Check Your Exorbitant Privilege!

The MAGA embrace of Thelma and Louise Economics

In 1897, Rudyard Kipling wrote a poem titled Recessional for Queen Victoria’s Diamond Jubilee (her 60th anniversary on the throne), containing the line: “Far-called, our navies melt away; On dune and headland sinks the fire: Lo, all our pomp of yesterday Is one with Nineveh and Tyre!”. While a strangely defeatist mood for a sovereign’s celebration of her 60th year on the throne, it does strike a chord in today’s climate - where Trump’s tariff announcement of a 10% universal tariff and other duties resulting in an average effective tariff rate of over 20% saw back-to-back stock market crashes worse than any day since the COVID pandemic began. Coupled with DOGE’s large cuts to science, education, and research, and his attacks on traditional US allies like Canada and Europe, some have been describing it as the end of the American Century, and perhaps even the beginning of a Chinese one.

How does this square with Trump’s “Golden Age” rhetoric?

Critical Trade Theory

Basically all economists agree that tariffs would be extremely harmful to the US, and global, economy, resulting in a spike in prices, a substantial breakdown of supply chains, and depressed output and employment given the previous two as well as investment and consumption scalebacks amidst uncertainty. If you look at US GDP in the first quarter (before the “Liberation Day” tariffs), it shrank by 0.3% annualized, mostly as a result of a staggering increase in imports because people wanted to anticipate tariffs. Meanwhile, consumption and investment grew as much as previously, because people and companies stocked up on imported goods.

Trump’s hatred is particularly of trade deficits - in a bizarrely “woke” turn, he seems to believe that any trade imbalance is the result of some hidden discrimination. The idea that trade deficits are inherently bad is complete nonsense - fundamentally, what a country wants from trade are imports, things it can more effectively buy than produce. To quote Paul Krugman (whose Nobel Prize is in international economics), “Exports are not an objective in and of themselves: the need to export is a burden that a country must bear because its import suppliers are crass enough to demand payment”. The key idea here is that countries need to export only as a way to pay for imports - if a country didn’t benefit in some way from trade, then it wouldn’t import anything. The principle relevant here is comparative advantage, which I won’t harp on about too much (just go to the OG tariff post), but the general notion is that even if a country is better at everything, unless it’s equally better, it can on net gain by focusing more on what it’s more better at. So this means that the welfare gains to trade are really big!

So when weighed against this panorama, MAGA supporters of the more intellectual variety make a case about global financial imbalances, and specifically point to a report by Council of Economic Advisors Chair Stephen Miran¹, whose argument is (roughly) as follows: because all other countries use the US dollar for trade (that is, the dollar is the world’s reserve currency) and US Treasuries are the safest (reserve) asset, then the US will have a lot of foreign capital going into the economy, resulting in a stronger dollar and therefore less competitive exports. This means that the US will import more than if it wasn’t at the center of the global economy, which has hurt American manufacturing - and at the same time has benefitted the financial services sector. That is, Miran (and by extension Trump and the other wackjobs in DC) are concerned about the costs of the US’s “exorbitant privilege” (as described by French President Valery Giscard D’Estaing in the 1970s), the ability of the US to run big trade deficits because the dollar is the reserve currency of the world.

The macroeconomic effects of a trade deficit are pretty complicated, but in general, it’s understood that they depend on a lot of things. The actual thing to understand is the balance of payments, which has three parts: the current account (the trade balance in goods, the trade balance in services, wages/rent/interests, and remittances), the capital account (irrelevant), and the financial account (real and financial investment). The US runs a big trade deficit and, services and other payments nonwithstanding, therefore has a big current account deficit. Because the dollar is the reserve currency, this means that the US can’t have international reserves, and because you can’t devalue the dollar directly, therefore the current account deficit (assuming there’s no large imbalances in the services trade or in stuff like wage payments and remittances) is the mirror image of a financial account surplus - that is, the idea that a country is attracting more investment than it is leaving. The US having a big current account deficit, therefore, means that a lot of foreign lending is pouring into the United States, which means is that if demand for dollars is really strong, the dollar will become stronger and the trade deficit bigger because the US has more money to spend more than it otherwise could.

So it’s just not true that the problem is insufficient national savings to fund investment in manufacturing because of depressed wages - the US does have sufficient capital. In fact, it has more than enough capital: American savings rates are low precisely because foreign capital allows Americans to consume more than the US produces - or, put another way, the dollar being the reserve currency means that US consumers enjoy a superior standard of living than they would if the US actually did need to pay for all its imports with real goods or services. Of course, these imbalances can have severe macroeconomic consequences (more on this later). However, insisting on balance also has: countries that take the exports-first approach are China and Germany, which repress consumption and wages respectively in order to remain competitive in global manufacturing - and both of them have had substantial economic slowdowns in the post-COVID era precisely because suppressing consumption is not necessarily sustainable either.

