Trump appoints “Death by China” trade guru

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From the FT:

Donald Trump plans to create a National Trade Council inside the White House to oversee industrial policy and is appointing a China hawk and one of the architects of the populist economic message to run the new group.

Mr Trump has chosen Peter Navarro, a Harvard-trained economist, to head the NTC, the Financial Times has learnt. The author of books such as Death by China and Crouching Tiger: What China’s Militarism Means for the World has for years warned that the US is engaged in an economic war with China and should adopt a more aggressive stance — a message that the president-elect sold to voters across the US during his campaign.

“I read one of Peter’s books on America’s trade problems years ago and was impressed by the clarity of his arguments and thoroughness of his research,” Mr Trump said. “He has presciently documented the harms inflicted by globalism on American workers, and laid out a path forward to restore our middle class.”

The Trump transition team described Mr Navarro as a “visionary economist” who would “develop trade policies that shrink our trade deficit, expand our growth, and help stop the exodus of jobs from our shores”. His appointment is the second restructuring of trade policy that will see Mr Trump attempt to follow through on his focus to resurrect manufacturing, and create more industrial jobs, in the American economy.

…The Trump team said the NTC would lead a “Buy America, Hire America” programme that would boost job creation in areas such as infrastructure and defence. It will work in tandem with three other offices in the White House: the National Security Council, the National Economic Council and the Domestic Policy Council.

They added that it would mark the first time there was an office dedicated to manufacturing inside the White House, in a strong signal that Mr Trump plans to follow through on the promises that he made on the campaign trail.

This looks like a pretty serious step towards radical China trade policy. Recall Deutsche yesterday:

One of the least talked about but possibly most important tax shifts in the history of the United States is House Speaker Paul Ryan’s and President-elect Trump’s “border tax adjustment” proposal.

This is part of the “Better Way” reform package and also figures prominently in the writings of senior Trump administration officials.

Put simply, the proposal would tax US imports at the corporate income tax rate, while exempting income earned from exports from any taxation.

The reform would closely mirror tax border adjustments in economies with consumption-based VAT tax systems.

If enacted, we believe the plan would be extremely bullish for the US dollar. What’s more, it would have a transformational impact on the US trade relationship with the rest of the world.

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To be sure, there are uncertainties related to all estimates above. First, there is a question mark on whether a border tax adjustment based on a territorial corporate tax system (as opposed to VAT) would be allowable under WTO rules. The question is highly complex, but senior Trump advisers have stated they would be willing to take the issue to the WTO.

It is also not clear what types of goods the new tax would cover – the broader the coverage the bigger the impact and vice versa.

Second, the impact on trade highlighted above should be considered an upper bound, as the post-crisis responsiveness of current account balances to relative price shifts has proven to be much lower.

Still, it is hard to argue that such a fundamental shift in tax treatment of US exports and imports would not have a material impact on trade relations and flows with the rest of the world. More importantly, Saravelos argues, the second-order impact of “re-shoring” may be more material given that US corporate activity has been disadvantaged due to the current unfavorable tax treatment of offshore profits.

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In the way is business, via Salon:

As lawmakers set out to implement one of the broadest reforms to the tax code in decades, one proposal has companies gearing up for a rebellion against politicians they traditionally view as close, pro-business allies. Republicans in the House of Representatives and President-elect Donald Trump seem prepared to deal a blow to import-dependent companies with taxes aimed at penalizing them for not buying “Made in America” goods.

The proposal is part of the House Ways and Means Committee’s blueprint for the tax overhaul, a sweeping raft of tax cuts its authors say would lead to an era of unprecedented growth. According to the House proposal, taxing imported goods “will eliminate the incentives created by our current tax system to move or locate operations outside the United States.”

Though technically not an import tariff, the so-called border tax adjustment prevents companies from writing off import costs on their taxable income, effectively raising their tax bills. Trump has repeatedly called for protective tariffs, so it’s likely he will be on board unless he’s convinced otherwise by industry leaders.

“Our goal should be to try to make everything we can in the United States so that the money gets put in the pockets of Americans,” incoming White House Chief of Staff Reince Priebus told radio host Hugh Hewitt on Wednesday. “And we want to see the potential for a change in that border adjustability so that American jobs are protected.”

To import-reliant businesses, the border tax adjustment is a poison pill, and bigger companies are preparing for war to ensure President-elect Donald Trump and his Republican allies in Congress know just how much they hate this idea.

More from Goldman which sees it as still unlikely:

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1. The potential switch to destination-based taxation in the US has far-reaching implications for the US Dollar. Under the current US taxation regime, goods and services are taxed based on their origin, rather than where they are sold. Under a new proposal being considered by House Republicans, taxes would be based instead on where the goods and products are sold, with a so-called “border adjustment” that would allow firms to deduct domestic wages. This would result in a lower tax rate for firms that are net exporters and a higher tax rate for net importers (“Tax Reform: Is the Destination-Basis Tax Coming to America?”, US Daily, November 22, 2016). In this FX Views, we give our initial take on the likely path for the Dollar should this switch actually occur, which we think has about a 30 percent probability (“Q & A on Tax Reform”, US Economics Analyst, December 16, 2016). While models suggest the adjustment should be uniform across other currencies, we expect the reaction would be quite different against EM and G10 currencies given the various countervailing forces that would come into play. Whatever the merits of the proposed legislation, we think markets would treat it as an escalation of trade tensions between the US and the rest of the world. We therefore expect the largest net exporters – such as KRW and the RMB – to weaken substantially against the Dollar. This would probably be compounded by concerns over supply chain disruptions for firms, weighing on investor sentiment which could contribute to a risk-off environment. For the G10, previous risk-off episodes demonstrate that the market acts by rolling back expectations for Fed hikes. In February of this year for example, the market went so far as to price some probability of a rate cut.

…In its current format, the House Republican plan also incorporates a plan for “border adjustment,” where firms can deduct the domestic cost of exports, like wages (that’s the tax rebate of $9 shown in column 2 of Exhibit 1). The plan that appears to be envisioned in the House Republican blueprint is probably not WTOcompliant, and could lead to an adverse ruling by the WTO. Since trade rules are ultimately enforced through tariffs, a decision by the US to continue implementation of this type of tax policy could ultimately lead to tariff retaliation among US trading partners, something our Global Economics team has shown would have significantly negative effects on US GDP growth (“Global Economic Implications of the Trump Agenda”, Global Economics Analyst, November 13, 2016). Less trade, and by extension lower potential growth in the US, could translate into a slower, smaller Fed 20 December 2016 Page 4 Goldman Sachs FX Views hiking cycle. In addition, concerns about supply chain disruptions that we highlighted above could weigh on investor sentiment. Moreover, this would obviously be seen as a negative impulse on China (not least because the exchange rate adjustment would take time, hurting China exports). That sets up for a repeat of the market dynamics from Q1 of this year, where China worries led to significant bouts of riskoff, and provided an additional boost to safe-haven currencies like JPY as markets rolled back Fed hike expectations (Exhibit 5). We expect in this environment the Dollar would strengthen again EM, but the net effect against the G10 is less obvious (Exhibit 6). We therefore expect EUR and JPY to outperform EM, as in most risk-off periods.

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One thing is certain, if this policy gets up, the Aussie dollar will crash right along with commodity prices.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.