Who Will Pay the Price for Trump’s Economic Goals?
Slash the trade deficit and the net inflow of foreign money dries up; this will hit share prices and raise the cost of borrowing for companies
Explaining what President Trump really wants has become a thriving industry in its own right, often proved wrong as soon as it is published. Two things are clear about his tariff policy, however: He wants a lower trade deficit and he wants investment to rebuild U.S. manufacturing. True believers who think he might achieve those goals should think through what else has to happen as a result.
The starting point is the balance of payments, the broadest measure of trade and investment in and out of the economy. Its two sides have to balance: the current account, which tallies up trade flows and some other stuff not worth getting into; and the capital and financial accounts, which measure, well, capital and money flowing in and out to buy things such as stocks and bonds and investments in factories.
For years, Americans have imported way more than they exported, thus the trade deficit in the current-account part of the equation. For the balance of payments to balance, there needs to be a corresponding inflow of capital. That has largely come from foreigners buying assets, most prominently stocks and government debt in the form of Treasurys.
Trump’s plan will disrupt that dynamic. Smaller trade deficits mean smaller inflows of capital.
Trump’s obsession is the goods deficit—and there are two ways it can come down.
The first is that the overall goods-and-services deficit remains unchanged, but services—about which Trump doesn’t seem to care and in which the U.S. runs a surplus—are sacrificed for manufacturing. To wit: hurt Wall Street and Silicon Valley to benefit Main Street. This, though, would need shifts in domestic tax and regulation.
The second way for the goods deficit to shrink is to reduce the overall trade deficit. That will mean less foreign money coming in (remember, the balance has to balance). Combine that with more investment in manufacturing—because imported goods are made less competitive by tariffs—and it will mean America has to provide more of the savings to finance new assembly plants, clean rooms and sweatshops.
But domestically things have to balance, too. More savings means less consumption. The flip side of America relying on foreign savings all these years is that it has been able to consume far more. The rest of the world has to work for a living, while America gets stuff in return for promising its full faith and credit.
At the risk of joining the Trumpsplainers, I’ve long thought of Trump as focused on people as workers rather than as consumers. The existing system is focused on delivering stuff to satisfy consumer wants, and let jobs fall where they will, even if that is outside the U.S., rather than delivering jobs and supplying only the stuff that ends up being produced.
Markets are trying to figure out the implications of upending this system. Here are four:
More expensive stuff, and less choice of stuff. Increasing saving means reducing consumption. The tariffs amount to the largest tax increase in decades, which counts as government “saving”—as well as pushing up the price for almost everything imported.
Higher interest rates. The capital inflows that offset the trade deficit help fund a big chunk of federal government borrowing. Slash the trade deficit and the net inflow of foreign money dries up. Bond yields will need to rise to attract domestic savers to buy Treasurys instead of stocks or corporate bonds, which will hit share prices and raise the cost of borrowing for companies.
Lower stock prices. Only a small chunk of foreign investments goes into building factories. If there were more foreign direct investment, it could finance at least some of the reconstruction of manufacturing. But we’ve assumed Trump succeeds in shrinking the trade and current-account deficits, so there will be less foreign money coming in (remember: balance). So more foreign factory building means less foreign buying of stocks and bonds, so lower stock prices.
A weaker dollar. In economic theory the dollar is the variable that moves when savings and investment don’t balance. If the U.S. saves too little to cover its investment, the dollar should weaken to make U.S. investments more attractive to foreigners.
In practice the dollar has been in demand for foreign reserves and for use in trade, as well as a safe place to stash the world’s savings. All three are now being questioned: reserve holders worry they could be cut off from their reserves the way Russia was, trade is likely to shrink thanks to tariffs, and investors are worried that U.S. law might no longer be the reliable protector of their assets.
Questions over the independence of the Federal Reserve, and Trump’s personal attacks on its chairman, Jerome Powell, have the potential to scare off buyers of both the dollar and Treasurys.
The dollar should also be weaker because the U.S. economy should be weaker. America spent a century at the forefront of technology, gradually abandoning low-wage, low-productivity industries in favor of increasingly complex production and high-value-added services such as chip design.
Bringing back those low-productivity jobs is possible if tariffs are high enough, but will reduce America’s economic lead over the rest of the world. Does America really want to bring back sewing jobs from Bangladesh or Cambodia? It looks like it, with the “reciprocal” tariffs set for those nations at 37% and 49%, respectively. Lower productivity, though, should mean a weaker currency, all else equal.
This simplifies somewhat. Interest rates, the dollar and the economy interact, so we get higher rates for any given level of the dollar and growth—with complex interactions as all three move.
Before Trump’s economists start spluttering into their coffee, a really good outcome is also imaginable—but seems to me highly unlikely. The deficit could drop because exports rise as demand in other countries rises, especially countries that have suppressed demand. Trump’s extreme approach on tariffs and defense shocked Germany into abandoning austerity, and part of China’s response to tariffs is to try to boost domestic consumption.
I’m skeptical that Germany and China will quickly welcome consumerism. But even if they did, there is no reason to think they would want to buy American manufactured goods, rather than the U.S.’s highly competitive services, energy and agricultural exports—and that is if they were willing to buy anything American at all, after the insults and unreliability of the past three months.
I doubt that Trump’s tariffs will bring much manufacturing back to America. If they do, investors and consumers will suffer.