Donald Trump and US Tariffs
History and thoughts.
Income tax became an inefficient nuisance, with more rules, more complications, and very expensive to the person and economy as a whole but the government needs revenue. Is there another source that can take its place? Tariffs is one that was used before in America, still used, and something that Donald Trump keeps musing about.
In the United States, before the income tax government revenue came from tariffs, and something that Donald Trump thinks he might be able to replace the income tax with. He has mentioned it years before he took to a political career, mentioned it in his recent campaign, and now that he won his Presidency it became clear that it will be a cornerstone idea he will try to initiate.
And this is businessman Howard Lutnick, the Secretary of Commerce nominee who echoes the same thoughts as Donald Trump. Howard also commented on the tariffs on Canada as being there to get Canada to take action but also left the door open to future tariffs to be studied.
While tariffs do reduce trade deficit, they are essentially competition equalizers with other nations protecting one’s industrialization. It is a protectionism mechanism, at its basics. For example, because of labour costs and regulations, it may be cheaper to manufacture something outside your country. Tariffs on that product will drive its price up and will allow for local manufacturing to compete with it.
The United States had industrial protectionist policies for most of its existence, and they only decreased substantially shortly after WW2. This is also when the 2nd wave of globalization began which is what some of Trump’s team attributed to trade deficits and economic weakness which isn’t exactly true.
America’s trade deficits, as a percentage of GDP, started with the collapse of the Bretton Woods Agreement in 1971. The Bretton Woods Agreement was an international monetary system signed in 1944 by 44 nations that saw to the return of the classic gold standard and stopped competitive currency devaluations.
Countries agreed to keep their currencies within 1% convertibility value into the USD, the USD will be convertible to gold at a value of $35 per ounce, and countries will settle internationally in USD. At the time the US controlled majority of the gold. It also gave birth to the IMF and World Bank Group.
European economic powerhouses; Britain and France, couldn’t compete with America’s industries anymore. In the 1930s Britain even created it is own economic bloc cutting out US goods. Two world wars, however, have done their damage and destroyed their domestic industries. They needed America’s help to rebuild and America wanted access to the British empire which together represented over half of the world’s trade.
The Bretton Woods Agreement officially made the US the superpower country; ending British Empire’s economic dominance and financial power which was shown when the US gave Britain $4.4B in aid that led them to sign the Agreement. This moment of dominance transition is rather more symbolic than I think some people appreciate as Britain didn’t want America to industrialize and forbid tariffs which are some of the reasons that led to the American Revolution.
When the United States achieved independence, under the Articles of Confederation the federal government couldn’t collect taxes directly. The power to levy taxes and tariffs came six years later when the United States Constitution came into effect. Tariffs was the second bill signed by President George Washington imposing 5% tariff on the majority of imports.
Leading to the War of 1812 tariffs in America averaged 12.5% but they didn’t have a strong enough impact to encourage domestic consumption. When the War broke tariffs doubled to 25% to account for government spending and new industries were developed as imports were disrupted - sound familiar?
These tariffs were so successful for the industrial development that manufacturers wanted them to stay and in fact, they even increased and kept increasing. In 1816 average tariffs went up to 35%, 40% in 1820 and until the end of WW2 the US had some of the highest tariffs in the world.
That didn’t come without hiccups. The Southern States didn’t want the protectionism as they were agrarian but the Northern States were industrial and they did. That was part of the reason for another war - The American Civil War. During the War tariffs climbed to 44%. Abraham Lincoln said: “Give us a protective tariff, and we will have the greatest nation on earth”. Again, sound familiar?
Tariffs worked early on because they were paramount for what was the development of a brand-new economy. It’s an economic principle that’s called the infant industry argument which believes that new industries don’t have the economies of scale to compete with their established competition (and countries), thus requiring protectionism to establish.
Tariffs are a fundamental part of the American School of Economics aka the National System. Free trade was viewed, at the time, as a British colonial system and the thought was that Britain would recolonize them which is why they were a catalyst to a few wars. It’s Jeffersonian democracy; American Republicanism, which is the foundation of the Constitution of The United States.
