Imagine the following scenario: A world leader who many consider an adversary, perhaps Vladimir Putin or Xi Jinping, uses his country’s military to institute an embargo around the United States. This invariably limits American’s access to valuable materials and products, increasing prices, and causes customers to scramble for substitutes or go without. The S&P 500 drops by 18% from the news of the build-up to the actual event, with 11 percentage points of that coming in just a few days after the embargo. Economists predict a resulting recession. Financial chaos ensues.
How would we regard this action on the part of Vladimir Putin or Xi Jinping? Most Americans would see it as an act of war with the likely goal of weakening and ultimately subjugating the U.S.
Now add a further twist. This embargo doesn’t arise from the actions of these adversaries, but instead from commands within the White House. How should we think about this now?
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Tariffs on materials such as steel and aluminum are equivalent to shooting oneself in the foot. For each American worker “helped” by the tariffs, there are many more American workers who are hurt. This is a result of the mathematical fact that more workers use steel and aluminum to produce products than the number of workers required to produce the raw material. One study concluded that, on net, Americans paid $900,000 for each steel job that was “saved” by prior tariffs.
The economic case against tariffs is neither novel nor subtle. Trade restrictions raise prices for both producers and consumers stifle competition, and invite retaliatory measures from outside nations. A tariff, in plain terms, is a tax on domestic prosperity masquerading as patriotism.
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The problem isn’t a deficit of knowledge or sentiment — it’s a surplus of power.
Montesquieu, writing in 1777, argued that liberty depends not on the virtue of those who govern, but on the dispersion of power among them. Madison, in crafting our constitutional architecture, advanced that insight by embedding friction into the process of governance — not to ensure that good policies would prevail, but to make it institutionally difficult for any single actor to impose their preferred policies unilaterally.
But over time, the institutional guardrails that once restrained executive discretion have been steadily dismantled. Section 232 of the Trade Expansion Act of 1962 and Section 301 of the Trade Act of 1974, for example, have furnished presidents with broad authority to impose tariffs without congressional approval — often under the vaguest invocations of “national security” or “unfair trade.” Under Section 232, the Secretary of Commerce can initiate investigations — sometimes at the president’s request or even unilaterally — into whether imports threaten national security. If such a threat is deemed to exist, the president has nearly unfettered discretion to act, free from oversight by the ITC or Congress. Section 301, originally intended to enforce US rights under trade agreements, likewise allows the president to retaliate against foreign practices deemed “unjustifiable” or “unreasonable.”
Everyone wants Main Street to prosper, but pitting Wall Street against the rest of the country is one of the hoariest pages in the faux populist handbook. See Mr. Moneybags in the Monopoly board game. It’s a favorite trope of the political left, with its claim that rich financiers are exploiting the proletariat, aka these days “the working class.”
It’s also nonsense. Wall Street as defined by the stock and financial markets is integral to prosperity on Main Street. Some 60% of Americans own stocks either directly themselves, or indirectly through their pensions or 401(k) plans. When stocks fall, as they have since Mr. Trump unveiled his tariff agenda, these investors suffer more than Goldman Sachs partners because their safe retirement margin is so much less.
The business of finance is also crucial to growing the businesses that employ workers. This is a remedial economic point, but investors with capital take risks on the growth of companies. When companies succeed, financiers get a return. When they fail, they can lose their investment or loan. One problem in recent years, since Sarbanes-Oxley passed in 2002, is that regulations have kept too many companies from floating equity in public markets so mom and pop can share in the upside.
Professor Peter Grossman’s letter in today’s Wall Street Journal is excellent:
President Trump likes to tout America’s late 19th-century economy as justification for high tariffs on foreign-made goods (“Trump and His ‘Little Disturbance’,” Review & Outlook, April 4). The economy then was growing rapidly, and the U.S. was fast becoming the most prosperous nation on earth. That, Mr. Trump implies, means tariffs aren’t barriers to prosperity and that a redo is welcome.
As some have pointed out (Letters, April 3), U.S. tariffs were declining in the late 1800s, and the link between tariffs and economic growth is illusory at best. But the real problem with Mr. Trump’s analysis is that another crucial element of prosperity was at work here, which he wouldn’t countenance now: open immigration.
