Donald Trump’s trade war is ostensibly meant to resurrect the United States as a manufacturing powerhouse. There is little chance of that. Half of U.S. imports are intermediate goods. As those prices rise, U.S. manufacturers will face higher input prices while firms in export industries will be hit by retaliatory tariffs abroad. U.S.-produced goods will cost more and be less competitive in global markets.
What Trump’s tariffs are instead accomplishing is to destabilize the one sector where the U.S. remains dominant: finance. Traditionally, the U.S. banking system has stood at the center of the world economy. American stock markets have provided the world’s deepest and most liquid capital pool. Investors sought out U.S. Treasuries as a safe and reliable investment asset. And the dollar has served as the closest thing to a global currency. As a result, the U.S. attracted cheap capital from the rest of the world, which in turn financed U.S. government deficits and high rates of consumer spending.
That is why, during times of political and economic turmoil, investors typically buy dollars and Treasuries as safe havens. Not now. Since Trump mounted his trade war with the world, stock prices have fallen, the dollar has slumped, and investors have demanded higher yields in return for holding U.S. government securities.
These trends amount to a deepening vote of no confidence in the political and economic leadership of Washington, D.C. The Trump Administration appears determined to collapse the liberal international order and return the world economy to the kind of zero-sum mercantilism reminiscent of the 18th century.
This crisis of faith in American leadership arises against the backdrop of pre-existing challenges to U.S. financial pre-eminence. The U.S. has used its financial leverage against adversaries (essentially denying countries such as Russia, Iran, North Korea, and Venezuela access to the global banking system) in such an aggressive fashion as to make even friends wonder whether these weapons might someday be turned against them. Further stress on the dollar-based international financial order arises from China’s efforts to promote internationalization of the renminbi – especially in cross-border trade and lending – and its creation of the Cross-Board Interbank Payment System (CIPS) as a China-centered alternative to the SWIFT messaging system that connects the world’s banks.
A long-time pillar of U.S. financial dominance has been the key role of the Federal Reserve in balancing inflation and unemployment while serving as a lender of last resort during crises. Yet the confidence inspired by the Fed rests upon its relative independence from direct political interference. Only a Fed capable of resisting pressures to juice the economy for the political benefit of presidents will retain credibility among investors as an inflation-fighter. This too is being undermined by Donald Trump’ s criticisms of Fed Chair Jerome Powell and his implied threats to replace Powell before his term is up – a power previously considered beyond a president’s reach, but one that could be endorsed by the Supreme Court in a pending case (Trump vs. Wilcox).
In August 2023, Fitch downgraded the rating attached to American government securities based upon concerns about both growing U.S. debt levels, which have reached 137% of GDP, and the periodic standoffs in the Congress over raising the debt ceiling. Another such game of financial chicken may be in the offing in the coming months if enough Democrats, seeking leverage over budgetary policy, join with fiscally conservative Republicans to delay a raise in the debt ceiling past a point of no return.
Vulnerabilities also arise from the heavy dependence of the U.S. on foreign investors, including sovereign states, to finance government debt. China alone holds $750 billion in U.S. Treasuries. The Chinese have been gradually whittling down this total, but could accelerate the process as a means to pressure the U.S. to relent on trade restrictions aimed at Chinese goods. The same is true of other governments that hold large quantities of American debt.
Even if no one of these stressors would be alone capable of inciting financial instability, the combination has created conditions ripe for disruption. Enter Donald Trump’s trade war, which has deepened worries about the recklessness and volatility of U.S. policy. Friends and adversaries alike are considering ways to “derisk” by lessening their exposure to U.S. trade and finance. This could mean a flight from the dollar and an unwillingness of investors to continue financing the U.S. Federal deficits except at an interest premium.
The Economist underscores the shaky fundamentals that underlie American vulnerability: “In the past 12 months, America has disbursed 7% of GDP more than it raised in revenue, and spent more on interest payments than on national defence. Over the next year officials must roll over debt worth nearly $9trn (30% of GDP).”
Vice President J.D. Vance has argued in favor of a weaker dollar while one top Trump economic adviser – Stephen Miran – has suggested taxing foreign Treasury holdings, a move that would likely prompt a bond sell-off
Foreigners hold $32 trillion in U.S. stocks and bonds. A sell-off of bonds and a retreat from the dollar could spike inflation, as a weak dollar pushes up import prices on top of tariffs, and swell the interest payments that the U.S. must pay on its massive debt obligations. The stock market would likely plunge, leading to a vicious downward spiral as investors liquidate assets to meet margin calls, thus further undermining asset prices and so on.
While the dollar remains dominant for now, the proportion of dollars in foreign reserves has gradually fallen from 73% to 58%. A more precipitous decline is not out of the question.
In the long run, a weaker dollar might make U.S. manufacturing for both the domestic and export markets more competitive, but this would be blunted if an ongoing trade war meant higher trade barriers overseas against American goods.
Any advantages from a weaker dollar would also be offset by the blows that Trump’s policies are inflicting upon American service industries in which, unlike manufacturing, the U.S. holds a surplus with the rest of the world. A weakening of the U.S. banking sector would undermine revenue from U.S. financial services abroad. Tourist revenue from overseas visitors has already plummeted, due to the trade war, rising political tensions, slower visa processing, and harsh immigration policies. The revenue that American colleges and universities (and surrounding communities) gain from the enrollment of international students is endangered by high-profile deportations and the unfriendly climate facing visitors from around the world. The administration’s attack on the independence of institutions of higher education also threatens to tarnish the brand of the sector, resulting in diminished flows of international students and high-quality scholars.
The burdens of American leadership in the world have been outweighed by the benefits of global interdependence and financial stability. But leaders can lead only when other are willing to follow. That requires a minimum of trust in the wisdom and reliability of the leader. As the Trump Administration trashes the international and domestic norms and institutions that have underpinned the liberal international order, other states and private actors will seek to derisk their relationship to the U.S., leading to growing American isolation. The short-run gains that might be had from bullying U.S. trade partners into one-sided “deals” pale in comparison with the long-run costs of destroying the bonds of trust that are the true source of American and global prosperity.
The Internationalist 