So if the theoretical case for Trump/Miran “MAGAnomics” is so weak, then why exactly do they want to reduce America’s “exorbitant privilege”? Well, if you read the tariff post, you know what I’m about to say: political economy. Exorbitant privilege results in the US trading more, and on average, trade is good for the average person: trade raises GDP from between 2% to 8%, or around 1 to 4 years of economic growth every year. However, these gains are not evenly concentrated: for instance, when China joined the World Trade Organization in 2000, US counties most exposed to Chinese competition saw steep declines in employment and output, particularly because of its effects on manufacturing. While, on average, these losses were offset by big gains by consumers, the effects were very concentrated in manufacturing heavy areas, which did not recover because the sectors that benefitted from exports and created jobs were elsewhere. In particular, the employment opportunities for non-college workers shrank, while the “knowledge economy” grew, which led to education-based political polarization: counties most exposed to trade with China saw the biggest shifts from Democrat to Republican, particularly after Donald Trump entered the scene in US politics - places where trade took the “jerbs” swung from left to right for a number of values-and-social-trust-related reasons, a fact common to all developed economies. I am going to, however, double down on the fact that trade is obviously beneficial - for example the reason why Chinese accession to the WTO was so destructive to US manufacturing was because trade with China increased, which meant that Chinese firms became more productive, because trade is good and beneficial. And even if US manufacturing is indeed important, the tariffs are unlikely to bring it back.

The political economy of MAGAnomics is such that the costs of exorbitant privilege are concentrated among one specific group - men without college degrees, who disproportionately worked in the manufacturing sector, and who now disproportionately support Trump. At the same time, the people benefitting the most from exorbitant privilege are the college educated (especially women), who are also Trump’s biggest detractors. So it means that Trump isn’t necessarily paying a political cost because he’s quite literally buying off his supporters - which also squares with the Tech MAGA agenda of punishing their own employees for pure economic self interest, as well as culture war and “structurally oriented” reasons.

The economic oppression olympics

But even considering that this is all just a big giveaway to the annoying idiots of the All In Podcast and the Adolf Treatler lumpenprecariat, what exactly would devaluing the dollar in the Trump/Miran manner do?

Let’s look at what “extraordinary privilege” is with a bit more detail. Fundamentally, the modern monetary system works by putting together a “core”, that is a country with exorbitant privilege, and a “periphery” of countries that have to export to the core - the core has a strong currency, and the periphery a weak one. This creates systemic global imbalances in payments - because the core runs persistent deficits in the current account, and persistent surpluses in the financial account - that is, it buys things from all other countries, while exporting financial services such as “money”, and “bonds”. The importance of the core countries for the balance of payments of every other country means that, the US is also setting global monetary policy, particularly because of the fact that, absent capital controls, both exchange rates and interest rates have to be congruent with the Fed rate, such that countries don’t see destabilizing outflows of capital (and see their currencies depreciate and/or their international reserves go down) in the short term.

This sets up an interesting tension: could the US (or any other prospective economic hegemon) face a tradeoff between global and domestic financial and monetary stability? Well, it used to: under the gold standard currency had to be backed by a fixed quantity of gold, then the Fed faced what’s known as Triffin’s Dilemma: if it had to continue providing liquidity to the rest of the world, they would run out of gold, which meant that the central economy would need to either stop running foreign deficits (and risk a global depression due to decreased monetary supply), or a “glut” of dollars provoking a loss of confidence and, once again, a global depression. Triffin’s solution was to de-peg the reserve currency from gold but without letting it racially change in value, which would mean the US could manage its foreign payments without capsizing the global economy. It’s worth noting that de-pegging the dollar does not mean devaluing the dollar: a dollar devaluation, which is what Miran and Trump want, would be a completely disastrous outcome for the global financial system, because it would either involve the US reducing the amount of liquidity it provides to the rest of the world, tightening global monetary policy and inducing a global recession. So the US leaving the gold standard in 1971 means that, unlike the gold-backed system, the post-Nixon system is sustainable because the US doesn’t need to do much to keep its currency stable, since it doesn’t need to balance against any reserves of anything - but it does need to commit to certain things. Which ones?

