The World Rebalances

At the speed of light

💬 As geopolitical tensions have risen, there is no doubt in my mind that China is the clear target of the US tariffs. The rest is theater.

A new era in globalization is no longer hypothetical. Tariffs imposed by Washington are causing panic, but they signal a broader strategic shift that has been underway since long before the second Trump Administration.

First, I offer a recap of recent events in light of US strategic interests, and second, an analysis of what can be done with the economic tools we have. Lastly, I try to connect economic policy to the geopolitical shifts that are changing the shape of our world, to offer context as we anticipate next week’s events.

The China Factor

Today, markets reacted extremely negatively to China’s announcement of a retaliatory tariff of 34% on US imports, effective April 10th. However, given the imbalance of trade between the two countries, the effects on the US are likely to be comparatively mild.

Data sources: USTR and the US Census Bureau

In spite of trade tensions, China has a record trade surplus with the US, while semiconductor and food exports from the US began to decline during the Biden Administration. American agricultural exports to China fell from $29.1B in 2023 to $24.7B in 2024, and will be affected by these new tariffs if they go into effect. However, these sectors are also the most likely to receive support from the Trump administration.

Vietnam and Cambodia, which are extensions of Chinese manufacturing hubs, have been similarly targeted with high US tariffs announced on April 2nd. It is increasingly clear that the focus is on creating a shock to reshape global supply chains, which have been slow to reform even after the Covid pandemic. The US is actively trying to lessen its dependence on China since the pandemic with industrial policy actions such as the CHIPS Act. Voluntary measures however don’t seem to be working. Breaking news: Vietnam has decided to part ways with China, offering zero tariffs, as NIKE stock surges in response.

The question is, why the rush now? It almost feels as though we are putting the country on an emergency war footing, but the more clear and present danger as markets perceive it is another bout of inflation due to increases in the costs of Chinese goods, which would affect many ordinary Americans. This could become a negative shock on demand, as increased prices act as a domestic consumption tax.

The Fed Is Silent

If investors were hoping for some relief from the market free fall, they did not receive any comfort from the Federal Reserve, when asked to comment:

❝ It is too soon to say what will be the effects on monetary policy.

Jerome Powell, April 4, 2025

Today would normally be all about the jobs report, which did not deliver any surprising news this morning. However, Federal Reserve Chairman Jerome Powell spoke today at a business meeting in New York but did not say anything new. A continued fall in markets might eventually dampen his protestations that he will be waiting for the data to come out before making a decision about changing the Fed funds rate on May 7th. The consensus for rate cuts this year has swiftly changed from two to four.

If the market does not improve, or tariffs do not lessen, an emergency cut cannot be ruled out. The last time stocks dropped this much, the Fed along with Treasury initiated a multi-trillion dollar bailout.

The Longer View

It is natural to focus on equity prices this week, and to blame their decline on Trump’s trade policies. However, the underlying shifts in globalization would be continuing regardless. In many cases the response has been delayed too long, and a rebalancing of some type had been inevitable. To weather the storm and see where we are going, it is essential to zoom out. Amid the cacophony of the present moment there are some analysts, while not justifying any missteps by Trump, who are attempting to look at the longer term.

Much of this relates to the role the US dollar plays in creating structural trade imbalances, which has seemingly reached its limits. Tariffs should have made the dollar stronger, but it has been weakening instead, another sign that we have reached a new stage. What has been interesting is the strength of the gold price, and the relative stability of Bitcoin, which has until now followed other risk assets up or down quite closely.

The US has had an exorbitant privilege since trade with China reopened decades ago. America imported Chinese goods, using USD bonds owned by China, which eliminated current account constraints— “a magical state of affairs”. However the cost of this arrangement was the hollowing out of US industrial capacity, which was fine when the US and China were friends and interest rates were low. That has changed. As Mark Blyth, professor of International economics at Brown University writes:

❝ Ending the current system will be massively disruptive, no doubt, and the prospect of US deindustrialization may prove illusory. But it is important to remember that both parties see it as necessary. The rebalancing began before Trump arrived on the scene, and is being driven by forces that may outlast him.

Trump, Tariffs, and the Fate of the Dollar, Apr 4, 2025

A New Era of Economic Experimentation

A view from 40,000 ft: the 2020’s will be remembered as a decade of economic experimentation. From Covid stimulus to tariffs to AI, we are sailing like Christopher Columbus across a very stormy sea using maps based on imaginary fears and a quest for treasure. Will we discover something useful at the end of this journey? Yes, at the very least, a more realistic map of how the global economy really works, and better ways to run it.

