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Financial advisors. Our service, AssetCamp, helps you confidently explain the current market and your portfolio decisions to your clients. With AssetCamp, elevate your expertise with stock and bond valuation tools, improve your planning by modeling expected stock and bond market returns, and strengthen messaging on financial markets with monthly strategy briefs for you and your clients. One advisor said I love it. AssetCamp puts easy to understand data at my fingertips that would have required hours of searching and several paid subscriptions. Experience it yourself with a seven day free trial at assetcamp.com that's a s s e-t c a m p.com welcome to Money for the Rest of Us, this is a personal finance show on money, how it works, how to invest it and how to live with without worrying about it. I'm your host David Stein. Today is episode 515. It's titled Tariffs and the Mar A Lago Accord. What Trump Really Wants it's been a rough year for US stocks. They're down about 5% year to date while global stocks have gained almost 9%. Non US stocks have outperformed the US market but by 14 percentage points year to date. Now back in early February when I was writing the monthly investment strategy report we do for PLUS members and assetcamp subscribers, I mentioned there was a lot of complacency in the markets. The VIX Volatility Index, which is a measure of fear. This is the implied volatility priced into US S&P570 stock options in early February was at 15 and a half. Today it's up to 28.7. The incremental yield or spread that investors demand on junk bonds, non investment grade bonds in the US in early February was 2.6% near its all time low. Now it's a half a percent higher spread of 3.1%. This morning President Trump announced online that he would increase the planned 25% tariff rate on steel, steel and aluminum coming from Canada to 50%. Trump said that was in retaliation to the export tax that Canada placed on electricity flowing into the U.S. there is more concern regarding a potential U.S. recession on Fox News on Sunday, President Trump was interviewed and they asked him whether there was a risk of a recession this year and he replied, I hate to predict things like that. There is a period of transition because what we're doing is very big. In his State of the Union address he said that there would be an adjustment period. Now some of the major investment banks have increased their probabilities of a recession. JP Morgan Chase says a US recession 40% probability in 2025 that's up from a 30% probability at the beginning of the year. Economist at Goldman Sachs raised their 12 month recession probability to 20%, up from 15% when we looked at leading economic indicators in our most recent investment strategy report. The risk of a recession is still low globally and in the US but it is increasing and will increase if the US Stock market continues to sell off. The new prime minister in Canada, Mark Carney said in his victory speech, america is not Canada and Canada never ever will be part of America in any way, shape or form. We didn't ask for this fight, but Canadians are always ready when someone else drops the gloves. So Americans should make no mistake in trade, as in hockey, Canada will win. There's a lot going on in financial markets right now, so I spent some time this week researching what some of the Trump administration's economic advisers have said to better understand what the game plan is. Is there an underlying economic philosophy that is driving what can at times seem seem like capricious decisions? We're going to levy tariffs, we're going to take them off. We're going to delay the tariffs a month. I found two interesting pieces that I'll link to in the show notes that shed some light on how Trump views tariffs and their overall aim when it trade the US Dollar and the global economic order. The first is a fireside chat with U.S. treasury Secretary Scott Besant. This is from last October before the election and it's from Simplify's entering the fall Thought Leadership series. Second piece is a lengthy white paper by Stephen Moran. He's President Trump's nominee for chairman of the Council of Economic Advisors. The Council of Economic Advisers advises the president on macroeconomic matters. There's a chair and there's two other members. The white paper is titled A User's Guide to Restructuring the Global Trading System. What we have to keep in mind when it comes to trade and President Trump is he views tariffs as a negotiating tool to achieve both economic and national security aims. Scott Moran wrote, president Trump views tariffs as generating negotiating leverage for making deals. Bessen alluded to a process of escalating tariffs in order to de escalate them. The idea of putting tariffs on in order to get rid of all the tariffs. And Bessen in looking at how he views tariffs or considers the Trump administration viewing it now now he's a part of the Trump administration so presumably these are his views. Is countries can be put into different boxes, be the green box for those that have the most favorable treatment and red less favorable. What are they judging it on, he said. Shared values, shared economy, shared defense, shared