To call the first two months of tariff policy under President Donald Trump turbulent would be an understatement. First, he announced 25% tariffs on all goods from Canada and Mexico and then delayed them for a month. Then, a month later, he reinstituted the 25% tariffs on Canada and Mexico, only to exempt auto-related goods the next day and then all goods covered by the United States-Mexico-Canada Agreement, which he had negotiated the day after that.
All this time, the president has steadily bumped tariffs on Chinese goods by 10% each month.
“There will always be changes and adjustments,” Trump said in remarks from the Oval Office on Friday. This came after he told a joint session of Congress, “There will be a little disturbance, but we’re OK with that.”
Economists broadly agree that tariffs are bad for consumers and manufacturers. When Trump raises tariffs on Chinese televisions, American consumers pay higher prices. When he hikes tariffs on Canadian aluminum, it raises costs for American automobile and airplane manufacturers, making it harder to sell goods domestically and internationally.
Trump’s tariffs raise some revenue, thus lowering the federal budget deficit, but Republicans are typically against tax hikes. Why is Trump implementing a policy that raises taxes on consumers and manufacturers at a time when the public says reducing inflation is what it cares most about?
The Trump critique
For as much as economic textbooks agree that tariffs are damaging, governments across the world evidently agree with Trump. India imposes an average 17% tariff on all imported goods, China’s average tariff is about 7.5%, and our European allies have an average tariff above 5%. Meanwhile, the U.S. imposes just a 2.5% average tariff on imports.
The rest of the world seems to think that whatever problems tariffs cause, they benefit their nation’s economy. Trump believes the federal government should start favoring American industry the same way foreign countries favor theirs.
Noting that Canada applies a 250% tariff on American dairy products beyond a set quota, Trump said, “Our country has been ripped off by everybody. That stops now.”
Trump wants every other country to play fair or equally. If any nation has high tariffs on American imports, Trump will place high tariffs on that country’s tariffs until it agrees to lower them. “Whatever they tariff us — other countries — we will tariff them,” Trump said during his joint session speech announcing across-the-board reciprocal tariffs starting April 2. “That’s reciprocal, back and forth. Whatever they tax us, we will tax them.”
Then, there are nontariff barriers countries use to disadvantage American firms. Chinese industrial espionage is an example, as are European Union subsidies to Airbus and Canadian rules mandating local content in online media. Our adversaries and allies constantly favor their domestic companies over ours, and for decades, we have let it happen. Trump wants it all to end, or tariffs go up.
There is also nontariff taxation that Trump believes foreign governments use to take advantage of the U.S., Canada, and Europe. For example, the EU recently enacted an undertaxed profits rule, or UTPR, that allows high-tax jurisdictions such as Germany, where an American company such as Microsoft may have a subsidiary, to impose a surtax on Microsoft’s German profits to make up for the “undertaxed” profits Microsoft earns in low-tax jurisdictions such as Ireland.
This UTPR explicitly violates U.S. sovereignty over its tax base and is simply statutory theft of tax revenues by the German treasury from the American treasury. Former President Joe Biden, as always indifferent to American interests, told Europe and Canada this was fine, but Trump disagrees. He is going to fight to get this revenue back.
Canada and many European nations have also adopted a digital services tax, or DST, which taxes revenue from certain digital services (e.g., online marketplaces, advertising, social media, and user data). Britain’s DST is 2%, Austria’s is 5%, and Canada’s and most of the rest of Europe is 3%. Trump and many tech companies in Silicon Valley believe this unfairly targets American corporations and want it repealed. Tariffs are one way Trump can exert leverage over Canada and Europe to force them to abandon their DST.
The reserve currency problem
According to economic textbooks, trade imbalances between nations level off over time because persistent imbalances trigger currency adjustments that, in turn, restore balance to trade.
For example, if the U.S. imports more from Europe than it exports, U.S. importers need to go outside the U.S. and buy enough euros to pay for the excess value of European imports. As U.S. importers use dollars to buy euros, it weakens the dollar and strengthens the euro, making European imports more expensive for Americans, who will switch to cheaper domestic options. A cheaper dollar makes U.S. exports less expensive for European consumers, who then buy more American exports, thus moving toward a trade balance.
But the textbook theory does not work out in practice for the U.S. because, thanks to the size and strength of our economy and our reputation for reliably delivering law and order, the dollar has become the world’s reserve currency.
