Catching You Up on Trump’s Tariffs
In international trade policy, tariffs have long been a divisive topic that has a big impact on both home economies and international trade ties. Trump’s aggressive trade agenda has reignited that debate, jolted markets, and raised serious questions about the future of global economic cooperation.
Among the many instances of tariff use in US history, the Smoot-Hawley Tariffs, implemented during the 1930s Great Depression, are arguably the most well-known. Yet, the US effective tariff rate was only raised by roughly six percentage points by that legislation. In contrast, prior to the 90-day moratorium that was issued, tariffs imposed by the US under President Donald Trump escalated from the low single digits to nearly 25%.
The economic aftershocks have not been confined to equities. The US Treasury market – typically a safe haven in times of uncertainty – has been unusually turbulent. Yields on 2-year Treasury notes, which usually track the Federal Reserve’s key policy rate, swung sharply – briefly rising above 5% before retreating as traders scrambled to price in the inflationary impact of tariffs and shifting Fed expectations towards far more rate cuts on an expected US recession.
The 10-year Treasury note yield, the benchmark of global borrowing costs, too oscillated wildly, initially climbing from around 4.20% to about 3.80% on large-scale safe-haven hoarding, then up beyond 4.50% on unwinding of large-scale hedge fund trades. It then fell down to around 4.25% after the announcement of the pause before climbing back up to around 4.50% currently. For context, such moves – all within the span of a less than a week – are practically unheard of, with volatility levels reaching the highest in nearly two years.
Bid-ask spreads (the gap between the highest price buyers are willing to pay and the lowest price sellers are willing to accept) widened, liquidity thinned, and volatility surged across the yield curve. The stress prompted some analysts to compare the market’s behavior to crisis-like episodes, underscoring the level of concern sparked by trade policy unpredictability. Primarily, it has raised questions about the safe haven status of US assets.
Trump’s tariffs have unsurprisingly generated considerable attention, often drawing parallels to the 1930s – a historical context that may not be the most flattering. Although the economic environment has evolved significantly since then, the fundamental principle of tariffs – protecting domestic industries by limiting foreign competition – remains unchanged. Nevertheless, the consequences of these isolationist policies in today’s global economy are far more severe.
The Most Beautiful Word in the World
That Trump’s tariff initiatives aren’t haphazard, despite how erratic they might seem, is a truth that may seem slightly hard to digest given most of his announcements came on social media sites and press conferences aboard Air Force One while he was making the trip to his local golf course. The plans were rooted in the president’s campaign pledges and a broader economic strategy he has stood by for decades. Specifically, Trump vowed to increase ‘tariffs’ – the “most beautiful word in the world” – particularly on goods from China and Mexico, as part of his overarching plan to address what he perceived as unfair trading practices contributing to US trade deficits. This strategy, labelled the ‘reciprocal tariff’ policy, sought to elevate import tariffs on countries with significant trade surpluses, effectively countering perceived inequities in global trade relations.
The Trump administration’s approach was heavily shaped by advisors like Senior Counselor for Trade and Manufacturing, Peter Navarro, who advocated for trade barriers to rectify trade imbalances. The justification for these tariffs was to “level the playing field” for American producers and penalize nations with which the US experienced substantial trade deficits. However, this methodology, especially its dependence on a formula for determining tariff rates based on trade deficits, drew criticism from many economists, who contended that it oversimplified the complex nature of international trade and neglected the broader consequences of such policies.
The declaration and enforcement of these tariffs produced immediate and remarkable effects on the financial markets. Volatility increased significantly as investors reacted to the unpredictability surrounding the tariff hikes. Stock markets particularly experienced sharp drops, with major indices falling into bear market territory, as concerns mounted about rising costs for businesses and consumers. Companies like Nintendo, for example, modified their operational approaches in preparation for higher tariffs on goods imported from China, indicating the widespread effects of these policies.
The economic impacts of the tariffs implemented by the Trump administration have been profound. In the short term, economists cautioned that these tariffs could lead to increased costs for both consumers and businesses, causing inflationary pressures. Furthermore, research from organizations like Capital Economics indicated that the tariffs could have a considerable global economic impact. For example, if fully enforced and sustained, global GDP might decline by up to 1.6%, a figure surpassing the effects of earlier crises such as the Eurozone debt crisis. The US itself faced forecasts of GDP shrinkage and rising inflation as a consequence of the trade barriers.
In response to the mounting economic uncertainty, the Trump administration temporarily suspended higher tariffs on 57 countries, with the notable exception of China, where tariffs have been raised to 125%. This suspension, which lasted for 90 days, was framed as an effort to facilitate negotiations with US trading partners and mitigate the economic disruptions caused by the tariff increases. However, despite the temporary reprieve, tariffs on China remained elevated, continuing to stoke tensions between the two countries and fueling concerns about a potential trade war.
This decision to suspend tariffs on certain countries, while maintaining others, exemplified the unpredictable nature of trade policy under the Trump administration. The oscillation between tariff imposition and suspension created a sense of uncertainty in global markets, as businesses and investors struggled to forecast the long-term trajectory of US trade policy.
Implications for the Global Trading System
The Trump administration’s tariff actions have highlighted several critical issues in international trade:
- The Principle of Mutually Beneficial Trade: The imposition of tariffs on countries with large trade surpluses with the US represents a shift away from the idea of mutually beneficial trade. While protectionist measures may provide temporary relief for specific industries, they often undermine the broader efficiency of global trade and increase costs for consumers.
- Evidence-Based Policymaking: The Trump administration’s use of trade deficits as the primary metric for imposing tariffs was widely criticized for its lack of nuance. Economists stressed the importance of grounding trade policy in comprehensive, evidence-based analysis, rather than relying on overly simplistic formulas that could distort the real effects of such policies.
- Global Economic Interconnectedness: Protectionist measures, such as tariffs, often lead to retaliatory actions from other countries, creating a cycle of trade conflicts. The Trump administration’s tariffs sparked responses not only from China, but also from the European Union and other major US trading partners. These retaliatory tariffs contributed to a rise in global trade tensions, which have had negative implications for global economic stability.
- Policy Credibility and Market Confidence: The unpredictability of the Trump administration’s tariff policy, including the frequent shifts between imposing and suspending tariffs, has raised concerns about the credibility of US trade policy. Such fluctuations undermine trust in the stability of international trade agreements and create uncertainty in global markets.
The tariff actions taken by the Trump administration were a bold and controversial effort to address perceived imbalances in US trade relations. However, the economic impact of these policies has been mixed, with short-term volatility and long-term uncertainty overshadowing any potential benefits. While tariffs may provide temporary protection for some domestic industries, they also raise costs for consumers, disrupt global trade, and contribute to broader economic instability.