Trump’s tariffs will "succeed" only if they cause a recession

Back to the Bronze Age? Contrary to what the president says, the trade deficit is a sign of strength — not weakness.

(A version of this story was published in The Boston Globe.)

“Who would have thought the market could keep rising—it’s the terrible trade imbalance—the Japanese and Arabs and Germans have to do something with their deteriorating dollars, and so they toss them back at us.” John Updike, S, 1988.

“The end of U.S. economic leadership”—The Wall Street Journal, yesterday.

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With President Trump making good on his tariff threats, recession fears are mounting fast. Goldman Sachs has raised its expected odds of a recession and the stock market greeted his latest tariffs by plunging 1,600 points.

The US economy has been growing for five straight years, since the sharp but brief COVID-19 recession. Will Trump’s tariffs end the good times and send economic growth, jobs, and incomes into a tailspin?

Nobody knows. But this much seems certain. To produce any meaningful reduction in the trade deficit — which on most days seems to be the president’s primary motivation — tariffs will have to be severe and prolonged enough so that they do cause a recession.

“I don’t see how without a recession we significantly move the trade balance,” said Maurice Obstfeld, a senior fellow at the Peterson Institute for International Economics.

Contrary to the implicit reasoning of the Trump economic team, trade imbalances are not caused by relative tariff levels (US tariffs are on a par with those of Canada, Japan, Europe, and Mexico — all allies and all among Trump’s targets). Rather, trade imbalances arise from relative differences in how much countries save and invest and from their underlying productivity.

The fact that the United States can exchange dollars (which we print without restriction) for Toyotas, avocados, and burgundy wine is a sign of strength, not of weakness.

Using tariffs to eliminate the trade deficit will risk undermining American strengths. Talk about a cure that is worse than the disease.

Far from being ripped off, Americans benefit from importing cheaper and/or better goods, which enhance our quality of life in myriad ways. Moreover, trade is part of a circular movement not only of goods but also of money. The US trade deficit of $918.4 billion last year was the mirror image of a $918.4 billion capital surplus, or infusion from overseas.

Sooner or later, all of the net $918.4 billion that Americans spent on foreign goods was invested in American capital assets such as stocks, real estate, bonds, or short-term assets such as Treasury bills. Alas, Trump has not read Updike.

If foreigners did not have an appetite to invest in the United States, the trade deficit could not exist. For instance, if Venezuela wanted to fund imports by selling investments in its local stock market, it would have no luck. International capital markets do not have anywhere near that kind of faith in Caracas.

But markets have a lot of faith in the American dollar and in American investment opportunities. In recent decades, even with Americans sending all those dollars overseas, the value of the dollar has generally been rising.

A related reason for the trade deficit is that America has a low rate of saving. In a closed economy, investment equals saving (just as a family can invest only whatever is left of its income after expenses).

But world economies are not closed (or were not, pending the full impact of Trump’s unbeautiful tariffs). Investment in an economy such as the United States is equal to what we save plus what foreigners invest in us — that $918.4 billion.

Thanks to our open markets and entrepreneurial culture, we have enough investment opportunities to attract nearly $1 trillion in surplus savings from the rest of the world. That is, again, a strength, not a weakness. Foreign capital lowers US interest rates and raises American living standards. It contributes to higher productivity, higher growth, and lower unemployment than in just about any other developed economy.

It is impossible to say whether the United States has a trade deficit “because” other nations are eager to lend or “because” we are eager to borrow. Obstfeld rightly dismisses this chicken-and-egg debate as “the trade deficit blame game.”

But it is inarguably clear that if you want to lower the trade deficit, you have to reverse, or diminish, those capital flows — meaning, make foreigners less willing to invest in the United States or induce Americans to start saving more and borrowing less.

Trump could take meaningful action against the trade deficit by reducing the government deficit, which would add to national saving. Of course, his signature fiscal objective, continuing his previous tax cuts, goes in the opposite direction.

But tariffs generally have no correlation with trade balances. Tariffs in Trump’s first term did not reduce the US trade deficit. One reason is that other nations retaliated. Thus, during Trump 1.0, foreign tariffs imposed on US agriculture caused farmers to lose an estimated $27 billion in exports. Similar tariffs are being levied against the United States now. Our imports may go down but so will our exports.

And to the extent that tariffs do reduce imports, Americans will provide fewer dollars in foreign-exchange markets. That will strengthen the dollar and put further pressure on American exports.

The only sure result of tariffs is less trade in either direction and (due to heightened uncertainty) less investment. As with any tax, economic output will suffer. If the tariffs are relatively minor, as during the first Trump administration, the result is slightly lessened prosperity.

The new Trump tariffs, including a 25 percent tax on automobiles, a 10 percent tax across the board, and more on nations who arouse this most magnanimous leader’s displeasure, are considerably more severe. But for these tariffs to “work” in the sense that Trump intends, the US economy would have to be singularly weakened, relative to those of other nations, to realign global capital flows. That would happen if American consumption plummeted (meaning more of our income was saved) and investment in the United States cratered. Both of these factors would diminish our appetite for foreign capital.

But any time America is suffering both less investment and less consumption, it is probably in a doozy of a recession. Foreigners currently hold about 20 percent of US stocks. If that capital were withdrawn, the result would not be pretty either for investors in American companies or for their employees. And the moment we exited the recession capital flows would likely revert, and so would our taste for avocados (and the trade deficit).

Why Trump is willing to gamble American prosperity to address the trade deficit is a ripe question. If it’s his “again” fetish — imagining, say, that many millions of factory jobs will arise “again” — he is poorly informed. Advanced economies, even those, such as Germany, with large trade surpluses, have seen a steadily declining factory share. Advanced economies do better focusing on higher-value jobs such as AI, and on the requisite education for their workers, not on repressing their strengths in a futile effort to return to a proto-Bronze Age. Moreover, manufacturers are customers for a large share of US imports, thus the Trump tariffs punish the sectors he imagines he is helping.

Greg Mankiw, an economist at Harvard, said it’s a pity that the term “trade deficit” found common usage. It would be just as accurate to speak of America as having an “investment surplus,” a term that connotes the country’s economic strengths.

The question is how far Trump will go to undermine those strengths.