US Trade Wars

Analysis

The US will end up with higher tariffs

1. Trump is ideologically committed to tariffs, and short of a disaster in implementation, the US is likely to end up with an increased tariff regime at the end of a protracted and probably chaotic negotiation process.
2. Trump’s baseline 10% tariffs on every nation are likely to stay in some form as they are a new revenue source for the government. Given the Republicans traditional hatred of new taxes, this might be Trump’s only way to (at least partially) address US fiscal problems and/or offset the costs of continued tax cuts.
3. The April-2-announced-then-paused additional tariffs on creditor nations (the so-called reciprocal tariffs) are primarily a negotiating tactic in Trump’s inimitable idiosyncratic style. He will ultimately reduce them or remove them where the targeted countries offer some significant concession to the US for their trade imbalance. In the short-run, this is a shakedown. In the longer-run, it is unclear whether Trump will continue to sustain sufficient market and public support for these add-on tariffs. 
4. Some form of super-tariff on China is likely to remain (see below).

The US tariff negotiation process could become messy

5. Trump will muddle though the tariff negotiation process: he will add new tariffs, pause tariffs, reduce tariffs, increase tariffs, remove tariffs, and back track as he negotiates with the rest of the world. If he fails to move forward with one country, he will shift focus to another country. He sees unpredictability as a negotiation strength. He does not play by the conventional bureaucratic rule book. 
6. Negotiating credibility requires him to be rougher, tougher and meaner than he was in 2018-2020 tariff cycle. Because Trump needs to be tougher, he is happy to take some market pain to pursue his negotiating strategy. His strategy will continue to provide short-term shocks to bond and equity markets in the US (and globally). 
7. But this is a high-wire act. Trump would not want to crash markets, see a flight of capital away from the US, nor bring on a full-blown recession. Hence, I expect markets to be tested and then eased back on multiple times. Market volatility will be high during the negotiations.
8. It is also a lot of work. Trump is trying to negotiate with perhaps up to 100-plus countries at once. This is a Herculean task for the US, that benefits the nations in the rest of the world. each of whom only need to negotiate one agreement with the US.
9. China, Mexico and Canada have been subject to this strategy once before in the 2018-2020 tariff cycle. All nations would have learnt that capitulating to Trump does not buy long-term reprieve or certainty from Trump’s US. Consequently, Trump is likely to find this round of negotiations much more challenging than the 2018-2020 round. He runs the risk of being seen as a one-trick-pony. No-one likes to be repeatedly extorted with the same strategy – it will be a case of once bitten, twice shy.  If Trump is not careful, rougher, tougher and meaner can quickly look like an over-exaggerated pantomime when it is ignored.

China is a particular focus of US concern

10. China is a growing threat to US hegemony and dominance. China has grown quickly over the past 35 years. Its global trade has exceeded the US every year since 2012. Trump’s tariffs appear to have the added objective of constraining China’s trade and geo-strategic ambitions. Trump undoubtedly wants to tighten the screws on what he sees as China’s poor trade practices. Consequently, China is likely to have higher US tariffs compared with other nations.
11. China is not without options in this negotiation:

• First the US negotiating hand is weakened by its large fiscal debt and deficit. If Trump moves too far or too fast, it could trigger a fast devaluation of the US dollar, a flight of capital from the US, an increase in the US inflation rate, and/or a increase in the US Treasury bond yield rate. 
• Second, the US negotiating hand is weakened by any public reaction to higher prices for Chinese imports or (if nothing is resolved quickly) empty supermarket shelves. 
• Finally, China can more easily purchase from the rest of the world what it currently imports from the US; than the US can import from the rest of the world what it imports from China.

12. It is possible that as part of its negotiations with other nations, the US will ask its interlocutors to impose similar tariffs on China. You can expect China to retaliate against any nation that participates in a US-led tariff blockade of China. If the US and China get into these positions, Australia could find itself with some difficult choices.
13. China would not want to lose face by being humiliated into providing more trade concessions.

