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  September 11th, 2017 | Written by

Caution Over Talk to Scrap NAFTA

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  • The US-Mexico trade deficit would very likely expand in the absence of NAFTA.
  • When Trump won the election, the Mexican peso sank more than 10 percent.
  • Withdrawing from NAFTA is counterproductive to reducing the US trade deficit with Mexico.

Right now, currency markets are assuming smooth sailing toward a renegotiated NAFTA, despite President Donald Trump’s threat, as recently as August 28, that he would likely terminate the deal.

But it wasn’t always so. When Trump won the election, the peso sank more than 10 percent. In January, amid talk of a possible US withdrawal from NAFTA, the peso dipped five percent. Rumors in April that Trump was about to sign an executive order to withdraw led to another five-percent drop.

If Trump’s problem with NAFTA is the growing trade deficit with Mexico, then talk of withdrawing from the agreement and slapping tariffs on Mexican imports is counterproductive, notes Caroline Freund, in a report from the Peterson Institute for International Economics. That’s because, the more the peso falls, the cheaper and more competitive Mexican imports become, yielding an even higher trade deficit. A US withdrawal from NAFTA, in other words, would boost the country’s trade deficit with Mexico.

The markets are currently quiescent, but Freund warns that “the renegotiation talks could still get derailed.” “And what we have learned from these past experiences,” she added, “is that if NAFTA is scrapped the peso will plunge.”

Freund predicts a 15 percent peso depreciation in the event NAFTA goes by the wayside. With an average US tariff of less than four percent, goods imported from Mexico would be 11 percent cheaper. But US goods facing an average tariff of seven percent would become 22 percent more expensive in Mexico.

The results: US agriculture exporters will lose, as will US buyers of light trucks.

“Because exchange rates adjust,” Freund concluded, “Mexican exporters will be compensated for the loss in competitiveness without NAFTA. In the short run, if history is a good guide to how much the peso will depreciate, the US-Mexico trade deficit would very likely expand in the absence of NAFTA.”