The president has a plan to make the world pay the US protection money. Frances Coppola explains.
Tariff Man is back. And he’s on a mission. President Trump wants to eliminate the US’s gaping trade deficit. To this end, he has imposed a baseline 10% ad valorem tariff on imports from every country on earth, irrespective of the trade balance; an additional import tariff on countries with a trade surplus vis-à-vis the US, calculated as their trade surplus divided by their imports from the US, subject to the 10% tariff floor; and specific tariffs on certain products, such as cars, on which he has imposed a blanket 25% ad valorem import tariff.
This adds up to the most draconian set of import restrictions since the Smoot-Hawley tariffs of 1930. Perhaps more importantly, it is also the most enormous tax hike on American consumers and producers in US history. But underlying it is a radical dream. Mr. Trump wants to reshape the global economic landscape – and he believes tariffs are the way to bring this about.
Import tariffs are taxes on imports. Mr. Trump has talked about replacing income tax with tariffs, saying that instead of taxing Americans, his administration will tax foreigners. But foreigners don’t pay import tariffs. Import tariffs are initially paid by domestic importers, which are of course American businesses. Who eventually pays depends on the extent to which importers can pass the costs on to suppliers and customers. If customers are not particularly price-sensitive – for example, if the goods are luxury goods, or essential goods for which there are few domestic substitutes – importers may be able to pass the entire tariff on to customers.
Suppliers might export elsewhere instead of cutting their prices to absorb the tariffs. So importers may have to eat their margins.
Realistically, though, there’s some elasticity in demand for most goods, so importers are unlikely to be able to pass on the entire cost. And suppliers might export elsewhere instead of cutting their prices to absorb the tariffs. So importers may have to eat their margins. This would mean lower returns to shareholders and smaller wage rises for employees. Some importers might lay off staff. Some might even go out of business.
Clearly, tariffs are both inflationary and deflationary. Inflationary, to the extent that they can be passed on to end customers; deflationary, to the extent that they cause importers to eat their margins.
The chairman of the Federal Reserve, Jay Powell, has indicated that the Fed will respond to rising inflation. But the Fed has a dual mandate. It must also respond to rising unemployment. If the margin-eating causes growth to slump and unemployment to rise, the Fed will be under pressure to cut interest rates despite rising inflation. The phenomenon known as “stagflation”, last seen in the 1970s, is looming on the horizon – and the Fed is facing a double bind.
If he goes ahead, then these tariffs will be the biggest wealth transfer from ordinary Americans to the rich since the 19th century.
Mr. Trump might help the Fed by doing some fiscal stimulus. He’s talking about tax cuts – for the rich. If he goes ahead, then these tariffs will be the biggest wealth transfer from ordinary Americans to the rich since the 19th century. But he’s playing a long game. Although American importers and consumers will feel pain in the short-term, Mr. Trump expects that the combination of high import tariffs with tax cuts and deregulation will benefit American businesses, leading to more and better jobs for American workers and lower prices for American consumers.
Hard-working Americans are not Mr. Trump’s target. His tariffs aim to force the countries that he believes have been ripping off the US by running persistent trade surpluses to change their ways. He wants not merely to close the US’s aggregate trade deficit, but all its bilateral trade deficits, including those with the poorest countries on earth. In future, everyone must buy from the US at least as much in US dollar terms as they sell to it.
And it doesn’t end there. Mr. Trump wants every country to pay a levy for the privilege of trading with the US, or – since his tariff list includes countries that don’t trade with the US, or even with anywhere at all – simply for the privilege of existing. Tribute, we might call it. That’s what the 10% baseline tariff is.
Mr. Trump has no intention of shifting on this. He thinks he has already been generous enough – after all, it’s only 10%.
Those who think this can be negotiated down are deluding themselves. Mr. Trump has no intention of shifting on this. He thinks he has already been generous enough – after all, it’s only 10%. He’s keen for countries to negotiate, but they need to understand that the purpose of negotiations is to stop him from raising it.
But why does Trump think he has the God-given right to charge a levy on foreign countries? The most obvious explanation is that the entire global trading and settlement system depends on the US dollar. For foreign countries to trade internationally, they need access to dollars. So we might regard the baseline 10% tariff as a fee for use of the dollar. Or, perhaps, an insurance premium. After all, as the economists Pierre Gourinchas and Helene Rey say, the US is de facto insurer to the world. When the global financial system goes into meltdown, the US bails it out. Why shouldn’t other countries pay for this?
The US has for many years acted as the consumer of last resort for the world. This has enabled these countries to build up dollar reserves to see them through bad times, while the US has only built up debt.
There’s also a rational reason for the much higher tariffs Mr. Trump has imposed on countries with persistent trade surpluses vis a vis the US. The US has for many years acted as the consumer of last resort for the world. This has enabled these countries to build up dollar reserves to see them through bad times, while the US has only built up debt. For Mr. Trump, the “exorbitant privilege” that enables the US to borrow more than almost any other country, at lower interest rates than almost any other country, is an unfair burden that has destroyed America’s productive base and left it dependent on the kindness of strangers. The US, uniquely among the nations, is unable to build up reserves. Mr. Trump wants to change this. Hence his ideas about a sovereign wealth fund, a Bitcoin strategic reserve – and a tax on all the countries that have built up reserves at, he believes, the US’s expense. He wants the world to continue to use the dollar, but on what he considers a fair basis. Pay for using it, and pay tax on your dollar reserves.
But Mr. Trump’s scheme may not play out in the way he expects. Economic theory says that the impact of tariffs on Americans should be mitigated by a rising real dollar index, but at present this is falling, making the impact worse. Stock markets are also falling as capital flees from the US, wiping out much of the pension wealth of ordinary Americans. Companies are looking for ways of avoiding the tariffs without reshoring production to the US. And countries are talking about deepening trading relationships between each other, rather than with the US. They might have to give up their trade surpluses, but that doesn’t necessarily mean they will trade more with the US.
Mr Trump dreams of the US once more being the manufacturing powerhouse at the heart of the international trading system, and every nation on earth paying to use the dollar and trade with the US. But he may find that the world simply turns its back on the US.