currency goals. In other words, if a nation is more aligned with US Interest, tariffs could be lower. But what is the goal? What are they trying to accomplish? From what I can see, one of the main goals is a weaker US dollar so that US Manufacturing is more competitive. Moran wrote. A robust and well diversified manufacturing sector is of renewed necessity. If you have no supply chains with which to produce weapons and defense systems, you have no national security. As President Trump argued, if you don't have steel, you don't have a country. The administration, from what I can see, believes that the US Dollar is too strong. Moran wrote. The root of the economic imbalances lies in the persistent dollar overvaluation that prevents the balancing of international trade. And this overvaluation is driven by inelastic demand for reserve assets. In other words, there's such demand to invest in in the US and hold US dollars that pushes up the value of the dollar relative to other currencies. And the strong dollar makes US exports more expensive and imports into the US cheaper. And that hurts US manufacturers. The US Is a reserve currency and the dollar it is used foremost coming out of World War II as part of the Bretton woods currency Accord, where the US was essentially willing to help out the world. It had the strongest economy and the dollar would be the world's reserve asset and the US Would help finance the recovery coming out of World War II. For the decades following World War II, as a reserve currency, other central banks could exchange US dollars that they aggregated and exchange it with the US central bank for gold. There was a fixed exchange rate between US dollar and gold. One ounce of gold was worth $35 and the dollar was exchangeable into gold. Up until 1971 when the Nixon administration closed the gold window and central banks could no longer exchange dollars for gold because there were too many dollars and the price of gold and dollars kept going up and up. And then in 1973, the US started allowing the US DOL weight in value relative to other currencies. And that's it is the regime we've been in floating currency exchange rates for most currencies. Some currencies are still pegged to the US Dollar, but the US is still the reserve currency. Because much of global trade occurs in the US Dollar, the bulk of central bank reserves outside of the US 60% are held in the US dollar. Much of foreign borrowing is done in the US dollars, including emerging market countries. Economist Paul Krugman says once a currency has established global dominance, that Very dominance tends to become self perpetuating. Making transactions in dollars is easier and cheaper because so many other people are using dollars. Borrowing dollars tends to be cheaper because a lot of the world trade is invoiced in dollars. And the low cost of financing encourages dollar invoicing. And so it's this perpetual cycle. The US has the deepest financial market in the world, so it's easier to trade dollar assets. There's demand to invest and own US Dollars. And how do investors and companies and governments get access to U.S. dollars? Those outside of the U.S. the U.S. runs a trade deficit, the current account deficit. In order to get dollars outside of the U.S. the U.S. has to buy more goods and services from overseas than it sells to them. So dollars flow out of the U.S. u.S. Has a capital surplus, which means more capital flows in to the US to invest in the country to buy government debt. And the flip side of that, the mirror image is a current account deficit, that's a trade deficit plus some additional elements that are included in that. But most of the current account consists of trade and goods and services. Sometimes having that reserve asset is called an exorbitant privilege because due to the strong demand for US dollar assets, interest rates in the US Are lower than they would be otherwise. And given the depth of the financial markets, US Government can can issue more debt than it would be otherwise without impacting interest rates. Because of this capital account surplus, this desire to invest in the US And US Households and businesses. Because the US Is running a trade deficit, the private sector is spending more buying goods and services than income that's coming in from selling goods and services overseas. The savings rate in the US Is lower than it is in other countries. And so capital is coming here to invest. There was a podcast episode that I'll link to where Paul Diggle, chief economist, and Luke Bartholomew, Deputy chief Economist at Aberdeen, they're an investment big global investment firm, they said it's important to note that the strong demand for U.S. assets keeps the dollar elevated. And that strong dollar squeezes US exports and encourages imports. And in that sense, you can think of it as creating the current account deficit, which is the natural necessary mirror image of the capital account surplus that comes from being the reserve issuer. And in particular it's the manufacturing sector that tends to suffer the most from that strong dollar. It's the most trade exposed part of the economy. And they point out then that when there's an economic weakness or a recession, it's US Manufacturing that's