We’ve defined tariffs and trade deficits, examined why we run trade deficits as the issuer of the global reserve currency, and discussed why and how tariffs are used. Before we get into the current administration’s tariff plan, I want to get something out of the way.
I generally try to remain politically agnostic when discussing economics. As such, I avoid showing my cards in terms of my political leanings. I have friends across the political spectrum. Some of my liberal friends hate everything President Trump does, and believe he and his team don’t know what they’re doing. Some of my conservative friends support everything he does, and seem to believe he can do no wrong.
I’d never agree with everything any political leader does. I call balls and strikes. When I believe a President’s policies are good, I’ll say so, and when I believe they’re bad, I’ll say that, too. I say this to establish that any criticism I make of the current tariff plan isn’t partisan, as is the case with most who criticize it. It has to do with economics, pure and simple.
I’ll also say this about President Trump, Treasury Secretary Bessent, Commerce Secretary Lutnick, and Counselor to the President Navarro. You may disagree with them. You may dislike them. You may even hate them. But it’s ridiculous to say they don’t know what they’re doing. These are four highly educated men, three of them very successful businessmen, one an economist. They understand trade policy better than you or I do.
On to the tariff plan.
When those four men walked out to the Rose Garden after the market closed (a wise strategic choice) on April 2 with the now-infamous tariff chart and announced the plan, my hair caught on fire, like so many other market observers and economists. (As a good friend put it, it was a very small fire.) Part of that had to do with the fact that I looked at equity futures and considered what my IRA balance was going to look like the next day.
But part of it had to do with the fact that the administration misrepresented the tariff rates that those other countries charge us – it was a complete fabrication. And I’d prefer they’d have told the truth.
By now this is pretty common knowledge, but let me explain how they came up with the “tariff rates” they claimed other countries charge on our exports. I’ve mentioned President Trump’s decades-long obsession with trade deficits, which he himself admits. They took each country’s trade deficit, and divided it by that country’s exports of goods to the U.S. (They ignored services altogether.)
Let’s return to the example of tiny Lesotho, with which we had a $234 billion trade deficit last year, resulting from exports to Lesotho of just $3 billion subtracted from imports from Lesotho of $237 billion. They divided the $234 billion trade deficit by Lesotho’s exports to the U.S. of $237 billion and came up with a “tariff rate” of 99%. They then claimed that for each country on the list, they would be “lenient” and only charge “half” of what that country purportedly charges the U.S. So in Lesotho’s case, they applied a reciprocal tariff of 50%.
The truth is that Lesotho’s Most-Favored-Nation (MFN) trade-weighted average tariff rate is 11.2%. A 50% tariff rate on imports from the tiny African country would dwarf what it charges its trading partners, and would crush its economy. The U.S. is its third-largest export market, representing nearly 20% of its exports.
The fact of the matter is that no one calculates tariff rates the way the Trump administration did. No one has ever calculated tariff rates that way. No one could find any examples in the economic literature of tariffs being calculated that way.
Tariffs are calculated in one of two ways: either a unit tariff, which is a fixed charge per unit (e.g., $1 per bushel of wheat) or an ad valorem tariff, which is a percentage of the value of the goods being imported (e.g., 5% of the price of each imported vehicle). These can be combined into a compound tariff (e.g., $100 per vehicle plus 5% of its price).
But again, no one – no one – calculates tariffs by dividing the trade deficit with a country by the imports from that country.
When the administration presented those numbers, the reaction was immediate. Equities tanked. Trading partners were shocked. And economists and market pundits thought that Trump, Bessent, Lutnick and Navarro didn’t know what they were doing.
In hindsight, I believe they did. Let’s illustrate one reason.
Consider Vietnam. Vietnam’s trade deficit with the U.S. in 2024 was $123 billion, on exports to the U.S. of $136 billion and imports from us of $13 billion. By the administration’s calculation, that amounts to a “tariff rate” of 90%. So we announced a “lenient” reciprocal tariff of 46% on Vietnam.
Vietnam’s actual trade-weighted MFN tariff rate? 5.3%.
Shortly after the tariff plan was rolled out, Vietnam offered to cut its tariff on exports to the U.S. to zero. While no deal has yet been made, I believe this gives us a peek into part of the strategy behind using the draconian calculation of other countries’ “tariff rates” on the U.S. and then cutting those in half to come up with a “lenient” retaliatory rate that is actual extremely punitive.
President Trump prides himself on his negotiating prowess. After Vietnam offered to drop their tariff rate to zero, some conservative commentators heaped praise on his deal-making ability, stating that he’d gotten Vietnam to drop its tariff rate from 90% to zero! In reality, they’d gone from 5.3% to zero, a pretty painless sacrifice when faced with a 46% tariff from your largest export market. Deals like this would paint a picture of the President as the consummate dealmaker.
