Trade Protectionism: A

Balancing Act
The more troublous the times, the worse does a laissez faire
system work- 1923, John Maynard Keynes
• J M Keynes was a classical economist who believed that taxes should be low, regulatory
interference minimal and that economic growth could be maximised only under a
regime of free trade.

This was until Great Britain went spiralling down in recession between WW I and WW II
• Due to Britain’s high fixed exchange rate (relative to gold)

• Today, global monetary system relies on a fiat dollar standard

• Makes sense to argue that current economic problems in US partly related to an exchange value-
which is too high for the US producers to be competitive.
In today’s economic sphere, can something like
free trade actually exist?
• In an era where price of stocks, interest rates and currencies are managed by central banks: ‘free
trade’ simply cannot exist.
Current Account + Capital Account = 0

Current Account = Net National Savings

• Capital inflows finance investments that inadequate US savings

can’t fund domestically.

• For the RoW, in the case of current account surplus- its net national
savings are positive- and these excess savings are invested in assets
from other countries like US Treasuries, African farmland etc.
Adding and comparing these components,

• Exports= Imports

• Capital Inflows= Capital Outflows

• World Savings = 0
But why the imbalance?

Since 1971, the fiat US dollar has become the world’s reserve currency.

US’s privilege of issuing this currency has allowed it to run a persistent trade deficit to
offset capital inflows

95% of currency-trading transactions are capital related rather than trade related-
Richard Koo, CEO, Nomura Research Institute
Thus, we end up with a large current account deficit and an ever-worsening gap as capital inflows
exceed capital outflows.

What can and should happen next?

• Currency devaluation- to boost exports- domestic employment-a step similar to what Britain had
to take in 1930s.

• Bilateral Trade Agreements-ineffective-as structural imbalances are global rather than bilateral- a
hassle to pass through the US Senate

• Border Adjustment Tax- easier to pass-would reduce consumption as a % of GDP- forcing upward
trends in national savings-thereby, reducing trade deficit

• Buying foreign government debt- a capital outflow for US- apart from improving the current
account deficit- would also lower exchange rate- leading to US exports being priced far more
competitively-further, this would not require Congressional approval-President will get to appoint
4/7 people in Federal Reserve Open Mkt Committee (FOMC)

• SDR instead of dollar as the reserve currency?