Liberation Day

Trump's new tariffs shock the world

“Ruination Day”, The Economist

Late in the afternoon on April 2nd, President Donald J. Trump shocked the world with his “Liberation Day” announcement of the largest tariff increases in modern US history, larger even than the 1930 Smoot Hawley tariffs which (in popular lore) helped turn a serious recession into the Great Depression. The President’s new tariffs will apply to just about every other country in the world, with a few curious exceptions including Russia and North Korea. Trump’s latest announcement follows ten weeks of on again-off again tariff pronouncements from the White House, interspersed with a series of gratuitous insults by our President and Vice-President directed at some of our country’s closest military allies and trading partners, as well as apparently serious suggestions from the White House that the United States would attempt to annex Canada, acquire Greenland, retake control of the Panama Canal and redevelop Gaza as a US-owned beach resort.

The President’s April 2 tariff announcement triggered a massive sell-off in the global capital markets, with US stocks suffering the largest two-day correction since the dark days of the Global Financial Crisis and the Covid pandemic, bringing the total loss in US equity market value since Trump’s inauguration to almost 20% as of Friday’s close. [US stocks were off another 5% in pre-market trading Monday morning, but have since recovered some of this loss.] The price of oil fell close to 15% following Trump’s tariff announcement and the US dollar lost 4% of its value. All told, an estimated $30 trillion in market value had been erased by the Friday close, equivalent to one full year of US GDP.

In response to Trump’s tariffs, China filed a formal complaint with the WTO, announced that it will impose large reciprocal tariffs on the United States, will restrict the export to the US of critical rare earth materials mined only in China and might devalue the yuan and dump UST bonds into the market. In contrast, most of our other major trading partners are wisely taking some time to consider their options, including imposing their own reciprocal tariffs and retaliating against US firms operating abroad. In Congress, Republicans appear mostly to be circling the wagons to defend themselves and their President, although a few brave souls have voiced support for Democratic efforts to claw back some of the extensive tariff authority which Congress has over the years abdicated to the Executive branch.

Economic uncertainty indicators have hit record highs, indicators of confidence have plunged, and businesses the world over have put a hold on large investment and spending decisions and are preparing to lay off employees after scrambling to restock their inventories at pre-tariff prices. Forecasters have increased their probabilities for a near-term recession—JP Morgan raised its odds to 60%— and Larry Summers has suggested that Trump’s tariffs could result in two million unemployed American workers and a $5,000 reduction in average US household income. All eyes are now on the Fed, which has been put in a difficult position by Trump’s tariffs and by the President’s repeated browbeating.

Not surprisingly, the White House phone lines have been ringing off the hook over the past few days, with outraged calls from US trading partners, business executives and Republican donors. But while White House aides have gamely manned the phones and attempted to defend the President’s new tariffs in the midst of a major financial market meltdown, the President himself left town on Air Force One to play golf and attend several private fundraisers, including one for the Saudi-backed LIV GOLF in which he has a personal financial stake.

With his latest tariff move, Donald Trump has single-handedly threatened to destabilize the global trading order established under American leadership over more than seventy years following World War II. He has put at risk the economic prosperity not only of America but of the world. He has placed American businesses in jeopardy at the hands of foreign governments. He has wiped out tens of trillions of dollars of value in the global capital markets. And he has done all this with a radical tariff plan which reflects not only gross economic ignorance—Rand Paul called it “fundamentally backwards and upside down”—but also a willful disregard of the potential consequences.

But what exactly has Trump done with his new tariff plan that has put us in such a perilous position?

Let’s explore.

How do Trump’s tariffs work? At this point, I assume that most readers will be familiar with the broad outlines of the new Trump Tariff plan. (White House “fact sheet” here). But for those readers who aren’t, let me recap just a few of the highlights. Beginning on April 5th, the United States will impose a 10% baseline tariff on essentially all goods imported into the United States. This baseline tariff does have some exemptions, including for USMCA-compliant goods coming into the United States from Canada and Mexico, for imported oil and gas, and for certain minerals not otherwise available in the United States. Also exempt from the new tariffs are goods which are already subject to previously announced tariffs (eg autos, steel and aluminum), and for the time being at least certain other products which the White House has identified as candidates for additional tariffs yet to be determined (eg lumber, copper, pharmaceuticals and semi-conductors). Trump’s new 10% baseline tariff will apply to almost every country in the world, with a small number of curious exceptions, most notably Russia and North Korea.