hit the most because that's when there's a flight to quality, the dollar strengthens and US manufacturing base becomes even less competitive on a price basis. Now there are other benefits to being the reserve currency. Moran refers to it as financial extraterritoriality. He says the reserve asset, the US dollar, is the lifeblood of the global trade and financial system, and it means that whoever controls the reserve asset and currency can exert some level of control on trade and financial transactions. The US can apply sanctions against other countries and businesses, freeze them out of the SWIFT system, the system used for transferring currency flows, and it can use that power to exert pressure on countries to achieve the US's foreign policy aims. This financial reserve asset gives the US power when it comes to geopolitical issues. Before we continue, let me pause and share some words from this week's sponsors. Deleteme makes it easy, quick and safe to remove your personal data online at a time when surveillance and data breaches are common enough to make everyone vulnerable. I've been using Deleteme for over a year and it does all the hard work of wiping you and your family's personal information from data brokers websites. Here's the process that you go through. It's what I went through. You just sign up and provide Deleteme with exactly what information you want deleted. Delete and their experts take it from there and they send regular personalized privacy reports. 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Special Offer for Money for the rest of us listeners get 20% off your first month of membership at Strawberry Me. David now here's the problem that Moran and Bessen and others see with the US having been the reserve currency for decades, the US GDP, the size of its economy as a percent of global GDP, has shrunk. Back in the 60s, it was 40% of global output. The value in dollars of what is produced now. For the past decade or so it's been around 26%, Moran writes. As the United States shrinks relative to global gdp, the current account or fiscal deficit it must run to fund global trade and savings pools grows larger as a share of the domestic economy, Moran says. Not only does the US have to run a trade deficit, but it also runs a budget deficit, which means the government spends more than it takes it in tax revenue and that, and it finances that through government bonds. But these deficits get larger as a percent of the global economy. The burden it continues. Therefore, as the rest of the world grows, the consequences for our own export sectors an overvalued dollar incentivizing imports becomes more difficult to bear and the pain inflicted on that portion of the economy increases, he Sundays. Eventually the US will get to a tipping point where the deficits get so large that investors start to get worried about potential default, the loss of the reserve asset. We can see that and we will see that if it happens in terms of higher interest rates and a wider term premium, the additional compensation investors demand for uncertainty. Moran finishes his thought saying, the paradox of being a reserve currency is that it leads to permanent twin deficits, budget deficit and a trade deficit, which in turn lead over time to an unsustainable accumulation of public and foreign debt that eventually undermines the safety and reserve currency status of such large debtor economy. That's what they're worried about and that's what they want to change now. In reading critiques of this paper, some have suggested, well, the number of individuals in the US involved in manufacturing. In other words, the manufacturing share of employment, it's down in the US but it's down in all areas around the world because manufacturers becoming more efficient, more productive, using more robotics. There are fewer people globally that are involved in manufacturing. And even if you see a graph of the dollar strengthening or weakening, the manufacturing share of employment has continued to fall. If we look at manufacturing as a percent of GDP in the US it was 13.2% in 2004, 20 years ago. Now it's 10.6%. But China's share, the share of manufacturing as a percent of GDP has also gone down.32% in 2004, 28% today. In fact, the percentage point drop is larger in China than it is in the US but it's still close to 28%. So much higher. Which is why Bessant says we're trying to make China rebalance China over manufactures and deprives its household sector. Households under consume. If you push them to rebalance, then that will lead to more US manufacturing. What Moran and others want is the US to be more competitive in high value manufacturing. They're not trying to reassure low value industries like textiles. They admit that Bangladesh will always have a competitive advantage when it comes to producing textiles. But there are other more complex manufacturing that they truly believe a weaker dollar will help in that being the reserve currency has hurt the competitiveness of US manufacturing. So even though manufacturing in terms of total employment has gone down around the world due to greater efficiencies, there's still the belief that the US can be more competitive if the dollar was weaker. And it needs to be