Well, to paraphrase Spiderman’s Uncle Ben (who once said that with great power comes great responsibility), with exorbitant privilege comes exorbitant duty. Normally the hegemon (that is, the country in charge) is described as the “world’s banker”: storing illiquid, risky assets in exchange for safe, liquid ones (dollars and bonds). While the US doesn’t (and can’t) directly stabilize other countries during financial downturns², the system ends up working as a kind of insurance paid to the US: the US provides risk-free assets to invest in risky ventures at home and abroad which, in good times, makes it profit, but in bad times, means it has to suck up a lot of big equity losses relative to its weight in the global economy. It’s worth noting that, unlike normal banks, it doesn’t mean the US does worse in recessions; in fact, it does better), because US assets are so not risky that the big losses from its risky assets are offset by increased global demand of safe assets. In the US’s case, the risk-taking is heightened, such that it’s more of a venture capitalist: liabilities are mostly in the short term, as risk-free dollar-denominated bonds, and can invest in risky foreign ventures.

The main cost the US pays is that they have to provide safe assets that everyone can rely on, which which somewhat paradoxically means that during good times they benefit from all the extra global capital flowing into the US, but since global risk-taking declines significantly during downturns, then the demand for safe assets increases significantly, which means that even if Americans lose a lot of money on failed ventures, the more than make up for it by earning even more money on providing safe assets. So the situation that you end up with is that being the world’s safe asset is both the benefit and the reason you have that benefit, mainly because the extra capital during upswings is, in a way, like every other country has to pay a “fee” for using the dollar, in return for safe asssets when a big global shock hits - meaning that, in a way, exorbitant privilege is kind of like a protection racket, which someone should tell Trump because it would make him happy.

The world’s Silicon Valley Bank

If it seems like the Americans are getting a pretty sweet deal, it’s only because they are. The obvious question, then, is why nobody else would want to step up.

Well, firstly, and quite simply, because the US is the most powerful country on the planet, especially militarily, and as such it has a better chance of winning wars against any potential rivals. The reason why this matters is quite obvious in a direct sense, but there’s also a more indirect one: if the US were to lose a war to an economic rival, it would probably be so economically devastated that it would default on a lot of its debt, which would destabilize the global economy. Considering that wars are extremely costly for all sides while the losing side also doesn’t get any of the benefits of winning, then then countries with stronger militaries will be able to borrow more money and therefore being a strong military power increases the chances of global hegemony. This is also not an especially new line of thinking: in The Economic Consequences of the Peace (1920), John Maynard Keynes argues that the extremely harsh reparations imposed on Germany after World War One would cause their economy to collapse either via an extremely severe monetary contraction or, what ultimately happened, hyperinflation. But this means that there can be a “geopolitical Triffin’s Dilemma” in a way: the US can retain its monetary stability, or it can counter Chinese power projection, and eventually the US might want to stop China’s rise more than keep its own position.

But it’s not just that the US is the biggest and scariest and baddest player in the world stage. The US is also, much more importantly, also committing to remaining a reliable and well run economic agent - and the main indicator is US government debt as a share of its own GDP, since it points to both macroeconomic prudence and capacity to handle repayment of complex assets. As we’ve stated basically once per paragraph so far, the main risk is that the US just goes belly up - that the global banker suffers a bank run, or that it goes welsh on its debt (no offense to the People of Wales-ness reading this). One of the main constraints for all past hegemons (and by “all past” this goes back to like, the Dutch Golden Age) is to have a responsible fiscal policy, since at some point it just starts becoming too risky to keep borrowing if the world’s bank has a balance sheet like it’s the third Lehman sibling. This means that, in a way, Triffin’s Dilemma still exists: the term “the global banker” was quite literally invented by Charles Kindleberger as a dunk on Triffin, because Triffin didn’t really notice that the economic hegemon didn’t actually need to fully balance its portfolio of liabilities and assets - like a bank, it benefitted from the possibility to borrow short and lend long, a dynamic even more pronounced for the modern US, which is more the global “venture capitalist” than anything else. However, if the terms “bank” and “venture capital” being so close together didn’t make anyone start anxiously sweating, one has to be reminded that banks can actually fail - in particular, because panics can spread and make all depositors withdraw.

For countries, this is known as a “currency crisis” and it’s a frequent topic of this blog - basically, the idea is that a country where people don’t know if the currency is going to be devalued or not is going to see people draw down reserves until it leads to the currency being inevitably devalued. The long and short of it is that, because it’s possible that the US would suddenly devalue the dollar to undercut other countries and wipe out the real value of American debt abroad, it’s possible that investors start looking to get out of the dollar to anticipate it, which would therefore suck capital out of the US at such a pace that the US would be forced to devalue its currency. This means that concerns over the stability of the dollar alone would create the conditions for the dollar to stop being the global economic hegemon, because people would start selling off US-related assets: stocks, bonds, and dollars.

