Chartbook 434 Back to the 1970s (again) - Trump and the balance of payments.

Trump loses in the Supreme Court. So what does he do? He invokes another law from the 1970s - this time it is the US Trade Act of 1974 rather than the International Emergency Economic Powers Act of 1977 - to impose new tariffs.

One could write an entire piece about the endless recycling of 1970s-era emergency legislation, which would take in the dark crisis rhetoric, the “American carnage” mentality in Mar-a-Lago and structural factors like the inability to pass new laws.

Anyway, this 1974 law seemingly gives the President the right to impose tariffs of up to 15 percent for up to 150 days under the so-called Sec 122. “Balance-of-Payments authority”.

I’m in the last three weeks with the book manuscript. Head down. Trying to focus. Saying no to things. But when economics, law and history intersect like this. Who can resist? And especially when the brilliant Brad Setser gets in on the action.

The question he asks in this brilliant thread, is does the US have a “balance of payments deficit” of the kind that would actually warrant action by Trump?

Now note, that Brad has chosen one of the three possible points of attack on Section 122. He singles out the question of the “balance of payments deficit”. But there is also reference in the law to “fundamental international payments problems” and an “international balance-of-payments disequilibrium”.

We will come back to this.

Brad singles out “bofp deficit” because it is actually an open question whether a modern economy can ever be said to be running a “bofp deficit”. The balance of payments is not the trade account, which can obviously be in surplus or deficit. It is not the current account which places the trade account alongside trade in services and flows of income from investments. The balance of payments combines all of those and sets them against capital account movements - both short and long-term flows of finance and funding.

One way of interpreting this is to say that the capital account “funds” the current account. A country pays for its trade deficits by taking up credits from abroad or attracting investments. But this is contentious because it could also be the other way around. Flows of credit on the capital account drive macroeconomic booms and busts that “suck in” imports or “force out” exports. Entire schools of macroeconomics hinge on this.

Don’t get hung up on that. The key point is that the balance of payments must, by definition, balance. It is a closed accounting system. 2+2=4.

So, in referring to a “balance-of-payments deficit”, is the 1974 law simply badly worded? In common parlance people do talk about a “balance of payments deficit”, when they actually mean a current account deficit or even, in Trump’s case, a trade deficit. Does the law simply reflect a common confusion? Or is there more to it than that?

History may help.

The law was written and passed in the early 1970s to help the US government manage the fallout from the collapse of the Bretton Woods fixed exchange rate system. And here is the thing. Under a gold-dollar-based fixed exchange rate system of the kind that prevailed until 1971-1973 under Bretton Woods, it was possible to talk meaningfully about the United States having a balance of payments deficit.

To talk of a bofp deficit meant that the balance of payments balanced (as it must by accounting identity), but only by virtue of large outflows on the “official reserves transactions balance” i.e. dollar reserves, which under Bretton Woods were the equivalent of gold. America’s reserve managers were balancing the nation’s books by paying in gold.

This is a great tweet from Phil Magness arguing strongly that the invocation of the 1974 law makes no sense because the balance of payments of the Bretton Woods era was different.

Note, that under the Bretton Woods system, the idea of a “balance of payments deficit” involved an interesting distinction between (1) private flows of trade and credit, (2) government flows in the course of ordinary hegemonic Cold War business, like “military expenditure” and “US government grants” and (3) balancing official reserve transfers. It was when (3) came into play, as it did in the early 1970s. that you had a balance of payments deficit.

Balancing by official reserves is convenient and it makes the accounting identity complete, but it is also a source of tension. In extremis, under a gold standard system you can “run out of reserves”, which then puts the entire Bretton Woods system in doubt. Which is why in official documents of the era you will find passages like this:

And why one might need a law to authorize emergency action in the event of a bofp deficit.

I don’t know enough about the politics behind the 1974 law to be able to confirm this. But folks at the time may even have imagined returning to a Bretton Woods style system one day. I rely on friends who are not under the gun as I am to tell us in detail about what was going on in Washington in 1974.

As Magness points out, the “balance of payments deficit” talk of the 1960s and 1970s is truly of that period. Unlike today it did not center on a huge trade deficit. For most of the Bretton Woods period the US ran trade surpluses.

So, a strong historicist reading would argue that the 1974 law really has no bearing on America’s current situation. Trump’s new round of tariffs should be challenged like the last lot were. We are not in the 1970s.

Furthermore, this whole problem is one of the reasons why monetarist advocates of floating rates like Milton Friedman long argued that Bretton Woods should be given up, as it was, by Nixon between 1971 and 1973. If you do, and comprehensively privatize international flows, then the issue of reserve movements and bofp deficits “disappears”. You cannot get yourself into the kind of pickle that the US faced in the early 1970s. Or at least, so they promised.

So the law that Trump is invoking sits on the cusp between two eras and the slippery concept of the “balance of payments deficit” marks the transition. And in a transition situation from closed economy to open, it is not unusual to have balance of payments difficulties mapped in the following terms.

This is from a San Francisco Fed presentation on “sudden stops”. See how the graphic on the right starts with “closed economy” followed by an “opening up”. The reserve depletion moment comes during the adjustment shock. The balance of payments balances throughout this story, but during the sudden stop phase it is stressed.

Deficit/surplus/balance is not the issue. Stress is.

That is not America’s situation today.

And, even in the 1970s, the situation was fast-moving and rhetoric outran reality. One might suspect that that is why the people framing the 1974 law also added in two other concepts which are not as logically problematic as the bofp deficit. They talk about "fundamental international payments problems” and bofp disequilibrium.

Now, Trumpites will no doubt be tempted to argue that the US clearly does have “fundamental problems with its international payments”. One may agree with the spirit of their claims or not. But whatever they mean is not in any reasonable sense what the 1974 law means by “Fundamental international payments problems”. In the context of the law, “fundamental international payments problems” means the risk of actually not being able to pay bills. That is not America’s problem. The US still issues the dominant currency. It pays its bills in dollars. It can “print” the dollars. We are in a fiat-dollar world.

And here is Gita Gopinath, until recently America’s #2 at the IMF, to make the point.

Cuba has “fundamental international payments problems”, the USA does not.

In the fevered minds of MAGA, the USA may be no more than one step away from relegation to third world status. And of course the USA is actually putting Cuba in a bind and in MAGA nightmares they may fear something similar one day being done to the USA. But that is not our actual reality.

So if defining a deficit is tricky and talking about payments problems is silly, what about “international balance-of-payments disequilibrium”?

If you were to advise the Trump side in any future litigation this is surely the route you would go down. It would not be hard to argue that the international balance of payments is out of equilibrium.

Surely this is how Brad Setser should be making his case.

His point would be unarguable if he shifted from deficit to disequilibrium which is also in the 1974 law.

But if we grant that the balance of payments is disequilibreated, then the next question is why? Is America’s deficit really an “international” one. Or is it a matter of national economic balance? Here comes Mark Sobel with four decades at the US Treasury to make the point:

This is going to be a fascinating argument to watch. And I do think it would be great to elaborate on the recurrent (not to say endless) return of the 1970s in US crisis discourse. Later this spring!

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