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The more President Donald Trump discusses trade deficits and tariffs, the more it becomes obvious he needs a corrective lesson on modern global economics.
Most glaring is Trump’s belief that “trade wars are good, and easy to win.”
Neither is true. At all.
In reality, tit-for-tat trade battles are awful — loaded with unpredictable consequences that can cripple businesses, hurt consumers and weaken the economies of nations.
Given the complex trading connections in the global economy, imposing tariffs like the ones Trump is threatening to slap on imported steel and aluminum is inherently dangerous. They can lead to a dizzying number of scenarios, any of which could result in losses of American jobs and higher prices for goods.
Let’s say China responded by putting a tariff on American wheat. Not only would that open the door for other countries to sell wheat to China, but it would result in a glut of wheat grown by U.S. producers. Prices would tumble due to the oversupply, which would almost certainly result in subsidies being provided to U.S. producers in order to keep them in business. Those subsidies, of course, would come at the expense of American taxpayers.
A more direct effect would hit U.S. companies who use steel and aluminum for their products, such as automakers, manufacturers and builders of all types. The duties would raise the cost of the metals they use in their products, which would force them to raise their prices to absorb the extra expense. Higher costs for consumers could easily lead to a falloff in demand, a slowdown in production and subsequent job reductions.
Granted, the tariff would help protect and energize the U.S. steel and aluminum manufacturing sector and bring back some jobs, but undoubtedly at a price. Any new jobs directly the result of the tariffs could be offset by losses of jobs in many other segments of the economy.
Meanwhile, one potential outcome is a win for Russia, which exports many of the same products as the U.S., including wheat. The Russians can sit back in comfort, wait for trade arrangements to fall apart and swoop in to meet demand for goods that were previously supplied by Americans.
So while there’s unquestionably a global glut of steel due largely to overproduction by China, the key to resolving the problem is not to start a trade war.
Also at issue in this furor over tariffs is that Trump’s actions demonstrate a misunderstanding of another fundamental fact about trade. It’s this: The strength of the dollar and the security of foreign investments in America are the largest factors in trade deficits, not tariffs on either side of a trading relationship.
The reason is that when the dollar is valued high relative to the currencies of other nations, it makes other countries’ goods cheaper to buy and thus Americans buy more foreign goods. Conversely, it makes American exports more expensive for consumers overseas, given that they have to make up the difference between the dollar and their currency. Thus, foreign buyers purchase fewer American goods when the dollar is strong. When that happens, bingo! You have a trade deficit.
As all this happens, the strength and security of American financial systems and our economy encourage heavy foreign investment, which continues to support a strong dollar. In broad terms, you have trade deficits when your economy is improving.
The relative strength of our currency vs. others is by far the most important factor in trade deficits. Tariffs seldomly materially change trade imbalances, they just create lots of unintended consequences.
Although the dollar has weakened under Trump because faith in American stability has been shaken, it’s still been on a strong run for years now, buoyed by heavy American consumerism, low interest rates and the country’s relative stability. That’s inspired confidence in it, which has helped keep it robust — and thus the strong dollar has fueled today’s trade deficit.
Some would argue that it’s grown too strong for America’s best interest, making the cost of doing business with U.S. interests prohibitive for other nations.
But while there can certainly come a point when the dollar gets too strong, we’re not nearly there yet.
If the U.S. trade imbalance ($566 billion in 2017) were truly crippling the economy, you’d see it in the workforce. Yet employment has risen as the trade deficit blossomed, and today our unemployment rate is close to historic lows.
That being the case, Trump doesn’t need to thump his chest on tariffs. He needs to take an economics lesson and let the markets naturally adjust on their own.