Donald Trump’s bluster is likely to lead to lower American living standards and higher inflation. But his advisers want to keep their jobs, and won’t tell him that.

Trump’s support base is heavily concentrated among white male manufacturing workers and former manufacturing workers. These people feel aggrieved because their jobs have fallen by more than a third since manufacturing employment peaked in 1979. In addition, their incomes have also fallen so that, as Nobel Prize winner, Joseph Stiglitz found, “the typical American man makes less than he did 45 years ago (after adjusting for inflation)”.

Not surprisingly, the MAGA movement is looking for someone else to blame for their predicament, and who better to blame than foreigners, especially Chinese foreigners?

The reality, however, is that trade and globalisation are not the main reason for the loss of manufacturing jobs. The direct impact of foreign competition is on production, and while US manufacturing employment has fallen by 35%, manufacturing production is higher than ever, although it has plateaued over the last 15 years.

Instead, the main reason for the loss of US manufacturing jobs is technological change, and increased tariff protection will not help restore those jobs.

Nevertheless, oblivious to sound reasoning, Trump has now increased the US tariff rate from an average of just 2.4% when he took office in January to an average of 18.3% – the highest since the 1930s Depression, and possibly still rising.

The sad thing is that these tariffs will actually damage the US economy. While Trump likes to say that US tariffs represent a tax on foreigners, nothing could be further from the truth. These US tariffs are effectively a tax on US consumers and manufacturers. For example, already General Motors has reported that tariffs cost it US$1.1 billion in the second quarter of this year.

Modelling shows that the tariffs will cause consumer prices to rise by an extra 1.8% this year, and that extra increase would have been more if exports to the US had not sped up before the tariffs took effect. Similarly, the modelling shows a significant negative impact on US GDP – typically a greater impact than on other countries.

Already the latest data shows that employment growth has slowed dramatically in the last three months as the tariffs started to impact. But Trump, in his insouciance, refuses to believe the facts and instead he sacked the head of the Bureau of Labour Statistics as a reward for her inconvenient truth.

But now Trump’s advisors have come up with another idea to achieve the MAGA dream. A lower exchange rate would make US manufacturing much more competitive, and there is no doubt that the US exchange rate is excessive when prices in the US are compared with prices for the same goods and services in other countries.

One way to estimate the amount of this exchange rate over-valuation is to compare each country’s GDP valued in terms of their purchasing power in US dollars — that is their PPP — with their GDP, using exchange rates. On this basis, according to IMF data, 182 countries have a higher GDP on a PPP basis and only 12 have a lower GDP than on an exchange rate basis. In other words, the US dollar is over-valued relative to the prices in most other countries.

The biggest over-valuation of the US dollar found was relative to the Sudanese currency, and many of these countries with currencies that are under-valued relative to the US dollar are not major competitors of the US. Nevertheless, some of these countries are major competitors.

China is a major competitor and its currency, relative to the US dollar, would appear to be under-valued by 69%, while the under-valuations for other major countries relative to the US are as follows: South Korea 66%, Italy 52%, Japan 45%, France 33%, Germany 31%, and the UK 21%. Interestingly, only three OECD countries had over-valued currencies based on these estimates: Australia 3.3%, Switzerland 7.9% and Norway 26.3%.

In sum, the available evidence shows that the US dollar is significantly over-valued compared to its main competitors. But that still leaves the problem of how to bring the US dollar down to a level at which American firms are competitive, and what are the costs?

The reality is that these days governments, and central banks, no longer regulate the exchange rate. Instead, it is determined by market forces, and in the US case it is foreign investors who have helped prop up its exchange rate at its apparently excessive level.

One obvious reason why the US dollar is so high is that its status as a reserve currency has encouraged other countries to hold US Government bonds. Foreign investors account for about 30% of US Government bond holdings, led by Japan and China.

Trump and key advisers like Stephen Miran, the chairman of the Council of Economic Advisers, who Trump has just appointed to the board of the Federal Reserve, favour lower interest rates, not least because they believe it will lead to lower capital inflows and thus a lower exchange rate, while at the same time, Trump is negotiating with other countries, as part of his tariff deals, to increase their investment in America.

But apart from this contradiction, what Trump and his key advisers also don’t understand is that the status of the US dollar as a reserve currency has effectively allowed the US to live beyond its means for a long time. Total domestic expenditure in the US, financed by foreign loans, has exceeded its production capability. Thus, these loans have effectively allowed US citizens to enjoy a higher standard of living than if there was a competitive exchange rate.

Most recently, Trump has sought to prolong this situation when on 4 July he signed his One Big Beautiful Bill which locked in the tax cuts from his first term in office. As a result, a US budget deficit equivalent to 7% of GDP is projected to continue forever unless policies change. But financing this continuing deficit is bound to put upward pressure on interest rates while foreign investors will not appreciate the loss in value of their investments if the dollar depreciates.

The question, therefore, now is how much longer can this situation continue in reality? Chinese ownership of US Government bonds has been on a declining trend for the past decade. Further, Trump’s hostility to the BRICS and other such groups of countries is encouraging them to stop using the US dollar payment system and to pay their bills in other currencies.

While Trump and his key advisers keep declaring they want a lower US dollar exchange rate, what they don’t seem to appreciate is how both a lower exchange rate and higher tariffs will inevitably increase inflation and reduce the American standard of living. Further, Trump’s fiscal policy is bound to maintain the upward pressure on interest rates and therefore the exchange rate. Finally, as the economy is still close to full employment, the switch in favour of manufacturing will not increase total output but rather will require existing employees to change their jobs.

In sum, Trump’s policies are most likely to result in a fall in American living standards or else there will be a surge in inflation or a mix of both.

The views expressed in this article may or may not reflect those of Pearls and Irritations.