I thought I would share some insight into trade, fiscal policy, and monetary policy dynamics. The free hand of supply and demand will always win out in the end. I will give an overview of why this is the reality.
Let's say there are two countries, the US and China. The US produces apples and oranges and uses dollars. China produces apples and oranges and uses the yen.
The current value of the dollar and yen are 1 dollar equals 1 yen. China has many oranges but not quite enough apples. The US has lots of apples but craves many more oranges. The trade between the two countries will be made in dollars and yen. Let's see what happens.
The current world price is apples and oranges are each worth 1 dollar and 1 yen.
China wants 500 thousand apples. The US wants 1 million oranges. The US sends China 1 million dollars for 1 million oranges and China sends the US 500 thousand yen for 500 thousand apples.
But China does not want 1 million dollars because it has to pay its companies in yen, and the US has the same problem it does not want yen since it pays its companies in dollars.
So, if the US and China then swap currencies 1 million dollars is worth 500 thousand yen making the new currency equilibrium 2 dollars are equal to 1 yen. This trading dynamic is back in balance with no trade deficit due to currency valuation. This is a simple example of how the free hand of supply and demand for oranges, apples, dollars and yen achieve balance all on their own.
However, for years China has been buying US debt with its excess dollars. So, in this regard there is no trade imbalance. China has been buying some US goods and the rest spent buying US debt with all the dollars the US has been spending in China. However, even though in terms of physical goods alone there has been a substantial trade imbalance, China solved its problem of too many dollars (pictures of dead presidents) by buying the US debt.
Yet this result is largely of the US's making because it has been running large budget deficits for years. Afterall, what is China to do with all the excess dollars it received over the years? It both facilitated the US demand for Chinese goods and preserved the value of its monetary holdings by buying US debt which pays interest.
The supply of US debt would decrease if the US would once again balance its budget. During the Clinton administration there was a great deal more cooperation between Democrats and Republicans and that made a balanced budget happen.
If the US were to do this again, it would cause the dollar to weaken relative to the yen since China would accumulate more dollars, and with there being no more US bonds for China to purchase the dollar would weaken relative to the yen.
So, what would happen if the Fed were to lower interest rates right now. It could increase the money supply by buying US debt. That would increase US debt prices and lower interest rates. Doing this during times of inflation increase inflation further it would also increase the value of US debt that China holds (its war chest to survive the trade war).
The tariffs are not a free market activity. They will cause severe disruptions to trade, investment and inflation. The free markets will apply its own pressures on supply and demand in all the markets for goods services (GNP), prices, interest rates, investments and jobs.
