A hidden force threatens President-elect Donald Trump’s efforts to revitalize American manufacturing. No, it’s not congressional Republicans, though they’ve been openly skeptical of his call for trade restrictions. And it’s not defiant Democrats, whose influence in Washington is relatively weak.
It’s the almighty dollar, which is powerful enough to undermine even the best of protectionist intentions.
Try to boost the “Made in America” sector through tariffs and other trade restrictions and you risk a self-defeating chain reaction. Instead of helping homegrown manufacturers, US-made goods actually become more expensive and imported goods get ever cheaper.
The reason? Because the value of the dollar goes up.
This isn’t an ironclad law, and there is lots of room for debate over details, but the baseline idea is well established. Here’s an example of how it might work, using Trump’s favorite trade villain: China.
During the campaign, Trump decried China as a currency manipulator and an unscrupulous trading partner, threatening to retaliate with a tariff on Chinese imports of up to 45 percent. That’s a substantial slap, enough to profoundly disrupt the Chinese economy.
But imagine that you live in China, or you’re an investor who owns lots of Chinese currency. The minute you start to believe Trump’s plans to impose a punitive tariff, you’ll want to trade those Chinese yuan for something less risky — like yen, euros, or maybe even dollars.
Nor will you be alone. Investors everywhere will look to sell their yuan. And that will drive down the yuan’s value, because what’s true of physical goods is true of currencies too: Eager sellers means lower prices.
Now, when the value of China’s currency falls, so does the value of Chinese goods. Each US dollar suddenly buys more Chinese-made clothes, steel, toys — you name it. That gives Americans a new reason to buy stuff from China: It’s cheaper. No matter that the whole point of the original tariff was to boost the fortunes of US manufacturers.
Here’s the kicker: As the yuan drops in value, the dollar is likely to rise. And a stronger dollar is bad for US exporters, since it effectively raises the prices of their products overseas.
If these risks sounds too theoretical — the kind of thing you’re more likely to find in a textbook than in the real world — look at Mexico.
Since Trump’s election, the value of the Mexican peso has fallen to a record low, driven down by fear of coming trade restrictions and Trump’s high-profile efforts to keep US companies like Carrier from setting up shop across the southern border. Yet, perversely, that weak currency actually makes Mexican-made goods more affordable, compared with US-made products.
It’s possible to make too much of this trap. For one thing, there are other reasons to support a tariff regime. It raises much-needed money, which could be directed toward programs for displaced workers.
Also, there is some uncertainty about whether a wide tariff regime would be entirely self-defeating — or just mostly self-defeating. Maybe the dollar would rise somewhat, but not quite enough to offset the full effect.
In that case, an “America-first” trade policy might still provide some benefits for domestic manufacturers and American workers, but it’s hard to be precise, since we have so little historical guidance. Trade restrictions used to be common, but in that era most countries were still on the gold standard — which left little room for offsetting currency fluctuations.
Even allowing for this uncertainty, the takeaway is clear. If Trump wants to nurture US manufacturing with an America-first trade policy, he has to worry about something more than a costly trade war. He had better hope the dollar doesn’t rise too much as a result. Otherwise, all his efforts could be for naught.