The Canada and Mexico tariffs previously imposed by the President pursuant to his emergency authority to stop the “invasion” of immigrants and fentanyl at our northern and southern borders will remain in effect indefinitely, until those ‘emergencies’ are resolved to the President’s satisfaction, or until he says they are.

Beginning on April 9th, the US will also impose additional country-specific tariffs on goods exported to the US from countries which currently run large trading surpluses with the United States. Among our largest trading partners, China will face a total tariff rate of 54%, Japan 34% and the European Union 30%, in each case a massive increase from the tariff rates currently in effect. (The average tariff applied to US imports is currently around 3%.)

The Trump Administration is calling these additional duties “reciprocal tariffs”, but they are not ‘reciprocal’ in any conventional sense of the term. In his Rose Garden remarks, Trump explained what he meant by ‘reciprocal tariffs’: “Reciprocal. That means they do it to us and we do it to them. Very simple. Can’t get any simpler than that.” This is not in fact how Trump’s so-called reciprocal tariffs are actually structured, but it is not entirely clear whether the President understands this. What is clear, however, is that he does not want us to understand it.

The rates of Trumps new ‘reciprocal’ tariffs have been set at levels determined not by the level of tariffs imposed by other countries on US exports, but rather by the relative size of each country’s individual bilateral trade surplus with the United States, that is by the excess value of the amount of goods they export to the US over the value of the goods they import from the US. Every country which runs a bilateral trade surplus with the United States will pay this additional tariff, in addition to the 10% baseline tariff, in an amount equal to 50% of their bilateral trade surplus with the US divided by the total value of their exports to the US. And so a country which exports $1 billion to the United States but imports only $500 million from the United States would face a new ‘reciprocal’ tariff on their US exports equal to 25%. [($1,000mm - $500mm)/$1000mm = 50%/2 = 25%]. And this 25% reciprocal tariff would be added to the baseline 10% tariff, for a total tariff of 35%.

President Trump has said the 50% discount rate embedded in the reciprocal tariff formula reflects his attempt to be “kind” to our trading partners, which I suspect may not be how this has been perceived. It has been reported that the Trump tariffs were mistakenly set at rates up to four times greater than should have been derived from economic research cited as support for the tariffs, apparently due to a mathematical misunderstanding by the Office of the USTR (which calculated the tariffs). Various senior Administration officials have subsequently attempted to distance themselves from the new tariffs, including Treasury Secretary Scott Bessent who told the press that he wasn’t responsible for “crunching the numbers”.

So what’s wrong with this approach? There are many things wrong with Trump’s new tariffs, wholly apart from some bad mathematics, but let me mention just a few of the most common criticisms. Trump’s tariffs are extremely high, the largest tariffs in modern American history, and as a result will likely disrupt global supply chains and substantially raise prices and costs to US businesses and consumers. American exporters and businesses operating abroad may get hammered by the retaliatory actions of other countries. Trump’s transactional on again-off again approach to tariffs over the past few months will make it very difficult for businesses to plan around the new tariffs, let alone to reconfigure their supply chains in response.

As discussed further below, Trump’s “reciprocal” tariffs are not in fact reciprocal, and in many cases bear absolutely no relationship to the tariff or non-tariff restrictions on trade adopted by other countries which run big trade surpluses with the United States. Trump’s tariffs will put at risk the continuing status of the USD as the global reserve currency, limiting American power abroad and reducing US wealth. And even if the new tariffs do in fact reduce some of our bilateral trading surpluses (not necessarily a good thing), this will likely have very little impact on the size of the overall US trade deficit, which is driven primarily by other more fundamental factors which the tariffs will not address.

