The Core Tradeoff

The persistent, price-inelastic demand for reserve assets gives the US the burden of an overvalued currency with only the gain of:

• modestly cheaper borrowing.
• geopolitical advantages of achieving core national security aims at minimal cost via financial extraterritoriality.

This overvaluation erodes the competitiveness of our export sector.

The tradeoff is thus between:

• export competitiveness and
• financial power projection.

Power projection is inextricable from the global security order which America underwrites.

• This is why the reserve status is intertwined with national security.

America provides a global defense shield to liberal democracies.

In exchange, America receives the benefits and burdens of reserve status.

This is why President Trump views other nations as taking advantage of America in both defense and trade simultaneously.*

The defense umbrella and our trade deficits are linked, through the currency.

In a Triffin world, this arrangement becomes more challenging as the United States shrinks as a share of global GDP and military might.

As the economic burdens on America grow with global GDP outpacing American GDP, America finds it more difficult to underwrite global security.*

• This is because the current account deficit grows and our ability to produce equipment becomes hollowed out.

The growing international deficit is a problem because of the increased strain it places on the American export sector and the socioeconomic problems that follow therefrom.

The bargain becomes less appealing in this context brings us to present, whereby there is growing consensus in America to change the relationship.

Reshaping the Global System

To change the status quo, there are:

• unilateral and multilateral approaches
• tariffs or currencies approaches

Unilateral solutions can lead to market volatility.

• These provide more flexibility to rapidly shift policy.

Multilateral solutions may create less volatility, but entail the difficulty of getting trading partners onboard.

• This curtails the potential gains from reshaping the system.

The U.S. dollar is the reserve asset because America provides:

• stability
• liquidity
• market depth
• rule of law.

These make America powerful enough to:

• project physical force worldwide and
• allow it to shape and defend the global international order.

The history of intertwinement between reserve currency status and national security is long.

In any possible reshaping of the global trading system, these linkages will become ever more explicit.

Both tariffs and currency policy are aimed at improving the competitiveness of American manufacturing, and thus increasing our industrial plant and allocating aggregate demand and jobs from the rest of the world stateside.

These policies are unlikely to result in significant reshoring of low-value-added industries like textiles, for which other countries—like Bangladesh—will retain comparative advantage despite significant swings in currency or tariff rates.

However, these policies can help preserve the American edge in high-value-added manufacturing, slow down and prevent further offshoring, and potentially increase negotiating leverage with which to procure agreements from other countries to open their markets to American exports or protect American intellectual property rights.

The Phase 1 trade deal with China in 2019 made advances in these domains, before China abdicated its commitments under that agreement.

Moreover, because many in the Trump camp see trade policy and national security as inextricably intertwined, many interventions will be targeted at industrial plant critical to security, to the extent they can.

National security will likely become ever more broadly conceived, for instance to include products like semiconductors and pharmaceuticals.

The dollar’s role weighs heavily on US manufacturing.

Yet President Trump has:

• emphasized the dollar’s status as the global reserve currency
• threatened to punish countries that move away from the dollar

I expect this tension to be resolved by policies that aim to preserve the status of the dollar, but improve burden sharing with our trading partners.

International trade policy will attempt to recapture some of the benefit our reserve provision conveys to trading partners and connect this economic burden sharing with defense burden sharing.

The Triffin effects have weighed on the manufacturing sector, there will be attempts to improve America’s position within the system without destroying the system.

No matter what policy is adopted, there is the risk of material adverse consequences for financial markets and the economy. However, there are steps the Administration can take to try to mitigate these consequences and make the policy changes as successful as possible.