TWO months into the Trump administration and we have had more sound and fury than concrete proposals about its economic agenda. The most alarming sign so far is that America forced the G20 to drop a pledge about resisting “all forms of protectionism” from a joint statement but this may be purely symbolic.

Nevertheless, Mr Trump’s determination to shake up the status quo may yet have global consequences. In a research note, Chris Watling of Longview Economics suggests that

Trump’s policies might inadvertently bring about a new international monetary order as the administration struggles to fulfil campaign promises in the light of the original misdiagnosis of the ‘trade deficit’ problem.

The current monetary system emerged from the downfall of Bretton Woods in the 1970s. Under the Bretton Woods system, devised in part by John Maynard Keynes (pictured, left), currencies were fixed to the dollar (with scope for occasional devaluations or revaluations) and the dollar was fixed against gold. But this required America to act as the anchor of the system; other central banks were entitled to sell their dollars for gold. In order to maintain confidence in the system, America would have to tighten policy if its gold reserves fell; that is, subordinate domestic economic policy to international demands. In 1971, Richard Nixon was unwilling to do this.

The post-1971 system had no monetary anchor and floating currencies; initially, it bore out the worst fears of those who believed in fixed rates. Inflation soared. But Paul Volcker (pictured, right) took charge of the Federal Reserve in 1979 and brought down inflation through ultra-high interest rates. The new system that emerged depended on the ability of independent (or quasi-independent) central banks to control inflation through monetary policy and (implicitly) the faith of consumers and investors that they could do so.

All financial systems involve trade-offs and the best-known is the trilemma; you can have a fixed exchange-rate system, an independent monetary policy and free capital movement but not all three. Under Bretton Woods, countries sacrificed free capital movement in order to have the other two. But with a floating exchange-rate system, you didn’t need to restrict capital and controls were rolled back in the 1980s. The second great era of globalisation (1870-1914 was the first) emerged. But this era also involved a trade-off.

Mr Watling gives a succinct explanation of what went on.

Globalisation enables companies and capital to be footloose. As such, and in the pursuit of profit maximisation, companies that could, shifted production and/or sourcing of goods overseas. That enhanced corporate profitability and as a result the corporate profit share of GDP has recently reached record multi-decade highs (with labour’s share conversely, reaching multi decade lows). The pay off, though, was the loss of significant numbers of previously well paid, middle ranking and blue collar Western jobs to overseas economies (hence the stagnation of median real incomes for male blue collar workers since the late 1970s – and the more recent stagnation of median household incomes). Initially (i.e. for the first 20 to 30 years), that loss of jobs didn’t matter. In response to the loss of domestic production, the Federal Reserve cut interest rates, increased liquidity and fostered the debt super cycle. As such, consumption became a greater part of the US economic pie (whilst exports/manufacturing shrunk).

In fact, globalisation is not the only potential explanation of the surge in inequality; technology may be just as important a factor. But voters, and some politicians, have seized on globalisation as the problem. In particular, one part of the Trump team, led by Peter Navarro, sees America’s trade deficits as “subtracting” from economic growth. In a mathematical sense this is right; GDP equals consumption, government spending, business investment plus exports minus imports. It is worked out that way because, obviously, things bought from abroad are not produced domestically. That does not mean that a trade deficit causes economic growth to slow; indeed widening trade deficits are associated with economic booms, and narrow deficits with recessions.

Another way of looking at a trade surplus or deficit is that the former involves a country spending less than it “earns” and the latter spending more. The surplus countries have piled up excess savings which eventually must be invested in the form of claims on deficit countries (China owns lots of Treasury bonds). Under the gold standard or Bretton Woods, these deficits could not persist for long as the exchange rate would come under pressure and the central bank would run out of reserves to support it.

But under a floating-rate system, there is no target to defend. As the world’s largest economy, America has an “exorbitant privilege”; people are happy to hold its currency. Thus it can run persistent trade deficits, or put another way, American consumers can spend as much as they like. As many point out this is a form of “vendor financing”—the Chinese lend the Americans the money they need to buy Chinese-made goods. Is this a better deal for the Americans or the Chinese? After all, the Americans get cheap goods and the Chinese get IOUs in a currency they do not control, yielding 2.4% or so.

Eliminating the deficit, as the Navarro camp desires, could thus happen in two ways. First, Americans could spend less. Under the gold standard (which some Republicans still favour), the central bank could enforce that by raising interest rates and restricting demand; the result would be a recession. But America prefers to bring back production (if it can) to domestic manufacturers. As Mr Watling adds

Taking back production from overseas, though, would result in less efficient production, and therefore higher prices for US consumers and a deflationary real income shock. Added to which it would also generate a deflationary growth shock in the surplus economies as they lose global production share.

So we would get a deflationary shock and recession either way. And in the process we might bring to an end the globalisation era of the last 35 years and usher in some new kind of system. Mr Trump could break the old order.

But what would emerge in its place? A few years ago, in a book called “Paper Promises: Money, Debt and the New World Order”, I suggested that economic history could be seen as a battle between creditors and debtors. Creditors tried to ensure that they would be repaid in real terms via monetary systems (the gold standard, fixed exchange rates); debtors argued for a more flexible monetary approach (think William Jennings Bryan and his free silver campaign). Eventually under a fixed money system, the debtors were unable to repay; the system collapsed and had to be remade. The creditor nation usually made the rules of the new system (Britain in the 19th century, America in the 20th). It seemed as if the crisis of 2008-09 was on a par with the inflationary problems of the 1970s (that ended Bretton Woods) and the depression of the 1930s (which finished off the gold standard). At the time, this led me to think a system would eventually be remade under Chinese auspices, since China is now the credit nation.

That hasn’t happened—or at least not yet. It is worth noting that Britain left the gold standard in 1931 but Bretton Woods was not agreed until 1944, and America abandoned Bretton Woods in 1971 but the Volcker-led central bank regime did not emerge until the early 1980s.

It is possible, of course, that we have already seen a new monetary system emerge—one in which both long-term and short-term rates are set by the central banks through quantitative easing. This system has survived since 2009 because, as economists have argued, a government with a compliant central bank, that can fund in its own currency, has no real financing constraint. That seems to have been true domestically but there could be an external financing constraint for countries with a trade deficit. Other countries have to be happy to accept their currency as payment.

Break one part of the current system—the ability of countries to export freely to the developed world—and it is no means certain that the other part of the system—the acceptance of the dollar and other developed-world currencies as payment will survive unscathed. The last crisis played out in the bond markets but the next could play out in the currency markets.