Trump Can Succeed On Trade By Ending Global Currency Manipulation

George Gilder
The Federalist
February 6, 2017
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World trade in goods and services has morphed into a gigantic manipulative carnival of currency trading. This needs to change.

Folks, we have a consensus here. Formidable thinkers such as Paul Krugman, Larry Summers, and David Stockman, some 370 economists including 19 Nobel Laureates, and editors at the Economist, Fortune, and Barron’s all believe that Donald Trump as president is a menace to world trade and prosperity.

President Trump has talked about 35 percent tariffs on foreign goods and an array of “border taxes,” such as the tariff with Mexico he proposed last week. He intends to name China a so-called “currency manipulator” on the basis of a mere bilateral trade gap. He’s denounced the North American Free Trade Agreement (NAFTA) and the omnibus Pacific Trade Treaty (PTT). He’s condemned China’s acceptance in the World Trade Organization (WTO—followed all this with a threat to withdraw from the WTO altogether.

In light of all this, you must concede that fear of a trade war is a plausible anxiety. It is held by Republicans, libertarians, and conservatives, as much as by Democrats, liberals, and socialists.

Our International Trading System Is Broken

As a free-trading supply sider, I long shared these fears. In my latest book, “The Scandal of Money,” I even quoted the view that anyone who holds that the Chinese are “currency manipulators” has the “economic understanding of a parakeet.” Since China has refused to float its currency freely in foreign exchange markets and mostly kept it pegged to the dollar — keeping the yuan roughly between 6 and 8 to the dollar for two decades with virtually no monthly moves over 1 percent — my view was that China was the opposite of a manipulator. During this period, the value of the dollar changed less in yuan than in virtually any other currency. If China is not a manipulator, so I imagined, manipulation of money provides no reason for caviling at the effects of free trade.

However, I was wrong. The global financial system is now wreaking chaos in the global economy. I now believe that the most promising strategic thrust of the Trump administration will be its confrontation of a sorely broken international trading system. World trade is no longer expanding for a reason, and Trump has put his finger on it. That reason is a combination of crazy quilt trade pacts, disguising wild and wooly monetary manipulation.

When individuals and companies in different countries trade with each other, the buyer of a good or service must first acquire the currency of the seller, which they can purchase in international currency markets. This business is dominated by large banks and governments, and is called foreign exchange trading, otherwise known as the “forex” market. But only a very small portion of currency trading is devoted to enabling trade in goods and services. More than 95 percent of it consists of speculative bets on the changing values of currencies.

Mass Currency Trading Destabilizes Free Trade

When you look at it closely, you realize that world trade in goods and services has been reduced to a relatively tiny and shrinking pretext for a gigantic manipulative carnival of currency trading. Total world trade in goods and services is less than two percent of trade in currencies. According to the latest figures from the Bank of International Settlements in Basel, Switzerland, foreign exchange trading is now some $5.1 trillion dollars a day — 25 times global GDP. Yet all this oceanic shuffling of monies produces currency values far more volatile and capricious than the transactions it is supposed to measure.

Dominated by 10 international banks that do 77 percent of the exchanges, currency trading is a speculative orgy that fails to correspond at all with relative productivities of workers, or comparative advantages between countries, or purchasing power parities between different markets.

The Japanese yen-US dollar exchange rate, for example, went from 80 yen to the dollar to some 300 yen and back without any remotely comparable change in the two economies. The Euro has risen and fallen more than 20 percent eight times over the last eight years. These currency shifts overwhelm the effects of changes in business or labor performance. A worker who lost a job because of the global economy might as well have been hit by lightning. No rhyme or reason explained it. What we call a crisis of trade is really a scandal of money.

NAFTA Illustrates the Dangers of Our Situation

For example, take the matter of NAFTA, repeatedly denounced as a “horrible deal” by candidate Trump. He was right. The problem was not its specific terms, however, but the preposterous movements of monetary values in its wake that rendered the entire agreement a capricious charade.

In the years after NAFTA went into effect in January 1994, the Mexican peso lost 87 percent of its value, dropping in dollar terms from nearly 35 cents to under a nickel. An abrupt decline came in December 1994 when the Mexican Central Bank devalued the peso by some 15 percent, and then in January 1995, when the peso was allowed to float. But amid the general downward trend, major shifts continued to occur over subsequent years, up and down. Meanwhile, under NAFTA, Mexican exports rose apace with the drop of the peso. While the peso dropped 5.8 fold, Mexican exports rose 6.6 fold.

