Has US scored a self-goal? Financial Express 24th April 2025

 

Donald Trump's aggressive tariff policies, designed to boost US production, risk backfiring. 1 They could lead to increased inflation for American consumers, a weaker dollar, and a potential shift away from dollar-denominated assets.

Has Donald Trump scored a self-goal with the tariff games of the past couple of months? Tariffs and strict immigration policy were meant to make America great again — the US would produce more goods and services with their own labour force and be less dependent on the rest of the world. With its economic might, this model looked theoretically possible, though not feasible. But the rather pusillanimous approach to tariffs has created a major disruption to the world economy, overwhelming the far more serious political conflicts in Ukraine and Gaza.

From the American point of view, this policy has got a large number of countries to open doors fully for negotiations. Any flexibility shown by countries on tariffs will be a victory for the US; but without bilateral treaties, where tariff rates become generalised, the doors are opened to all countries, raising the threat of dumping. This can be the larger threat of lowering duties on automobiles, engineering goods, food products, chemicals, electronics, etc.

But what will be the impact on the US? To begin with, any concession given by any country on lowering tariffs for American goods will mean higher exports for the US. Will this amount be large enough to offset its existing bilateral deficits? One cannot be sure, given that the US continues to be the largest importer of goods. Therefore, if its new tariff structure is rationalised based on how other countries lower their tariffs, the gains can be only on the exports side.

But what if other countries do not lower their tariffs or retaliate with higher tariffs (like China)? In that case, the exercise could turn out to be counterproductive. Let us get back to the basics. Why does the US import so much from Mexico, Canada, or China? The laws of comparative advantage hold where other countries produce goods at a lower cost. For instance, textile, leather, electronics, and pharma goods can be produced in the US, albeit at a higher cost. Metal goods could be difficult to produce if the reserves are limited. Therefore, trade has addressed issues of economies of scale.

With high tariffs being imposed on all countries, there are various possibilities. First, with tariff competition, there can be substitution across exporting countries. India can export electronics at a relatively lower rate than China, and hence the US still gets the goods, but at a higher cost from another producer. The European Union (EU) has a lower tariff rate and can take over exports of other countries with higher tariffs. But from the US point of view, the goods would cost the final consumer more, as the tariffs would have been raised.

The other possibility is that the US builds the same capacity to produce goods it imported earlier. Here, the time factor would come into play as such capacities cannot be set up in a few months’ time. They would require a year or two to accomplish. However, counter-intuitively, it can be said that this could have been done earlier too; but it was not the preferred option because of the cost involved. With migrant workers now being out of the frame, US labour may not have the capability of such relatively low skills, or would be available at a higher cost.

Hence, either way, the price effect cannot be escaped and inflation will be higher for sure. This is why the Fed has been raising the red flag intermittently on being cautious about rate cuts on this score.

The markets, however, have reacted with alacrity. The stock market has seen a downside to growth in the US and has taken a southward movement. The dollar has started falling against other major currencies, with the dollar index now going at less than 100 from a high of 108-109. A weaker dollar has meant potential appreciation for other currencies, which will also raise their export prices. This can mean even more expensive imports for the US.

The bond yields, however, have behaved differently, with the 10-year treasury now moving in the 4.4-4.5% range. The reason is not hard to guess. The potential outcome of this tariff saga has made investors sell American treasuries, thus leading to a fall in their prices and a rise in the yields. In such a situation, the biggest beneficiary has been gold, where the price has been moving up steadily towards the $3,500/ounce mark. Last year, it was observed that domestic households, investors, and central banks preferred gold as a safe haven in a situation where the world economy looked fragile, especially after Trump won the elections.

In such a situation, a pertinent question to ask is, if investors are moving away from dollar securities to other assets like gold is there a threat to the greenback? This can be considered a temporary phenomenon as one assumes that there will be more clarity after the 90-day period ends. This can probably be the time for the euro to become more preferred as an anchor currency. The EU appears fairly steady, with discipline among the 20 group members. Presently the weight of the euro in the overall basket of forex reserves is 18-20%, though this is mainly due to member countries holding the currency. This can be an opportune moment for countries to take some affirmative steps towards de-dollarisation.

India stands to probably gain some advantage at the macro level, with its tariff threat of 26% being lower than that of other competing nations. Besides, there is urgency being shown in bilateral negotiations, which can make our position stronger. Hence, while specific sectors have to be worried about the implications there could be some collateral benefits trickling in, especially if India can become the supply engine for goods hitherto procured from China by the US. The next few months will be critical for sure.