One of the main reasons cited by the US administration for introducing a new tariff regime is the intention of re-industrialising the US. In this column we discuss the premises of this approach, and its likely implications.
As we discussed in our recent analysis on “Neo–Imperialism” (which will be complemented by our upcoming research), the intellectual premise behind the US administration’s actions is that the world is going to be divided into spheres of influence, with China exerting its influence over South-East Asia, Central Asia, Eastern Europe and Africa, the US projecting its power over North and Central America, Western Europe, Australia, New Zealand and Japan, and South America and the Middle East being left as contended areas. The US would “seal” its North American borders by re-taking control of the Panama Canal (to the South) and increasing its grip over Greenland and Canada (“one way or another”) to the North, so as to face Russia/China directly over the Arctic.
These spheres of influence would naturally compete and co-exist at the same time, and will try to prevail over the other. The elements over which this competition will be based will be the usual three components of the production function, i.e. labour, capital and total factor productivity, which can be translated into population, industrial production and technological superiority.
The US knows that given the current borders of the spheres of influence, the US and its allies cannot compete on population size, even if all Latin America and the Middle East ended up siding with the Americans. China’s BRI already includes 75% of the world’s population. On tech, the US believes that it enjoys a position of superiority, which can be challenged by China but not reversed. Hence industrial production may be the field that decides who is going to prevail in the long run (as happened during WW2, when US and Soviet industrial capacity overwhelmed Germany’s and Japan’s). This could be read as the ultimate reason why the US wants to re-industrialise.
Even assuming that this strategic motivation holds, re-industrialising the US economy after years of de-industrialisation is easier said than done. To understand why this is, we need to return back to the US decision to abandon Bretton Woods, and its associated “gold standard”, in 1971. Together with the two oil shocks of the 1970s, that led to the high inflation of the 1970s and 1980s. What thenallowed inflation to be defeated?
First, there was the increased independence granted to central banks, which could raise interest rates to levels consistent with “breaking the back of inflation”, even at the cost of economic contraction (a trade off that politically-mandated central banks would not make). Second, the beginning of globalisation (which started with the trip of Nixon to China in 1972, as we have discussed before), which for the most part coincided with China becoming the manufacturing hub of the world. China could provide the West the goods it wanted at a fraction of the cost, and price, that could be provided by the so-called “most industrialised nations” of the G5 (and eventually G7). The off-shoring process that derived from this led to the structural dis-inflation of the 1990s-2000s, which has accompanied us until recently.
Lower inflation meant lower market rates, especially at the longer end of the yield curve. This has incentivised the issuance of public and private debt, which has reached record high levels during peacetime. The ability to finance debt at low rates pushed up the market capitalisation (and valuation) of companies and incentivised private consumption beyond domestic production, thus generating the massive current account (and public budget) deficits that Trump laments and ascribes to “evil foreigners exploiting the US.”
Now, what Trump is suggesting is reversing the process: re-shore and re-industrialise the US, while reducing (de-jure or de-facto) the Federal Reserve’s independence. This would lead to higher (and possibly structurally high) inflation, which would destroy the real value of private and public debt and crash the market valuation of US corporates. Soon the various economic components of America (households, corporations, bond markets, policymakers and investors) will have to decide whether they are willing to pay this price to reach the ultimate goal of the administration.