No entrepreneurial creativity or worker efficiency or technological virtuosity could dent the overwhelming impact of the drastic relentless change in the unit of account. It emitted—as Ross Perot put it—a “giant sucking sound” symbolizing a major reorganization of North American manufacturing. Yet the entire costly and tempestuous change was mostly an effect of monetary speculation.

How Can We Fix the Broken System?

In the face of this history, the Trump administration should show that it grasps the monetary roots of the disorders it cites. So long as central banks possess the power to change currency values virtually at will, free trade cannot be either fair or efficient. Free trade is incompatible with arbitrarily floating exchange rates. With the exchange market vastly larger than the real markets that it measures, currencies are an obese tail that wildly wags the dog of actual economic values. With money controlled by politicians in the guise of central bankers, it cannot serve as an objective measuring stick of commerce. As Friedrich Hayek put it, “the root and source of all monetary evil is the government’s monopoly on money.”

The chief alternative to floating currencies historically has been currencies fixed to gold. In the new century, digital currencies beyond the control of politicians may also play a key role, probably in conjunction with gold. The U.S. Constitution grants to neither Congress nor the president the right to demonetize gold and silver. Although not prohibiting paper currencies, the Constitution does not permit the government to establish a monopoly in them.

As a step toward restoration of this constitutional regime, a key early measure of the Trump administration should be an executive order requiring equal treatment of gold, silver, and dollars as money as the Constitution provides. This does not mean the replacement of the dollar, which is itself by far the most powerful and ascendant global currency. It does not mean ending the Federal Reserve and its venerable role as a lender of last resort in crises. It means that government agencies shall give equal treatment to statements of account or payments expressed in ounces or grams of gold or silver. It means that tax authorities should not punitively treat transactions in gold or digital currencies as capital gains events. The executive order could open a new constitutional path for innovation in finance.

Trump’s Team Should Remove Barriers to Trade

Not only might such a measure provide a barrier to future monetary manipulation, it also is crucial to the advance of many new innovations in digital money that link it to gold. The Internet is a global network that operates across borders as a matter of course; its software stack needs a transactions layer based on a global currency. Taxing the use of Internet currencies artificially disables them. The Trump administration should remove the obstacles to the establishment of money beyond the control of central banks.

This short-term restoration of the rules of constitutional money should be combined with a strategic plan for monetary reform throughout the world economy. Far from an obstacle to good economic and political relations with our trading partners, Trump’s stance against arbitrary currency manipulation and Byzantine trade deals provides the opportunity for a new strategic initiative to put the world economy back on track with real money.

We Need A New Bretton Woods Agreement

Rather than conducting a trade war with China, Russia, Japan and Europe, the U.S. can launch a new monetary conference to bring them all into a new monetary regime. Modeled on the Bretton Woods Agreement in 1944 for a post-war dollar standard disciplined by a tie to gold, such a new initiative could rescue the global environment from a trend toward economic conflict to a path toward monetary cooperation and reconciliation.

Bretton Woods remained in effect from 1946 to 1971, and provided for the best 25-year period of global economic growth in history: 2.5 percent a year. It broke down in 1971 because of a failure to adapt to the effects of inflation through the Korean and Vietnam Wars that falsified the $35 gold price.

The chief of the Chinese Central Bank has already called for global money linked to gold. And Russia, as a source of gold, is also amenable to movement toward a new gold standard.

The Trading Industry Needs to Face Real Competition

This agreement would forestall one of the most serious perils faced by the U.S. economy, as Trump lowers tax rates and removes regulations that deter companies from repatriating as much as $2 trillion of foreign profits. Although many advocates of a link to gold stress its limit on inflation, a fixed currency equally prevents deflation, or the rise in currency values. Any such massive movement of money from overseas will necessarily exert an upward pressure on the dollar.

The result will be to increase the trade deficit and exert further pressure on U.S. manufacturing exporters. The best way to obviate both inflation and deflation is a global agreement to tie currencies to gold in the spirit of Bretton Woods.

Recognition that free trade and floating currencies are incompatible will not come easily—not to an economic profession that sees foreign exchange as an expression of virtually perfect competition. The Trump administration should test this economic dogma by making this $5.1 trillion-dollar-a-day industry face competition from the fixed exchange rates that throughout history have accompanied the eras of most impressive economic progress and prosperity.

George Gilder is Chairman of George Gilder Fund Management, LLC, Senior Fellow at Discovery Institute, and the former Editor in Chief of the Gilder Technology Report. He has written several books, and is a contributing editor of Forbes magazine and a frequent writer for The Economist, The American Spectator, the Harvard Business Review, The Wall Street Journal, and other publications.