The Wall Street Journal editors have made a monumental error of judgment. In their unsigned piece “Great Trump Tariff Rollback” (3/13/25) they announce that the Trump Administration has lost its trade war against Adam Smith.
The editors in unison with the US stock market are celebrating the administration’s pull back from its maximalist tariff applications. An essential condition, however, for Adam Smith to triumph ultimately, has not been fulfilled. This is for there to be free trade in capital as an accompaniment to free trade in goods. At very least that requires a roll-back of financial repression, exchange restrictions, and currency manipulation.
Further the Wall Street editors are mistaken to describe economic warriors in Washington as in a battle against Adam Smith. In fact the America First warriors and Adam Smith may yet find common cause against the foreign repressors and manipulators, most of all in China and the EU.
The importance of capital to the advancement of Adam Smith’s principles starts with the observation taught in economics 101 that trade balances are determined in a simultaneous process with net capital flows. If there is something sinister about the trade balance outcomes, then there is also something awry about the global flow of capital.
If America First warriors in the present global trade conflict were to focus on the capital culprits behind present the alleged malaises, they would choose surely China and the euro-zone as the areas of chief interest. The euro-zone and China are each in current account surplus by around $400bn. China’s goods trade surplus is at around $700bn. Chinese surpluses would be much larger if we guesstimated the camouflaging of capital exports in balance of payments statistics.
In themselves large current account surpluses are not indicative of malaise. They could be indicative of equally large underlying savings surpluses matched by deficits in other parts of the world and all consistent with the free play of uncorrupted invisible hands. This was indeed the case with huge British and French surpluses under the pre-1914 international gold standard. But then capital flow freedom and sound money meant that pattern was benign. Not so today.
In the case of China, there is systemic currency manipulation and severe obstruction in certain key channels of capital flow. State intervention in various forms influences heavily the power and composition of trade in assets. Given all this, we cannot say that the “invisible hands of the free market” are guiding simultaneous determination of trade and capital flow outcomes.
If Washington’s America First warriors were serious about working to roll-back the corruption of global goods trade they should have these capital matters very much within sight and devise strategy to deal with them. The America First trade warriors already have a well-rehearsed list of grievances as regards anti-competitive and interventionist practices in individual product markets, including tariff or non-tariff barriers to imports and artificial stimulants to exports. But action on these is no substitute for an overall strategy regarding capital flows.
A key problem here is that the cheapness of certain foreign currencies (such as the yuan or yen) stem in significant part from inflationary monetary policy frameworks which are broadly similar to that of the Federal Reserve. As the Chinese real estate bubble economy continues to burst, prices of goods and services should have fallen to a level well below that of the boom years. In turn those present cheap prices would have stimulated households and businesses to bring forward spending in anticipation of higher prices later. Instead, the People’s Bank of China (PBOC) is aiming for an inflation target of “under 3 per cent” with monetary conditions correspondingly stimulative – meaning a cheap currency.
In principle, Washington could persuade Beijing to combat the market gaps which lie behind China’s giant savings surplus – matched by a surplus of capital exports and a current account surplus. Action could include the alleviation of financial repression. Evidence of this malaise includes the banking system full of loans to sponsored state entities whose projects would not pass a market test. Bank deposit rates are far below what would reign under competitive free market conditions, where competition would include the availability to Chinese savers of foreign financial instruments and intermediation.
Washington would also press for reforms in the pension industry such as to make this more efficient and responsive to customer needs. US negotiators would also demand the lifting of China’s exchange controls. Accordingly, Chinese citizens would have complete freedom to buy foreign assets of their choosing and foreigners would be free of restriction on their dealings in yuan, including borrowing this for whatever purpose. Exchange control freedom would most likely mean a big increase in foreign demand for yuan assets, an important offset to capital exports.
A principal form of capital export under the present regime is now the yuan carry trade. This has flourished such as to become a principal form of capital export from China. Near zero rates in China when coupled with present US money and bond rates at above 4% have driven a massive switch by Chinese businesses from dollar to yuan liabilities – in effect repaying dollar loans by borrowing in yuan. Personal capital outflows now include the high-pressure channels of crypto transactions alongside massive hoarding of gold.
In turning to the EU, any serious campaign led by Washington for freer trade – of course with the US particular interests at the forefront – would encounter some of the same issues as for China. The high overall savings surplus in the euro-zone, concentrated in Germany and Holland, has much of its source in financial repression and a the deeply ailing European Monetary System.
European financial institutions are full of weak assets – loans and bonds which have been built up in the context of multiple financing schemes with the European Central Bank (ECB). Conditions in the banking industry are far from competitive with cross-border offering of financial services restricted in important respects. Individuals confront an ultimate known unknown which threatens their financial survival unless they have built up buffer savings.
The known unknown is the timing and possible circumstances whereby Germany would walk away from the burdens of supporting the euro. The euro would collapse albeit that Germany and Holland could try to replace this with a reincarnated new hard money. Meanwhile the European monetary union remains endemically predisposed to currency manipulation. Its flaws mean high savings surplus, correspondingly large capital exports, and policy rates which are depressed - even into negative territory as between 2014-22.
Perversely, at present in financial markets, there are celebrations about the new coalition government in Germany having scrapped a constitutional limit on deficit financing alongside its drawing up a vast program of infrastructure and military spending. This means, according to the present bullish speculators on the euro and European equities, that the EU will cure the disease of economic sclerosis. Hence capital inflows should rise, and the savings surplus dwindle. This narrative is extraordinarily feeble.
The forsaking of fiscal discipline in Germany calls into question how well in the future that country can perform its key anchoring role in EMU. If German credit deteriorates, surely its implicit financial backing for EU institutions from the ECB down comes into question.
Suppose another sovereign debt or banking crisis were to emerge in the euro-zone. How could Berlin seriously come to the assistance of all without its own debt rating plunging – possibly amidst a deep political crisis as the right populist opposition (the AfD) gained further support. And there is no prospect of any US aid via the IMF as occurred under the Obama Administration during the 2010-12/13 crisis. Hence, we should expect the euro-zone savings surplus to rise not fall as a consequence of Germany’s pivot away from fiscal constitutionality.
Finally, also dubious, is the narrative about military spending as a boost to the euro and EU economy. The narrators and their excited listeners seem to believe that more guns and less butter are good for prosperity. Maybe that could be true for a member country whose arms industry becomes a huge exporter to the rest of the world – with guns sold for butter. But that is hardly in prospect here.
So how will Washington deal with this current EU situation – likely to feature a further build-up of euro-zone savings even considering widened fiscal deficits? (Yes - Ricardo effect still alive.) The short answer is not much. Instead, Washington’s America First warriors are likely to focus exclusively on trade in goods markets rather than opening a capital chapter. The negotiations will be around the key objectives of the EU removing its barriers to the import of US agricultural goods and autos.
