Trump Tariffs and Global Outcomes
In an era marked by shifting economic paradigms and escalating geopolitical tensions, the role of tariffs has transcended their traditional function as instruments of trade policy. While often perceived as tools to balance trade deficits or protect domestic industries, tariffs wield profound influence over capital flows, currency dynamics, and global debt sustainability. This article delves into these lesser-explored dimensions, challenging the conventional view that tariffs are mere trade balancers.
Through a historical and analytical lens, we will explore how tariffs have been used as instruments of broader economic strategy, shaping financial and geopolitical landscapes. The series begins by examining the historical context of U.S. tariff policies and the organic rise of the U.S. dollar as the world reserve currency, before exploring how tariffs can reshape global capital flows. The second part investigates the intersection of tariffs with debt sustainability and the vulnerabilities they expose in China’s economic framework. Finally, the series concludes by addressing the broader systemic implications of tariffs on inflation, energy markets, and the delicate equilibrium between global currencies.
By framing tariffs as catalysts for structural reform and strategic leverage in international negotiations, this article aims to bridge the gap between traditional trade economics and the complex realities of a highly interconnected global economy. Whether as tools of economic negotiation or as triggers of geopolitical rebalancing, tariffs are poised to play a defining role in shaping the economic landscape of the 21st century.
Historical Context: The Role of Tariffs in U.S. Economic Policy
The United States has a long and complex history with tariffs. In the 19th century, tariffs were a cornerstone of federal revenue and industrial policy. The Tariff of 1828, infamously known as the “Tariff of Abominations,” helped foster industrial growth in the North but worsened economic disparities with the agrarian South, sowing seeds of division that contributed to the Civil War.
The 20th century brought the Smoot-Hawley Tariff Act of 1930, enacted during the Great Depression to protect domestic industries. Instead of fostering recovery, it prompted retaliation from key trading partners, collapsing global trade and deepening economic hardship. This act became a cautionary example of how protectionist policies can backfire when applied during fragile economic conditions.
By the Reagan era, tariffs targeted specific sectors, such as Japan’s automotive and electronics industries, aiming to defend U.S. manufacturing. While these measures temporarily shielded domestic industries, they spurred unintended consequences, such as the restructuring of global supply chains and shifting capital flows. These historical episodes demonstrate that tariffs are more than trade measures — they are powerful economic tools with far-reaching consequences.
The 1985 Plaza Accord is worth mentioning here. The agreement between major economies to weaken the U.S. dollar was aimed to address trade imbalances but also ushered in inflationary pressures. But in 1985, US Debt to GDP stood at 42% — allowing US to have greater flexibility to engage in currency devaluation than it does now as the present-day U.S. economy, marked by record-high debt levels and persistent supply chain disruptions, is not in a position to absorb the inflationary effects of full-scale currency debasement.
Instead, the path forward necessitates a careful sequence of policy measures. The foundation lies in revitalizing U.S. manufacturing and reducing the debt-to-GDP ratio. As production capabilities expand and economic growth outpaces debt accumulation, a weaker dollar will eventually benefit the U.S. by boosting export competitiveness. However, attempting to devalue the currency prematurely would undermine these efforts, emphasizing the importance of a nuanced approach to tariffs and broader economic policy. It is also worth noting that today’s economy is far more interconnected than the global economy of the 1980s or any period before. As a result, the impact of tariffs — whether positive or negative — will likely be more pronounced, amplified by long and variable lags that make their effects harder to predict.
To better understand these lags, this analysis will use capital markets as a critical lens, exploring how tariffs shape capital flows and examining their downstream effects on economic growth, sovereign debt sustainability, and private consumption patterns.
The Organic Rise of the USD as the World Reserve Currency
Central to US tariffs in the 21st century is the mechanisms of the US Dollar’s place in the global economy as the world reserve currency. While many complain about the abuses by the US government, misappropriating the power of the WRC, few understand that USD as WRC is not an imperial tool of the US but a free market tool. The USD’s rise as the world reserve currency (WRC) was not a deliberate imposition by the United States but an organic outcome of the post-World War II global economic environment. The war left much of Europe and Asia in ruins, with shattered economies and unstable currencies. Amid this upheaval, the USD emerged as the anchor of global stability, backed by the largest gold reserves in the world and an industrial base untouched by wartime destruction.
The devastation of World War II created an urgent need for a stable international monetary system. The Bretton Woods Agreement of 1944 institutionalized the USD as the cornerstone of this system, pegging it to gold at $35 per ounce while other currencies were pegged to the dollar. This system provided the stability that global trade and reconstruction demanded.
A key driver of the USD’s dominance was its liquidity and trustworthiness, underscored by the U.S.’s vast gold reserves. In 1945, the U.S. held over two-thirds of the world’s monetary gold, far outpacing other nations. This provided the backing necessary to inspire confidence in the USD as a global reserve currency.
The rise of the eurodollar market in the 1950s and 1960s further entrenched the USD’s position. This offshore market allowed dollars to circulate outside U.S. jurisdiction, driven by international banks and corporations seeking to trade and invest in USD. This demonstrated a critical factor in the USD’s dominance: its acceptance and utility in free markets. The eurodollar system showcased the organic preference for a freely traded, liquid currency over imposed alternatives, such as the British pound in earlier decades or the Soviet bloc’s attempts at currency controls.