Now let’s dig a bit deeper into some of these criticisms in an effort to understand better what exactly is wrong with Trump’s tariffs, and why.

Bilateral deficits are entirely normal, and are good, not bad. Even in a world where the United States’ overall trading deficit was close to zero, which it clearly is not and likely never will be, the United States will always have some trading relationships which are in surplus and some which are in deficit, in goods and/or in services. Eliminating or even reducing substantially all of our bilateral deficit account balances would be neither a practical nor a sensible thing to do, as should be eminently clear to anyone who has ever run a business or managed their own personal affairs. Most of us understand this at an intuitive level, but we do sometimes lose sight of the big picture when we hear fancy phrases like “bilateral trade deficit” and “reciprocal tariffs”, or when we read about confusing tariff formulas with some fancy math using Greek letters.

If you are a young working professional with a family, you likely run an overall trade deficit with the rest of the world. Your income does not cover the cost of your spending and investments (eg that new house, or the kids education), but you finance the difference with borrowing (mortgage loans and student loan debt). Later in life, when the kids have flown the coop, your earnings will hopefully exceed your spending and you will use the difference to pay down that debt and top up your retirement savings plan. At all points in life, whether your overall trade balance is positive or negative, most of your bilateral account balances will be negative (in deficit). You will sell your services to your employer for cash (services surplus), but you will then spend the cash at the farmers market (goods deficit) and getting your hair cut (services deficit). And you will make everything balance with an exchange of cash (not goods and services), borrowing when necessary. Money will flow into your bank account from your employer and then out to the farmer and to your barber. Yes, you could attempt to balance all these bilateral trading accounts, perhaps swapping home-made baked goods for eggs at the farmers market, or offering to change the oil in your barber’s car in exchange for your haircut. But even though you could in theory do this, you won’t, because you and your trading partners both understand that this would be not only impractical but more importantly inefficient. To maximize economic efficiency, you will wisely allocate most of your time to making money on Wall Street (or on Main Street), not banking cookies at home for purposes of barter-based exchange with others.

We all understand this, at least intuitively. But does President Trump? Well he must, at least at some level. To my knowledge he doesn’t cut his own hair, make his own clothes or for that matter carry his own golf clubs. But if Trump understands this, he doesn’t say so in public. According to Trump, if other countries sell more goods to us than we sell to them, they must be “screwing” us somehow, even if we don’t know exactly how they are doing it. And so when Bangladesh exports $8.4 billion of apparel and other goods to the US, and buys only $2.2 billion of machinery and other goods from the US, the United States is getting “ripped off” to the tune of $6.2 billion. Which in Trump’s view of trade economics is somehow equivalent to Bangladesh stealing $6.2 billion from the US Treasury’s deposit account at the Fed.

And less we think that this is all just President Trump spewing his usual falsehoods for public consumption by his MAGA base, the President’s top trade advisor, Peter Navarro, has repeatedly made clear that the goal of the President’s tariffs is not to lower other countries’ tariffs, but rather to eliminate the US trading deficit with each of these countries. “Zero tariffs are not enough”, he recently said in regards to Vietnam. “We must eliminate the deficit” Which in this case is on the order of $120 billion a year, consisting of low-tech electronics, apparel, furniture, food products and toys, very little of which is economical to manufacture in the United States.

This is utter nonsense, of course, but it seems to be the core principal underlying much of the new tariff plan, which the President himself ironically selected from a Chinese menu of alternatives prepared by his advisors, none of whom will admit publicly to being the author of this particular plan.

Eliminating bilateral deficits will not reduce the overall US trade deficit. There are many factors which contribute to the US balance of trade with individual countries or in individual goods and services, including tariff and non-tariff restrictions on trade (including government subsidies, currency manipulation and the like). But according to economists, the size of the overall US balance of trade is primarily the result of global imbalances in savings and investment in the US and other countries. China runs big trade surpluses because it has a high net savings rate and the US runs big trade deficits because we have a high net spending rate. China saves and invests more than it consumes domestically, and the US consumes domestically more than it saves and invests. As a result, China has become a large net exporter and net lender to the rest of the world, and the United States becomes a large net importer and borrower from the rest of the world. The US trade deficit is in effect financed by loans from abroad, which results in a net zero balance of payments.

