Trump’s Tariffs Look Like a Giant Mistake: It was said of the Habsburgs that they learnt nothing and forgot nothing. Something similar might be said of President Trump when it comes to trade policy.
Donald Trump Is Going All In on Tariffs
Having learnt nothing from the failure of his policies during his first term to prevent the widening of the trade deficit in office, Mr. Trump is now proposing more of the same economic policy mix.
Except this time, he is doing those policies on steroids.
This is likely to compound the Federal Reserve’s task in regaining inflation control. Worse yet, it threatens to send an already struggling world economy into a recession in a manner that could come back to our shores.
That in turn could lead to a Republican shellacking in the 2026 mid-term election.
The Tariff Strategy Explained
The two main components of economic policy during the first Trump administration were the increased resort to import tariffs and a major tax cut.
Import tariffs of between 10 and 20 percent were imposed on around $350 billion of imports from China as well as on steel and aluminum imports.
At the same time, the Tax Cut and Jobs Act made a major cut in the corporate tax rate. The Congressional Budget Office estimated that those tax cuts would add around $1.5 trillion to the budget deficit over the next decade.
Despite higher tariffs, far from narrowing, during Mr. Trump’s first term the trade deficit of goods and services increased by some 40 percent from $480 billion in 2016 to $680 billion in 2019. It did so because the large tax cuts had the effect of both lowering the country’s savings rate by increasing the budget deficit and of increasing the country’s investment rate by incentivizing investment through tax cuts.
The key lesson that Mr. Trump should have learned in his first term was that a country’s trade deficit is determined by its savings-investment balance and not by the level of its import tariffs. So long as a country saves less than it invests, it will record a trade deficit no matter how high its tariff wall might be.
Donald Trump Just Didn’t Learn
It would be an understatement to say that Mr. Trump is now proposing a more aggressive policy mix of import tariff hikes and tax cuts than he did in his first term.
Last month, he imposed a 10 percent tariff on all imports from China and a 25 percent tariff on all steel and aluminum imports. Yesterday, he announced that next week, the import tariff on China will be raised to 20 percent, and a 25 percent tariff will be levied on Canada and Mexico, our two largest trade partners.
In addition, Europe has been put on notice that it is next in line for a 25 percent tariff, while all our trade partners have been threatened with reciprocal tariffs if they run large bilateral trade surpluses with us.
On the tax cut front, Mr. Trump is now proposing an extension of the 2017 Tax Cut and Jobs Act and eliminating income taxes on Social Security benefits and tips. According to the Committee for a Responsible Budget, over the next decade Mr. Trump’s tax cuts could add over $4 trillion to the budget deficit that is already running as high as 6 ½ percent of GDP.
Trump Could Made the Debt Worse
We have to expect that in the same way that the widening of the budget deficit contributed to a worsening in the trade deficit in the first Trump term, it will do so again in the second term.
We also have to expect that at a time when inflation is still running above the Fed’s 2 percent inflation target, the tariff hikes could add almost 1 percentage point to inflation. That in turn could cause the Fed to be wary about resuming its interest rate cutting cycle.
Worse yet, we have to be concerned that Mr. Trump’s tariff hikes will tip an already struggling global economy into recession. China, the world’s second largest economy is presently in the midst of the bursting of its massive housing and credit market bubble.
For its part, Germany, Europe’s largest economy, has now been in recession for two years and is beset by political polarization. The last thing that an export-intensive Chinese and German economy now need is a shock to their export sectors.
Needless to add, closer to home, the Canadian and Mexican economies, which are so closely integrated with our economy, must also be expected to succumb to recessions.
Mr. Tariff Man
It would be fanciful to think that our economy would not be adversely impacted by economic developments abroad. The more than likely retaliation by our trade partners with trade measures of their own would hit our export sector hard.
At the same time, loan problems abroad could add strains to our financial system which is already having to cope with large commercial real estate lending losses. A recession abroad will also hardly be good news for our stock market since the S&P 500 companies derive almost 30 percent of their profits from their overseas operations.
Donald Trump speaking to supporters at an immigration policy speech at the Phoenix Convention Center in Phoenix, Arizona.
For all of these reasons, we have to hope that Mr. Trump makes a trade policy U-turn soon. Unfortunately, all the clues are pointing in the direction of Mr. Trump doing everything that might be expected from somebody who likes being referred to as “Mr. Tariff Man”.
About the Author: Dr. Desmond Lachman
American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging-market economic strategist at Salomon Smith Barney.
