Over at City Journal, Josh Hendrickson has a thought-provoking piece in which he asks us to consider some of the unseen and positive aspects of the Trump tariff policy. He argues that the tariffs are just one part of the overall domestic strategy, which revolves around these three objectives:
“First, it wants to maintain but reduce the financial burdens associated with the U.S.’s leading role. Second, it wants to get our national debt on a more sustainable path. Third, it wants to restore America’s industrial capacity.”
Hendrickson then explains that these objectives should be seen in the context of our global financial system, including the fact that “the U.S. dollar is the world’s reserve currency, and the U.S. Treasury security is the global reserve asset.” While this has some advantages, it also comes at a price. That cost is mainly that the dollar is overvalued, and it makes imports cheaper and encourages politicians to be fiscally irresponsible. So, part of the strategy is to devalue the dollar, which requires international cooperation. And that’s where tariffs come in.
He explains:
If the Trump administration wants to reduce these costs and achieve its objectives, it must reform the international monetary system and devalue the dollar. That will require some degree of international cooperation. Other countries won’t be eager to participate, though, since devaluing the dollar or encouraging the use of longer-duration Treasury bonds imposes costs on them. Tariffs can bring those countries to the table. While imposing duties on imports will raise prices for American consumers, it will also appreciate the value of the dollar, offsetting at least some of the cost to consumers and generating revenue for the U.S. government. Because the appreciation of the dollar shifts part of the burden of the tariffs onto foreign exporters, policymakers might be willing to tolerate a short-run appreciation if it is used to facilitate the negotiation of a longer-term depreciation. America’s willingness to deploy tariffs also signals that it will endure some costs to get what it wants, which could encourage other nations to negotiate.
He concludes:
Tariffs might generate some revenue in the short run, but their larger effect—bringing countries to the negotiating table—could help the Trump administration achieve its long-term objectives.
I assume Hendrickson is correct that tariffs are part of some broader strategy, that the real plan may be the long-term one he lays out in his piece—even though the Tariff Man does like tariffs for tariff-sake. However, I am less inclined to believe the plan will work, in part, because the strategy is full of internal inconsistencies as evidenced above.
One contradiction is indirectly acknowledged by Hendrickson. It is weird to use tariffs—which tend to lead to an appreciation of the dollar—as a tool to devalue the dollar. He writes that tariffs will “appreciate the value of the dollar, offsetting at least some of the cost to consumers.” It’s true that by making imports more expensive for Americans, U.S. tariffs reduce Americans’ demand for foreign currencies (Recall that China’s renminbi depreciated by about 7 percent in response to the 2018 tariffs). When tariffs are imposed, the value of the dollar rises relative to that of foreign currencies. This outcome is directly at odds with a strategy that aims to achieve dollar devaluation.
My disagreement with Hendrickson is about how much impact tariffs will actually have on consumers. He believes that the appreciation of the dollar will offset some of the higher prices resulting from the tariffs. I believe that there is likely no offsetting of the cost of the tariffs if you take their full impact under consideration.
Let me explain. While tariffs can strengthen the dollar by reducing the demand for foreign goods and, consequently, foreign currencies, a stronger dollar rarely offsets all consumer costs—Hendrickson doesn’t claim they do. Tariffs directly increase the price of imported goods; that, after all, is what protective tariffs are designed to do. And although a stronger dollar might make imports slightly cheaper, this effect is usually marginal compared to the direct price hikes caused by tariffs. There is some good literature on currency only partially offsetting costs to consumers.
But the cost of tariffs doesn’t stop there. Hendrickson writes “the appreciation of the dollar shifts part of the burden of the tariffs onto foreign exporters.” This is only partially true and depends on price elasticity—how much demand for, and supply of, a good will change when its price changes. In most cases, as we painfully learned during the first Trump term, American consumers bear most of the tariff burden because importers pass the bulk of these costs on to consumers. In addition, the appreciation of the U.S. dollar really hurts U.S. exporters—many of whom are also U.S. importers (of goods used as inputs) who get hurt by the tariffs in the first place. This explains why we observe that imposing restrictive tariffs that lower imports also reduces exports. And then, of course, our exporters get hurt by the inevitable rounds of retaliations, not to mention the enormous uncertainty that trade wars inject into an economy.
The bottom line is that there is no getting around the fact that American consumers and producers will be significantly hurt by the tariffs, and we shouldn’t expect much offset from the price hike. This makes using tariffs to achieve the overall domestic strategy very costly to consumers.
Which brings me to the fact that I think Hendrickson probably overestimates the effectiveness of tariffs as a negotiating tool—which he sees as the ultimate goal for the tariffs in this strategy. He claims that tariffs can force other countries to the table. So far, President Trump has had success with using tariffs to gain leverage with Colombia, India and maybe even the EU. But it’s not clear when the shock-and-awe factor will wear off or whether it will be worth the cost of market turbulence. Historical evidence isn’t so supportive either.
For example, the first Trump administration’s tariffs on China led to retaliatory tariffs rather than productive negotiations. In practice, tariffs often trigger trade wars instead of fostering cooperation. China, Canada and Mexico have already announced they would retaliate in response to the latest round of Trump tariffs. Additionally, countries have alternative trade partners and might simply redirect trade flows rather than negotiating under pressure.
Hendrickson briefly mentions “encouraging the use of longer-duration Treasury bonds” without adequately explaining how such encouragement fits into the broader argument. U.S. government promotion of longer-duration bonds to attract capital inflows would likely increase demand for dollars, thereby strengthening the dollar—again contradicting the stated goal of devaluation.
Finally, I can’t help but comment on this sentence:
Another consequence of America’s role in the system is that it encourages us to accumulate debt. As foreign countries’ economies grow, so does their demand for reserves. If the U.S. doesn’t supply enough debt to meet that growing demand, our borrowing costs decline, which motivates politicians to run larger deficits.
We don't have a debt issue because of foreign demand dynamics: U.S. policymakers have an addiction to spending—it's really that simple. I will grant him that it’s true that if interest rates were higher, policymakers couldn’t get away with spending as easily. But politicians face strong incentives to borrow rather than to pay for spending, and low interest rates are just one of them.