Final observations

14. While Trump will continue to use the rhetoric of repatriating industry to the US, his approach is unlikely to achieve this goal (it just doesn’t offer the policy certainty over the 20+ year time horizon business needs to bring manufacturing back to the US). I suspect Trump knows this. Nonetheless, the rhetoric is useful red meat for his supporters.
15. I do not for one second think Trump is playing 4D-chess or executing a sophisticated and finely calibrated optimal tariff theory approach. It is not who he is. This is a bare-knuckled playground bully brawl.
    

Context: The state of the US economy, fiscal policy and trade policy

The economy (Trump inherited a strong economy: high growth, high employment and low inflation at least up until March 2025):

• US GDP (the size of the US economy) is \$30 trillion, growing at 2.8 per cent per year in December 2024. In nominal terms, it is the world's largest economy (China is second on \$18.8 trillion in nominal terms; but in terms of purchasing power parity (PPP), which accounts for differences in the cost of living, China's GDP is estimated to be \$40.7 trillion).
• The unemployment rate was 4.2 per cent in March 2025 (with 7.1 million unemployed).
• The annual US inflation rate (CPI) is 2.4% (March 2025), peaked at 9.1% in 2022. Still above the 2% target.
• Currently there is no hard data suggesting an economic downturn or recession is unfolding. But there is some soft data of concern.

The composition of the US economy has changed over the past 50 years (with sectoral and regional winners/loses):

• Manufacturing in 1980: 21% of GDP and 22% of employment. Now: 11% of GDP and 8% of employment.
• Services sector in 1980: 53% of GDP and 55% employment. Now: 77% of GDP and 82% of employment.
• A hollowed out middle class from 61% of adults in 1980 to 50% now (proportionately more lower and upper income households).
• Drivers: technology/digital revolution, growing global competition/trade, automation, changing competitive advantages over time.
• Some have argued that North American Free Trade Agreement (NAFTA, 1992) and/or China's ascension to the World Trade Organisation (WTO, 2001) are responsible for the US decline in manufacturing jobs. However, the overall decline in U.S. manufacturing jobs started much earlier, pretty much just after World War II, and has been remarkably steady over time.
• Dissatisfaction with these changes has been deployed in support of grievance-politics and (left- and right-wing) populist politics in the US.

Fiscal policy (Trump, like most recent Presidents before him, inherited a fiscal policy mess: long-standing structural fiscal deficits, large and growing national debt, debt ceiling issues soon):

• In the US financial year 2024 (ending 30 September), the US Federal government spent \$6.7 trillion and collected \$4.9 trillion in revenue (of which \$2.2 trillion was individual income tax), resulting in a budget deficit of \$1.8 trillion. The projected budget deficit in 2025 is \$1.9 trillion.
• At 6.4% of GDP, the US is running the second largest fiscal deficit in the OECD after Israel.
• One motivation for new US tariffs is to increase government revenue. One motivation for the US Department of Government Efficiency (DOGE) is reducing the size of the annual government outlays.
• The total US government debt, as of 4 March 2025, is \$36.2 trillion (120% of GDP – high, but not unmanageable). The US spends more on interest payments than it does on defence. The government spent \$875.5 billion on interest payments for the national debt in FY 2023. Total defence spending was \$820.3 billion in 2023.
• In 2024 \$8.5 trillion was held by foreign investors: Japan (\$1.13t) China (\$784b) UK (\$750b) Luxembourg (\$417b) Canada (\$412b)
• The US funds its debt by issuing US Treasuries (UST) in the bond market (tradable in secondary markets). Bonds are loan, with fixed interest paid 6-monthly over the life of the bond, and the bond value returned on maturity.
• The US must source \$9.2 trillion in USTs in 2025 just to cover maturing bonds, with \$6 trillion maturing in June 2025. 
• The UST yield rates for 10-year bonds over recent months have been between 4 and 5 per cent per year.
• The current US debt ceiling mechanism will be exceeded in Aug/Sep 2025, necessitating new arrangements.