This state of play will continue as long as the US continues to run large fiscal deficits, and Trump’s new bilateral tariffs will not change these dynamics. And to the extent Trump’s tax cut and budget plans end up increasing the federal deficit, they will make future US trade deficits larger, not smaller, regardless of what happens to our bilateral trade deficits with Vietnam and Bangladesh.

Americans will likely pay a large share of the new taxes. Those who listen to President Trump praise his own tariff plan might easily forget, or simply not understand, that tariffs are taxes applied on goods and services imported into the United States. The amount of the tariff is collected from US importers, not from the foreign exporters. And so when President Trump talks about the “trillions of dollars” of incremental federal revenue which will be generated from his new tariffs, which may or may not prove to be the case, we must remember that all of this money will have been collected from Americans, and not from foreigners, as Trump so regularly asserts.

From an economic perspective, the more important (but less clear) question is who ultimately bears the economic cost of these tariffs. If the full amount of the tariffs is passed through to US consumers in the form of higher prices, the economic cost will be borne by Americans. If on the other hand exporters reduce their selling prices by the full amount of the tariff, so as to leave the end price to their customers unchanged, then the cost of the tariffs will have been borne by the exporters (ie foreigners). In most cases, the net result will be somewhere in between these two extreme possibilities, and the result will vary over time and with the particular goods being considered.

If US consumers can easily switch from tariffed to non-tariffed products, or if foreign exporters can’t easily find other markets for their goods, the economic burden of the tariffs may fall primarily on the exporters, but if these dynamics are reversed the outcome will be reversed as well. The impact of tariffs on US consumers will also depend on changes in the foreign exchange value of the US dollar over time; a stronger dollar will tend to reduce the price impact of tariffs on US business and consumers, and a weaker dollar will tend to increase it.

In industries with highly integrated cross-border supply chains, such as the North American auto market, the imposition of tariffs can be highly destabilizing to production processes and raise input costs to US manufacturers as well as final prices to consumers, even for goods which are manufactured (or assembled) predominantly in the USA.

But however the economic costs are distributed, high tariffs generally have the overall effect of reducing the volume of international trade and making the world on balance poorer and not richer. This is not always the case, but it is usually the case, and there are times when the imposition of particularly large tariffs can create extreme economic disruption, dislocation and even depression, as we saw in the 1930s and as we may be about to witness again.

Trump’s tariffs will threaten the role of the USD as the global reserve currency. As discussed above, when the US runs a large trade deficit, the outflow of dollars from the United States is effectively financed by our trading partners, who recycle the dollars they receive from trade back into the US, most notably through the purchase of UST bonds or other USD financial assets. But the use of US dollars in international trade is not limited to trade conducted directly with the United States. A majority of all goods traded internationally are priced in US dollars, which is now effectively the world’s sole ‘reserve currency’. In the Americas 96% of all trade is done in USD; in Asia the share is 74%; in Europe 34% (most is in Euros); and in the Rest of the World 79%.

And because such a large share of international trade is denominated in US dollars, it is not only the United States’ direct trading partners who need to deal in US dollars; so does everyone else who is transacting in USD denominated goods and services, whoever their trading counterparties may be. Those who are net sellers of USD products accumulate dollars, and those who are net buyers must borrow dollars. As the volume of international trading grows with the size of the global economy, so does the demand for US dollars, even when the US itself is not involved in the underlying trade. This increasing volume of USD denominated trade tends to drive up the value of the USD on foreign exchange markets, effectively making US imports less expensive and US exports more expensive, leading to what many economists believe is a persistently “overvalued” dollar. (Overvalued in purchasing power terms, that is.)

