The Trump administration quickly responded to the Supreme Court’s ruling striking down its sweeping tariffs by announcing a global 15% tariff on goods, citing its authority under section 122 of the 1974 Trade Act.
Section 122 allows the president to impose tariffs of up to 15% to address “large and serious” balance-of-payments deficits or prevent a significant currency depreciation. Do the new tariffs meet the definition?
No matter how one looks the current circumstances—the condition of the U.S. economy, its balance of payments or its currency regime—none of these meet the standards outlined under section 122.
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But as this question plays out in the administration and the courts, the prospect of businesses receiving tariff refunds, estimated at $130 billion to $175 billion, anytime soon becomes increasingly remote.
If anything, the use of section 122 for another round of tariffs will ensure another round policy unpredictability that will only further hinder businesses’ ability to make decisions on hiring and investment.
What’s more, section 122 requires Congress to approve any new tariffs after 150 days, which will prompt businesses and households to either pull forward planned purchases, or simply delay them until the tariffs expire. The impact on imports and inventory accumulation will roil monthly and quarterly macroeconomic data.
The balance of payments question
Section 122 specifies that the president can act to address an international balance of payments problems to restrict imports for 150 days with tariffs that are not to exceed 15%.
SEC. 122. BALANCE-OF-PAYMENTS AUTHORITY. (a) Whenever fundamental international payments problems require special import measures to restrict imports— (1) to deal with large and serious United States balance-of-payments deficits, (2) to prevent an imminent and significant depreciation of the dollar in foreign exchange markets, or (3) to cooperate with other countries in correcting an international balance-of-payments disequilibrium, the President shall proclaim, for a period not exceeding 150 days (unless such period is extended by Act of Congress).
So, what is an international balance-of-payments crisis?
A balance-of-payments crisis reflects a condition where a country can no longer obtain sufficient financing through global capital markets nor acquire the foreign currency necessary to pay for critical imports or service external debt, which typically leads to a sharp depreciation of the home currency.
On a technical basis, this dynamic occurs when the current account deficit and external debt obligations cannot be met or financed with capital inflows and currency reserves which results in a sharp jump in interest rates.
Traditionally, such a crisis reveals itself through capital flight to the external sector, a sudden end to capital inflows, a rapid loss of foreign currency reserves and a deep devaluation of the home currency.
None of this is happening.
The U.S. maintains a liquid $30 trillion Treasury market, with a daily churn of $1.2 trillion per day, that is the foundation of the global financial system. There is plentiful demand for American debt and equities, and the U.S. has no problem financing its deficits.
Each day, as the global systemically important banks seek to balance their books and trading operations in New York, approximately $13 trillion in liquidity needs are met through trading Treasury securities as collateral.
When it comes to balance of payments, the U.S. is healthy.
Nor is the U.S. caught in a currency crisis. The global currency churn some days reaches $9 trillion, and the U.S. dollar is on nearly 90% of those trades. The dollar made up approximately 57% of global foreign exchange reserves through the end of last year, according to the International Monetary Fund’s COFER data.
Does the U.S run large trade and current account deficits? Should it get its fiscal house in order?
The answer to both is yes and Washington should move sooner rather than later on the fiscal situation.
Yet because a pegged exchange rate is a pre-condition of a balance-of-payments crisis, the U.S., with its floating currency regime that is the linchpin of the global financial system, neither is a candidate for such a crisis nor is the U.S caught in one currently.
Quite simply, as long as Washington retains its floating exchange rate regime, it eliminates a balance of payments crisis because there is not a surplus nor a deficit that can trigger an exchange rate crisis.
The evidence simply does meet the standards to impose new tariffs under section 122.
What is section 122 for?
The 1974 Trade Act and section 122 are a relic of a past age, when the dollar’s peg to gold under the 1944 Bretton Woods accords broke down.
During the late 1960s and early 1970s, the United States fell under financial strain as it spent on the Vietnam War and the Great Society. That period could have resulted in a classic balance-of-payments crisis, but it did not.
The abrogation of the Bretton Woods accords by Richard Nixon in the early 1970s resulted in the development of the current floating currency regime and the adaptation of a variety of floating, fixed and pegged regimes among major trading nations.
Today, U.S. payments are in balance and there are sufficient capital inflows. In addition, the currency reserve status of the U.S. and global demand for dollar-denominated assets and the dollar do not suggest that any balance-of-payments crisis is at hand.
Just as important, the United States’ large trade deficit—which is conceptually distinct from a balance-of-payments crisis—is in turn financed by the recycling of those dollars back into the U.S. in terms of capital inflows.
The takeaway
The U.S. is not experiencing a balance-of-payments crisis, nor will it in the immediate future.
The use of section 122 will be challenged in both Congress and the courts by American commercial community.
The economic implications will be interesting as short-term incentives to purchase goods and accumulate inventory take hold.
Additionally, the Supreme Court’s ruling may lead to challenges or suspensions of current memorandums of understanding that shape trade frameworks between the U.S. and several countries, as these are not formal agreements enforceable by domestic or international law.
Incentives to strike, rework or sustain those frameworks for understanding are likely to collapse and countries may simply choose to wait until U.S. trade policy gains more clarity.