Simply; economic independence = political independence. I would argue it is still true today and is probably viewed more so now under Donald Trump. It’s patriotism at its core.
Tariffs played a crucial role in the transition from the Industrial Revolution to the Second Industrial Revolution paired with infrastructure investment and access to capital for entrepreneurs - something that America is still leading at and for some reason other countries just can’t get their heads around. It moved people from agriculture towards industries and innovation. Risk taking.
This was America’s manufacturing golden age which lasted until WW2. Everything as a consequence was booming as well. Oil and gas, sewage systems, railway, mining, finance, and many more industries were built and gave way to incredible wage growth, and skilled labour demand which attracted millions of immigrants from Europe.
America’s economy was growing twice as fast as European economies just like today’s emerging markets. America was that emerging market back then.
Tariffs worked in the formation of America’s economy but it was also due to its geographical location - the fact that it wasn’t part of Europe and wasn’t impacted by two world wars to the same extent. While European countries were destroying each other, America was building with no risk and with more reward as it had increased demand from Europe for goods because many of their industries were shut down.
Wars end and postwar reconstruction is an economic boom on its own that impacts trade demand. During WW1, America’s agricultural industry had a surge in growth and prosperity but shortly after the war demand decreased as redevelopment of Europe’s agriculture industries took place. America’s farm income fell by around 40%.
Panic set in and other industries demanded action from their government electing Republicans to control the White House and Congress. That action that the industries wanted was tariffs of course, and so the Emergency Tariff Act in 1921 came into effect mostly focusing on raising duties on agricultural products, and just a year later the Fordney-McCumber Act of 1922 became law.
Like for any policy, market timing, and other conditions play a critical role in its outcome. The Fordney-McCumber Act of 1922 was ill-timed. It increased tariffs back up from when they were dropped in the Tariff Act of 1913 aka the Revenue Act of 1913 which also re-introduced the federal income tax for the first time since 1872. The Fordney-McCumber Act of 1922 also gave the President power to raise or lower rates on goods.
I would say at this point tariffs became political appeasement rather than political and economic strategy. The Fordney-McCumber Act of 1922 complicated access of allies to America’s economy which they needed to make the payments on the war loans from America. European countries retaliated with significant tariffs back.
America’s tariffs failed to stimulate the economy and protect their industries while causing havoc in the global financial system. The issue here was that America’s economy was overproducing because of the stimulus from the war. It was an artificial boom, after the boom comes the bust. Tariffs made it worse, and now we have the Great Depression.
What was the solution? More protectionism, increasing the tariffs again. The Smoot-Hawley Tariff Act came into law in 1930 increasing tariffs to their second highest level in America’s history after the Tariff of 1828 which was called the Tariff of Abominations by the Southern States.
In 1927 the League of Nations, now the UN, in the World Economic Conference agreed that it was time to end tariffs as they were too destabilizing as the countries’ debts had to be paid. Goods and services did that. Trade and monetary policy have an important relationship.
The US was not part of the League of Nations and when the Smoot-Hawley Tariff Act came into effect other countries responded aggressively and protested. Canada responded by increasing extra duties on American goods and decreasing tariffs on imports from the British Empire.
Implementing tariffs which made products more expensive during The Great Depression when people already had less money and disposable income was essentially non-existent made things worse. The tariff wars made it much worse.
US trade with the world fell by two-thirds between 1929 and 1932. Gross National Product collapsed from $103B in 1929 to $55.6B in 1933. World trade fell by two-thirds from 1929 to 1934.
This was a majorly failed isolationist policy. It’s hard to collect debt from overseas when you block trade from overseas that pays for the debt. The world was much closer intertwined than America even considered and the failure of banks in Europe hurt the US as well.
The US moved from isolationism and protectionism towards the significance of international trade, and a step towards globalization, in 1934 with the Reciprocal Trade Agreements Act. It gave the President the power to negotiate bilateral trade. Duties started going down, America’s economy started recovering, and its place in the global economy was secured.
