Good morning. France’s bond yields are the same as Greece’s; China’s are below Japan’s. Up is down, black is white, and Unhedged is back from a week away to explain it all, to the degree it can be explained at all. Email your thoughts on our brave new world to robert.armstrong@ft.com.

A new Plaza accords

Optimists about Donald Trump’s trade agenda see the imposition of high tariffs as the opening gambit in a game of multiple moves.

In the simplest game, the higher tariffs trigger a negotiation that leads to mutual tariff reductions. This is the vision that Kevin Hassett, recently appointed to lead the National Economic Council, laid out in an interview with Unhedged. Others see a more ambitious game, culminating in the reconfiguration of global trade and capital flows. Treasury-Secretary-to-be Scott Bessent, in an interview with the FT, described his strength as “understanding how complex systems either accelerate or break down” and said that “we are in the midst of a reordering on international trade and relationships, and I’d like to be a part of that.” 

What might the bigger game look like, and how might it influence markets? I believe if Bessent’s “reordering” takes place, markets could be in for a shock. 

My colleague Alan Beattie recently made the case that it is impossible to read a coherent economic agenda off of Trump’s economic appointments:

It is very unclear how [tariffs] might be employed, or for what end, or what other economic and financial tools might also be deployed, or whom [Trump] will be listening to at any given time. This week is a warning to anyone who thinks they have the Trump administration all figured out. They do not.

I agree with this. It is consistent with what we saw in Trump’s first term. In contrast to the meaningful changes Trump I made in tax policy, the administration’s trade policy was scattershot and resulted mainly in a cosmetic rerouting of trade that left global relationships and the US current account deficit unchanged. That said, the Trump II team may have a different character, and Bessent may amass enough capital in the White House to try something big. 

One vision of that something was articulated in the FT by the economist Shahin Vallée. He sees tariffs drawing the countries that run trade surpluses with the US into a “new plaza accords”,

an international grand bargain in the form of a co-ordinated and gradual depreciation of the dollar in exchange for a reduction in American tariffs. This would not only force China to accept more currency flexibility but would also help other countries to contribute more meaningfully to global rebalancing by boosting domestic demand.

In return, the US would commit to reducing tariffs and to some degree of fiscal consolidation. This would stabilise the dollar and promote a rebalancing of the world economy conducive to better allocation of global investments and savings.

My question on reading this was: is the dollar even overvalued? I put this to Vallée, and he agreed that it isn’t. But the imposition of tariffs will make it so. 

Vallée sees the run-up to the grand bargain as having three phases. The current honeymoon phase is characterised by optimism about tax cuts to come, and lack of clarity about what tariffs we will get and what they will mean. The second phase is unpleasant: tariffs get real, which weighs on sentiment and pushes the dollar higher. Countermeasures from Europe, Canada and Mexico bite. The Renminbi weakens. The dollar rises and global financial conditions tighten. Many emerging markets fall into distress. “This phase needs to be painful,” Vallée says. “Trump needs to hate it.” Tax cuts and softer monetary policy (perhaps delivered by a new Fed chair or shadow Fed chair) will only do so much to reduce the pain. 

Perhaps 18 months into the new administration, global discomfort brings the world to the negotiating table, seeking a deal in which the dollar weakens, the US spends less, primarily by cutting its budget deficit, while the rest of the world — particularly China, Germany, and Japan — spends more. 

There are two obvious objections. Why would the Chinese come along with such a deal after the long deflationary winter of the Japanese economy in the decades following the 1985 Plaza accords? Vallée does not see this as fatal:

The Chinese are not in the same position today as the Japanese were in the mid-90s, when Japan was booming, and the accords imploded the Japanese real estate bubble. The Chinese are already in deflation, and they need a rebalancing towards domestic demand. I can see why the Chinese would resist it, and why an appreciating Renminbi would increase deflationary forces. But if [the bargain] forces them to deal with domestic imbalances, strengthening the social safety net and increase consumption, I don’t think that a deal necessarily leads to profound deflationary shock in China

Michael Pettis, a Beijing-based economist who also believes global imbalances are a problem requiring a structural solution, thinks that “deficit countries have most of the cards”; if they impose tariffs and reduce their deficits, there is little the surplus countries can do. 

The other objection is that, for the US, reducing its trade deficit means reducing consumption (public, private or both) and that it lacks the will to do so. The idea that the adjustment can be made entirely through the elimination of wasteful government spending is of course a fantasy. At the very least, cuts in services that are politically popular would be required. Households will have to adjust, too. 

Pettis cautions that we should not see this in zero-sum terms. “We don’t want consumption in the deficit countries to go down, we want the consumption share of GDP to go down — we want production to go up.”

Assuming resistance to a deal can be overcome, what would a new plaza accord mean for US assets? What would happen in Vallee’s second phase — the pain phase — is hard to predict. Tariffs could drive cost inflation and reduce corporate profits, a strong dollar would reduce the value of revenue earned abroad, global demand would suffer, and domestic producers might struggle to increase production. But all of this may be less important than the flight to safety that global financial stress would create, which would support both Treasuries and US stocks. In a turbulent moment, the US will remain very attractive.

But the global rebalancing that follows a global deal would be bad for US assets. The reason for this is that the US trade deficit that any deal would aim to reduce corresponds, on the other side of the ledger, to big flows of capital into the US from abroad. These flows help explain the extraordinary performance and valuation of US risk assets, relative to the rest of the world, since the great financial crisis. To put it another way, the current global regime creates excess savings abroad which flow to US capital markets, which are open and deep, driving prices higher. The whole point of a deal would be to eliminate the imbalances that generate these excess savings. A new Plaza accord, while bringing benefits to the real economy, is very likely to hurt Wall Street. 

It is hard to say how the Trump administration would respond to this trade-off. “The real question is, who drives policy? Is it Wall Street, or the people in the administration who want to revive the US economy?” asks Pettis. Facing a hostile market, Trump might retreat from structural reform, stick with cosmetic bilateral tariffs, and focus on other areas of policy. Or, in full populist mode, he might embrace the enmity of Wall Street, as Franklin Roosevelt did. I have no idea which is more likely.

One good read

Javier Milei