There are several things that can move across borders: goods (imports and exports) and factors of production (capital and labor). Ideally a country should be open to receiving each of them. Most economists oppose trade barriers but acknowledge that, should tariffs exist, they ought to be low to allow for prices to reflect the costs of production, not government’s visible hand.
If goods are restricted by tariffs, the factors of production need to be free to move. In other words, if a good made in country A is sought by consumers in country B but is taxed by tariffs, then capital should be able to move to the consumers along with the labor that makes the product. Blocking the free flow of both goods and either of the major inputs means the consumers in country B—in this case, the U.S.—are the losers.
Nineteenth-century America permitted virtually unimpeded flows of capital and labor. That had more to do with American prosperity than any tariffs did. The claim that such levies sparked the growth of the American economy and can do so again is nonsense.
Em. Prof. Peter Z. Grossman
Butler University
Countries hold dollars to facilitate world trade, and this benefits the United States. By “selling” dollars—which we can produce at minimal cost (albeit it does help that we spend on the military to keep the sea lanes open)—we acquire real goods and services in exchange, realizing an “exorbitant privilege.” Does that privilege impose a hidden cost on our manufacturing sector? Not really.
In the short run, increased global demand for dollars can push up the exchange rate, making exports more expensive. Yet this effect arises whatever the cause of the increased demand for dollars. If foreigners want to buy more US tractors this appreciates the dollar and makes it more expensive for foreigners to buy US computers. Is our tractor industry a nefarious burden on our computer industry? I don’t think so but more importantly, this is a short-run effect. Exchange rates adjust first, but other prices follow, with purchasing power parity (PPP) tendencies limiting any long-term overvaluation.
To see why, imagine a global single-currency world (e.g., a gold standard or a stablecoin pegged to the US dollar). In this scenario, increased demand for US assets would primarily lead to lower US interest rates or higher US asset prices, equilibrating the market without altering the relative price of US goods through the exchange rate mechanism. With freely floating exchange rates, the exchange rate moves first and the effect of the increased demand is moderated and spread widely but as other prices adjust the long-run equilibrium is the same as in a world with one currency. There’s no permanent “extra” appreciation that would systematically erode manufacturing competitiveness. Notice also that the moderating effect of floating exchange rates works in both directions so when there is deprecation the initial effect is spread more widely giving industries time to adjust as we move to the final equilibrium.
None of this to deny that some industries may feel short-run pressure from currency swings but these pressures are not different from all of the ordinary ups and down of market demand and supply, some of which, as I hove noted, floating exchange rates tend to moderate.
Ensuring a robust manufacturing sector depends on sound domestic policies, innovation, and workforce development, rather than trying to devalue the currency or curtail trade. Far from being a nefarious cost, the U.S. role as issuer of the world’s reserve currency confers significant financial and economic advantages that, in the long run, do not meaningfully erode the nation’s manufacturing base.
There are some concepts that seem so obvious as to need no explanation. But once in a while I discover that not everyone views the world in the same way, and the obvious may require a bit of explanation.
Let’s start by considering a world with no money, relying on barter. Suppose Australia wishes to buy some big Caterpillar tractors and Boeing jets. Unfortunately, the US is not particularly interested in buying the stuff that Australia exports, such as iron, coal and beef. We already have plenty of those commodities. So no trade occurs.
Now let’s introduce money. Australia can pay for those US exports with money. The US can use that money to buy clothes, consumer electronics and home appliances from China. China can then take that money and buy iron, coal and beef from Australia. The use of money facilitates a three-way trade that would have been almost impossible under a system of barter.
You might also notice that each of the bilateral trade relationships is unbalanced, with one country in deficit and one country in surplus. But for the world as a whole there’s no obvious problem. Those bilateral deficits and surpluses are no more meaningful than if I had a deficit with my grocery store and a surplus with the students I taught. Individuals, cities, states and entire nations always have lots of bilateral deficits and surpluses. That’s what it means to move beyond barter.
Some are now advocating that we move back closer to barter, that we try to balance every bilateral trading relationship. Well, not every relationship, but at least every trading relationship between countries.
David Henderson reminds us of an important feature of spontaneous order.
Trump’s tariffs will inflict great damage on the guitar industry. (HT Emmanuel Martin)