And that’s what you’re seeing now: Trump’s attacks on the rule of law mean the US is a less safe place to invest, and Trump’s tariffs are both extremely economically destructive and represent a huge betrayal of the rules of economic engagement that the US set for all other countries, which means that the US is less reliable as an economic partner. Similarly, Trump acting so erratically and unpredictably makes American government assets less attractive, which compounds with Trump’s atrocious fiscal policy that would blow up the deficit. So between trade policies which are designed to devalue the dollar, a weaker rule of law in the United States, and a much larger US government deficit and therefore a larger debt burden, Trump’s policies are putting the US on a crash course with reality - since, as seen above foreign players are already getting out of American assets, which could spark a crisis of confidence.

Party like it’s 1929

Obviously the nations have been led into the tariff orgy of the past two years by a wild spirit of sauve qui peut. Each has been determined to ward off disaster from its own producers and its own finances by any means possible. And none was hindered by the knowledge that the inevitable result of such a policy, when relentlessly pursued by eighty or ninety sovereign states, is to drive world prices still lower, to reduce still further the volume of international exchanges, to swell the ranks of the unemployed in industrial centers, and to add to the prevailing financial confusion. For it is one of the plainest lessons from the experience of recent years that, far from being a cure, tariffs are to be numbered among the active causes of our present disaster.

Percy Wells Bidwell, “Trade, Tariffs, the Depression” (1932)

What, exactly, is going to happen now? Nothing good. The main comparison people are making is to the 2007 financial crisis and the Great Recession. The main fact noted is that, in the late 1990s and early 2000s, people started worrying about the shortage of safe assets: basically, a bunch of Asian and Latin American countries (as well as Russia) crashed and burned in the late 90s, and then the dotcom bubble burst, which made people less likely to make risky bets, and instead redirected them to safe bets - like American mortgages. To quote Doechii on that one: oopsie, made a whoopsie!

But the big difference between the Great Recession and now is that the US actually cared, deeply, about the stability of the global economy - and in fact President Bush and his economic team (mirroring the late 90s “Committee to Save the World”) worked really hard to stabilize the financial system globally and prevent the world economy from turning into the Hunger Games for Currencies - for example, by turning the G20 summit from a pointless photo op into a real forum for political coordination.

The way to understand why international cooperation is important is to understand four things: first, that global risk gets translated into pressure on currencies (known as the “risk premium”; by definition, all interest rates equal global rates plus expected devaluation plus risk premium). Second, that a currency devaluation is a tariff of sorts, since the goal is to reduce imports and boost exports. Third, that higher tariffs are a best response to higher global tariffs (because the alternative is just a bigger trade deficit). Fourth, that currency depreciations and trade wars are frequently contractionary. Put together, this means that unless countries all commit to coordinate and play nice, you can enter the “Kindleberger spiral” where they all hike up their trade barriers as a way to protect their economies, which throws the world economy into a prolonged demand-side death spiral.

In fact, the last time the world saw a generalized global recession that did not feature the global hegemon organizing the response was the Great Depression, which is also what Kindleberger was writing about. I’ve talked about the trade aspect of the Depression in the previous tariff post. But I haven’t talked about the international monetary aspect yet - which is what this post is about.

Let’s go back a few paragraphs: back in 1929, every country was on the gold standard, which meant that a balance of payments deficit meant either external borrowing (which necessitated higher interest rates) or an outflow of gold. Meanwhile, countries with bit balance of payments surpluses had stronger economies - and there was no mechanism for correcting global imbalances, since domestically countries could either depreciate their currencies (which was considered economically unsound for largely ideological reasons), or suffer prolonged bouts of deflation. The US, the Bank of England, and most notably the Banque de France (France was an egregious accumulator of gold) started rapidly accumulating reserves at the expense of everyone else, and usually sterilized these purchases, meaning that the monetary supply in these countries grew - and it shrank in others, as a way to offset the lost gold while not depreciating.

