Trump’s tariff push risks backfiring, threatening U.S. growth, global investment, and the economic stability he promises.
While US President Donald Trump has left no doubt about his love of tariffs, the world is still waiting to see precisely what he will do. He has named China, Canada, and Mexico as his first targets, but it remains to be seen whether he wants a grand slam, or more conditional measures linked to other policy issues (such as acquiring TikTok). For now, the only certainty is that his administration will use tariffs to extract concessions where it can.
The issue is complicated, though, because tariffs interact closely with other components of economic policy such as the exchange rate. In theory, higher tariffs should reduce import demand and push up the exchange rate, ultimately making foreign goods cheaper again. This is why Trump previously claimed that tariffs do not actually cost Americans anything, on the grounds that it is America’s trade partners who pay.
But trade and exchange-rate policies are generally handled by different agencies – the Departments of Commerce and the Treasury, respectively – and conflict has frequently been a feature of their interactions. In the 1930s, the world ended up deeply divided because trade negotiators claimed that they could do nothing until exchange rates were fixed, while monetary officials argued that no exchange-rate settlement was possible until there had been a general opening of trade. In the event, protectionism escalated.
Complicating matters further, another mechanism has since come to the fore: the balance of payments. Since a country with a large trade deficit, like the United States, must pay for its imports somehow, it relies on foreigners to buy its securities or invest in its companies. These inflows of foreign funds to the US are running at very high levels, because Americans do not save very much. The country imports savings from the rest of the world to pay for its trade deficit. If it did not, Americans would have to consume less, which would be experienced as a decline in their standard of living.
Higher tariffs jeopardize this arrangement, because the US needs foreign investment to drive its future growth. Former President Joe Biden understood that foreign capital was necessary to “build back better,” and Trump should know that he cannot deliver his promised “golden age” without it. Perhaps that is why some of his first guests in the White House were Masayoshi Son of the Japanese investment giant SoftBank, the Chairman of Oracle, and the CEO of OpenAI, the “big money and high quality people” behind a new $100 billion venture (Stargate) to build AI infrastructure.
The irony should be obvious. Trump’s bid to reclaim sovereignty and usher in a “new era of national success” depends on the same combination of technology and globalized finance that eroded the American middle class and turned many Americans into Trump voters in the first place. But this dependence on global capital is not just ironic; it also leaves America vulnerable. If the foreign money were to dry up, Trump’s promised miracle would become a nightmare.
One early warning would be if bond markets grew anxious about America’s capacity to repay the large debt it has accumulated. Since 2022, when UK Prime Minister Liz Truss made a similar gamble on growth, the bond market has returned as a force that even Americans cannot ignore. The “exorbitant privilege” of issuing the main global reserve currency does not mean that you can do absolutely anything. Market sentiment can shift, and when it does, it is usually quite dramatic – as in 1931 or 1971. Credibility can fall victim to suspicion and doubt overnight, especially in a world where the US dollar has been weaponized for various political ends.
Foreign funding also could decline if the bright future that has been promised suddenly seems over-hyped, or if the technology disappoints. Many investors already worry that today’s sky-high valuations for tech stocks may indicate a bubble. A big bet on this potential new engine of growth will require vast investments, but if the bubble bursts, plenty of projects will become stranded assets.
Yet another reason that foreign funding could end is that certain governments intervene to stop their countries’ citizens and firms from investing in the US. This is one potential response to a new trade war or a strong dollar regime. If French wine, German cars, or Chinese cars, aircraft, and solar panels cannot be sold competitively in America, those governments might start weighing their options, and figures like Son could face more hurdles in trying to bring jobs and investment to the US.
In fact, one of the easiest ways for governments to affect cross-border capital flows is to revise how foreign investments are taxed. With US tech giants already complaining to Trump about the unfavorable tax treatment that they receive elsewhere, notably in Europe, tax policy could become yet another weaponized issue. The OECD’s negotiated global corporate minimum tax is clearly under threat, since Trump and congressional Republicans seem eager to cut corporate taxes as much as they can.
If they do, Europeans may have even more reasons to retaliate by increasing taxes not only on foreign companies in Europe, but also on their own corporations’ and citizens’ investments in the US. Doing so could divert some European funds back to Europe, while making it even more difficult for the US to balance its current account.
Economic fashions are contagious. It is only a matter of time before someone follows Trump’s own logic and offers a plan to “Make Europe Great Again.” A US debt crisis could be the perverse result of his administration’s campaign against globalism.
Harold James is the Claude and Lore Kelly Professor in European Studies at Princeton University.