Why is President Trump so keen on tariffs?

Donald Trump has chosen cabinet members and advisers who believe, as he does, that trade is unfair to the US. They want to use tariffs to narrow the deficit and increase manufacturing jobs at home. They have all defended the policy in the media.

Some place more emphasis on the use of tariffs to get other countries to the negotiating table with a view to getting trade barriers down. Scott Bessent, the Treasury Secretary, is seen as a reassuring voice on TV and is used to set out the case for negotiating trade deals with trade partners. With his Wall Street background, he is viewed as best at calming troubled markets.

Howard Lutnick, the Commerce Secretary, and Jamieson Greer, the US Trade Representative, are heavily engaged in responding to foreign country offers of trade talks. They are thought to support the possibility of a series of freer trade deals emerging. If President Trump uses the ramp down presented by offers of lower tariffs and barriers to trade by others, markets will be relieved.

Peter Navarro, his Trade and Manufacturing Adviser, is thought to be more hawkish, valuing the revenue tariffs raise and wanting a bigger reset of the world trading system. All the team must respond to President Trump’s love of deals, arguing for lower tariff agreements starting with countries such as Japan, Korea and the UK. They also will be aware that he can be influenced by the wish to raise substantial revenue from tariffs, seeing them as more of a hit on the exporting countries and companies than on the US consumer.

In the end, the president will decide the balance. Currently, he seems to favour a general 10% tariff on everything as a base, with freer trade deals or higher tariffs on specific countries and products where there is no deal. He will also be aware of much larger arguments amongst his advisers, where some want a major remodelling of world trade and its connections to world defence and security.

The thinker who has done most to set out the issues is the Chairman of his Council of Economic Advisers, Stephen Miran. His “Users Guide to restructuring the global trading system” sets out an analysis of what he thinks has gone wrong for the US and looks at various far-reaching remedies. His past writing is not a statement of government policy.

The problem of twin deficits

From time-to-time, markets and commentators have become concerned about the US running both a large balance of payments deficit and a large government deficit. Over the years, there has been a big expansion of state debt and there have been large sales of US Treasuries to foreigners to finance these deficits.

The US has been in current account deficit continuously since 1982, with the exception of two quarters in 1991. The state debt has risen to 125% of gross domestic product. Stephen Miran argues that the US has been closing factories to import manufactured goods from China and other overseas countries and has been exporting Treasury Securities to pay the bills.

He believes the role of the dollar as the world’s reserve currency makes Treasury bonds attractive as reserves for foreign trading and banking systems, inflating demand for US paper. He thinks this has, in practice, led to a permanently overvalued dollar more than to overvalued Treasuries, where a plentiful supply of new debt has helped moderate prices.

He fears an eventual doom loop, though does not think there will be a crisis anytime soon. A high dollar reduces US production further, the trade deficit widens so the US must sell more Treasuries. The state must borrow more as well-paid jobs are lost to foreign competition.

At some distant point, there could be a loss of confidence in the dollar as the reserve currency and in Treasuries as the preferred safe asset. He sees tariffs as the way of starting to tackle the trade deficit and helping to onshore more manufacturing investment and employment.

He argues that, when President Trump tried this with tariffs on China in his first term, the tariffs generated revenue for the Treasury but had little impact on the US price level because the dollar strengthened by almost as much as the average tariff increase. He warns that if tariffs are raised and the dollar falls there will be more of a price impact and more volatility in markets, which is what has been happening second time round. He points out that, as the US only imports 10% of its needs, a 10% tariff hike if all passed on would only raise the consumer price index by 1%. That would be a one-off assuming no further tariff rise the following year.

Keeping confidence in the dollar

President Trump sees the US as being too generous to the world in allowing an overpriced dollar and low barriers to permit China, Germany, Canada, Mexico and others to run large trade surpluses with the US. He also thinks the US has been offering a free defence umbrella to Nato and other allies. He is taking action to cut the US commitment to Ukraine and European defence. He is concerned that the US is losing its ability to defend itself by allowing the rundown of crucial raw materials, metals and components needed to manufacture weapons and ammunition.

To ensure the US can arm itself, he sees the need to onshore everything from steel and aluminium to microprocessors and engineered parts. The tariff policy is aimed at reinforcing the defence policy, with more emphasis on the ability to defend the homeland with an Iron Dome defence, and to intervene where needed in the world in support of US wider interests.

The President is also aware that the US can exercise power and influence short of sending military force. Indeed, he speaks passionately for peace and prefers to use tough language and economic and financial levers to secure policy change abroad. The US position in financial and currency markets with the main reserve currency and reserve assets means it can use financial sanctions and denial of access to the US system as leverage to change a foreign government’s policy.

Mr Miran sees the potential danger in policies that seek to lower the dollar too far too fast having some knock-on adverse effect. Foreign countries may become less willing to hold so many dollar assets. Despite this, he has floated the idea that to make Treasuries less compelling in conditions of a rising dollar the US might need to impose a so-called user fee on them for foreign owners.

What might President Trump decide?

The range of views amongst his trade and economic team leave the President free to choose from a wide range of options. It looks as if he will listen to those who want to do deals with friendly countries where they can be exempted from the worst of the new US tariffs in return for lowering barriers they currently impose on the US. That would be helpful for world markets and economies.

It seems likely he will want to keep an average higher tariff as a source of revenue to cut the budget deficit and help pay for tax cuts. He needs imports to be dearer and more difficult to deliver his onshoring investment policy. He needs to be careful that he does not damage confidence in the dollar and US assets too much.

US Treasuries remain the most liquid and reliable “safe” assets, but they can lose holders a lot of money with devaluation of the dollar or with higher interest rates hitting the value of longer dated bonds. This President has a clear understanding of the extent of US power – and he does not set out to diminish it but to use it. If he does not moderate his trade war and seek some peace treaties over trade with partners, he could hit confidence more and damage the very economy he wishes to strengthen.