Trump’s Economic Trap

Tariffs are the talk of the town. Donald Trump promised to make America great again, and seems determined to leverage his country’s relentless demand to make that happen.

After all, his challenge is enormous. Much like central banks have become “lenders of last resort”, the U.S. has taken on a similar role – but with a twist. Instead of being the world’s ultimate lender, the U.S. has become its ultimate consumer, driving its fiscal debt to a staggering thirty trillion dollars.

This is where tariffs come into play. While they could help the U.S. reduce its fiscal deficit, the path forward is anything but clear, hence the global apprehension. Trump may consider various strategies to address the issue, but there is a significant risk he could misstep.

Above all, the problem arises from the U.S.’s trade relationship with China. Whereas the U.S. runs the world’s biggest trade deficit, China runs the biggest trade surplus, and this is not coincidence.

Ultimately, income can either be consumed or invested, and China’s has leaned for the latter. Through heavy industrial incentives, Beijing has enhanced investment but has made its demand feeble. As a result, Chinese products have found their way into the U.S. market, boosting American demand but stifling its investment. So far, the U.S. government has worked to fill that gap, but now its fiscal space is running scarce.

The solution, however, is far from straightforward. According to the OEC, almost half of China’s exports to the U.S. are retail products. As this is a highly competitive sector, general tariffs would likely be passed on to consumers, driving inflation higher. Moreover, China holds over a trillion dollars in U.S. debt, and it may threaten to sell these holdings to make interest payments more painful for Washington.

To make matters worse, the inflationary risks from Mr. Trump’s unrealistic promises have recently pushed currency traders further along this trend. The dollar has strengthened, making foreign products in the U.S. even cheaper than local ones, further harming the U.S. industry. This shift stems from traders’ expectation that, with rising inflation, the Fed will pursue a contractionary monetary policy, making dollar returns more attractive than those in other currencies.

The key to resolving this conundrum lies in Trump’s pragmatism. If tariffs were applied selectively — targeting industries where the U.S. lags behind — they could potentially boost private investment while ameliorating the risks of higher inflation. This concept was highlighted by Michael Pettis in The Financial Times.

Take electric vehicles, for instance, an industry Mr Trump’s close advisor Elon Musk happens to lead. In that industry, tariffs may result in more expensive Chinese EVs, increasing demand for Teslas and effectively enhancing investment in the sector while reducing the risks of rampant inflation. The overall effect could be positive, and Mr Trump would have to play this card across the board.

Interestingly, this strategy will require a different kind of leader – one with less noise and more substance. After all, to counter the dollar’s recent appreciation, the markets would need reassurance that the U.S. President won’t go all-in on his promises, but instead will show greater statesmanship. Mr Trump will have to learn, again, how to behave before markets.

As his term goes by, Mr. Trump might end up resembling Joe Biden – a careful, strategic statesman defending specific American industries against foreign monetary policy. This would be ideal for the U.S. economy, but costly for Mr Trump’s popularity. After all, this is exactly what he criticised of Joe Biden.

It will be interesting to see how journalists raise these questions. Why is Mr Trump not delivering on his promises? And more importantly, why does he seem to be acting like ‘Sleepy Joe’? Prepare for no rational answers, but more drama in response. It promises to be fun – let's just hope it doesn't get too risky.