Trumponomics 2.0. This Time The Whole World Is Jeopardized

Donald Trump has extended increased tariffs to the entire globe, including islands inhabited only by penguins. The tariffs announced by the White House exceeded all the wildest expectations and sowed understandable anxiety. The world is preparing for a global recession, but it is too early to panic.

A sharp change of course

The Trump administration's explanation of the methodology behind setting the tariffs fundamentally shifts the emphasis in the motives of the US tariff war. Its main goal is now to shift existing trade balances in favor of the United States. Countries that had a trade surplus with the United States (i.e., sold more to it than they bought from it) received rates equal to half of the ratio of the US share in their total exports. Countries that had a negative or conditionally equal foreign trade balance with the United States received fixed rates plus 10 percent. This, according to the authors of the formula, should eventually reduce the US foreign trade deficit to zero.

As a reminder, the initial goal of the tariff war was to encourage American manufacturers to return home. As we have already explained, the main product of the United States is services, which the domestic market has concentrated on, while the production of goods has been moved to other countries with cheaper labor and logistically closer raw materials, primarily to Canada, Mexico and China. So Trump's original intention was to bring these industries back to the United States.

But as we all know, the closest countries to the US — Canada and Mexico — avoided another increase in duties, and not because they had already received a 25 percent surcharge on all imports. After all, the Trump administration later clarified that the increased duty would apply only to goods outside the United States-Mexico-Canada Trade Agreement (USMCA). The agreement covers very large sectors, such as agriculture, automotive industry, pharmaceuticals, IT, etc. Thus, the two countries have finally avoided the worst-case scenario, in which all existing joint production chains would collapse and the main sales market would be closed, with the United States no longer being that much afraid of the risks of commodity shortages for basic consumer products.

Instead, the fight against the foreign trade deficit, which in the United States stands at almost 4 percent of GDP and has been constant since the 1970s, has come to the fore in the tariff war. With chronically negative figures, the feeling of being cheated is understandable. And so is the enemy. Trump identified it during his first presidency, noting that China's share of the US foreign trade deficit has steadily increased from a fifth to a half since the early 2000s. Duties were raised back then.

As of 2024, the share of goods entering the United States duty-free was 99.9 percent for Mexico, 98.2 percent for Canada and only 38 percent for China. But the duties were not draconian; the average tariff on Chinese goods, taking into account trade volumes, still barely reached 3 percent. Of course, this is significantly higher than Canada's 0.12 percent, but it is not comparable to the current 54 percent.

However, China's trade deficit was not affected by the tougher conditions, and it continued to grow, as Chinese goods were happily replaced by imports from other countries, including Vietnam, South Korea and India.

A broad-based offensive

So this time, Trump mounted a broad-based offensive, leaving no one behind. Duties were imposed on a total of 180 countries, 60 of which received rates that were 10 percent higher than the “universal” ones.

In fact, the scale of the new tariffs is causing considerable concern in the world, including talk of a global recession and advice from sane analysts to stock up on soap and toothpaste. The panic is understandable: a forecast taking into account so many countries, commodity transactions, production chains and possible retaliatory measures is impossible even in times of active use of AI.

However, one thing is already clearer than ever: the United States has dealt the main blow to the world's second largest economy.

After the introduction of 54 percent of duties, China's direct losses from limited access to the US market alone could reach $510 billion. We have built a model of the goods that will suffer the greatest disadvantage using the Observatory of Economic Complexity (see Figure 1).

As you can see, these are not raw materials, but a list of rather specific finished products for which buyers should be sought only in mature economies, and given China's volumes, in large mature economies. Therefore, it is unlikely that China will be able to quickly and easily find a replacement for the United States and will definitely have a lot of trouble. All the more so considering that the People’s Republic is now currently experiencing deflation and a declining demand in its domestic market.

Chinese economists are confident that a catastrophe will not occur, while Goldman Sachs has already predicted a 1.7 percent decline in China's GDP, a 4.5 percent decline in total exports and a 30 percent decline in exports to the United States. To make matters worse, many Chinese manufacturers began to move production to Vietnam and Thailand on the eve of the US election, but after Vietnam and Thailand received a 46 and a 36 percent duty, these investments turned out to be in vain.

There would be many people in the United States who would like to replace China, but not all of them are now on an equal footing. Of the countries that could quickly enter the American market with similar products (see Figure 2), there are only Mexico and Canada, and they were given back the USMCA.

So, while the China-led East Asia is weakening, North America will obviously become stronger.