Trade policy (long standing trade deficit / a smaller trade exposure compared with other nations)

• The US imports more from the rest of the world than it exports (\$4.1 trillion compared with \$3.2 trillion in 2024). Put another way, the US consumes more than it produces; or it spends more than it earns. The rest of the world pays for this by investing in (lending to) the US (see UST bonds above).
• The annual U.S. trade deficit for 2024 was \$918.4 billion, a 17% increase from the \$789.7 billion deficit in 2023.
• In 2023, the five countries with the largest trade surpluses with the US were China (\$283B), Mexico (\$213B), Canada (\$141B), Vietnam (\$108B), and Japan (\$63B). Australia had a trade deficit with the US in 2023 of \$17.7B.
• Over the period 1999-2019, the dollar accounted for 96% of trade invoicing in the Americas, 74% in the Asia-Pacific region, and 79% in the rest of the world. The exception is Europe, where the euro is dominant with 66%.
• The US is less trade exposed ([imports + exports] / GDP) than other OECD nations. The US sits at 25.3% in 2023; the next lowest OECD nations are Japan on 58.7% and Australia on 61.2%. 15 OECD member nations are > 100%.
• In 2012, China replaced the US as the largest trading nation. Most nations around the world have more trade with China than the US. [See this map].
• The twin deficits hypothesis argues that fiscal and trade deficits are correlated (but other factors are also important).  

Context: the costs and benefits of being the global reserve currency

Substantial benefits (AKA the “exorbitant privilege” of being the global currency)

• Lower borrowing costs – high demand for your currency reduces interest rates.
• Capital inflows/Capital attraction – foreigners need to hold US dollars in reserve to trade – some of these reserves are held in US Treasury Bonds – always a ready market for your currency.
• Businesses not exposed to currency exchange fluctuations – everything is bought and sold in the local currency.
• The infrastructure for global exchange (the Society for Worldwide Interbank Financial Telecommunication - SWIFT) gives the US leverage over other country access to the system.
• Being the global reserve currency gives the US a mechanism to impose sanctions on countries it disagrees with - but exercise of this power comes at some cost to the US. [For example, the US sanctions against Russia include exclusions from SWIFT, preventing Russia paying dividends to international holders of Russian bonds (forcing Russia into technical default), and the freezing of Russian assets held in the US].

Some downside costs:

• Strong demand for your currency makes it over-valued. This makes imports relatively cheap and exports relatively expensive, which both harms local manufacturing and results in persistent trade deficits
• Other countries expect your country to stabilise the world economy in times of economic crisis
• Rest-of-the-world concerned that the global currency makes your nation too powerful both politically and economically (the original “exorbitant privilege” critique from France in the 1960s).
• US inflation impacts the rest-of-the-world. Fed tightening is global tightening. A strengthening \$ (typical after Fed tightening) = weaker other currency = higher import prices. Excessive US demand puts up global prices. 

Context: tariffs

A tariff is a fee charged by the government (sometimes called a tax, a duty or an excise) and in the first instance it is paid for by the importer on goods and/or services coming into a country from abroad.

While an importer initially pays the tariff, who ultimately pays is complex and varies across nations and products. Typically, a large proportion of any US tariff would be paid for by the US consumer who buys the imported goods or services, as the importer would typically add this cost on to the wholesale price, which retailers would then pass on in the retail price. But not all the cost will fall on the US consumer, and certainly not in all situations, because:

• The importer might decide to reduce its profit margin and absorb some of the costs, at least initially,
• Similarly, the retailer might decide to reduce its profit margin and absorb some of the costs,
• The importer might ask the manufacturer to take a hit to its profitability, and/or
• The manufacturer might decide to increase its sale price to the rest of the world, so that it can cross-subsidise exports to the large US market at a price that (even with a tariff) sustains sufficient US sales.

Most economists have a negative view of tariffs:

• Free trade allows all nations to maximise utility by focusing on their areas of natural competitive advantage.
• Tariffs result in lower global growth and wealth; they are almost always a lose-lose solution overall.
• In importing countries, tariffs raise prices for consumers and lower their standard of living. In exporting countries, they reduce the volume exported and consequently the number of people employed.
• Tariffs protect domestic industries from competition, discouraging innovation, efficiency and competitiveness.
• Tariffs often result in retaliation by other nations
• Tariffs often result in a quagmire of special pleading by interest groups seeking to extract (costly to consumer) benefits from the government for their business sectors and union members.