more competitive for national security reasons to be producing things. And that's their belief that these deficits, budget deficit, the trade deficit need to be brought down. The dollar needs to be weaker. And the way that you do that is you reduce the trade deficit and you also reduce the capital surplus. Make the US less compelling to invest in fewer flows into the US because you need to shrink both because they're the mirror image. The trade deficit needs to decrease and the capital surplus needs to decrease. And they're using tariffs as the tool to help accomplish that. Moran says it's easier to imagine that after a series of punitive tariffs, trading partners like Europe and China become more receptive to some manner of currency accord in exchange for a reduction of tariffs. Using the tariffs to inflict pain on trading Partners in order to get them to take actions to strengthen their currency and lead to a weaker dollar so the US manufacturers become more competitive. Now, Moran refers to a currency accord. The Bretton woods was a currency cord. And these accords that are agreements regarding currencies and exchange rate and they usually name it wherever the accord was struck. So Bretton woods was in New Hampshire in 1985. There was the Plaza Accord in which the Reagan administration negotiated with UK Free France, Germany and Japan to strengthen their currencies and weaken the US dollar. Because US dollar had appreciated from 1980 to 1986 it appreciated 86%. The US dollar index Dixie was at 160.4. Now we're at 103.9. And the trade deficit as a percent of GDP in 1985 was 3%. So we had had that trade deficit. There was a budget deficit and a very strong dollar. And they worked together to weaken the dollar primarily by those countries raising their interest rates and reducing the spread between U.S. interest rates and the interest rates of the trading partners. Things are different today. Though the currency exchange markets were much smaller, it's much more difficult to impact currency rates. And one of the challenges to this is that tariffs typically lead to currency appreciation. For the country running the trade deficit, it doesn't weaken it. And that's what if we look at the tariffs placed in 2018, 2019 on China, tariffs between 10 and 50% and more than $300 billion of imports from China, the Chinese renminbi weakened and US dollars strengthened. And that offset the cost to US consumers and businesses of the tariffs because the dollar strengthened. And even though tariffs were applied, if they were added to the cost of goods because of the strengthening dollar, it helped to offset that. And there's a lot of disagreements about tariffs. In our strategy report we we talked about one of the big issues is how much of the tariffs will be absorbed by the exporter, how much will be passed on to the importer and how much will that importer pass on those higher costs to the consumer? Will this higher prices be a one time thing or will it continue to contribute to inflation? There's disagreement on that. I saw there's one study by an economics firm that believed full size pickup trucks in the US would be $9,000 higher if Trump administration moves forward with 25% tariffs on Mexico and Canada and now with 50% tariffs on perhaps Canadian steel. Now what is the true impact of tariffs? How negative is it? I'll link to a blog post by the Federal Reserve bank of New York where they looked at the cost of those 2018, 2019 tariffs. And they said one of the costs you don't see that they captured was the stock market fell 11% during the days that tariffs were announced. And they tried to isolate that. Their analysis showed that it wasn't just fear, it was companies that were most impacted by the tariffs. Their stocks were revalued downward because their cash flows would be less, because having to pay more for inputs into what they sold or what they manufactured. And they felt that the negative welfare impact of tariffs as those tariffs placed against China 2018, 2019 was negative 3%. So their view was tariffs are negative. The Trump administration sees it as a negotiating tool. According to Bessant, they would like to not have any tariffs, but they want to accomplish their foreign policy and economic policy aims, which is a smaller trade deficit, a smaller capital surplus and a weaker dollar so that the US can be competitive in manufacturing because that will help its national security. How then if there's going to be a currency accord, Some have called it the Mar a Lago accord after the Trump resort property in Florida. How to get trading partners or even trading competitors, political competitors like China, to agree to strengthen their currencies to allow for the US dollar to weaken. They're using tariffs to sort of force them to do that. But the easiest way to do that is like they did in 1985, it's adjusting interest rates. US rates come down, other countries rates go up, but China doesn't want to raise their interest rates. Their economy is not booming. Europe the same way. Although Germany last week announced plans to majorly expand defense spending and infrastructure spending. And interest rates there went up almost a half a percent in a week to now they're 2.9% on the 10 year government