Trump's tariff war and its adverse impact

Since Trump was inaugurated as president of the United States on January 20, 2025 he has implemented a series of actions which amount to a trade war against the rest of the world. On April 2, 2025 he announced so-called reciprocal tariffs with different levels for different countries. Right from the start he challenged the Most Favoured Nation (MFN) rule under which the tariff-setting country applied the same tariff level to every other country for each specific good. [Exceptions to this occur under FTAs.] Under Trump's approach the tariff level for the same commodity would depend upon the country of origin of the import. It undermined one of the most basic rules of international trade. Subsequently, Trump delayed the implementation of the reciprocal tariffs until July 9, 2025 to allow negotiations to take place between the United States (US) and other countries so as to adjust the initial value of the reciprocal tariff and other trade related items so an agreement might be reached with the US. Later the date was extended to August 1, 2025. In addition to this fundamental action Trump declared a minimum 10 per cent tariff on all imports into the US with a few exceptions. Different types of commodities had higher tariffs imposed; these included steel, aluminium, automobiles, automobiles spares, and more recently copper. Changes were made on the tariff rates from time to time on Canada and Mexico. Trump negotiated partial agreements with the UK, Vietnam, and another agreement with China scheduled to last 90 days. Details on all of these trade agreements were vague in nature

What was this all about? First Trump believes that the US is being badly treated as it runs a large trade deficit with the rest of the world, as well as deficits with almost every country. In Trump's view of economics the trade deficit is to the disadvantage of the US and he is determined to reduce the deficit to zero or even to achieve a surplus. One should remember that these decisions covered only trade in goods, omitting trade in services for which the US usually had a surplus.

How is it possible for the US to continuously run a trade deficit? Countries running a surplus with the US were content to accept dollars to cover the difference. In effect, the surplus country sent its goods to the US and accepted part of the payment in US government securities, cash, or deposits in the Federal Reserve Bank of New York. Countries were prepared to do this as they wanted to maintain reserves for emergencies. In such emergencies expenditures of dollars would be necessary to purchase commodities. In addition, individuals and companies may wish to hold their surplus funds in dollars rather than in local currency. During the past 80 years most of the foreign exchange transactions were made in dollars and a very large per cent of foreign trade was denominated in dollar prices. Both the US and other countries were content with the large trade deficit run by the US. In the international trading system, the US dollar became the standard unit of value in trade. Prior to 1972 the US dollar had been redeemable in gold so that a country holding US dollars could exchange these for gold. But in 1972 the US broke this link and everyone accepted the new situation that the dollar was an acceptable currency.

One of the consequences of the US trade deficit was that more of the production of goods that had been taking place in the US shifted to other countries. The goods the US required in excess of its exports had to come from somewhere, so other countries around the world constructed factories and sold goods replacing what had been previously been manufactured in the US. This resulted in considerable loss of jobs in the US and the destruction of many businesses. Large parts of the Midwest of the US, that had been the centre of manufacturing, were simply closed down and workers lost their jobs. This had a very serious effect on the American population which found itself unemployed or engaged in work that was less remunerative then before. This phenomenon Trump called the carnage of the US. In his inaugural address in 2017 his first term as president he describes the destruction of the American manufacturing sector, the loss of jobs and the destruction of communities that had been built around these factories. Much of his political support derives from persons who were adversely affected by the destruction of the American manufacturing sector. It is this line of thought that led him to believe that the destruction of the manufacturing sector must be reversed. To achieve this he is raising tariffs so that imported goods will be much more expensive and new factories can start up in the US to compete with the imports.

The greater the trade imbalance against the US, the higher the reciprocal tariff rates. This reciprocal tariff rate was meant to be an approximation of a tariff level that would reduce the US deficit to zero for that particular country. Of course in achieving this, rest of the world must abandon its wish to hold dollars. The world financial system was based upon the use of dollars combined with confidence that the legal system in the US would ensure that the holder of dollars would be able to change these into other currencies or to use them to purchase commodities. Furthermore countries which faced financial difficulties were often able to borrow dollars from the Federal Reserve to enable them to make the necessary economic adjustments to return to equilibrium. This system generally worked very well, even in the great financial crisis of 2008-9. The Federal Reserve was willing to extend the so-called swap lines to major central banks to ensure there was an adequate supply of dollars. If Mr. Trump were to be successful in closing the trade gap, there would be no flow of dollars to the rest of the world. Then the question of financial stability and trading currencies would be uncertain with a very negative effect on international trade. Furthermore, this reduction of exports from the rest of the world to the United States would reduce gross domestic product (GDP) and employment of nations other than the USA. World GDP would fall or grow more slowly. Employment demand in the US would rise but since already unemployment is low this would lead to higher wages and inflation in the USA. American GDP would decline as the efficiency of US manufacturing would be reduced. 

Another objective of the Trump strategy is to weaken the trading relationships between China and other countries particularly in South and Southeast Asia. The Trump administration believes that it is in a protracted existential conflict with China with trade remaining an extremely important instrument. Weakening the Chinese economy is a clear objective of Trump's policies and one objective of his tariff strategy. This has important implications for Bangladesh and is taken up elsewhere.

One must realise that the Trump tariff war is dynamic and other countries or groups of countries will respond to the actions that Trump is taking. As other countries adjust tariffs and other trade conditions a new equilibrium for international trade will emerge. This equilibrium will be characterised by reduced world GDP as labour and capital will not be allocated in as optimal way as at present. Countries will introduce numerous rules and regulations that prevent labour and capital to be used in the best way instead national objectives will become more important and supporting enterprise through subsidy or other regulations will favour national companies reducing trade. How much will the world lose in output due to the misallocation that will arise from the trade wars now starting? It is impossible to make an accurate estimate of the extent of this loss but it should be of the order of 10 to 15 per cent.

For the US the Yale Budget Lab has made some estimates of the economic consequences of the tariffs. The estimates given here are as of the tariffs that had been announced up to July 11, 2025. Americans consumers will face an average effective tariff rate of about 18 per cent the highest rate since 1934. The price level in the US will increase by 1.9 per cent and in the average household income will fall $2500. Unemployment should increase about 0.4 per cent. Tariffs collected over a 10 year period would amount to $2.3 trillion. This compares to the expected tax reductions in the famous BBB Act of $3.9 trillion

The short run impact on the US price of wearing apparel would be an increase of 37.5 per cent. This would reduce the demand. In addition to this price effect the household income would fall particularly in lower levels (these households receive less food support and have to pay for more of their medical expenses). Altogether one expects a significant drop in demand for clothing in the United States as a result of these reciprocal tariffs.

The estimates of the impact of the Trump tariff changes daily as he adjusts or threatens to change tariff rates.  The overall impact of the Trump tariff strategy will be to raise prices and lower household incomes in the US and also probably raise exports to other countries. The rest of the world will find its GDP lowered with the drop of sales to the US and probably prices also reduced. It is hard to know the ultimate outcome of the dynamic adjustments that will take place to all of these changes. But one can be certain that the allocation of labour and capital in all countries will reduce GDP. The effect on prices will ultimately depend on monetary policy. It should be noted that the stability of the world financial system will decline with the reduced supply of dollars while countries will be adjusting to how to maintain appropriate reserve levels in different currencies and the trading impact of the use of several currencies rather than the dollar.

The Trump tariff policy will have an adverse impact on virtually all countries especially the US.

Dr Forrest Cookson, economist.

forrest.cookson@gmail.com