Trump’s tariffs turmoil – an empire in decline

Kate Deer puts Trump’s tariff strategy in the context of an empire in decline.

When US president Trump hiked up prices of global trade by introducing sweeping tariffs, it was widely interpreted as the action of a powerful but deluded maniac. But what if his move represents the opposite, a calculated move by someone who might have far less power than we think?

Empires are often at their most lethal and destructive when they are reaching their end. From the siege of Constantinople which marked the end of the Byzantine Empire to the Bengal Famine, which accelerated the struggle for Indian independence. Fast forward to today and US weapons are butchering civilians in Gaza while US stock markets are crashing. 

For the past century, the US has established itself at the heart of the global financial system, hence the old adage: ‘When America sneezes the World catches a cold’, many now rightly fear that the damaging effects of these tariffs will have repercussions across the world. 

Economists across the political spectrum pointed out why this was a bad idea: tariffs are a tax on imports. While they help raise money for the US government in the short term, they are likely to drive up prices for US consumers. 

Moreover, because of increasingly complex supply chains that evolved over the past half a century, it could make it much harder to source and manufacture goods that are vital for the US economy. This raises the question, why did he do it?

What on earth was he thinking?

At the heart of Trump’s dramatic measures is a very simple problem. The US could soon find itself in a position where it will struggle to refinance its debts. Donald Trump himself should know a thing or two about running out of money, having been involved in at least six bankruptcies. 

Countries can’t really go bankrupt in the same way that businesses or households do because they have the option to issue more debt, also known as government bonds. However, the extent to which they can rack up debt is largely dependent on their soft power. If nations are being perceived as powerful investors are far more willing to lend them money by buying their bonds. 

On this front, the US has so far got a pretty sweet deal. Since the end of the Second World War, the US dollar has emerged as a global reserve currency which is widely accepted everywhere, and US government debt has become synonymous for being a haven asset. This has allowed successive US governments to rack up more than $36trn in sovereign debt. 

By the end of last year, US debt to GDP stood at 123 per cent to GDP. In contrast, many African nations’ debt to GDP levels are half of that and they struggle to raise more money. A big reason for rising debt levels in the US has been the stark rise in military spending, which has increased by more than 60 per cent since the 1980s. In 2023 alone, the US government spent $820bn on defence alone. But this bill is starting to become unsustainable. 

Having a currency that is seen as a go-to-asset comes at a price. It has made it harder for the US firms to compete with cheaper imports and has significantly contributed to the demise of US manufacturing. 

Trump believes that the strong dollar is a key reason for the demise of US industry and his tariffs are aimed at forcing a total reset with trading partners. By hiking up the costs of imports, the administration hopes to achieve three things: disincentivise imports with the hope that this would prompt firms to invest in US manufacturing instead. Trump also wants to weaken the dollar and raise revenue from tariffs, a strategy dubbed by financial market analysts as the Mar-a-Lago accord. Another core element of this new trade order is that Western countries will increasingly be forced to foot their own military spending bill in a bid to bring down US borrowing. 

Trump’s advisers know that the strong dollar is not a new problem to the US. In the 1980’s, then Federal Reserve chair Paul Volcker hiked Central Bank interest rates in order to fight inflation. This move, often described as the Volcker shock, plunged the US into a recession and drove up the value of the dollar. 

The US administration under Ronald Reagan responded with the so-called Plaza Accord, a deal between the G7 nations which forced the then main trading partners of the US, France, West Germany, Britain and Japan to hike up the value of their currencies in order to artificially bring down the value of the dollar. 

Why the plan is likely to fail

But Trump may have bitten off more than he can chew, as the immediate stock market reaction to his announcements illustrates. US stock markets dropped by more than 10 per cent in the immediate aftermath of the announcement. 

Stock markets crashed because investors understood perhaps better than Trump that a strategy which worked in the 1980’s cannot be as simply replicated in today’s world. This is in part because supply chains are much more complex than they were 40 years ago. Trump’s tariffs  could make it harder to access vital goods for US society to function, from pharmaceuticals such as antibiotics to critical minerals and semiconductors. 