Mostly, America’s industries didn’t need protectionism, they were ready to take on the world as electrification accelerated industrial innovation. Their economic opportunity was participating in others’ economies. The USD became officially gold-backed global reserve currency with the Bretton Woods Agreement and moved towards political influence. Foreign affairs.
In 1948 the US sent Western Europe $13.3B, with the Marshal Plan, to start rebuilding European economies and stop the spread of communism. They increased their presence in Europe further in 1951 with the Mutual Security Act which increased foreign aid in grants to 1961. The US was in a Cold War with the Soviet Union and against the influence of communism.
Trade barriers came down, tariffs came down. The US was running a trade surplus. The problem is now that the USD is a global reserve currency and it complicates things. The domestic economic interests created demand and the other countries’ economic demands that are served by the global reserve currency are in conflict. The US has to provide these other countries with currency supply.
How do you provide other countries with currency supply? Trade deficits. Being a global reserve currency the US has to run a trade deficit or else it will have to drastically increase monetary supply which will cause hyperinflation and financial stress internally and externally leading to other countries not being able to repay their debts as was the case in the Great Depression.
The other problem was being gold-backed and in 1958 foreign currencies became convertible to gold. Between foreign aid, the Korean War, and the Vietnam War the US was sending a lot of currency out while having to create currency at home backed by gold. The US experienced inflation which means the USD was getting devalued so the currency held overseas was overvalued. Imports technically became much cheaper than exports.
The USD peg to the price of gold hasn’t changed in decades while the currency was technically becoming worth less and gold still had a free market price otherwise. It was cheaper to get USD from America then buy gold with it. Arbitrage. The demand for gold increased, which led to the outflow of gold from the US, and more currency creation meant having to get more gold. There just wasn’t and isn’t enough gold to sustain currency as it is finite and currency creation is technically infinite.
With the Smithsonian Agreement in 1971, they tried to raise the fluctuation rate currencies of industrialized countries to 2.25% against the USD, and raise the price of gold peg to $38 an ounce. This means the USD got devalued. None of this worked as it was also working against the national interests of the US to reduce unemployment and with the Federal Reserve reducing rates to stimulate the economy more dollars flowed out. This is the paradox of being a global reserve currency.
The Bretton Woods Agreement collapsed in 1971 and the USD came off the gold standard and became fiat. As prices were essentially being artificially held by a peg it gave rise to resources. Gold, oil, etc all started increasing from here on. When you see the memes “what the heck happened in 1971”, this is what happened. This is also when the US started having trade deficits.
This was a soft default by the US which Nixon did try to avoid with wage and price freezes but inflation ran high as the currency supply increased and other nations refused to change their currency for the USD. The value of USD dropped by a third in the 1970s and the FX markets were a mess. The USD remained the world reserve currency.
The US entered a period of stagflation. The economy was growing slower while inflation and unemployment were high. Wage renegotiations wanted higher wages driving inflation higher resulting in union employment drop. Other inputs like the oil crisis made things worse. Many other economies were suffering as well.
Just like the post-WW1 economic expansion came to an end, this was the post-WW2 expansion coming to an end with added currency markets resettling. The 1973-74 stock market crash was the worst downturn since the Great Depression.
Interest rates were high and double digits for many many years. Pre-recession unemployment took over 20 years to reach. OECD real GDP growth averaged down from almost 5% in the 1960s to 3% in the 1970s to 2% in the 1980s. During the Bretton Woods Agreement, the world saw 38 financial crises. Afterwards from 1973 to 1997, there were 139.
While there were always tariffs, they were nothing more than mid-level political afterthought during this whole period and pretty much right up to Donald Trump’s first term.
What really helped save the USD and the US economy was the USD becoming the petrodollar. Oil trade was growing, and with its increasing demand, it also increased demand for the USD giving it value which is what is needed for a fiat. Traders and exporters would park their excess USD in US treasuries which helps keep interest rates low and finance America’s government budget and trade deficits.
