The international financial markets are the closest thing we have to a global consensus view on economics. And the wisdom of this crowd is usually greater than that of your average politician. More often than not, the crowd wins. In the UK, the financial markets sank Liz Truss without much of a fight. And bond market vigilantes have ended many political careers. Last week, it passed its devastating judgment on Donald Trump’s “Liberation Day”.
But Trump has a fighting chance in what would otherwise be a hopeless contest — because, today, the crowd acts more like a herd than a group of people who come to their views independently.
Whether Trump wins or loses will depend on what he does next. Will the President fold? Short answer: no. Tariffs define him. They are where he differs from all the other leaders of the Right. They agree on immigration and on gender politics, but I cannot think of a single one who wants to impose tariffs. It has been most amusing watching staunch conservative commentators and Trump supporters in the UK tying themselves in knots over this contradiction.
But nor do I think Trump will play the game to the bitter end. It would be incredibly costly to try to rebalance the global economy through the hammer of trade tariffs alone. What I think he may end up doing instead is follow the thinking of the two smartest people in his economic team — the ones he ignored on tariffs. They are Scott Bessent, the treasury secretary, and Stephen Miran, chairman of his Council of Economic Advisers. While both men strongly support rebalancing, they don’t have Trump’s one-track mind when it comes to tariffs. They do know, however, that he is the one politician likely to complete the feat.
The most concise rendition of Trump’s approach came from Caroline Leavitt, his press secretary, last week: “Our country has been one of the most open economies in the world… But too many foreign countries have their markets closed to our exports. This is fundamentally unfair. The lack of reciprocity contributes to our large and persistent annual trade deficit that’s gutted our industries and hollowed out key workforces. But those days of America… being ripped off are over.”
Miran’s version is more nuanced. Last November, he wrote a much-quoted paper, in which he pleaded for a far more cautious approach, one in which the administration would announce the tariffs but implement them only gradually. For Miran, the tariffs are a gun on the negotiating table — ideally not to be used. For him, the ultimate goal is the devaluation of the dollar. “There is a path,” he writes, “by which these policies can be implemented without material adverse consequences, but it is narrow and will require currency offset for tariffs and either gradualism or coordination with allies or the Federal Reserve on the dollar. Potential for unwelcome economic and market volatility is substantial.”
From where we’re standing, it might look like Tariff Man won over the “rebalancers”. But I think Miran’s version will ultimately prevail. For one thing, the problem of global imbalances is not primarily about unfair trading practices. It is about macroeconomic policies. China and Germany have systematically suppressed consumption and investment; their policies have been designed to support exports and reduce imports. Germany mostly imports what it needs for its own industries — raw materials like oil and gas — as well as intermediate goods. If it is hit by a tariff, it will maintain the trade imbalance by importing even less. But if Germany were hit by a falling dollar, this game would no longer work: the imports would get cheaper, and the exports more expensive. Miran’s idea is that you hit them with a combination of both.
The broader community of international economists, however, does not think this way. Their world is one in which everybody specialises in what they are good at, in which trade imbalances arise naturally, and in which people migrate across borders. This is hyper-globalisation — an era which ended a few years ago.
The system was under attack even before Trump set fire to it. The return of geopolitics is not conducive to a world in which all the cars are made in Germany, and all the smartphones in China. Trump is not the only leader who wants to reshore industries. Joe Biden started this with his Inflation Reduction Act. Emmanuel Macron has similar plans.
“Hyper-globalisation was under attack even before Trump set fire to it.”
To rebuild this new system, I expect Trump will stick with his trade policies for now, but though will bevel some of its edges. He could strike a free trade deal with some friendly countries such as the UK, Australia, New Zealand, and Vietnam — though will not include the EU and China.
He may also go a little easier on Canada and Mexico to minimise the disruption of trade flows in the North American free-trade region. He can still impose tariffs on a few industries, like steel or even cars. But having a functional free-trade zone around you would make it easier to impose tariffs on the rest of the world.
The key to Trump’s success will be the dollar. He’s been lucky so far, since the dollar has devalued since he took office. Against the euro, the dollar fell by 8%, which was not supposed to happen. Economic theory suggests that if you impose tariffs, the dollar would go up, and partially cancel their effects. But economic theory was proved wrong. If Trump manages to defy the economists and get the dollar devalued by, say, 20% against the major trading partners, he can lean back, declare victory and gradually reduce the tariffs.
This would be a shift of truly historical proportions. Our current system of dollar hegemony is over 80 years old, instigated by the Bretton Woods system which tied the value of the US dollar to gold. When, in 1971, Richard Nixon ended this, the advanced economies then transitioned to a new system of free-floating exchange rates where the value of currencies were determined in the financial markets. But the world was still dollar-centric
In 1985, when high US interest rates led to a massive rise in the dollar’s exchange rate against the European currencies and the Japanese yen, the finance ministers of the world’s most industrial nations descended on New York, and reached the famous Plaza Accord, in which they agreed to bring down the value of the dollar to re-balance the global economy. This was a different world: a place of gentle financial diplomacy where people would meet and coordinate.
But after the collapse of Communism, around 1990, such coordination became rarer. The world suffered increasing financial instability — the bond market crash in 1994, the Asian financial crisis in 1997, the Russian financial crisis a year later, the Global Financial Crisis in 2008, the eurozone’s sovereign debt crisis from 2010 to 2015, and the inflation shock that started in 2021, which still hasn’t been fully reversed. And now, this fundamentally unstable system is heading for its day of reckoning.
It is easier, though, to diagnose a system’s faults than to come up with something new. At the moment, there is no alternative. The euro cannot take over: it is a currency without a government or the infrastructure to act as a global reserve currency. China cannot fill the gap either, because its capital markets are not open, and because you cannot simultaneously pretend to support the global economy and refuse to import from it.
Miran was right in his warning that the road to a global deal is treacherous. We saw this last week. The smart thing for Trump to do now, then, would be to put the tariff gun on the negotiating table. Europe, Japan, South Korea and other industrialised economies would agree to increase their exchange rate against the dollar. The US would reduce the tariffs and keep only those justified on grounds of national supply security. It’s a far more sensible approach than bilateral trade deals and tariff wars.
Economic history is littered with examples when establishment opinion and market consensus were simply wrong. I trust the wisdom of the crowd when it comes to horse racing, but not on economics and finance. The chances that Trump may end up being right — or that at least he gets what he wants — are greater than the herd might think.