Nonetheless, limited arguments can be made in respect of narrowly targeted (preferably time-limited) tariffs

• Protecting industries for reasons of national security in the context of geopolitical uncertainty [Although direct subsidies can often do this job more cheaply with less impact on consumers overall].
• Time limited support for developing nations to develop local-based globally competitive industries
• Protecting nations from the unfair trade practices by other countries (eg government subsidised dumping)
• Correcting for un-costed externalities in production (eg pollution or labour exploitation)

One theoretical possibility: Optimal tariff theory (OTT) is a concept in international trade economics that suggests a large country with global market power (ie, the ability to influence world prices) can in some circumstances improve its welfare by imposing a tariff on imports, even though tariffs reduce global efficiency. How it works:

• A tariff reduces the large country’s demand for imports.
• This can push down the world price of the imported good.
• The country now pays less for what it imports — improving its terms of trade.
• If the terms-of-trade gain > efficiency loss, the country gains overall (but typically by only a small fraction).

But:

• Although OTT can theoretically work for a large country (say US, China or the EU), in practice, it rarely works cleanly or predictably, and the proportion of real-world cases where it “works” is very small.
• Trade-partner nations can still retaliate (and they are likely to) – wiping the otherwise small benefit
• It is very challenging to identify the optimum rate at which to set the tariff – making it impractical
• Supply chain frictions, and information asymmetries also make this calculation challenging/impractical
• Very easy for special interests to subvert the optimisation objective for protectionism, where everyone loses
• While OTT might benefit a large country in some specific circumstances, global well-being declines

Context: a Chronology of Trump’s US tariffs

In the first Trump administration:

• January 2017 – US withdraws from the Trans-Pacific Partnership (TPP), a proposed free trade agreement between 12 countries bordering the Pacific Ocean (including Australia). After the US withdrew, the remaining members entered into the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP)
• August 2017 – US said it would investigate China’s intellectual property practices
• January 2018 – 20-50% reducing tariffs over four years on washing machines and solar panels to protect US industry (largely targeted at China, South Korea and Mexico)
• March 2018 – imposed 25% tariffs on steel and aluminium – for national security reasons – initially applied to all countries, but overtime exemptions and quotas were given (including to Australia) - Many countries hit back with their own tariffs on US goods (eg, bourbon, motorcycles, orange juice)
• July 2018 – 25% tariff on a range of Chinese imports (in response to the 2017 investigation) – China responded with targeted tariffs including on US soybeans.
• August 2018 – 25% tariffs applied to additional selected Chinese goods. China responded with further tariffs and a complaint to the World Trade Organisation (WTO)
• September 2018 – tariffs at 10% on additional selected Chinese goods – raised to 25% in 2019
• November 2018 – The United States Mexico Canada Agreement (USMCA) replaced the North American Free Trade Agreement (NAFTA) – USMCA updates NAFTA including provisions on intellectual property, digital trade, access to Canadian dairy market, and environmental and labour standards.
• January 2020 – A “phase one” trade deal agreed with China – China committed to buy more US imports, enforce IP rights in China, and limit technology transfer to China. Both countries agreed to not devalue their currency for national advantage. US kept tariffs at 25% on machinery, electronics, automative parts, and metals. US Tariffs were reduced to 7.5% on consumer electronics, clothing, and footwear. US tariffs scheduled to come into effect in December 2019 cancelled (on smartphones, laptops and toys). China retained tariffs on US soybeans, pork, beef, LNG and automobiles. China missed its US purchasing target (possibly because of COVID and the associated slump in world trade).

During the Biden Administration:

• Largely retained the “phase one” agreement tariffs on China – but reinstated a small number of exclusions on certain goods to benefit US business (eg. industrial parts and electronics).
• The solar panel tariffs were extended in 2022 for another four years.
• The washing machine tariffs ended in 2023.