The USD’s role as a reserve currency was not simply limited to trade or economic stability but also post war reconstruction. The Marshall Plan, implemented in 1948, was not just an economic reconstruction program but also a key mechanism for the international distribution of dollars. By funneling billions of dollars into European economies, the U.S. helped rebuild war-torn nations and stabilized their economies, indirectly reinforcing the USD’s status as the WRC. This effect was not simply limited to Europe or east Asia but was a global phenomenon. For nearly three decades after the war, the USD’s share of global reserves continued to rise, signifying a characteristic of USD that continues to play a major role in global macro — in times of uncertainty and economic weakness, USD is a safe haven.
Not surprisingly, the USD share of global trade also follows a similar trend.
This is important because these trends have a significant impact on the value of USD and as one might suspect, tariffs have intermittently played a role in shaping the currency’s value and global position. For example, the Kennedy Round of trade negotiation in the 60s contributed heavily to the steep rise in USD global reserves. Similarly, in the 70s, the Tokyo Round that sought to reduce tariffs also helped reduce the share of global reserves denominated in USD in the early 80s. This makes sense as higher tariffs mean a) increased uncertainty in the global markets about future economic outcomes and USD as a safe haven result in higher dollar; and b) less US imports which subsequently create relatively more demand for dollars compared to other currencies wherein exports from the rest of the world to the US experience a downturn.
Tariffs as a Tool to Reshape Capital Flows
Having covered the historical context of tariffs and the linkages between trade, USD, and global financial reserves, it is appropriate to understand how all of these aspects of global macro come together to define capital flows. Tariffs are more than tools for balancing trade deficits; they fundamentally reshape the flow of global capital. By influencing trade dynamics and production incentives, tariffs drive shifts in capital allocation that ripple through global markets, impacting the value of currencies, the balance of investment flows, and the geographic distribution of manufacturing activity.
No leader in the recent past has understood this better than President-elect Trump. Behind all the rhetoric, Trump is a deal maker and every move of his is designed to gesticulate American strength in defining global trade norms. In the first Trump presidency, US used tariffs to create a clear economic incentive for companies to shift their manufacturing to avoid the increased costs associated with exporting to the U.S. This strategy aimed not just to reduce the trade deficit but also to restore U.S. manufacturing competitiveness. A few examples:
a. Polestar (Swedish Electric Vehicle Manufacturer), primarily owned by China’s Geely, began producing its Polestar 3 SUV at Volvo’s plant in South Carolina. This strategic move allows Polestar to avoid significant tariffs on Chinese-made vehicles imposed by the U.S. and Europe, ensuring smoother access to these markets.
b. Mlily (Chinese Mattress Brand), established a factory in the U.S. to sidestep anti-dumping tariffs. With North America accounting for 62% of its revenue in 2021, Mlily’s U.S. production base enables the company to maintain its market share while avoiding high tariffs on imported mattresses.
c. Hailiang (Chinese Copper Tube Manufacturer), a Chinese copper tube manufacturer, set up a production facility in Sealy, Texas, in 2018. This decision was influenced by U.S. anti-dumping measures, prompting the company to produce domestically to better serve the U.S. market and avoid associated tariffs.
d. Toyota and Mazda (Japanese Automakers), collaborated to build a joint manufacturing plant in Huntsville, Alabama. This $1.6 billion investment ensures they can produce vehicles domestically, bypassing tariffs and staying competitive in the U.S. market.
e. Samsung and LG (Korean Electronics Giants), established manufacturing facilities in South Carolina and Tennessee, respectively. These plants enabled the companies to continue serving American consumers while avoiding import-related costs.
These are just some of the examples. But it isn’t simply about manufacturing capacity of the US or reducing dependence on China. The reason tariffs are a key component of Trump’s America First agenda is that tariffs have also helped increase personal savings rate. In the immediate aftermath of 2018 Trump tariffs, the personal savings rate jumped higher in 2018, but given the globally connected nature of the world economy, they were soon followed by recessionary fears in 2019 which weighed down on the personal savings rate.
Post 2020 data is hard to analyze as the global and the US economy is still adjusting to the global supply shock of the Covid crisis. But the reasoning, at least for Trump, is clear: Tariffs bring manufacturing back to the US and drive US dollar higher (DXY jumped from 89 on Jan 01 2018 to 99.3 on Sept 02, 2019) which puts currency pressures on countries like China. That is a big leverage for Trump to begin negotiations. However, the global economy cannot sustain a high US dollar for long — high USD makes US exports costlier and as such US trade deficits can widen. At the same time, tariffs make import costlier creating global excesses and slow down in growth. These are the exact dynamics that created recessionary fears in 2019.
While challenging to achieve and unlikely to be executed perfectly by Trump, the tariff strategy is fundamentally designed to drive manufacturing back to the U.S. This effort is supported by cheaper energy and reduced regulatory compliance costs, setting the stage for a long-term shift in trade dynamics. Over time, the sequence becomes clear: first, tariffs push the USD higher, along with accompanying deregulation to attract capital; next, manufacturing begins to reshore, further supported by affordable energy. Finally, as domestic production capacity strengthens and U.S. debt-to-GDP ratios stabilize, the stage is set for a weaker USD to support export competitiveness and reduce trade deficits. Understanding this sequence is critical to anticipating the trajectory of economic and trade policies moving forward.
This is part one of a three part series. You can read part two here.
