OPINION: High tariffs, weak dollar? A recipe for disaster

One shouldn’t get too wound up by what Kamala Harris or Donald Trump say they plan to do as president. Candidates always make promises that they know they won’t be able to keep.

But when Trump says he’ll boost U.S. manufacturing by raising import tariffs and pushing down the dollar’s exchange rate, I see reasons to worry: The president has the power to attempt both by fiat, and the plan is inherently contradictory.

To understand the problem, one must first understand the nature of trade imbalances. If U.S. domestic investment exceeds the combined savings of U.S. households, businesses and government, the gap must be filled by borrowing from abroad. This requires dollars, which foreigners obtain mostly by selling more goods and services to the U.S. than they buy from it. It also requires that the dollar be valued at a level that, from the U.S. perspective, generates a trade deficit sufficient to cover the domestic saving shortfall. A stronger dollar, for example, increases the deficit by making U.S. exports less competitive and imports more affordable.

Now consider what happens when the U.S. raises import tariffs (let’s assume for now no foreign retaliation). Costlier imports make U.S. producers more competitive domestically. But as long as the domestic saving shortfall doesn’t change, the trade deficit can’t fall. Instead, the dollar must appreciate to restore balance by reducing U.S. exports. As a result, U.S. producers’ total sales don’t change: They just sell more at home and less abroad.

In other words, as long as the U.S. keeps borrowing at the same pace, the policies of higher tariffs and a weaker dollar are fundamentally at odds. One way out of this dilemma would be to shrink the domestic savings shortfall by reducing the federal budget deficit. But Trump’s proposed tax cuts would do the opposite, increasing the budget deficit by an estimated $4 trillion over the next decade. All else equal, a bigger deficit means less saving, which means that the dollar would have to appreciate even more.

There’s another, less desirable way to reduce the domestic saving shortfall: Trigger a U.S. recession in order to push down investment relative to savings. Trump’s policies could conceivably achieve this inadvertently if the drag of costlier imports on the consumption by low-to-middle-income U.S. households proved greater than the boost of tax cuts for businesses and higher-income households, which tend to save more of their gains.

The potential damage doesn’t end there. Higher tariffs would also stoke inflation as import prices increased and domestic producers gained pricing power. Foreign governments would probably retaliate, making U.S. exports even less competitive abroad. Economic friction would increase as U.S. businesses were forced to adjust their production to accommodate the shifts in domestic and foreign prices. Productivity would suffer as output shifted from areas where the U.S. had a comparative advantage to areas where tariffs provided shelter from foreign competition.

Trump’s promises may sound good to voters hoping that higher tariffs would foster a renaissance in U.S. manufacturing. If only it were so easy. Unfortunately, the U.S. would end up less well off.

Bill Dudley, a Bloomberg Opinion columnist, served as president of the Federal Reserve Bank of New York from 2009 to 2018. He is the chair of the Bretton Woods Committee, and has been a non-executive director at Swiss bank UBS since 2019. This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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