this out in the early days of the Bretton Woods system that was based on fixed exchange rates as well as a promise by the US to exchange dollars for gold if any country needed to.
The old Bretton Woods system collapsed more than 50 years ago. Exchange rates are no longer fixed. Capital flows with greater ease between countries. The convertibility of US dollars into gold is history.
Yet, the underlying logic of the Triffin Dilemma still holds. So the flip side of a sharp decline in the US trade deficit in the coming years—assuming Trump succeeds on this front—could lead to a shrinking pool of global liquidity.
That in itself will have profound consequences for other countries, including India. The strategic quest to reduce dependence on China makes sense for the US, but the nature of the transition could lead to unforeseen global shocks.
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