Good morning from New Economy Brief.
Trillions of dollars have been wiped off the international stock markets, forecasters are warning of stagflation and global depression. Pretty much all economic indicators are flashing red – so why is the Trump Administration doing this? Is there method in the madness, or is it bound to backfire?
This week’s New Economy Brief explores how Trump’s tariffs could fit into a larger plan to reindustrialise the US and bring about “generational change in the international trade and financial systems.” This is part of a series aimed at helping you understand these potentially seismic shifts in the global economy.
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What were the ‘Liberation Day’ tariffs for?
Trump's team have been very clear about their intentions from the get-go. Tariffs were a key feature of Trump's election messaging, continuing the trend towards viewing trade in zero-sum terms – as a matter of winners and losers rather than mutual benefit. This began in his first term, continued under Biden, and is particularly clear in the context of competition with China. Last week’s ‘Liberation Day’ brought in blanket baseline 10% tariffs on imports, with higher tariffs for countries with which the US runs a bigger goods trade deficit. Much of the reaction has focused on how simplistic this formula seems. But commentators like Chatham House's Heather Hurlburt warn that many are "missing the bigger picture”.
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A User’s Guide to Restructuring the Global Trading System.
To understand what the administration might be trying to achieve, we need to take a brief detour through the history of the global trading system. As the leading champion of the General Agreement on Tariffs and Trade (GATT), part of the post war Bretton Woods settlement, the US was central in establishing a trading system based on non-discrimination (i.e. broadly equal treatment between products from different countries) and a general push to remove barriers to trade. This system expanded markets for US exports and allowed it to dominate global trade for several decades. But today isn’t the first time the US has threatened to blow up the system it created. In the 1970s, it responded to a cluster of challenges to its dominance (including high inflation and rivals becoming increasingly competitive in manufacturing – sound familiar?) by ending the global monetary system set up at Bretton Woods, in which the value of the US dollar – and through it, of every major currency – was linked to gold.
What’s money got to do with it? The monetary system that started in the 1970s – with currencies floating freely on the market, with dollars acting as the 'reserve currency' that others are valued against and that central banks hold their reserves in – is at the core of the Trump team’s diagnosis of the US’s lack of trade competitiveness. In this view, the ever-growing demand for the dollar increases its value, making exports less competitive while encouraging cheaper imports and driving the US into a trade deficit. This ultimately hollows out the US industrial base, leaving its economy increasingly dependent on finance and consumption-led growth.
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Back to the present.
In this context, key advisors in Trump’s team want to achieve two things: devaluing the dollar over the long term to reduce the US trade deficit and reindustrialise their economy (seen as key to national security), while also maintaining it as the global reserve currency.
How does this all hang together? This plan for a “grand reordering of global finance and trade” has been termed the ‘Mar-a-Lago Accord’. The dollar’s status as global reserve currency is usually seen as a major US advantage, not least because it allows cheap borrowing and unrestrained military spending. But the Trump administration has come to view the provision of international security and the reserve currency to facilitate global trade as a ‘burden’ whose costs trading partners should share.
Where do tariffs come in? One way to understand the ‘Liberation Day’ tariffs is as an opening gambit to start bi-lateral negotiations with other governments to force them to rebalance trade in US interests (such as Trump’s demand for the EU to buy $350 billion of American energy in exchange for a lower tariff), allow their currencies to increase in value relative to the dollar and – for US allies – spend more on defence. This plan links trade, monetary and security policies in an explicitly transactional way.
Beyond tit for tat. Peter Navarro, Trump’s senior counsellor for trade and manufacturing, has complained about a long list of what he terms "non-tariff weapons" that other countries use to make US exports less competitive, ranging from currency manipulation, VAT and IP theft all the way through to "discriminatory product standards” (think chlorinated chicken…). Removing these may be part of the US’s price for agreeing to lower tariffs in the negotiations. But as the FT’s Gillian Tett suggests, the administration may also look to pull off a more fundamental rebalancing of the terms of trade by pushing foreign investors into longer-term dollar holdings. This could allow the US to have its cake and eat it too, combining devaluation of the dollar and more competitive trade with cheap borrowing, all while safeguarding the dollar’s long-term dominance as the reserve currency.