(It should be noted that Vietnam is also a China proxy. As U.S. imports from China have trended downward, Vietnam’s exports to the U.S. have increased, in part due to China shifting production into its fellow Communist neighbor to the south. And Vietnam, like China, has been guilty of currency manipulation, dumping, unfair subsidies, IP theft, and cyber-espionage. So there are other reasons to impose high tariffs on Vietnam besides trade tit-for-tat.)
While I’m not a fan of the calculation used, and I think there are associated medium-term risks, I believe it was strategic for reasons beyond the President’s ego. But let’s turn to the likely end game. There are three possible scenarios, and two are implausible.
The first is that these are broad, long-term tariffs aimed at permanently eliminating trade deficits and completely re-shoring manufacturing. I’ve already addressed the damage that would cause to our status as the global reserve currency. It’s also impossible, but even if it weren’t, it would take decades. Little progress would be made during President Trump’s term, so he wouldn’t have an opportunity to take a victory lap for his policies, and he loves taking victory laps. The economic fallout would also likely hand the White House to a Democrat in 2028, who would surely reverse the tariff policy. This obviously isn’t the end game.
The second scenario – I actually saw this floated, and not by conspiracy theorists – is that the administration was trying to tank the stock market to drive a flight to quality (Treasuries), driving bond yields down. With $9 trillion in debt coming due in 2025, each basis point of yield is worth $1 billion in borrowing cost. So when the ten-year yield dropped 20 basis points, that would have saved $20 billion.
Two problems: one, that’s a drop in the bucket, even if you combine it with the tax cuts, savings from DOGE, lower energy costs, deregulation, revenue from tariffs, and other economic positives. And second, yields returned to where they were before the rollout or higher, negating any potential savings. This obviously wasn’t the plan.
The third possibility is that the plan all along was to use the flawed calculation of the “tariff rate” other countries charge us to justify the exorbitantly high reciprocal tariffs that were announced on those countries. Of course, we now know that after Treasury yields spiked by 50 basis points, when tariff hawk Navarro was away from the White House, the more diplomatic Bessent (who’s also responsible for refinancing the debt), accompanied by Lutnick, met privately with Trump and persuaded him to pause the reciprocal tariffs on all countries but China for 90 days.
At first blush, it appeared that the administration was bumbling through its strategy, making things up as it went along. However, there’s a good chance that the private meeting in which Bessent talked the President into the pause was more along the lines of, “The time for the pause is now,” rather than, “Gee, maybe we should think about a pause on the tariffs.” In other words, maybe a pause was part of the strategy all along; the timing of its announcement was the question mark.
So why use the phony “tariff rate” to justify those high reciprocal tariffs? To pressure key trading partners into coming to the table quickly to make trade deals.
I believe that the administration wants to quickly forge trade alliances with key partners like Canada, Mexico (through accelerated renegotiation of USMCA), the EU and member nations, Japan, South Korea, Australia, and India. Other countries like Israel are of strategic interest beyond just trade. The same is true of China proxy Vietnam, and other Asian nations like Taiwan, Thailand, Indonesia, Singapore, and Malaysia.
Further, I believe the administration wants to keep the pressure on China to isolate them while it makes these trade deals, to force them to eventually come to the table. The U.S. does not want China to strike a deal first, because, as Bessent said, “The first person that makes a deal gets the best deal.” And the strategy with China goes far beyond trade.
I don’t believe the U.S. necessarily wants to eliminate trade deficits with all those countries, because I believe that Trump, Bessent, Lutnick, and even Navarro understand what it means to be the issuer of the global reserve currency. I believe they just want a more level playing field, and reduced tariffs worldwide. Remember, the U.S. historically has charged lower MFN tariffs than most of its trading partners.
As far as re-shoring manufacturing, I don’t believe they’re too concerned about that. I believe it’s an objective to some degree. But I believe they’re just as interested in moving production of critical security and supply chain infrastructure from China to other countries. We know we can’t produce most things as cheaply in the U.S. as we can in China. But we can produce them just as cheaply in India or Singapore or Malaysia – and those countries don’t hate us. Key priorities include pharmaceuticals, technology, war materiel, and microprocessors.
Now, all of the countries I listed, and some others, are already negotiating with the U.S., and it’s likely that the first deals will be announced the week after I post this. So you may be saying, “Brilliant deduction, Captain Obvious.”
In my defense, I came to this conclusion two weeks ago. What tipped me off that this might be the end game?
Tiny Lesotho. And I’ll save that story for the last post in the series.
No comments:
Post a Comment