So which is it, Mr President? Trade surplus or gold standard?

Because you can't have both.

Trade is not a zero sum game.
The gold standard does not create stability.
Mercantilism and the gold standard are dangerous ideas by themselves. They certainly don't mix.



IDEAS OF ECONOMICS PAST
It seems the Trump administration is filling will relics of economic prehistory - mercantilists and gold bugs. Both are discredited ideas. But even worse, they are mutually exclusive.

Mercantilism asserts that international trade is a zero sum game of winners and losers. When we trade, your gain is my loss, and my gain is your loss. Therefore, a country should seek to export as much as possible, and import as little as possible, thereby running a large trade surplus.

And gold bugs have an affinity with the 'good old days' when countries operated on the gold standard. The argument goes that by fixing the exchange rate to a finite commodity like gold, it will bring stability, rather than the volatility inherent in flexible exchange rates of the modern world.

And when you combine these arguments, a country's success is measured by the size of its trade surplus and the accumulation of precious metals (gold) that consequently flow into the country.

Both Trump and his trade advisor Peter Navarro are guilty of the mercantilist fallacy (although, as Catherine Rampell aptly put it, "to be fair even ... 18th century mercantilists knew to slap tariffs on finished goods, not inputs"). During Trump's campaign, he also spoke of how 'great' it would be for the US to return to the gold standard. And the under secretary of Treasury for international affairs, David Malpass, said in 2011 that the US should raise interest rates to strengthen the US dollar (to a level at which it probably would have been under a gold standard).



WHAT'S WRONG WITH THESE IDEAS?
Where to begin ...

Trade is not a zero sum game, it's a positive sum game where both sides of the bargain have the potential to win. The buyer gets the goods or services, and the seller gets paid. Do you feel like you've 'lost' when you buy a burger from your local shop, simply because the shopkeeper didn't buy something from you in return? Does this 'trade deficit' with the local shopkeeper make you angry? No. Because a trade deficit is not necessarily a bad thing when you both get something. Win-win.

Consequently, a country's wealth is not measured by its ability to sell to other countries more than it buys. It's measured by the degree to which it specialises in the production of goods and services that it is good at producing - a process that is facilitated by international trade, not hindered.

To reinforce the stupidity of the mercantilist view, it was discredited by Adam Smith's Wealth of Nations in 1776 - almost 250 years ago!

As for the gold standard, it does not create stability. International volatility doesn't just disappear when you fix the exchange rate. Rather, it must subsequently be absorbed by the inflation and unemployment rates. This is what would have happened back in 2011 if David Malpass had his way - unemployment was still at 9% and higher interest rates to maintain a stronger exchange rate was the last thing the country needed. A flexible exchange rate that absorbs international shocks so that the Central Bank can stabilise unemployment and inflation is infinitely preferable to an economy that swings from depression to boom, an inflation rate that swings between -5% and +20%, and an unemployment rate that swings between 2% and 25% (not precise numbers, but valid for the point of comparison).



WHY THESE IDEAS DON'T MIX
Now for the true stupidity - that these mercantilists and gold bugs currently occupy the same White House.

Under a gold standard, when a country runs a trade surplus (as per the mercantilist view), it causes gold to flow into the country, which is then 'sterilised' by the Central Bank printing more money. This drives up inflation, thereby making the country marginally less internationally competitive, causing exports to fall, imports to rise, and gold to flow back out of the country, thereby returning the trade balance to zero.

Conversely, a trade deficit results in gold outflows, deflation, improved competitiveness and a return of gold until the trade balance once again is zero.

See the problem here? One can not simultaneously maintain a trade surplus and a gold standard if the game is played fairly. Of course, when gold flows into a country, they could hoard it instead of sterilising it with new money creation. This would maintain an artificially strong exchange rate and a trade surplus while on the gold standard.

Of course, that would be cheating, because that country's trading partners would be forced to maintain trade deficits to sustain the cheating country's surplus. And if they weren't happy about that and decided to retaliate, run their own surpluses, raise interest rates to attract gold back to them, which they would then hoard, and refrain from printing money themselves, we get a little something called the Great Depression.

Moreover, Trump himself criticised China for doing just that in the past - except instead of hoarding their own currency, China hoarded foreign currency to artificially undervalue their exchange rate to support their export industries at the expense of their trading partners (including the US). China stopped doing this before Trump even announced his presidential candidacy. But Trump didn't get that memo, and actually tried to take credit for China stopping its currency undervaluation. And now he's surrounding himself with people who want to break the exact rules he bemoaned China for breaking?

And even to the extent that a gold standard would relieve any trade deficit (if a permanent trade surplus weren't the objective), once again, it would do so via wild swings in inflation and unemployment - volatility that causes much more damage and hardship to human lives than a volatile exchange rate. And not something that would make Trump look good. As WJ Ashley (a 19th century protectionist, but still a voice well-respected by the other side) once said:

"All observers of working-class life will agree that a period of low wages and of partial or complete unemployment has a negative and degrading effect, far greater than the positive elevating effect of a period of high wages and overtime."

These ideas are truly destructive by themselves. To try to combine them in the 21st Century, with all the history we now have, truly beggars belief.

Is there no one left in this administration with even the slightest understanding of economic theory or history?