In the second Trump administration:

• January 22 –Trump announced a planned 10% tariff on Chinese imports, citing concerns over fentanyl shipments from China to Mexico and Canada.
• February 1 – Implemented the 10% tariff on Chinese goods. China responded with 15% tariff on US coal and LNG, and a 10% tariff on crude oil, agricultural machinery, and large-displacement car
• February 10 – Announced plans to hike steel and aluminium tariffs starting March 12, removing exemptions from the 2018 tariffs, resulting in a minimum 25% tax on all steel imports and raising aluminium tariffs from 10% to 25%.
• March 3 – Increased tariffs on Chinese goods by an additional 10%, totalling 20%. China responded with a 15% tariff on US chicken, wheat, corn, and cotton; and a 10% tariff on sorghum, soybeans, pork, beef, aquatic products, fruits, vegetables, and dairy products. Also imposed new 25% tariffs on imports from Mexico and Canada. Canada announced a 25% tariff of selected US goods.
• April 2 – Declared “Liberation Day,” announcing a 10% universal tariff on all imports (excluding Canada and Mexico) effective April 5. Additionally, imposed (allegedly reciprocal) country-specific tariffs, including a 34% increase on Chinese goods, effective April 9. China announced 34% tariffs on US goods and raised a complaint with the WTO.
• April 9 – Raised tariffs on Chinese goods to 125%. China raised its tariffs to 84%
• April 11 – Clarified that the tariff rate on Chinese goods had risen to 145%. China raised its tariffs to 125%
• UST yields and the US Dollar Index diverged. Usually, rising UST yields attract foreign capital which strengthens the US dollar, so that they move together. Bond markets had doubts, and investors asked for higher risk premiums (could be about the US tariff policy and/or the chaotic way in which it is being rolled out).
• April 23 – Trump foreshadowed a reduction in tariffs on Chinese imports, indicating a softer stance towards China. Although this has been denied by other administration spokespersons. China responded, If the US genuinely wants to solve the problem through dialogue and negotiation, it should stop threatening and blackmailing and engage in dialogue with China based on equality, respect and mutual benefit.

Motivations for the current round of tariffs under Trump 2.0

Trump’s team has provided various, vague and sometimes conflicting rationales for its tariff announcements. Analysts have also speculated on the underlying motivation. At various times, one or more of the following might be motivating the tariffs:

Revenue (fiscal policy) objectives

• Increase government revenues in the face of substantial and continuing fiscal deficits.
• To offset the costs for proposed tax relief measures

Trade policy objectives

• Reduce the US trade deficit
• Address unfair trade practices, such as state subsidised dumping, currency manipulation, and theft of intellectual property
• Removal of non-monetary trade-barriers

Monetary policy objectives

• Reduce the value of the (arguably over-valued) USD against its major trading partners
• Lower interest rates – both the overnight cash rate set by the Federal Reserve, and the long-term bond rate set by market participants.

Industry/employment policy objectives

• Bring back industry and manufacturing jobs to the US (by reducing overseas competition)

Foreign policy objectives (negotiation tactics)

• Tariffs are simply a negotiating tool to get nations to the negotiating table. The US’s long-term objective is free and fair trade. 
• Reduce the flow of illicit drugs into the US – particularly fentanyl (implicitly a negotiating tactic, the tariff remains in place until the targeted nation acts in a way that the US deems sufficient).
• Reduce the flow of illegal immigrants into the US (implicitly a negotiating tactic)

Strategic and national security objectives

• Nationally sustainable manufacture of weapons, military transport, infrastructure, etc. (ie shielding strategic industries and raw materials)
• De-risking supply chains, making US industry and supply chains independent of a foreign adversary
• Extending/maintaining US hegemony/dominance over China, by excluding China from world trade.

Some of these objectives are in tension. For example, the US cannot negotiate a tariff away in order to achieve some other objective if it also wants to use tariffs to raise revenue or to on-shore industry.