US - The US has already lost the trade war

Trump’s trade war is on track to fail. While there is at least a path through which tariffs can be used to achieve the administration’s stated goals, the erratic implementation makes them ineffective. There’s no well-structured predictable plan for tariffs, leaving companies in limbo. There appears to be no planned response to retaliation or actions from the rest of the world, be it on trade, or broader. Over the past few weeks, the narrative has shifted from the US against the rest of the world to the US against China, with the US requesting that the rest of the world falls in line. The idea of strong-arming(former) allies into countering China is treacherous, with China positioning itself as the sensible, predictable, and even more friendly of the two. There is a significant risk of the US losing its status as the leader of the western world, or at the very least, as the leader of the financial system.

Trump and his advisors have at different times raised three apparent goals of this trade war: reshoring manufacturing, raising revenue to decrease the deficit, and getting better (trade) deals. If the aim is to bring back manufacturing to the US through tariff policy, you’d want to offer clear incentives for firms to invest. You provide them with a clear and adequately long timeline and make it credible that these trade barriers are sufficiently high and stable to make the business case. The Trump administration has done the opposite, with erratic, rapid policy changes, frequent reversals and delays. This does not provide the necessary business climate for firms to reshore their production. Moreover, the current policy of enormous tariffs on China and more moderate tariffs elsewhere, more likely than not drives investment to China’s neighbors instead of the US. As for the second aim, the projected revenues – projected to be in the range of about $150-200bn per year - do very little to reduce the deficit of almost $2tn. Proposed tax cuts more than offset any revenues. Time will tell whether the US will get better trade deals, though this aim is certainly not helped by the fact that the US’s own negotiators do not seem to have a clear objective, with officials from other countries frequently reporting back that it’s unclear what the Americans actually want.

Recent developments point toward growing evidence that the US’s major trading partners, and particularly China, have the upper hand. Most of the recent changes in tariff policy were undoing previously applied tariffs - forced by financial (in particular Treasury) markets - and the fear of an inflation shock in consumer goods. Trump has mid-term elections to think about. China therefore has escalation dominance; the cost of escalation is higher for the US than for China, and China can likely bear pain longer. China retaliated because it believed it would hurt the US more than itself.. The US is reliant on China for various vital goods, and it does not have the capacity yet to produce domestically. It started the war without preparing, cutting off supply before securing adequate domestic production.

So, in the short-term, the tariff policy hits the US harder than most of its trading partners. In the longer-term, things look worse. Industrial policy has generally been regarded as unsuccessful, as governments fail to identify the right industries. Due to recent changes in the geopolitical landscape one can make the case that some inefficiency is simply the cost of securing strategic goods, such as energy, semiconductors, pharmaceuticals and critical minerals. Ironically, due to the US’ reliance on foreign producers, Trump has now exempted most of exactly these strategic goods from high tariffs, limiting the incentive to build these industries at home. Rather, the administration seems intent on betting on the industries of the past, not the industries that are strategically necessary or likely to provide future growth. They want to open coal plants and drill for more oil, support combustion engine cars, and cut R&D budgets, as emphasized by the recent withdrawal of funding to Harvard. Such research and talent are imperative to the innovation needed to stay ahead in the industries of the future, such as robotics and green energy – sectors where China’s lead has grown.

Finally, while China controls global manufacturing, the US controls the global financial system. In trying to bring back manufacturing, and reducing its dependence on China, the US is destroying its reputation and risks losing its dominance of the financial system, perhaps even to China. Although no viable substitute for the dollar or US payment systems exists, countries are actively working on alternatives. China has started that process a long time ago and is increasingly conducting its trade in its own currency. Europe needs its own payments systems, and the euro needs closer financial integration to achieve deeper, more liquid capital markets. These are both clearly articulated policy objectives, although progress is slow. The US government’s actions are accelerating these developments. The cost of losing dollar dominance, and with that the direct benefits and all the soft power that is associated with it, far exceed the short-term pain from tariffs. Tariffs can be unwound quickly, but regaining the world’s trust will take much longer.