Most informed observers believe that the role of the USD as the global reserve currency has on balance been a net positive for the United States. The resulting “strong dollar” has allowed Americans to import foreign goods at lower effective prices than would otherwise have been the case and it has allowed American companies to outsource manufacturing and other operations to foreign suppliers, or to move some of their own operations abroad, on more economical terms. The role of the USD as the global reserve currency has allowed the USD to leverage our military and defense spending with the threat of financial sanctions—shutting hostile foreign governments off from the USD financial system—and to exercise power and influence on the global stage far in excess of what one would normally expect from a country our size, a phenomenon which the French foreign minister Valéry Giscard d'Estaing in 1965 famously called America’s “exorbitant privilege”.

This exorbitant privilege is one which few American presidents would willingly give up, and President Trump would seem to be no exception, at least based on what he says publicly. But much of what he has done since he took office, not only with the new tariffs but also with some of his foreign policy and defense initiatives, will encourage other countries to find practical work-arounds to reduce their dependence on USD denominated trade and their reliance on the USD financial system. And if they are successful, this could seriously erode America’s power on the world stage, as well as our own domestic prosperity.

Trump’s tariffs will not bring back US manufacturing. As discussed above, it is generally believed that the role of the USD as the global reserve currency has on balance been good for the United States, allowing us to import large quantities of ‘cheap’ foreign goods and to finance our fiscal deficits at lower cost and with more certainty than would otherwise have been the case. But there has been a downside to all of this as well, at least for some Americans and American communities, most notably the “off-shoring” of some US manufacturing in the post-WWII period, and in particular following the implementation of NAFTA in 1992.

US manufacturing today represents approximately 10% of US GDP, down from 27%% in 1950 and 16% before NAFTA (1992), reflecting a clear decline in the relative contribution of manufacturing output to the US economy. US manufacturing employment has fallen as well, from 18 million in the early 1990s to around 12 million today; the absolute size of US manufacturing employment today is about equal to what it was in 1950, albeit with a big change in the overall US population. This does not mean that the value of US manufacturing output has fallen in absolute terms (it has not), only that manufacturing output has grown more slowly than other parts of the economy, most notably in the services sectors (eg financial services, health care and technology). Most rich countries across the world have experienced similar declines in their manufacturing sectors over time, for fundamental economic reasons that are largely unrelated to the liberalization of trade.

Manufacturing is often a tough, dirty, labor-intensive and low-margin business which can often be conducted more efficiently in developing countries, not rich ones. In an entirely free-trade world, manufacturing and other economic production will flow to those countries which have at least a ‘comparative’ (if not an ‘absolute’) advantage in labor cost, energy supply or some other critical aspect of the manufacturing process. And so over the past decades we have seen a large amount of US manufacturing, particularly low-margin manufacturing, shift from the US to countries in the developing world (eg Mexico for automobiles and Bangladesh for apparel), but also to more advanced countries with specialized manufacturing capabilities (eg semiconductors in Taiwan) or readily available energy resources (eg hydroelectric power in Canada).

The establishment of NAFTA in 1992 accelerated this “off-shoring” trend in the United States, but it also resulted in reduced costs and more efficient manufacturing processes for domestic manufacturers, achieved via complex and closely integrated North American supply chains. The North American auto industry is a good example, which is now under great pressure from Trump’s tariffs. And the same thing has happened outside of North America, for example with the manufacturing and assembly of US products in places like China (think i-phones), and with US companies who built local manufacturing plants abroad to more effectively compete in those markets (relative to exporting from the US). All of this has reduced the cost and price of manufactured goods globally, with the US consumer being a big beneficiary.

In the mind of President Trump, however, the decline in US manufacturing has been horrible for America and for Americans, the direct result of poor governance by “global elites” who cared more about making cheap imports available on Amazon than about the employment of steel workers in Cleveland and auto workers in Michigan. In his Liberation Day speech, the President opened with these words, which tell us quite a bit about how he thinks, or at least what he wants us to believe, about the impact which his new tariffs will have on US manufacturing.