Trade deficits here helped maintain the petrodollar which was crucial to geopolitical influence. A whole sector of finance turned into a trillion-dollar industry of international currency trade and finance backboned by the USD resulted from this.
The US has already increased spending on social (welfare) programs after the Great Depression and with the Great Society - War on Poverty programs that created major new federal programs establishing higher federal spending requirements into the US budgets. This was originally an unintentional move moved the US towards Keynesian economics.
Rather than tariffs, the US pivoted to using fiscal and monetary policy with the government having a bigger role in the economy driving up the total spending in the economy, hoping to benefit from the multiplier effect. When politicians write cheques it becomes more political rather than what is the best for society, and that changes many things including the productivity of the dollar and where it goes.
Industries went from wanting tariffs as they did for over 100 years in the US to government stimulus and protectionism with monetary policies. This includes raising military spending to stimulate the economy becoming a permanent war economy. Military spending gave the US advancements within the industry and politically but it is now the biggest cost to taxpayers.
What drastically changed over the last 50 years is that America’s government has grown to record size and increased spending to record levels - including on things that have nothing to do with America or the economy but more political and ideological spending that produces very little ROI for the dollar its costing them.
This reckless spending has benefited many industries including innovation, tech, and digital services but the rest of it is highly inefficient. The US has printed over $12T just in the last 4 years and now the overall debt is over $36T costing Americans over $1T a year which produces no more benefits to their future and becoming a serious liability.
I don’t know why many are afraid to admit it but America’s financial situation is a disaster, and unsustainable. This is what was handed to Donald Trump to deal with in his second term. While I don’t recall Trump saying this, Elon Musk who is running DOGE has said that America is on a path to default without action. I agree with that, and it’s clear that Trump sees it as well and not kicking the can down the road like many politicians have and would have.
This is Donald Trump’s last term and he is trying to fix the twin deficits; budget and trade deficits. This is important to understand. He has to do what is good for the future of his country and no one else’s that has been benefiting from the spending and trade. Other countries should want that long-term too as defaulting America isn’t good for anyone else either.
This is a long-running global stimulus that has to be slowly curtailed or we will see a bust. He has to cut the size of government and inefficient spending to decrease budget deficits as they are also based on expansionary monetary policy. In other words, the US is creating its own currency devaluation and inflation because of it.
Trade deficits are obviously something the US should naturally look at. Many countries have protectionism for their exports to the US, and use currency devaluation to compete with other countries for trade surpluses - how China operates.
The levels of tariffs that Trump is talking about to try and balance out trade deficits, however, are highly unsustainable and something that the US hasn’t seen in over 80 years. Any benefit could be crowded out unless there is growth in national savings and investment - without new aggressive money printing. The danger is that this tariff policy will lead to a tariff war for the US, and increase internal costs and inflation further which will make their debt even more expensive to carry negating other efforts to reduce the impacts of budget deficits. It’s not something that they can afford.
The US doesn’t need to and must not run trade deficits this high but it must run trade deficits more or less because it is a global reserve currency. There is no doubt that the future global monetary system will have to be rethought. In the meantime, the US has to implement some fiscal austerity policies and return to budget surplus as it had in 1998-2001 even though it had trade deficits.
The US can’t replace the income tax or a large portion of it with tariffs as Donald Trump’s administration keeps mentioning anytime soon. What it must focus on is to get rid of the artificial governmental increase to the aggregated demand and utilize the money already in circulation to boost consumer and business spending which will increase productivity and profits thus making everyone’s lives and the economy better.
More importantly, one of the reasons the US can do this and pivot fast is because they didn’t red tape their economy shut and unproductive like many Western countries did. Donald Trump is getting rid of even more red tape to unleash this. Red tape are essentially tariffs - shackles on your own economy. The US has an incredible competitive advantage here.
Time for others to rise and make their economies better and grow the size of the pie for all.