Moreover, currencies today cannot be controlled be as easily by Central Banks as they could 40 years ago due to the increased complexity of financial markets and the rise of digital currencies. 

It took only days for Trump to announce a partial suspension of his plans. While equity markets temporarily recovered as soon as Trump signalled a delay to his plans, what ultimately caused the US administration to back down was the turmoil on US bond markets.

At some point last week, yields on 10 year US government debt surged to 4.5 per cent, compared to 3.7 per cent at the beginning of the year. Rising yields mean that the price of government debt is falling, investors are less keen to hold and asset once seen as the ultimate save haven. 

This is a big problem for the US government, not just because it sits in a huge amount of debt but also because much of it has a relatively short maturity. According to a 2024 analysis, half of all outstanding treasuries were due to mature in 2026. This means that the debt has to be refinanced, at potentially much higher rates. 

Added to that is the fact that Trump has just announced major tax cuts, which are expected to add around $6trn to US national debt. But Trump will now struggle to fund these cuts.

Investors have been turning their backs on a combination of a number of reasons. One, the prospect of a weaker dollar is making it less attractive to hold dollar denominated debt. 

This is accelerated by the activities of hedge funds, which for years have been taking advantage of treasury futures trading at a premium to treasuries. In a process that is eerily resemblant to the LDI crisis, these so-called basis trades are often highly leveraged. The term leverage means hedge funds borrow money to have more money to gable with. But when markets move suddenly, as was the case with gilt yields spiking under Liz Truss or Treasury or with US treasury yields suddenly rising, the hedge funds who took out loans to invest more have to pay their creditors safety guarantees, called collateral. In this case, they end up selling the assets they can most easily sell first, which is often government debt. This pushes the price of that debt further down, a vicious circle. 

The US administration didn’t help matters by floating the idea that foreign governments who hold US treasuries could be forced to swap them for long-dated debt offering no coupons. This would essentially coerce governments to take on a lot of the long-term borrowing risks with no reward, essentially a form of appropriation. 

The Chinese administration has seen the writings on the wall. While it was once the biggest owner of US debt, it has over the past years drastically reduced its holdings of US debt. Instead, Japan is now the biggest foreign owner of US debt, China is now the second biggest holder, closely followed by Britain, which owns some $740bn of US debt.

What does this mean for us?

True to his style, Trump is likely to turn around and announce that it was always his intention to backtrack on most of the tariffs and that the initial Rose Garden announcement was merely the starting point of a negotiation. But that is not entirely true. The damaging consequences of a trade war with China are already here to last and global trust in the US Treasuries as a safe haven has been permanently undermined. Trump has bitten off more than he can chew and the consequences will be felt across the globe.

It is important to understand these challenges as structural, rather than simply the actions of a narcissistic madman. Perhaps the question to ask is: if Trump had not been elected as US president, would Kamala Harris have implemented similar policies? She may not have been as crass about it, but she almost certainly would have introduced tariffs too.

Rising trade tensions and the strength of the dollar are a systemic challenge for the US which preceded Trump and will continue. It is now often downplayed but the Biden administration already racked up tariffs with China, in a bid to counteract the rising strength of the dollar and cheap Chinese imports. 

The wider picture is the emergence of an increasingly multi-polar world order where the US is no longer a hegemonic force. It is hard to predict how these changes will play out in Britain but it is likely that we will also witness growing pressure on bond markets and rising inflation, which might mean that borrowing costs remain higher, both for the Britain governments and for households. The Labour government is likely to respond to these challenges by cutting back on welfare spending whilst ramping up defence spending. We should push back hard against that, spending more on weapons will not make us safer. In contrast, onshoring some of the supply chains in a bid to guard against Trade tensions could potentially work in our favour, giving workers more bargaining power. Rather than attempting a failed economic model reliant on arms spending whilst dismantling the welfare state, we should invest in the energy transition and focus on redistributing wealth, the gradual demise of the US as a global hegemon could be an opportunity to build back something better.