Trump wants tariffs with no tradeoffs. It won't happen

National Post, 12 February 2025

Tariffs are inflationary, raising consumer prices for Americans on oil, electricity, automobiles, groceries and much else

The Trump tariff turmoil is a teaching moment. That’s a sliver of silver — nickel? — lining to the dark economic clouds gathering.

There are no economic policies without tradeoffs.

Canadians were reminded of that during recent years. A pandemic causes an economic collapse, so massive government stimulus is unleashed. Deficit-financed government spending at such scale is likely to cause inflation. Dealing with inflation requires higher interest rates. Higher interest rates reduce demand and investment, risking an economic slowdown.

The tariff tradeoffs are related to the strong U.S. dollar, a consequence of a national currency serving the entire world as a trustworthy store of value. This drives up the demand for U.S. dollars, and therefore their price. The relative price of a currency is the exchange rate.

This has certain benefits for Americans. They can run massive deficits and carry eye-watering levels of national debt relatively cheaply; the entire world buys U.S. Treasury bills at fairly low rates of interest. Indeed, the sheer amount of U.S. debt requires buyers from around the world, which increases demand for the dollar.

Then comes the tradeoff. The strong dollar makes it relatively cheaper for Americans to buy foreign goods — imports increase. American exports become more expensive abroad. This can lead to a trade deficit, which means a country imports more than it exports. In contrast, a weaker dollar would reduce the trade deficit by making imports more expensive and exports less expensive.

This year marks the 40th anniversary of the Plaza Accord, which attempted to reduce America’s trade deficit precisely by reducing the value of the U.S. dollar. In his 2006 memoir, James Baker, the U.S. Treasury secretary in 1985, devoted an appendix to the Plaza Accord, which began by noting that “item one on our agenda was the dollar.”

A secret meeting of exchequer chiefs from the U.S., United Kingdom, France, West Germany and Japan was held at New York’s famous Plaza Hotel in September 1985. (That hotel would be bought by Donald Trump in 1988 and sold at a massive loss in 1995 to stave off bankruptcy.)

The five nations agreed to sell their U.S. dollar reserves, increasing supply to drive down the price. The U.S. dollar did decline, so much so that by 1987 the Plaza Accord was updated to stabilize the dollar’s slide.

The Plaza Accord did reduce the trade deficit. As is always the case, it had other effects. It made American purchases cheaper in Japanese yen, and Japanese companies went on a buying spree of trophy American real estate, culminating in the 1989 purchase of Rockefeller Center, just a few blocks away from Trump Tower on New York’s Fifth Avenue.

The same dynamics that gave rise to the Plaza Accord were behind Trump’s 1987 full-page ad in leading American newspapers, where he inveighed against Japan benefitting from American markets and defence spending, but not paying its fair share.

Specifically, Trump observed that Japan had “brilliantly managed to maintain a weak yen against a strong dollar.” The Plaza Accord was beginning to change that, and Trump noted that the Japanese were “openly complaining.”

“It’s time for us to end our vast deficits by making Japan pay,” Trump wrote.

While he has changed his positions on many issues over the years, the American trade deficit has remained Trump’s obsession. Tariffs today are meant to correct that deficit by making imports to the U.S. much more expensive. Japan must pay, as well as China, Canada, Mexico and soon everyone else. To be precise, Americans who do business with foreigners must pay.

The tradeoffs will come. Tariffs are inflationary, raising consumer prices for Americans on oil, electricity, automobiles, groceries and much else besides. Inflation will require American interest rates to remain constant or even rise, making it more attractive to hold American assets, especially Treasury debt. That means upward pressure on the U.S. dollar, which makes imports relatively cheaper, thereby counteracting some of the tariff effect on the trade deficit.

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