Trump's tariffs will ‘succeed' only if they cause a recession

Boston Globe

02-04-2025

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.
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'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 (
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.
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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
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.
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 'beautiful' 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.
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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 reduces 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
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
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.
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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, are 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
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,
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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.