The impact on the EU will not be as dramatic, but it will not be invisible either. Among the countries of the Union, Germany is the main trading partner of the United States, with Ireland, Italy, France and the Netherlands also being in the top five. Accordingly, these are the economies of the Union that will suffer the most from the introduction of a 20 percent duty by the United States. Germany and Italy mainly supply cars, Ireland sells medicines, vaccines and chemicals, whereas France and the Netherlands provides oil products. The volumes of supplies are relatively small, and it will be easy to redirect them to other markets, but the countries will still feel the temporary shock: $156 billion for Germany, $71.6 billion for Ireland, $70.5 billion for Italy, $51 billion for France and $32.9 billion for the Netherlands.

And what about Ukraine? Let's be honest, the announced 10 percent duty is unlikely to undermine the Ukrainian economy significantly. Our trade with the United States has always been sluggish, with few non-duty-free exceptions, and mostly focused on metallurgical products, whose producers are in a permanent crisis after the full-scale invasion. For other goods (such as vegetable oil, fruit juices or chocolate), supplies are so small that it will not be a problem to find other buyers for them. But don't rush to rejoice: the global crisis is unlikely to bypass us, as it may well reduce demand for Ukrainian exports from our main partners if they are weakened.

The pressure from large businesses to open access to the capacious and solvent Russian market, which is currently inaccessible to most due to sanctions but very tasty in the current environment, is likely to increase.

Trade with the United States was very attractive for most major trading partners: the average duty rate was about 3 percent and a significant number of goods were supplied at zero rates. And for everyone, without exception, these conditions will no longer apply, which will not go unnoticed.

A global shock

According Bloomberg Economics, the latest customs decisions will result in the average effective tariff rate in the United States increasing from 3 percent to about 22 percent. Omair Sharif, President of Inflation Insights LLC, says that it will be between 25 and 30 percent. But even the universal 10 percent is a lot if your country has been actively trading with the US.

Mark Zandi, Chief Economist at Moody's Analytics, noted that the current increase in US duties is quite comparable to the import duties that the country introduced in the 1930s and which contributed to the Great Depression. The US economy is now stronger, so there is no question of a depression, but recession, i.e. a prolonged decline in economic activity in all sectors, and stagnation (lack of economic growth) will be the main consequences of the White House's current customs policy, according to the Moody's economist.

Economist Samuel Tombs of Pantheon Macroeconomics has estimated that, ceteris paribus, the US inflation rate could rise from 2.8 to 4.8 percent. We won't be scared by such figures, but for Americans accustomed to stability, this is a significant increase; during the Covid-19 crisis, the highest recorded inflation rate in the United States was 5.6 percent.

However, over time, some market “compensation” is possible: the dollar will strengthen due to a reduction in imports, which may make imports somewhat cheaper for Americans in the future. Also, American analysts hope that local distributors, who have been making good money on duty-free deliveries for years, will share the “tariff burden” with consumers and not include all the costs associated with the increase in duties in their final prices.

There are hopes that the US Federal Reserve will also try to mitigate the situation, although its decisions will not be easy.

On the one hand, a rise in inflation will require them to tighten their monetary policy, i.e. to raise the key policy rate. On the other hand, maintaining economic growth and curbing unemployment will require, on the other hand, a reduction in the key policy rate and a monetary easing regime.

In fact, the Federal Reserve's choice will, among other things, determine the depth of the global crisis, as the Fed's discount rate directly affects the US stock market, which is a bunch of global companies. If the rate rises, then, on the one hand, the companies' debt service costs, which they all have, increase, which means that their profits go down, and, on the other hand, their stock prices decrease because they are mostly tied to projected future cash flows. In fact, the markets have already reacted with a mild panic: the Dow Jones index lost 2.7 percent, the S&P500 index — more than 3.2 percent, and the Nasdaq index — 4 percent.

So, we have the following factors that can potentially shake the global economy: the unprecedented scale of the spread of duties and the size of the rates; the likelihood of stagnation in the world’s largest economy, which will affect all its partners; its indirect impact on the stock market and the profits of global companies; the expected recession in the world’s second largest economy and the impact on its main partners; and possible retaliatory duties from other countries.

There will be so much cooling that it is definitely going to make itself felt, but it is too early to panic. Global markets have experienced many shocks and have always adapted to the new reality faster than forecasters expected. Additional diversification, as well as a slight cooling, may well turn out to be health treatments rather than torture. Especially since Trump's bold tariffs, imposed without any foreseen consultations with the World Trade Organization, put the same decisive end to international economic law as Putin's invasion of Ukraine did on international law. So it is high time to steel ourselves.