Why the dollar is depreciating today

In a previous post, I noted that, other things being equal, trade restrictions strengthen the dollar. A reader asks, why then is the dollar depreciating in the wake of the newly announced Trump tariffs?

The answer, I believe, is that other things are not equal. In particular, the policy has reduced investor confidence in the U.S. economy. That's also why the U.S. stock market is declining relative to stock markets abroad.

The WSJ explains the dollar depreciation as follows:

The dollar’s sharp falls after President Trump’s tariff announcement raises concerns about the risk of a broader confidence crisis, Deutsche Bank’s George Saravelos says in a note. “Developments since the start of the year make us worried about a broader undermining of confidence in the U.S. economic outlook and the medium-term desirability of dollar allocations.” This risks an unwinding of overweight positions in U.S. assets from countries that have exported capital to the U.S. over the past decade.

Are you feeling liberated yet?

I called it

Almost nine years ago, I wrote that I would not support Mr. Trump's candidacy:

Mr. Trump has not laid out a coherent economic worldview, but one recurrent theme is hostility to a free and open system of international trade. From my perspective as an economics policy wonk, that by itself is disqualifying.

And then there are issues of temperament. I am not a psychologist, so I cannot figure out what Mr. Trump's personal demons are. But he does not show the admirable disposition that I saw in previous presidents and presidential candidates I have had the honor to work for.

Sadly, today's announcement about tariffs makes clear that I was right. Welcome to the kakistocracy.

Two of the best international finance economists opine on Trump policy

• Maury Obstfeld
• Jeff Frankel

Might President Trump stumble onto a good policy?

I don't have much faith in the Trump administration's economic policy, but I see one small glimmer of hope. The president plans to announce his new tariff policy on April 2. So far, he has said two things about it. First, the goal is reciprocity. Second, he wants to treat a value-added tax, which most other nations have, as a tariff.

I don't buy either of these arguments. On reciprocity: Why should I shoot myself in the foot just because you shoot yourself in the foot? On the value-added tax, he is just wrong. A value-added tax is a consumption tax, not a trade restriction. (See here.)

But what if these two misguided arguments together lead Trump to propose a value-added tax? 

That would be great. The new tax could finance cuts in other, more distortionary taxes, reduce the budget deficit, or some combination of the two. I have written about the virtues of a value-added tax here and here. 

I know, I am probably engaged in wishful thinking.

America First?

 
From my Harvard colleague Oleg Itskhoki. (Click on image to enlarge.)

A new review of my favorite textbook

 Here or here.

Four good readings about Trump policy

• Andrés Rodríguez-Clare and Arnaud Costinot
• Clifford Winston
• Cliff Asness
• Larry Summers

Kevin Hassett forgets Econ 101

On ABC's This Week, I watched the following exchange in a discussion of President Trump's trade policies: 

HASSETT: Let's think about it just the way we would do it in Econ 101. If I buy a Mercedes, then it goes into consumption. 

KARL: Yes. 

HASSETT: So, you know, I – the, say, $100,000 for a Mercedes goes into consumption, but then it comes out of imports and so it has no effect on GDP. And a lot of times when we think about the welfare of Americans, we're thinking about GDP per the number of Americans, per capita. 

If you buy a Buick, then it goes into consumption, but it doesn't come out of imports. And so it goes into GDP. That's why – that’s what the “d” is, it’s domestic production. And so, if you want to increase the welfare of Americans, then it’s better to have the stuff produced here. And that’s a very, very simple fact that the president is pushing very hard.

No, Kevin, that's not the way we do it in Econ 101. What happens when Americans switch from buying German cars to buying American cars is that these consumers supply fewer dollars in the market for foreign-currency exchange. As a result, the dollar appreciates. That appreciation makes U.S. goods more expensive compared with foreign goods, reducing U.S. exports and raising other U.S. imports.

Trade restrictions do not increase GDP. Indeed, by interfering with the international marketplace and the forces of comparative advantage, they reduce productivity and thereby GDP.

Please, Kevin, stop invoking Econ 101 to support President Trump's trade policies. It misleads the public, and it insults those of us who have spent our lives teaching (and writing textbooks for) Econ 101.

