On April 2nd 2025, President Trump announced a package of what he called reciprocal tariffs, in order to punish nations which according to him were ripping off the United States. In a matter of hours, the formula which was used to calculate the tariff percentages was found, showcasing the lack of strategic economic policy and rather brute force power threats in his actions. Yet as the former Greek finance minister, Yanis Varoufakis said in an interview to The Times,“ Trump may walk like a buffoon, talk like a buffoon and look like one, but it's a profound mistake to think that he is one and hence underestimate him ”. Whether you agree with his political alignment or not, nobody can reach the most powerful position in the world without intelligence. If we can say one thing for certain about Trump, is that he is fixated on strategy. His plan might be ambiguous, but there definitely is a plan. This article examines the possible strategic planning behind the President's "Liberation day”, as well as what additional policies can be expected in the future.
International trade is central to the heightened standard of living societies are able to enjoy today. It allows nations to specialize in areas in which they have comparative advantages, increasing the total welfare of both exporting and importing nations. Despite the undisputed benefit of free international trade, many nations opt to limit it by enforcing tariffs and quotas.Tariffs are strategic taxes placed on foreign imports, with the goal of reducing import quantity, while quotas are direct import quantity restrictions that have similar effects with tariffs. There are several reasons why a nation would opt to enforce protectionist policies. The most common are the national security concern, the infant industry and unfair advantage arguments. The former, states that a nation that is heavily dependent on imports, is vulnerable during times of heightened tension, presenting a case why a country would need to sabotage free trade in order to enhance domestic production. The latter are both arguments involving the lobbying of powerful domestic corporations who are seeking to reduce market competitiveness, in order to unfairly benefit at the cost of consumer welfare.
The problem is that tariffs and quotas are simply very risky policies, not to mention that, by themselves, they are not even effective in altering the trade balance. Usually tariffs are utilized as a bargaining chip by powerful countries to negotiate with others over import prices. The thing is, the threat of tariffs is almost always a lose-lose situation. The best and most unlikely outcome is if the threat works. Other countries lower their trade barriers or make concessions to avoid the tariff. In contrast, if the threat does not work, then the threatening nation has to either not enforce it and lose prestige in the global political stage, or go ahead with the threat and basically shoot itself in the foot by increasing prices. In fact, the threat of tariffs can even backfire and lead to a trade war with constantly increasing reciprocal tariffs, which will be catastrophic for both nations. You might say, ok tariffs are unlikely to achieve their strategic goal, but what do you mean they aren't even effective?. Even though it might seem shocking, trade policies DO NOT affect the trade balance.
The trade balance is the difference between a country's exports’ value and its imports’ value. It is often depicted as NX in economic textbooks and it is one of the four components of GDP. To understand why trade policies do not affect the trade balance, it is necessary to analyze what happens to the foreign currency involved in international trade. When a country engages in international trade, it receives payment in foreign currency. The now owner of foreign currency is unable to utilize it domestically and thus due to an accounting identity, must be using it to purchase foreign assets. This leads us to a crucial macroeconomic frontier: Net Capital Outflow. NCO is the difference between the purchase of foreign assets by domestic residents and the purchase of domestic assets by foreign residents. In an open economy NCO = NX. This is due to the fact that every unit of currency transferred between countries during international trade, has to end up as the purchase of assets. In the market for foreign currency exchange, Net Capital Outflow acts as the supply, while Net exports represent the demand. It is fairly easy to comprehend that net exports depend on the real exchange rate, thus forming a curve. In contrast, Net Capital Outflow is a constant because it is determined by the yield of foreign and domestic assets and not the exchange rate. Now it is understandable why trade policies do not affect the trade balance. Because in the long run, NX=NCO, the only way for a country to alter its trade balance is to shift Net Capital Outflow. When it enforces trade policies, it is simply reestablishing the exchange rate, but these policies leave the yields of assets unaffected, and thus preserving Net Capital Outflow.
Being an importing country is unsustainable and certainly harmful in the long run. Due to the equality of NX=NCO, if a nation is importing more than it is exporting, it must be financing the purchase of imports by selling domestic assets. Physical capital is a determinant of productivity, which in turn is a determinant of growth. Importers are enjoying current consumption while dooming themselves in the future. Donald Trump clearly understands this, and this is the reason why the trade balance has been a central focus to his agenda since the day he stepped in the Oval office. The US has been running a trade deficit for the last 50 years, and President Trump is determined to change that. There are many mathematical ways that this can be achieved, but to stop the US from the crash course it is headed, many of those ways are simply not economically viable. In the model that has just been analyzed, there is one variable that can directly increase the exports of the United States: The Fed’s policy interest rate or Federal Funds Rate.
Lowering the FFR would directly reduce the cost of borrowing bringing down the yields of domestic assets. Because foreign assets will become more attractive in comparison with domestic ones, Net Capital Outflow will increase, impacting positively the trade balance. In fact, Donald Trump has numerously called out the Chairman of the Federal Reserve, Jerome Powell, for keeping the federal funds rate unreasonably high, preventing investment and growth, going as far as calling for his resignation. Furthermore, Trump is popular for his promised tax cuts to large corporations or fat cuts as they are known. In principle, tax cuts increase the disposable income of firms, allowing them to invest in R&D, a larger workforce and expansion into international markets. Coupled with Trump’s plan to make US exports less expensive by depreciating the dollar, firms will have the incentive they need to funnel capital into productive activity. From April 2nd, the dollar's exchange rate to the euro has plunged more than 8%, confirming the assumption that Trump is in fact attempting to weaken his own currency.
In simple terms, the tariffs were just the opening ceremony to our era's Nixon Shock. Donald Trump's plan is balancing a fine line between mutual destruction and a decisive victory. He wants to depreciate the value of the dollar, so that American exports can increase, all the while keeping its global hegemony as reserve currency. He is awaiting for the upcoming appointment of the new chairman of the federal reserve in 2026 to enforce his ideas into action, in order to follow through with tax cuts and further protectionist policies. If indeed this was his strategy all along, then at least by economic theory, it is sound. However, the world doesn't always abide by textbook theory, and the risk the American people have incurred from his antics is substantial. It is foolish to even question whether Trump's tariffs were strategically planned, but in the end, Trump’s gamble is not whether tariffs can shift trade, but whether the world economy can withstand the shockwaves of his experiment.