Last week, Donald Trump set the global trading system ablaze by imposing massive additional tariffs on countries with large trade surpluses with the US, such as China (34%), Japan (24%), South Korea (26%), Vietnam (46%), India (27%), the European Union (20%) and others. The repercussions are mind-boggling. A month ago, I suggested, “Unless something changes, Trump is a huge threat right now, which is perhaps not being fully recognised.”
In fact, way back in mid-November, I wrote, “It would be suicidal to assume that his promised actions would be tempered… Even if a part of Trumponomics is implemented, it will hit the rest of the world like a tidal wave.”
This has now happened. The tariff war seems to be escalating as the US has decided to put an additional 50% tariff when China retaliated with its own tariff of 34%. As economists, policy-makers and businesses scramble to chart a dangerous and unpredictable future, they are first trying to discover a method in Mr Trump’s madness. What is Mr Trump actually trying to achieve? Here is the logic from Trump apologists.
The Supposed Method
1.Force yields lower: The biggest problem for the US is its massive national debt of US$36trn (trillion), of which US$9.2trn must be refinanced in 2025. The only short-term fix for this is lower yields which would mean lower interest payments. How can Mr Trump drive yields down or induce massive buying of US bonds, especially when inflation is not low? By playing the madman which creates tremendous uncertainty. Abnormally large tariffs create panic and a risk-off scenario, where investors exit stocks and pile into US Treasuries, thus lowering yields. What would help additionally is the US Federal Reserve (Fed) cutting interest rates. This is why Mr Trump was yelling at Jay Powell, chairman of the US Fed, to cut interest rates during the Fed's press conference on Friday.
2.Cut deficit: A lower yield will do nothing to reduce debt. Therefore, the second plank of Mr Trump’s strategy is to cut the deficit by apparently eliminating 'waste and fraud' from the US federal budget. This is the work of DOGE, overseen by Elon Musk. DOGE aims to slash US$2trn from the US federal budget, which totals over US$6.75 trillion.
3.Tariff revenues: The third plank of the strategy is to raise revenues. For Mr Trump, the most obvious revenue source is tariffs. According to the Trump camp, tariffs could generate US$600bn-US$700bn (billion) annually.
4.Geostrategy: The next part of the strategy is supposedly to force negotiations with Europe, Japan, Australia, South Korea and Taiwan—countries that depend on the US for their security—in a way that benefits US trade and investment. This is why the Trump team went after these long-standing allies first.
5.Reshoring: The final plank of this strategy is to force exporters to make their products in the US. While there are no estimates on how much investment and how many jobs this will create, there are only a few pledges from companies like Taiwan Semiconductor, Hyundai Motors, Nvidia and Apple.
What if the Plan Fails?
Even assuming this is all well thought-out, it is an extremely risky strategy, akin to running blind on a tightrope. For one, tariffs come into effect immediately and are so huge that significant costs will be passed on to US consumers and businesses. This could lead to an inflation spike and job losses. If inflation remains high, the Fed may raise rates, and the ‘lower-yield’ plan will fail. The Fed can cut rates during a recession, but that would also lead to massive job losses and lower tax revenues.
The savings effected by DOGE could fall far short of target while causing massive disruptions in US society. Mr Trump cannot have trade deals, tariffs, jobs and reshoring all at the same time. If trade deals are struck, there will be no need for reshoring. Reshoring will take years.
As the Alcoa chairman has said, the company makes large investment decisions based on a 20-30-year outlook, not on months and years. Why would anyone commit to long-term investment in the US based on a presidential diktat when the presidency itself lasts just four years?
The biggest issue is the assumption that while Mr Trump upends the existing order at his will, ‘all other things will remain equal.’ They will not. China, which is ruled with an iron hand, has an enormous capacity to endure pain that most democracies don’t. It has retaliated with a 34% increase in tariffs on US imports, sanctions on select US companies and a ban on some rare earth exports that the US electronics industry depends on. China, the world’s largest holder of US Treasuries, can even force yields up by dumping US debt.
It Will Be Messy
Countries will attempt to work out deals with the US which will be messy, long drawn-out and likely to be capriciously altered. As the world learns of these negotiations in real-time from Mr Trump’s social media handles, strategies will have to be drawn and redrawn, buffeted by mercurial shifts in Mr Trump’s imperious demands, backed by outright falsehoods.
The most likely outcome is higher tariffs, but at lower rates than the current ones, along with lower economic growth across the board—perhaps leading to a recession, lower US tax revenues, new trade alliances with China at the centre and continued uncertainty.
Not since COVID has the world faced such a dire threat to growth and stability. Equity markets, which are derivatives of business and economy, will react with extreme volatility to each twist and turn.
Buckle up.
(This article first appeared in Business Standard newspaper)
Comments
Pksengupta
2 weeks ago
Why are we ignoring domestic protests from people who will be affected and from their political leaders? Leaders at all levels from a mayor/sheriff upward will have to speak up on behalf their people. Trump depends on Opinion polls. If the polls go below 40% , he will have to react and protect his razor thin Congressional majority
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