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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a senior associate of the Carnegie Endowment for International Peace
There has been justified concern this month that the chaos unleashed on financial markets around the world by the Trump administration’s “liberation day” tariffs may ultimately undermine the global credibility of the US dollar. But this should not divert attention from a more serious discussion about how the global role of the dollar affects the American economy.
Maintaining the dollar’s role as the dominant “safe” currency requires that the US economy accommodate what economist Dani Rodrik has characterised as an inherent contradiction between global integration and national sovereignty. He notes that countries that choose more global integration must relinquish control over their domestic economies, whereas countries that choose to retain domestic control must limit the extent to which their economies are open to trade and capital flows.
In a hyperglobalised world this creates trade tensions. It is one thing if all countries choose to give up the same degree of control over their domestic economies in favour of more globalisation. It is very different if some major economies choose to retain control over their domestic economies.
This is because in every country, internal and external economic imbalances must always align. When some nations restrict capital and trade flows to maintain favourable domestic conditions by controlling their external imbalances, they can in effect impose their internal imbalances on those of their trade partners who retain less control over their trade and capital accounts. The British economist Joan Robinson called these “beggar-my-neighbour” trade policies, and said they would ultimately lead to a rise in global trade conflict.
For instance, when a country suppresses domestic demand in order to subsidise its own manufacturing, in an open global trading environment the resulting trade surpluses might normally be reversed by market forces. But by restricting its trade and capital accounts and intervening in its currency, that country can prevent such an adjustment. In this case its manufacturing trade surplus must be absorbed by those of its partners who exert much less control over their trade and capital accounts. What is more, as its share of global manufacturing rises relative to its share of global demand, that of its more open trade partners must decline.
That’s why it is not just coincidence that the US, with its deep, flexible and well-governed financial markets has manufacturing shares of GDP well below the global average, unlike economies such as China’s with persistent surpluses, who have manufacturing shares well above the global average. Industrial policies aimed at restructuring more highly controlled domestic economies also in effect restructure the economies of their more open trade partners.
It is clear that Washington’s recent trade and capital policies have been erratic — on Wednesday President Donald Trump announced a 90-day pause in “reciprocal” tariffs on most countries with the exception of China. These policies are unlikely to be effective in addressing the causes of US economic imbalances and leave the door open to increases in other, non-tariff forms of industrial subsidies.
But recognising the flaws in these policies should not mean dismissing the structural problems they seek to address. The fact remains that global economic imbalances are real. The challenge is not whether the US should act to correct these imbalances, but rather how it should do so in a way that is both effective and sustainable. The best solution lies in a more co-ordinated approach to global economic governance, perhaps in the formation of a new customs union along the lines proposed by Keynes in 1944. To join, countries must recognise the external consequences of their policies and must take steps to keep domestic demand and domestic supply in overall balance.
However if the world is unable to come to such an agreement, the US is justified in acting unilaterally to reverse its role in accommodating policy distortions abroad, as it is doing now. The most effective way is likely to be by imposing controls on the US capital account that limit the ability of surplus countries to balance their surpluses by acquiring US assets. While this may at first seem to go against current US policy under Trump, who wants to increase foreign direct investment, if done correctly capital controls would in fact have little effect on direct investment. A less effective way is through controls on the US trade account, with bilateral tariffs an especially clumsy way of addressing the root causes of trade imbalances.
The dominance of the dollar in global trade and finance has long been assumed to be a net benefit for the American economy, but this assumption is increasingly being challenged. While it benefits Wall Street and global owners of moveable capital, these benefits come at a cost to American manufacturers and farmers.
In a world where some countries actively manage their external imbalances and others do not, the US dollar’s role as the primary safe currency has made America the chief enabler of global economic distortions. Addressing these imbalances requires a fundamental re-evaluation of the rules governing global trade and capital flows.
