Deficit delusions
Trump’s tariffs have at least eight frequently contradictory aims (as I have said before). Let’s focus on the trade deficit, that being the one at which April’s “liberation day” tariffs (that got finally sort of implemented in August) were aimed. There was a fall in the goods deficit in August. Is the plan working?
Answer: not so far. And, if it does, it almost certainly won’t be in the way Trump wants. The standard macro view is that tariffs can’t be used to close current account deficits, which are driven largely by relative savings rates.
As a recent paper published by Yale Jackson School of Global Affairs points out, there are certain circumstances under which they might. But they involve raising the price level and hurting real consumption, which isn’t really the outcome Trump wants. (If you really want to go for it, you can raise tariffs until they cause a full-blown recession, whereupon the trade deficit will certainly fall on a cyclical basis.)
There have been some pretty big swings in imports and exports this year, but they look a lot more like tactical front- and back-running of tariffs by companies, not shifts in production. As the academic Richard Baldwin points out, there was a massive surge in imports straight after Trump was elected last year as companies built up stocks of imported goods, particularly capital and input goods. This caused the trade deficit to explode.
Then imports and exports fell when the tariffs were announced and implemented after March 2025, bringing the trade balance to similar deficit levels as before. The fall in exports seems to reflect US manufacturers’ inability to sell abroad owing to difficulties obtaining imported inputs, in a development as unpredictable as Christmas.
Geographically there has been a bit of a shift in bilateral deficits from Asia to elsewhere (and from China to other countries nearby, such as Vietnam). But nothing radical.
Brad Setser of the Council on Foreign Relations removed gold and pharmaceuticals, goods that are both relatively easy to stockpile, from trade flow data, and found it made the trade balance quite steady. The deficit fell in August, but there have since been massive surges in imports of chips and electronics from Taiwan to build data centres.
Baldwin’s conclusion is that the Trump tariffs have “temporarily distorted but did not repair” the trade balance by first causing a front-running surge and then curtailing it. That seems about right so far. Companies may well now engage in “back-running”, holding off buying imports if they think tariffs will come down as Trump agrees more bilateral deals.
If the deficit doesn’t fall, Trump could acknowledge that tariffs aren’t working to fix it and whack them back up again (unlikely). Or he could turn to other instruments to try to close the trade gap (more likely). Or he could just lie and say the deficit is falling even when it isn’t (the favourite). In any case, the standard economic view that tariffs don’t close deficits is so far holding. Reality has a pronounced macroeconomic bias.
Exploiting Trump’s weakness
Last week in the Trade Secrets column I wrote about whether Trump’s tariff campaign was approaching its upper limits, as the inflationary threat intensifies its unpopularity. Is this a weakness trading partners currently negotiating gunboat deals can exploit? Or, at the very least, is there evidence that their publics are turning against too craven an approach?
There have certainly been a couple of examples of spine emerging, though it’s far too early to call a trend. One is Indonesia, whose government has signalled it will resist “poison pill” clauses that the US is trying to insert into its trade deal.
This is an interesting contrast with fellow Asean countries, such as Malaysia and Cambodia, which opted for the tactic of signing deals and hoping the US didn’t actually try to use its leverage. To be fair, it is easier for Indonesia, as it is much less reliant on exports to the US.
Where else? Well, Switzerland was among the hardest hit by Trump’s tariffs in August, before it negotiated a deal in November that brought them down sharply. Now there are complaints about the sordid way the pact was stitched up by a Swiss corporate oligarchy who gave Trump a Rolex clock and engraved gold bar to put on his desk. There’s no pleasing some folk, and I’m edging towards the conclusion that the Swiss are a hot-headed and erratic people.
It’s anyone’s guess whether this distaste for bling bargaining is going to kill the agreement as it wends painfully through the labyrinth of the Swiss budget process. The interesting thing will be if Switzerland ends up holding one of the country’s frequent referendums on the issue, showing us directly what happens when the public gets to vote on a gunboat deal.
As ever, the big test case on standing up to Trump is the EU. The bloc is making defiant noises about not rewriting its tech rule book in return for lower steel tariffs, while having already signalled that, to some extent, it will do just that. One thing to note is that Brussels still seems to think Trump will stick to the deals he makes. This is despite his reneging on the supposed understanding back in July that the US would support Ukraine in return for the EU accepting some tariffs.