The chaos is part of the plan. Economists like Jason Furman warn that the tariffs will be self-defeating and fail to reindustrialise the US. But it is also important to understand that trade policy is also foreign policy, so this is about geopolitics and not just economics. The tariffs’ economic fallout could be part of the plan: to hold the global economy hostage and force other nations to come to the table and negotiate better terms of trade for the US, or in James Meadway’s words “kick over the table, and demand everyone starts again.” The tariffs also aim to weaken perceived adversaries that run huge trade surpluses with the US, such as China – seen as free riding off the US provision of the global reserve currency (and military defence) that enables that trade. Trump’s team think they can win a trade war with China “even with full retaliation”, based on the evidence from this academic paper, and see the tariff chaos as a way create “negotiating leverage”.
Will it work? It is early days, and lots of the impacts are uncertain. We will see whether the US financial class has the political power to force a U-turn as tariffs hit stocks, or whether the apparent tensions in Trump’s camp lead to clear victory for either side. Perhaps the most critical question will be how far the rest of the world is willing or able to pay the price that the US demands – or whether enough critical players also start to see the US-backed trade, defence and financial system as more of a burden than a benefit. We will explore impacts and potential responses in more detail in the coming issues, including a deep dive on the potentially devastating impacts on the Global South. But as Heather Hurlburt points out, the Trump administration's plan speaks directly to “two ideas that resonate deeply with American voters: that past decades’ trade and security policies have been net negatives for Americans, and that they ought instead to produce tangible daily benefits. The longer these ideas are dangled in front of voters, the less likely it is we will see a return to a system in which the US plays by any trade rules at all.”
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How is the UK responding?
On Monday, the PM and Chancellor visited a Jaguar Land Rover factory, where Starmer announced a relaxation of phaseout targets for non Electric Vehicles in response to US tariffs on car imports. While Starmer emphasised that this “is not the extent” of their response, it isn’t a promising start.
If these tariffs escalate into a full-blown global recession, the UK will face severe economic consequences. Starmer said on Monday that "this is a changing and completely new world”, echoing his language when raising defence spending in February. Yet so far the Prime Minister has stuck to an increasingly tired script, ruling out tax rises or changes to the fiscal rules and peddling the false narrative that weakening climate policy is the route to growth. If the world really has changed so fundamentally, many will be asking what it will take for the government to change course.
Asset-based welfare. Asset-building policies such as the Child Trust Fund (CTF) scheme of the 2000s could help tackle wealth inequality and the problems it causes, argues a new paper by the Fairness Foundation. The analysis by Dr Ben Tippett from King’s College London finds that while the proportion of individuals with zero or negative financial wealth in the UK has fallen slightly, their average debt level grew from £5,009 in 2008-10 to £8,313 in 2020-22.
Europe’s fiscal framework. Now that Germany has made sweeping changes to relax its strict fiscal straitjacket, the EU should reconsider its own rules in order to unleash its economic potential, argues the New Economic Foundation’s Sebastian Mang. We discussed Germany’s changes to its constitutional debt brake last month.
Green transport and manufacturing growth. Producing green vehicles such as electric trains and cars in the UK will help to reduce domestic carbon emissions and boost growth in the face of the impact of tariffs on manufacturing, according to the Institute for Public Policy Research (IPPR). However, the new report also points out that barriers to green transport still exist, such as a lack of charging infrastructure and high electricity costs.
Reducing the debt burden in the Global South. Increasing lending to low- and middle- income countries in local currencies through Multilateral Development Banks could help countries achieve sustainable development goals and reduce debt vulnerabilities, explains Positive Money. The authors highlight that in 2023, 59 countries had high debt levels, compared to just 22 in 2011, with many now spending more on interest payments than on health, education, and investment.
Public opinion on climate change during the general election. A new publication from Green Alliance outlines some of the key patterns in public opinion on climate change during last year’s general election. Using polling undertaken by CAST (the Centre for Climate Change and Social Transformation), it finds that there was broad support for climate action. By testing hypothetical political candidates with the public, the research also shows that campaigning on a rollback of net zero policies would not have led to tangible electoral gain.