Although recent stock market losses in response to tariff announcements have been unexpectedly punishing, the White House seems undeterred by the squall. Scott Bessent, once a very successful investor who is now US Treasury Secretary, said the following yesterday:

❝ We were on track for a financial crash. Government spending was out of control. If felt like 1998 or 2007. We’ve pulled off that path and set up long-term growth instead by imposing tariffs

US Debt Levels are Unsustainable

Bessent is not wrong about the fiscal dangers to the US. At least some of our current indebtedness is due to policy mistakes made during the Covid emergency. This resulted in inflation, and caused the Fed to raise interest rates. This meant that our interest costs alone, to borrow the money to pay for all US government spending, now exceed outlays for defense.

This new limitation has led to geopolitical rifts, as the US can truly not afford to defend all of its allies. Europe and Japan seem to be stepping up, some 80 years after the end of World War II. Something had to be done, and these are the choices, the same as for any household:

• Increase income

• Lower spending, both fixed expenses and discretionary expenses

• Lower interest rates to lessen existing debt and to spur growth

1. Increasing Revenue: The Role of Tariffs

The most common way for a government to increase income is to raise taxes, which is unlikely in this or most Republican administrations. As I have written previously, tariffs are a form of tax that one government levies against the other. The only reason the US can do this is because we are the most important buyers in the world. Discussion of how the new tariff rates were decided are good fodder for X posts but are mostly irrelevant—angels on the head of a pin. As I have written before, tariffs are a method of trying to balance out taxation regimes. China’s taxation policies and practices are highly inefficient. Vietnam is a satellite of that country for manufacturing purposes so there is overlap, hence they have been treated similarly.

Manufacturers in China and Vietnam basically have two choices if their governments cannot negotiate a deal with the US. They can lower prices in order to absorb the cost of tariffs, or they can charge more. Ignoring the debate about what constitutes excess capacity, China produces more than it consumes. It has to sell. For a variety of products, price increases are likely to be de minimis, which is exactly what has happened in the past.

Remember, China is not a monolith. There is intense competition between similar industries across many provinces, a hangover of Mao-era economic policies when many industries were duplicated for defense purposes, rather than allowing regional specialization. Too many companies are doing the same thing, and each wants to survive and keep their employees working.

The American consumer created, benefits from, and still supports the very survival of globalization. There is no substitute, as trade balances between the US and China, the world’s two largest economies clearly demonstrate. As geopolitical tensions have risen, there is no doubt in my mind that the clear target of the tariffs is to weaken China’s economy. The rest is theater. Most other countries, under the specter of a global recession, will negotiate and the tariffs will fall away, even as exemptions become a cottage industry in Washington during this process. Not just for countries, but for US companies such as Apple with significant supply chains overseas.

Beyond financial markets, the effects are already being felt. Fitch has downgraded China’s foreign currency rating citing concerns about slowing growth and a debt-to-GDP ratio of over 280% in 2024. New investment is coming to the US as companies scramble to rejigger supply chains and reshore. Once a Democratic Party precept, bringing US manufacturing home is now a pillar of Republican economic policy.

Tariffs as a Tool of Geopolitical Strategy

The new tariffs come on the heels of an increase in military exercises in the waters around Taiwan. While many people are analyzing the tariffs from an economic point of view, that is too narrow a lens. Secretary of State Marco Rubio tweeted yesterday:

❝ It is not that complicated: China threatens our security and prosperity. At today’s meeting with the Indo-Pacific partners, we agreed the region needs to be free from China’s coercive and unfair trade policies. Our security depends on it.”

This weekend is a major holiday in China (grave sweeping) so I was surprised at the swiftness of the reply from Beijing this morning. Nevertheless, they are on the back foot here, with goods to sell to a world where economic growth is slowing.

2. Lowering Government Spending: A Political Battle

This effort has begun in earnest at the Federal level and should be replicated at the state and local levels throughout the country. Chicago is sadly a good example of a city that won’t do what is necessary and will spend, largely on entitlements, until the well runs completely dry. It would be far better to bite the bullet and cut pension payments now to make them sustainable for the long haul, but the political will is just not there. However, being kind today is to be cruel tomorrow.

Regardless of where your political sympathies lie, we are witnessing extraordinary political will being exercised in Washington right now. As Jason Furman, who served under President Obama has written:

❝ The tragedy (and puzzle) of Donald Trump is that he is doing something too few Presidents have had the courage to do: incur large, widespread short-run pain—while being reasonably transparent about it—in the service of long run gain. (The tragedy is that he is mistaken on the LR.)

The reality is that no one really knows how this will unfold. Markets are reacting negatively, but other events could cause it to rebound. In any case, Wall Street is not the US economy. The dramatic fall in share prices over the last couple of days has led to a hue and cry and much exaggeration. To quote another Treasury Secretary, Larry Summers, in an extraordinary case of exaggeration for an economist who said that “the best estimate of the loss from tariff policy is now closer to $30 trillion or $300,000 per family of four”. My reply: that is not an estimate. That is a sound bite.