bond. Back in 2021, it was almost negative and a half percent. And so we've seen the dollar weaken since it's high right before the Trump inauguration, It's down about 5%. But if we look at the levels that would really be needed for us to become more competitive for exports and manufacturing, we're talking a 30% depreciation in US dollars down back to where it was in 2011. And that could be accomplished by adjustments in interest rate. But that would be some type of multilateral agreement with Europe. But it doesn't just have to be interest rates. Moran suggested that the US's European partners could liquidate its bond holdings. It's government treasuries that it holds and sell dollars. So they sell dollars to buy their own currency that helps strengthen their currency. They, they own treasury bills now that the risk is, that impacts interest rates. And so he suggest that they could liquidate, liquidate their bond holdings, sell dollars, but they could only also with the remaining holdings, buy hundred year bonds that the US could issue or the military could issue. And the agreement would be buy these long term bonds in exchange for we continue to provide security to Europe. And so by forcing them to sell their short term bonds, sell dollars, buy their currency and buy these, these a hundred year bonds that will extend out the duration and hopefully keep us longer term interest rates down. And as part of that they would put in swap agreements with the Federal Reserve. So if a country needed to, to get access to cash, they could take that 100 year bond and use it as collateral and then borrow from the Federal Reserve. So that's one option force compel tariff countries to sell some of their shorter term treasury bonds and sell dollars. Another would be to apply a user fee to use the International Emergency Economic Powers act passed in 1977 and use that and start charging countries a fee for owning treasury bonds essentially as an interest rate cut, but to discourage them from buying debt. Now that's sort of a far out approach, but the whole idea is tariffs lead to a strengthening currency for the country trying to bring down its trade deficit. But at the same time the Trump administration wants a weaker dollar. So they're gonna have to use unorthodox methods. And there's risk to that. The biggest risk is the US stock market sells off as it is currently doing, and the dollar weakens as it's currently doing. And so there's a negative wealth impact where wealthier households and middle class households feel the pinch as their 401k balances go down. And so they get risk averse and start stop spending and the US enters into a recession. Then there's non US investors that have the double whammy of a falling US stocks and a huge amount of inflows for this capital surplus has gone into US stocks. So the stock market's falling and the US dollar is weakening, which means when those returns are translated into the euro or the yen, the returns are even lower. And so those investors start selling assets leading to even more downward pressure on stocks and upward pressure on interest rates. There could be outflows from U.S. investors as they tilt more toward investing overseas because valuations are cheaper and their currencies are strengthening and potentially their economy's doing better because those nations are trying to reduce their trade deficits. We could get an escalating trade war as we're seeing tit for tat, geopolitical conflicts, perhaps more inflation, reorganizing the financial order to try to maintain some of the power of the reserve currency, but also weakening the currency. That's not easy to do, which is why Besson said it's a 10 year project. They say they're gonna do it slowly, but there is risk to continuing the way it has been. And I agree there is risk to maintaining these huge deficits, a trade deficit and a budget deficit and the need to reduce them. It's just how much collateral damage there'll be as part of that process. Because this is something that has evolved over decades and it could take a decade for it to reverse. But Trump administration is trying to do it using tariffs as a negotiating tactic, but it is fraught with risk. We'll see how this evolves. We'll continue to monitor it, but that's what the Trump administration wants. Weaker dollar, smaller deficits, but also they still want the dollar to become a reserve currency. They just want. They sort of want it all and they feel like they're deserving for it all because they're providing security, military security for much of the world. We'll see how it goes. That's episode 5:15. Thanks for listening. You may be missing some of the best money for the Rest of Us Content Our weekly Insider's Guide email newsletter goes beyond what we cover in our podcast episodes and helps elevate your investment journey with information that works best in written and visual formats. With the Insider's Guide, you can discover investing in economic insights provided only to our newsletter subscribers. Unlock greater investing confidence with high value snippets from our premium products plus membership and asset cap. Further, connect with the money for the rest of Us team and community. 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