“My fellow Americans, this is Liberation Day. April 2, 2025 will forever be remembered as the day American industry was reborn, the day America’s destiny was reclaimed, and the day that we began to make America wealthy again…. For decades, our country has been looted, pillaged, and plundered by nations near and far, both friend and foe alike. American steelworkers, auto workers, farmers, and skilled craftsmen – we have a lot of them here with us today – they really suffered gravely. They watched in anguish as foreign leaders have stolen our jobs, foreign cheaters have ransacked our factories, and foreign scavengers have torn apart our once beautiful American dream….Our country and its taxpayers have been ripped off for more than fifty years, but it is not going to happen anymore. It’s not going to happen.

“With today’s action, we are finally going to be able to make America great again, greater than ever before. Jobs and factories will come roaring back into our country, and you see it happening already. We will supercharge our domestic industrial base. We will pry open foreign markets and break down foreign trade barriers. And ultimately, more production at home will mean stronger competition and lower prices for consumers. This will be indeed the golden age of America. It’s coming back, and we’re going to come back very strongly.”

There is as usual a kernel of truth in what President Trump has said about the decline of manufacturing (and manufacturing jobs) in the United States, particularly in the years after NAFTA. But it is also deeply ironic given that it was Donald Trump himself who before becoming President imported his own Trump-branded shirts from China and Vietnam and retailed them at big mark-ups via Macy’s. Wholly apart from his personal hypocrisy however, the US manufacturing narrative is not really as President Trump describes it. “The US didn’t lose manufacturing, we revolutionized it”, says the Cato Institute. “Higher output, less labor, fewer resources. That’s progress….If you want to blame someone for lower employment, blame technology, not trade.”

In any event it is highly unlikely that Trump’s new tariffs will bring American manufacturing “roaring back” to where it was thirty years ago (let alone fifty years ago), even if it does reduce the US bilateral trade deficit with some foreign countries in certain products. US and foreign companies have spent decades building their highly integrated global supply chains to optimize input costs and streamline production, and these will be very expensive and disruptive to restructure, particularly in a world where US trade policy is highly unpredictable and where most countries outside the USA remain committed to the principles of free trade. Apple, for example, has said that it is considering reducing some of its Chinese assembly operations, but it will be moving these to India, not back to the United States.

It is also worth noting that US manufacturing, like much global manufacturing, is becoming increasingly high-tech, reducing the labor content in manufactured goods. And so when Howard Lutnick talks about bringing apparel manufacturing back to the US—yes he really said this—what he has in mind is increasing US production of these goods with robotics and not with humans working in sweat shops. His goal is to bring back manufacturing, but not necessarily manufacturing jobs. Which is not exactly what the President told those auto and steel workers in his Liberation Day speech.

What comes next? The implications and likely effects of President Trump’s new tariffs are at present unclear and hard to predict, in part because no one knows what our volatile President will do next or how the rest of the world will react. But as we consider the future possibilities, we should resist the inclination to view them solely through an America-centric lens—what will Trump’s tariffs do to our bilateral balance of trade with Country X or to the price of Product Y—but rather consider what the larger impact may be on the global economic order developed under US leadership over the past 70+ years, during what was rightly called “the American Century”

In today’s world, no country can really afford to go it alone, not even a country as rich and powerful as the United States (or China). As Americans, we share a world with 8 billion people living in 195 countries on seven continents, and our economy is closely intertwined with all of theirs, whether we like it or not.

The United States is currently going through a period of profound and painful political change, and it has become clear that a sizable minority of our citizens fervently believe that America will be better off if we have less, not more, involvement with the rest of the world. “America First” is a slogan which has at times resonated widely with large numbers of Americans, but no prior US administration has taken this principle nearly as far as President Trump has, or done so quite so recklessly, even in the years leading up to the two world wars.

I will not hazard to predict how any of this will shake out, but I am not optimistic. If the experience of the past ten weeks is any guide to the future, we are not in a good place and this will not likely improve with time. We may soon discover that we are standing alone on the world stage, without a single reliable friend or ally, as we address unprecedented challenges to our way of life, and possibly to our very survival.

Which is not, for me at least, a very comforting thought.