Mar-a-Lago Accord: It's not easy to say "great"

Source: FT Chinese Network

Stephen Milan believes that the reserve status of the dollar, the overvaluation of the dollar, and the trade deficit face a trade-off. The overvalued dollar reduces the competitiveness of manufacturing, but it also sustains "dollar hegemony." How to reform the excessive deficit and the decline of manufacturing?

Stephen Miran, Trump's chairman of the Council of Economic Advisers, who entered Wall Street as a foreign exchange trader immediately after graduating with a Ph.D. in economics, said at his Senate incumbency hearing in February that the market test had made him no longer "bookish" but "down-to-earth". Explaining why he is qualified for the position of economic adviser to the president, Milan said that his ordinary family background makes him pay more attention to ordinary people; When his mentor Feldstein (a former economic adviser to Reagan) and Milan discussed their papers, they always asked, "Assuming I'm a senator, I have to be able to understand what you're saying," and Milan said the training prepared him to talk to professional politicians. Shortly before the November 2024 election, Milan, who also worked as a strategist at an investment fund, wrote an op-ed discussing the various economic strategies, trade-offs, and risk considerations that could and should be taken after Trump's victory, detailing the new international financial system known as the Mar-a-Lago Accord. Naturally, after he was reused, the Mar-a-Lago Accord gained considerable attention both in the United States and beyond.

Mar-a-Lago Agreement: An Overview

This is a 40-page essay to the effect that it is as follows. The U.S. dollar is still facing the "Triffin" conundrum under the Bretton Woods system, where the U.S. dollar has the status of a reserve currency, and sovereign states have accumulated dollar reserve assets, and the continued accumulation of U.S. dollar assets means that the U.S. continues to run a trade deficit (net exports of goods by foreigners in exchange for dollars). From the perspective of the merchandise trade balance, the intervention of financial programs (the accumulation of dollar assets by foreign countries) leads to the overvaluation of the dollar, and the international competitiveness of American goods decreases, which in turn leads to a decline in manufacturing employment and output. But there is also a great national security benefit to maintaining the status of dollar reserves through the overvaluation of the dollar, which is what Milan calls "financial extraterritoriality". For example, he said that if a security threat needs to be combated, it is only necessary to check its accounts and confiscate its dollar assets to achieve a great effect. Therefore, in Milan's view, the current dollar reserve status, the overvaluation of the dollar and the trade deficit face a trade-off: on the one hand, the overvalued dollar makes the competitiveness of the US manufacturing industry less competitive, and on the other hand, the overvalued dollar is a necessary condition for maintaining the "dollar hegemony", and the latter is of great importance to national security. Current dissatisfaction with the system is focused on the excessive trade deficit and the excessive decline of the manufacturing sector, so it is necessary to find ways to reform it.

Next, Milan analyzed the benefits that tariff protectionism can bring, believing that tariffs are effective; he emphasized that tariffs can lead to the appreciation of the dollar and the benefits of appreciation for the United States, such as helping to reduce inflation. He detailed the issues of domestic and international burden-sharing of tariffs, advocated for a gradual implementation strategy, and discussed optimal tariff rates (he suggested an average of around 20%), as well as various related issues.

After discussing tariffs, Milan began to discuss the exchange rate. Following on from the previous discussion of the Triffin problem, Milan believes that the depreciation of the dollar can also achieve the effect of enhancing the competitiveness of the US manufacturing industry. However, there is a big risk of the depreciation of the dollar, that is, under the expectation of depreciation, foreign investors may sell US bonds and lead to an increase in long-term interest rates, which will make the fiscal burden heavier, and real estate and other industries will be under pressure, accompanied by greater market risks. Milan also discussed the various obstacles to international coordination, such as the lack of incentive for major trading partners to cooperate. How to deal with these difficulties in the process of dollar depreciation, here Milan leads to the "Mar-a-Lago Agreement": 1) national security is a public good, the United States provides this product to the partner country, and the protected country needs to cooperate and pay through the purchase of US Treasury bonds; 2) national security is a long-term capital good, and protected countries need to buy long-term treasury bonds (to bear long-term interest rate risk); 3) The U.S. refuses to provide national security guarantees if a protected country refuses to exchange short-term U.S. debt for long-term Treasury bonds.

Milan explained how the agreement works, and that the depreciation of the dollar is good for reviving American manufacturing; Attract trading partners through tariff sticks and "carrots" that provide national security benefits, allowing them to sell some of their dollar reserve assets and buy local currency assets, thereby devaluing the dollar; In order to defend against the interest rate risk of U.S. bonds during the depreciation of the U.S. dollar, trading partners need to exchange their holdings of short-term U.S. Treasury bonds for long-term Treasury bonds, so as to lower long-term interest rates and maintain economic and financial market stability. Finally, during the depreciation of the dollar, the Fed can carry out various operations to stabilize financial markets (such as providing liquidity tools to international investors who hold long-term US bonds) in an effort to achieve an orderly depreciation.

Milan was thoughtful, considering the fact that security partners don't actually hold much of the U.S. debt, and went on to think of new solutions. In the end, Milan believes that there is a "not too wide road" that will be able to achieve the depreciation of the dollar and make the manufacturing industry internationally competitive; At the same time, partner countries will share more of the cost of the national security umbrella, either by redistributing effective global demand (by shifting more to U.S. products) and by exposing international trading partners to more interest rate risk. On page 29 of the report, Milan concludes that the agreement will have a historical status comparable to that of the Bretton Woods system.

This is the main content of the Mar-a-Lago agreement that has been widely discussed recently in the United States and overseas.

