We’ve been hearing about tariffs non-stop since President Trump started discussing them in detail early in his new administration. The tariffs were on-again, off-again over the course of February and March, before getting serious in April when the tariffs actually came into effect.
Some were not as high as Trump first declared, with some exemptions and extensions. But almost every US trading partner had at least a 10% tariff imposed on them. Some were as high as 150% – China being a good example.
But what is Trump trying to achieve?
Back to the American System
Trump is pursuing a twenty-first-century version of what was originally known as the American System.
Alexander Hamilton invented the American System in 1790. A succession of US presidents and leading political figures supported it, including George Washington, Henry Clay, John Quincy Adams, Abraham Lincoln, William McKinley, Calvin Coolidge, and Dwight Eisenhower.
The American System relied on the following policies:
- High tariffs to support manufacturing and high-paying jobs
- Infrastructure investment (public and private) to support productivity
- A strong army and navy to protect the US, but not to fight foreign wars
- A central bank with limited powers to provide liquidity to commerce
The American System prevailed from 1790 to 1962, with occasional periods of agrarian ascendency and some disruptions such as the Civil War.
But beginning with the Trade Expansion Act of 1962, the Trade Act of 1974, and successive rounds under the General Agreement on Tariffs and Trade (today the WTO), the US slowly embraced the neo-liberal consensus, which included drastic tariff cuts. As jobs moved offshore to take advantage of cheap labour, capital followed as foreign direct investment.
The result was the hollowing-out of US manufacturing, wage stagnation, slower growth, greater debt and a succession of failed wars.
The open border policy of Biden was consistent with neo-liberal views on the end of sovereignty, spelling a death-knell for American jobs and social cohesion.
What Trump hopes to achieve is a return to the pre-1962 glory days with the revival of the American System. Foreign companies will be free to sell goods to Americans, but only if manufactured in the US.
Opening the door to foreign companies willing to operate in the US will lead to a wave of inbound investment in the US, a reduction in US trade deficits, a stronger dollar (as the world demands dollars to invest here), and higher wages for US workers.
Higher wages will raise real incomes, stimulate consumption, decrease income inequality and expand the tax base to help reduce deficits without raising tax rates.
Why the US needs an American System Reset now
So far, President Trump is staying true to his “America First” agenda by using tariffs to protect US industry from unfair foreign competition.
To understand the depth of the trade deficit problem, it’s useful to review the chart below showing just how large US trade deficits are and the major culprits on a country-by-country basis:
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Are tariffs good or bad?
Tariffs are not inherently good or bad for an economy. Their impact depends on initial conditions when the tariffs are imposed. So tariffs are a tool that should be applied judiciously.
A country that overinvests and under-consumes will be hurt by tariffs. The tariffs will increase investment and restrain consumption making the imbalance worse. That’s what happened to the US under the Smoot-Hawley Tariffs in 1930 and later. But the US was an exporter back then.
A country that over-consumes and underinvests will benefit from tariffs. That’s the situation in the US today. The tariffs will increase investment as foreign and domestic investors build new plants behind the US tariff walls.
Tariffs will channel consumer dollars from consumption into savings, which is also desirable. In the end, consumption will expand not because of cheap imports but because of high-paying US jobs.
The tariff and trade wars now erupting will undoubtedly disrupt global supply chains. Reconfiguring supply chains will take one to two years. But once that’s done, the new supply chains will prove durable. Supply chains are adaptable with a lag. US soybeans will soon be on their way to Japan and the Netherlands if China doesn’t want them. The US has almost all of the leverage in this current trade war.
Once Trump announced his high reciprocal tariffs in early April, trading partners rushed to make deals with the USTR that would lower tariffs and end non-tariff barriers (NTBs) that restrict trade through regulations instead of tariffs. India, Japan and Italy were among the first to contact Trump. They will get the best deals.
Those choosing confrontation such as China could well end up with the worst results. The US is already working around the clock on a plan to substitute US production for Chinese imports. This could cause China’s unemployment to grow while US employment surges.
Tariffs gave the US prosperity from 1790 until 1969. They can work again.
Here’s how to profit as Trump proves it.
All the best,
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Jim Rickards,
Strategist, Strategic Intelligence Australia
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