In 1928 and 1929, the Federal Reserve started hiking up interest rates for two reasons: first, to stop gold from leaving the United States. Second, to stop a “stock market bubble”. This did not work and caused a recession (duh) and, more importantly, a financial panic, and the US passed the Smoot-Hawley tariff to protect the economy and the supply of gold. The transmission of the US recession and France’s gold hoarding into the rest of the world mostly rested on the fact that most of the world’s leading economies were engaging in “managed money”: Germany was juggling its entire monetary system on avoiding its sizeable WW1 reparations bill, whereas Britain was stuck in perpetual deflation to keep the pound anchored to gold. The fact that the alternative to devaluation was deflation meant that falling prices pushed down wages and pushed up (real) interest rates, at the same time as causing “debt deflation” that meant large-scale bankruptcies and rapidly escalated into a full-blown banking and financial crisis. Therefore, in order to avoid both deflation and depreciation, countries turned to a third alternative: protectionism - such that countries with the strongest ideological committment to the gold standard also had the highest tariff rates, to protect their gold parity while holding their reserves.

So the takeaway isn’t that the Depression was caused by global imbalances - it’s that those global imbalances were not managed by any central player, which caused a manageable recession to become completely uncontrollable as countries started turning each other’s “guts into soup beans”, to harken back to the same Doechii song. This means that, without any party capable of committing all players to the same rulebook, the entire world could enter a death spiral of deflation, crisis, and protectionism (especially considering the “fear of floating”). To take a more parochial example, when the US stopped committing to stabilizing Argentina’s economy with more funding in late 2001 (understandably, since their plate was full back then), the economy rapidly unraveled as confidence in the financial system collapsed.

Conclusion

The 1991 movie Thelma and Louise ends with the two titular characters surrounded by the police at the edge of a cliff - and their options are, placed in an unsustainable situation, to either give in, or fly off the cliff. They decide they can’t go back, and jump off at full speed - the film ends with a freeze frame of the car suspended in the air, finally having achieved the freedom they wanted all along.

That’s sort of the MAGA project - to turn back the clock, bring the factories back, own the libs, and put everyone back in “their place”. To achieve this, besides Big Tariffs, Stephen Miran and his posse also have some “practical” proposals: commitments to buy US products, a swap of Treasuries with 100-year old bonds in order to reduce pressures on the dollar, or just a straight-up protection racket where countries pay directly to the US for the privilege of using its currency. This is, of course, not a workable or logical plan in the real world. But even if it won’t work in practice, the “Mar-A-Lago Accord” logic also don’t work in theory.

The “exorbitant privilege” of the US economy that MAGA wants to get rid of is not unique to the dollar - in fact, over the past four centuries, some country has had some variety of it, resulting in the same pattern: increased borrowing and economic benefits from it. The USD, as those in the business call it, has been the reserve currency for around a century, and its importance to global monetary and financial operations heightened after Nixon took it off the gold standard in 1971. But this doesn’t come for free: the key cost, besides distributional considerations, is a commitment to stability. The biggest risk to any hegemonic effort is that the “world’s banker” might want to wipe out a lot of its debt by devaluing its currency, which would completely wreck the global economy by affecting every other country’s monetary policy. Like, for example, during the Great Depression. To quote Bidwell again:

If this depression has proved anything it is that international trade and international finance are fundamentally inseparable. We can shut off the flow of goods, but if we do we shall at the same time dam the outflowing stream of capital exports and the inward flow of interest from our foreign debtors, and of capital repayments. One cannot but admire the single-mindedness of those who, understanding these facts, still demand isolation. But for most of us the abandonment of 18 billions of commercial obligations, to say nothing of war debts, is too great a price to pay for the doubtful benefits of commercial isolation.

The main effect of the agenda of isolationism and protectionism isn’t just some misguided masturbatory RETVRN fantasy of white male supremacy - it also undermines the basic world order, the rule of law, and liberalism itself. Back in 1933, John Maynard Keynes drew a line between the desire for “national self sufficiency” and ideological extremism, destructive and short sigthed policies, and authoritarianism.

We have no clear idea laid up in our minds beforehand of exactly what we want. We shall discover it as we move along, and we shall have to mould our material in accordance with our experience. Now for this process bold, free and remorseless criticism is a sine qua non of ultimate success. We need the collaboration of all the bright spirits of the age. (…) If not, I, at any rate, will soon be back again in my old nineteenth-century ideals, where the play of mind on mind created for us the inheritance which we are seeking today to divert to our own appropriate purposes.

1. Other sources point to trade advisor Peter Navarro, who has much more scatter-brained and less coherent arguments for protectionism. He’s also, unsurprisingly, a complete nut.

2. I mean it actually does - not just by funding global lenders of last resort like the IMF and the BIS but also by just giving direct loans to other central banks.