It's not easy to say "great"

The Milan report was rigorous in its analysis of many issues, and it was insightful when he spoke of international competition for effective demand. It is also fair to argue that the demand for U.S. reserve assets, that is, the merchandise trade surplus with the U.S., has created an imbalance in the structure of the U.S. economy, and that the cost is mainly due to the decline of U.S. manufacturing, while the financial sector has gained more benefits. The financial "extraterritoriality" that comes with the dollar's reserve status is helpful for national security and is generally in line with reality. In particular, he talked about the possibility of a global tariff chain reaction (tariff wall) against China, which I also discussed in this magazine. Milan's discussion of optimal tariffs is also theoretically underpinned: there is a trade-off between the benefits of tariffs in lower-priced foreign payments and the welfare losses caused by price distortions, arguing that tariffs below 20 percent generally promote welfare.

However, the full-text analysis is far from supporting a new international financial system at the level of the Bretton Woods system. The concept of national security is too broad for him. In the current international financial system, the United States provides the main reserve assets and plays a certain role in ensuring national security, but this role is far less than the author believes. In addition, it may not be a good idea to mix economic and national security issues together, as such "accounts" are difficult to settle. The system designed by Milan was also very organisationally cumbersome, requiring constant coordination and involvement from the U.S. Treasury Department, the Federal Reserve, and the economic departments of various countries. In terms of operation, Milan has repeatedly emphasized the need to use a gradual method to find the best "parameters", but as a practitioner of the financial market, he should know that it is almost difficult for the financial market to have a controllable "gradual", which is expected to lead to a sudden change in many things.

Another big drawback of the Mar-a-Lago Accord is the conceptual misunderstanding of the benefits of a weaker dollar. The depreciation of the U.S. dollar means that the international relative purchasing power of U.S. residents' income has declined, which corresponds to the fact that the U.S. has to export more and import less, which is a kind of "hard life", the essence of which is to work more and consume less to repay the dollar debt (foreigners have reduced their dollar holdings). If the U.S. economy lacks demand, unemployment is rampant, and the economy is driven by devaluation and exports, then the benefits of devaluation are worth mentioning; But at a time when the U.S. labor market is fully employed, I don't see much benefit from further "working" through devaluation, and at the same time the low-income group of Trump voters will be frustrated, because a weaker dollar could mean a significant increase in the cost of daily necessities for them. The explanation for forcing foreign countries to swap their holdings of short-term U.S. bonds for long-term U.S. bonds also benefits the United States by allowing international investors to take on more interest rate risk. Interest rate risk is real, but it is only volatile, and the cost of this fluctuation is limited in the long run, which means that the cost shared by partner countries through this channel is very small.

It can be seen that the system designed by Milan is too complex and troublesome, while the benefits are minimal. Looking back at the Bretton Woods system, it is much simpler and clearer. Since the gold standard has been proven unworkable, and complete fiat currencies and floating exchange rates face the historical lesson of mutual distrust among countries, Keynes proposed a compromise system: the dollar was linked to gold, while other major currencies were linked to the dollar. When a country faces significant economic imbalance, it can adjust its exchange rate against the dollar after mutual consultation. The reason for the end of this system is also very clear: the economy grew, there were more dollars, while gold was limited, and everyone no longer believed that 35 dollars could still be exchanged for an ounce of gold. After the link between gold and the dollar ended, the world entered the era of fiat currencies and floating exchange rates (unexpectedly, it worked well).

Since Trump took office again, the frequency of words like great and unparalleled used by cabinet officials has reached new heights. For example, Milan referred to Trump's "tariff upheaval" on April 9 as a model of great deal-making art. However, the "Mar-a-Lago agreement" that made him famous, which includes the idea of listing Trump's residence as a landmark in world financial history, seems difficult to achieve greatness.

Total amount is total amount, industry is industry

The decline of American manufacturing is caused by the high value of the dollar. The commonly cited high labor costs in the U.S. are essentially due to the high exchange rate of the dollar. Under the current system, the U.S. has achieved full employment and high welfare, so using dollar devaluation as a macroeconomic policy to address localized and structural manufacturing issues is mismatched. The overall economic situation is good, so why disturb it? For localized problems, we should fix issues where they arise, which is simpler and more feasible. Here, I believe Milan has not clearly distinguished between priorities.

A good way to address the decline of U.S. manufacturing is to subsidize "critical" manufacturing (perhaps by imposing tariff protections on certain "key" industries), such as subsidizing the purchase of "critical products" such as automobiles, semiconductors, and materials made in the United States. The total amount belongs to the total, and the part belongs to the part, which is simple and clear. It may only take hundreds of billions of dollars in subsidies per year to add 1.5 million high-end jobs to U.S. manufacturing, roughly achieving the goal of "security" while maintaining the sustainability of the current world economic system, in which the U.S. has greatly benefited. While industry subsidies are a conservative approach (and the one with the least total social cost), Milan is caught in the dilemma of a grand system, hoping to regulate the complex financial system to reap the benefits, and his strategy is very complex, leaving many "living mouths", which deviates from the essence of conservatism, even though he considers himself to be part of a conservative movement.

The greater reason for using the "wrong prescription" may be forgetting the promise to benefit the public, rather than a lack of intellect. Subsidizing specific manufacturing industries requires funds, and the only possible source of funding is taxing the wealthy. The policymakers in the White House would rather risk significant macroeconomic risks (shared by all residents) than impose taxes on the wealthy. Currently, macro risks have already manifested; can this remind them to return to their "original intention"?