The Case for More Aggressive Tariffs, Exchange Rates, and Monetary Policy

During President Donald Trump’s first term, economists wrongly predicted disastrous inflation from increased tariffs. Instead, inflation averaged just 1.9 percent while real wages rose. While inflation has increased significantly in recent years — with the Consumer Price Index now up nearly 20 percent — this has been driven largely by the Covid pandemic, supply-chain shortages caused by the Ukraine war and the fact that the United States produces fewer goods than it should.

As the presidential election approaches, opponents of tariffs are again warning of economic calamity if Trump’s proposals are implemented. A recent op-ed in The Hill by economist Nicholas Sargen is another example in a long line of wrongheaded predictions of worsening inflation if Trump is reelected.

Sargen seizes upon reports that Trump will seek more input in Federal Reserve decisions to achieve low interest rates and balance trade through tariffs and realigning the dollar exchange rate. While Trump has campaigned on increasing tariffs on the world and on China, he has not publicly endorsed the other proposals. His campaign has also clarified that no policy is considered official unless Trump personally signs off on it.

Nonetheless, the typical pro-free trade economic analysis has been wrong for years. The free trade view of buying cheap imports regardless of the impact on domestic employment and the industrial base is now being rightly rejected by both parties. Indeed, Nobel laureate Paul Samuelson argued that protectionism is beneficial for growth when an economy is operating at less than full capacity and that “tariffs can then reduce unemployment, can add to the [GDP], and increase the total of real wages earned.”

The U.S. economy is facing underutilization of capacity due to deindustrialization and underemployment. Tariffs and trade barriers are supply side, pro-growth policies. China, Japan, South Korea and other major countries utilized industrial strategy, exchange rate management and trade barriers to manage their rise to first-world status.

Contrary to predictions, Trump’s tariffs did not lead to inflation. IMF economists, including Alberto Cavallo, Gita Gopinath, Brent Neiman and Jenny Tang, found no detectable consumer inflation from these tariffs.

Mark Zandi, chief economist at Moody’s, attributes recent inflation primarily to supply shocks from the pandemic and the Ukraine war, not trade policies like tariffs. It is essential to distinguish between these temporary disruptions and the long-term benefits, including disinflationary impacts, of strengthening domestic productive capacity.

The Federal Reserve’s recent rate hikes also made the dollar more expensive, as a tsunami of global capital sought higher marginal returns by buying dollar financial assets, which continues to drive the dollar higher. A more expensive dollar means all goods, services and labor in the U.S. cost more to foreign buyers, and imports are even cheaper. This undermines America’s ability to reindustrialize for military supply or civilian production purposes.

Realigning the dollar exchange rate in a measured, sensible way could rebalance trade as well as produce significant economic growth. While Trump has not proposed doing so, the idea is not new.

In 1985, the Reagan administration, facing the biggest trade deficit and the strongest dollar in American history at the time, negotiated the Plaza Accord. This multilateral agreement with undervalued-currency countries — Japan, Great Britain, West Germany and France — drove their currencies substantially higher and the dollar substantially lower in a very short period of time. Within five years, U.S. trade was nearly balanced, employment increased — and no inflation resulted.

Recently, three IMF economists recommended that countries utilize exchange rate and capital flow management to improve their economies, including problematic trade imbalances, rather than being subject to the destabilizing effects of global speculative capital.

Conventional economists, wedded to their theoretical textbook views of the world, need to pay attention to major economies’ results in managing their exchange rates. The Japanese yen and Chinese yuan serve as an illustrative case. Both countries’ currencies have been very weak many times in past decades, and are especially so now. Both Japan and China are heavily dependent on imports — which weak currencies make more expensive — yet have experienced lower inflation rates compared to the U.S. This challenges the simplistic view that currency devaluation inherently leads to inflation.

While inflation must always be monitored, it should not be used as a reason to avoid using monetary policy to strengthen a nation’s production and employment base. Rather, it should be used sensibly along with other tools rather than avoided completely.

Economists that focus upon only the speculative negative consequences of trade, industrial and monetary policy have done this nation a great disservice. Policymakers who followed their ideological prescriptions brought on the China Shock and massive trade deficits, which harmed our national security and economically destabilized large swaths of middle America. Nobel Prize laureate Angus Deaton confessed in his recent book that he no longer supports unfettered free trade because of the devastation caused to American families, life expectancy and political contentiousness.

The next president should use every tool to rebuild America’s productivity, industrial base and middle class. And they should ignore the conventional economic textbook view that predicts calamity if those tools are used, especially because these predictions never come true.