Trump tariffs: The global bond market achieved what diplomacy couldn’t
Summary
- It was ultimately a sharp sell-off of Treasury bonds that made the US pull back from its ‘reciprocal tariff’ misadventure. It has revealed a limit to how far Trump can push his trade agenda.
Just before a budget was to be presented by the Narendra Modi government some years ago, I was contacted by finance ministry officials who wanted the fiscal-deficit estimate reported accurately. I didn’t see the urgency, but understood the anxiety—the then chief economic advisor’s public statements on the deficit had worried the ministry and Reserve Bank of India (RBI).
On budget day, I was in the Lok Sabha press gallery. The finance minister read out the deficit numbers in the speech. To my relief, the officials hadn’t misled me. One of them walked up to me as I was leaving and said: “The RBI governor has just messaged the finance secretary: The bond markets are saluting you."
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In India, the government exercises far more control over the bond market than in other countries, since it owns several of this market’s players and holds influence over RBI, an influential participant. But no government can shrug off sell-offs in the bond market, which it uses to finance itself.
In the US, President Donald Trump, who was unmoved by the equity meltdown over his tariff war, beat a retreat at the first sign of an adverse reaction in the market for US Treasury bonds.
Sell-offs in equities of the magnitude seen since Trump’s trade agenda began to unfold tend to increase demand for US government debt, normally seen as one of the world’s safest assets. Instead, Trump’s April tariffs led to a fire-sale in the global bond market, as hedge funds started unwinding certain positions, raising the spectre of intervention by the US Federal Reserve to stabilize the market, as was seen after covid.
Also Read: Trump’s great tariff pause: What made him blink?
US Treasury Secretary Scott Bessent, a former hedge-fund manager, would have seen the risk of all US assets—equities, bonds and the dollar—tanking together. The dollar is also usually a safe haven in times of recession warnings of the sort sounded by Fed chair Jerome Powell over the tariff war.
Ultimately, last week’s bond market rout made Trump pause most of his ‘Liberation Day’ tariffs for 90 days, something all the diplomatic tools that US allies and countries like India used hadn’t been able to accomplish. The US will charge all countries only its baseline 10% tariff. Cars imported into the US will still face a blanket 25% tariff.
But the de-escalation hasn’t calmed the bond market yet. Perhaps because Trump has at the same time escalated his tariff war with China, a top-holder of US Treasuries. Tariffs on China are to go up even higher, to 145%.
What if China starts selling its bond holdings? There’s no evidence yet of that. But Beijing has let the renminbi weaken against the dollar to cushion the blow of tariffs, potentially opening a second front: a currency war.
Trump campaigned on using trade policy as a tool to protect the American working class, which was resentful of rising disparities that arose from US corporations building global supply chains by moving swathes of production and jobs to China, raking in profits even as wages stagnated.
Also Read: Tariff pause: A chance for the EU to come back stronger and more united
But his goal seems to go beyond simple protectionism. The US has long been keen to see global trade less dependent on US consumption and less vulnerable to China’s low-cost manufacturing overcapacity. The Biden administration too tried to move in this direction with its Inflation Reduction Act and Chips Act.
The trouble with Trump’s tariffs is that they are hardly sound trade policy. They are not ‘reciprocal,’ as the high rate declared on 2 April for countries like Japan and South Korea, with which the US has free trade agreements.
The country-specific tariffs are actually designed to close US trade deficits. The formula used for fixing them is unsophisticated, but not as much as the commentariat has made it out. It aims to raise the prices of imports so that demand contracts, closing the trade deficit. The formula, thus, is consistent with the price-raising economic logic of tariffs (bit.ly/3XWFSTk).
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Trump’s economists have made a couple of assumptions in these calculations. The first is that for every 10% hike in tariffs, there will be a 2.5% rise in prices, which suggests that they expect that a quarter of the tariffs will be passed on in the form of higher prices to US consumers. The second is that for every 10% increase in prices, there will be a 40% drop in how much Americans will buy.
These assumptions are crude, as they don’t account for varying elasticities of demand—as if consumer responses to higher prices of computers, shrimp and bananas will be the same. Besides, they are oblivious to the fact that tariffs on China in Trump’s first term were almost fully passed on to US consumers.
The subsequent exemption from the tariff war of computers, chips and smartphones reveals how muddled US policy is. Re-shoring low-tech factories, while letting China retain hi-tech industries, now seems to be the goal.
The trouble with the American line of thinking also is that it ignores the fact that not all trade deficits arise out of discrimination towards US businesses. The US runs trade deficits with non-rich countries not due to any resistance to its exports, but because not enough people in those markets are rich enough to buy US products such as iPhones. Another problem, as the rout in US Treasuries shows, is that capital flows move much faster, and can swamp trade flows.
The author is consulting editor, Mint, and senior fellow (consultant), ICRIER.
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