According to the International Monetary Fund, 60% of all reserves held by governments worldwide are in U.S. dollars. For most of this century, it was 70%. Firms throughout the world use the dollar for international transactions even when neither U.S. goods nor U.S. firms are involved. International oil markets are priced in dollars. The euro is a distant second to the dollar, accounting for just 20% of world reserves.
Being the world’s reserve currency comes with some advantages, including lower borrowing costs and the ability to sanction recalcitrant people and regimes by freezing assets or denying access to the U.S. financial system.
But it also comes with costs, such as trade imbalances that never even out as they do for other countries. This means domestic manufacturers and farmers are at a permanent disadvantage as the dollar stays strong, making both U.S. exports more expensive and foreign imports cheaper.
These structural trade imbalances mean foreign investments flow into the U.S. but do not help develop our manufacturing base. Instead, they primarily drive up real estate prices and boost the financial sector.
The big winners of the dollar’s status as a reserve currency are Wall Street bankers and wealthy asset holders. The losers are manufacturers and farmers, the heart of the middle class.
Having our cake and eating it, too
Trump does want to keep the dollar’s reserve status and has threatened to punish any country that moves away from using the dollar. But he also wants our allies, particularly those that most benefit from the global security and stability we provide, to share the burdens that come with our reserve currency. Tariffs can be used to accomplish this.
At an event last June in Washington, D.C., Manhattan Institute President Reihan Salam asked Treasury Secretary Scott Bessent if he saw a role for tariffs as a revenue source. While Bessent acknowledged that was one role tariffs would play in a Trump administration, he said Trump also viewed tariffs as a much larger tool for achieving both economic and security goals.
“I was at a recent Council on Foreign Relations meeting, and Jared Bernstein was talking about Biden policy,” Bessent began. “In the Q&A, a woman from a European think tank said to him, ‘You know you said the word friendshoring seven times, but you never tell us what it means to be a friend.’”
“So I think in terms of tariffs,” Bessent continued. “I think in terms of currencies, I think in terms of bilateral trade agreements, I think in terms of security agreements, I think in terms of values, I think we should make it very clear that there is a green, a yellow, and a red bucket. And we let everyone know where they are, and here is what we ask of you … and you can choose which bucket you want to be in.”
Building on the bucket metaphor, Stephen Miran, whom Trump has nominated as chairman of his Council of Economic Advisors, recently illustrated what it might take to be placed in each bucket.
“One can imagine a long list of trade and security criteria which might lead to higher or lower tariffs, premised on the notion that access to U.S. consumer markets is a privilege that must be earned, not a right,” Miran wrote.
“For example, maybe the U.S. wants to discriminate based on:
Does the nation apply similar tariff rates to its imports from the U.S. as America does on its exports here?
Does the nation have a history of suppressing its currency, for instance via the accumulation of excessive quantities of foreign exchange reserves?
Does the nation open its markets to U.S. firms in the same way America opens its markets to foreign firms operating stateside?
Does the nation respect American intellectual property rights?
Does the nation help China evade tariffs via re-export?
Does the nation pay its NATO obligations in full?
Does the nation side with China, Russia, and Iran in key international disputes, for instance at the United Nations?
Does the nation help sanctioned entities evade sanctions or trade with sanctioned entities?
Does the nation support or oppose U.S. security efforts in various theaters?
Does the nation harbor enemies of the U.S., e.g. terrorists or cybercriminals?”
“Such a system can embody the view that national security and trade are joined at the hip,” Miran wrote, a view shared by Trump. “Countries that want to be inside the defense umbrella must also be inside the fair trade umbrella.”
Can Trump execute?
The U.S. economy is the envy of the world, but voters have told pollsters for decades that our nation is on the wrong track. While incomes for college-educated people have grown substantially in the past 50 years, those for non-college-educated people have not, and for non-college-educated men, they have fallen. Persistent trade imbalances are a big reason for this. Trump’s voters voted for him to fix it. That is what he is trying to do.
But is he doing it effectively?
TRUMP OFFICIALS ACKNOWLEDGE TEMPORARY PAIN AMID TARIFFS AND MARKET UNEASE
“There is a path by which the Trump administration can reconfigure global trading and financial systems to America’s benefit,” Miran concluded, “but it is narrow and will require careful planning, precise execution, and attention to steps to minimize adverse consequences.”
Careful planning and precise execution do not seem to be what Trump is delivering so far.