The geopolitical effects of lowering fiscal spending in the US are profound. Cutting military expenditures overseas will save the US money. Our friendly competitors such as Japan and the EU will be forced to divert support for social programs to defense spending. The reality is the subsidization of European defense in particular by the United States allowed the EU countries to offer its citizens, and in some cases non-citizens, extensive social services. That era is coming to an end.

3. Lowering Debt Costs Will Drive a New Monetary Policy Agenda

President Trump has been nothing but clear about his intentions to lower interest rates, and Jay Powell has been unwilling to accommodate him. Lower interest rates mean less money spent on our soon to be $37 trillion in debt and will lower mortgage rates. A bill to cap interest rates on credit cards could have a volcanic effect on consumption, and the long-delayed student loan relief bill is being revived.

Before the tariffs, or the threat of tariffs hit, betting was going against further Fed cuts in 2025. Now however, it might be foolish to bet against a cut on May 7th. The market reaction, especially if it continues or even remains at present levels, has painted Powell into a corner. If employment slows—this morning’s report was mixed—, we could have 3 or 4 cuts this year. Over the course of 2025, this could reverse the market decline and increase confidence.

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A Map Redrawn

We are still in the early days of this administration, and it can be difficult to distinguish posturing from policy. But there should be little surprise about what has unfolded. Tariffs were promised, and tariffs were delivered. Market volatility was inevitable.

What is clearer now is that economic policy plays a critical part in the geostrategic plans of the White House. Donald Trump is in fact similar to Xi Jinping in this regard. Both are willing to take on economic pain in order to achieve their long term goals.

During the previous era of globalization, growth was powered by cheap labor, cheap capital, and security provided for its allies for free by the US. That time is now ending. We have been told that government costs are going to be slashed. Branko Milanovic, an economist at CUNY’s Stone Center, makes this comment:

❝I ask my liberal friends of a certain age: why is that that you loved it when the young, good-looking reformers cut the govt to size and privatized everything in Eastern Europe and you do not seem to like it now?

Looking at Europe today, Eastern Europe has outperformed, and Poland has accomplished an economic miracle. More on that subject, as well as other US policies including a weak dollar and a US sovereign debt fund in my next article.

However just to note, if the US can emulate Poland instead of Japan, and successfully embrace structural reform, fiscal restraint, and regional integration, and prioritizing growth over entitlements, the US economy could roar back on a sustainable basis. This would be preferable to Japan’s relative stagnation, due to high debt, demography and the absence of true reforms.

So in conclusion, although the Trump administration has rocked markets, it telegraphed its economic policy intentions very clearly. The question is will we be able to rebalance without causing lasting instability and uncertainty? Will the US withstand this short term storm for long term gain, or will the howling winds of political backlash blow us off course?

Since the White House is unlikely to change its mind, the best case scenario is that Beijing finds a way forward this weekend—or the Fed steps up since credit also appears to be tightening. 💬

–𝓁𝓎𝓇𝒾𝒸

Editor-in-Chief

📍Chicago

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More on Tariffs on econVue

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EXCERPT BELOW:

The root cause of China’s economic malaise—taxation policies—has led to distortions and misallocations of capital. Overproduction in export-led industries such as electric vehicles is clearly supported by the government subsidies. Hyper competition in generic pharmaceuticals is another example of companies selling below costs in order to stay alive—for now. Disinflation (now estimated at 1%) is taking hold, and this race to the bottom is creating ripple effects in other global markets. The increasing lack of transparency in China’s economic statistics makes all of this difficult to study and document—another casualty of China’s centralized rule.

This is where external taxation comes into play. Tariffs are as a way to normalize prices that have been artificially lowered through government intervention. The Theory of Optimum Tariffs in economics examines how a country can maximize the benefits of imposing tariffs if it is able to avoid retaliation from its trade partners. The question is what are China’s options to upcoming changes in US trade policies?

Optimal Tariff Theory ⧉

⧉ "The optimal tariff theory argues that a country that is a large importer of a particular commodity can shift the economic burden of an import tariff from domestic consumers to foreign suppliers if the country has monopsony power in the market—the country is a primary buyer from many competing suppliers. This monopsony power results in a supply that is relatively inelastic or insensitive to price changes, which forces exporters to lower their pre-tariff prices when facing a tariff increase in order to maintain the same supply level and allows importing countries to capture revenue that exporters previously received." 

I believe that this is the operating principle behind the Trump Tariffs. Although many economists disagree, as Laura Bowen writes above and in Chicago Policy Review ⁷“Despite over a century of theoretical debate on the incidence of tariffs, sound empirical evidence on who bears the burden of trade tariffs is sparse.”

Not only the US, but the EU is also likely to raise tariffs on a number of Chinese imports in 2025. As we look ahead, it might be useful to remember the arc of history in China’s relationship with global powers over the past half century.

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