I talk with Filippo Gaddo

From the Society of Professional Economists.

Do tariffs cause inflation?

There has been some debate between Trump critics and Trump defenders about whether tariffs cause inflation. Some defenders, including the Commerce Secretary Howard Lutnick, say that tariffs don't necessarily cause inflation. My view is that these defenders have a point, but not a good one.

Tariffs reduce productivity because they prevent the international marketplace from allocating resources to their best use. Lower productivity means lower real incomes. Lower real incomes could take the form of either (1) a higher price level for given nominal incomes or (2) lower nominal incomes for a given price level. Whether (1) or (2) occurs depends largely on monetary policy.

When Trump critics say that tariffs cause inflation, they are implicitly assuming case (1). That case may be the more likely one, but it is not necessarily the way things will play out. 

Bottom line: Trump critics should say that the tariffs will reduce American living standards (as well as living standards abroad) without invoking the word "inflation."

What I am reading

An intriguing new paper by John Cochrane picks up on a question that Ricardo Reis and I worked on long ago: Which models of the Phillips curve generate realistic dynamics? I have not yet processed all of what John has to say on the topic, but it seems like it might be a big step in the right direction.

Two Amazingly Stupid Ideas

It is hard to tell which is worse:

The Trump administration may exclude government spending from GDP

Trump calls for creation of a ‘crypto strategic reserve’

Bad as these ideas are, neither is as dangerous and morally bankrupt as cozying up to the autocratic war criminal who is trying to violently annex his neighbor.

A Crypto Fairy Tale

From the wise Owen Lamont.

A VAT is not a trade restriction

The Wall Street Journal reports a deeply troubling misunderstanding of economics among President Trump's advisers:

Trump’s team will likely target nations such as European Union members with value-added taxes, or VATs. The president’s trade advisers have long viewed VATs as an export subsidy because companies are given rebates when they export abroad. VATs “will be viewed as a tariff,” Trump said in the Oval Office.

Doug Irwin explains why this is nonsense:

Another fallacy is that other countries’ value-added taxes constitute discrimination against the U.S. Most European countries tax imported goods because they also levy taxes on domestic producers. In the end, VATs are taxes on consumption and don’t discriminate against imports. 

Summer Camp for Economic Theorists

My colleague Eric Maskin would like to draw your attention to this opportunity.

Principles of Trade Policy

The Wall Street Journal rightly calls the new Trump tariffs "the dumbest trade war in history." One positive side effect, however, is that they led me to stumble upon this old article by Doug Irwin, which I don't recall having previously seen. Though nearly 30 years old, Doug's piece is a great introduction to some of the most important ideas of international economics, which are especially relevant now. Highly recommended to anyone interested in a serious but nontechnical discussion of the key issues.

I talk with Michael Klein

On the Econofact podcast.

The Case for More H1B Visas

Apparently, there is an ongoing debate in Trumpworld about whether more H1B visas are a good thing. From an economic perspective, the answer is a clear yes.

From the standpoint of economic efficiency, allowing a highly skilled immigrant to work at a U.S. firm is, for standard reasons, beneficial. The transaction is voluntary, so both the employee and employer are better off.  And there are no obvious negative externalities (not counting, of course, pecuniary externalities). In addition, the U.S. government collects more revenue in the form of payroll and income taxes.

From the standpoint of economic equality, allowing a highly skilled immigrant is again beneficial. The relative wage of skilled versus unskilled workers depends on, among other things, the relative supply of the two types of worker. When highly skilled workers immigrate into the United States, the demand for less skilled workers rises. 

Think of technology firms that need both engineers and janitors. When the supply of engineers rises, the demand for janitors increases, leading to higher janitor wages.

So an increase in H1Bs visas not only expands economic liberty (arguably a good thing in itself) but also increases both efficiency and equality.

Score one for Vivek and Elon.

Update: A friend points out there may be significant positive externalities in form of new knowledge that highly skilled immigrants would produce. I agree. That strengthens the case.

A Great Podcast about the Great Economist Franco Modigliani

Not about his economics, but about his early life and escape from fascist Italy. Told by his grandson David Modigliani. I listened to it via Audible, but it's probably available at other outlets as well.