The Breakdown - Tariffs and the Attempt to Remake the Global Trading Order

Episode Date: November 29, 2024

The President-elect and new Treasury Secretary are laying out perhaps the most ambitious global economic realignment in the 21st century. Neither endorsing nor vilifying the plan, NLW attempts to lay out what appears to be the thinking behind the proposed tariff strategy. Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? It is Friday, November 29th, and today we are talking tariffs. Before we get to that, however, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod. All right, friends.

are happy and full coming off of a wonderful Thanksgiving. Since it is a quiet day, we're doing something a little bit different, going a little bit deeper on a very increasingly important topic, which is, of course, tariffs. Basically, we're trying to understand what's actually going on and what the perspectives are beyond all the political bluster, and to figure out what this might mean for all of us, depending on how different policies get enacted. What's for sure is that President-elect Donald Trump has wasted no time wielding the tariff cudgel. In a Monday evening Truth Social Post, Trump, raised the threat of tariffs against the nation's closest trading partners in some of its closest allies. For China, Trump threatened an additional 10% tariff on all exports. For Mexico and Canada,

the threat was 25%. Trump wrote, as everyone is aware, thousands of people are pouring through Mexico and Canada, bringing crime and drugs at levels never before seen. Right now, a caravan coming from Mexico composed of thousands of people seems to be unstoppable in its quest to come through our currently open border. Trump pledged to sign executive orders imposing tariffs on day one in office, adding, this tariff will remain in effect until such time as drugs, in particular fentanyl, and all illegal aliens stop this invasion of our country. Both Mexico and Canada have the absolute right and power to easily solve this long-simmering problem. We hereby demand they use this power, and until such time as they do, it's time for them to pay a very big price. For China, Trump demanded the country

implement the death penalty for drug traffickers linked to the fentanyl trade. And it is worth noting that this is a page out of the previous Trump playbook. In May of 2019, Trump threatened a 5% tariff against Mexico, which would escalate if they didn't address border crossings. Mexico complied with the demand and the tariff was never enforced. In the previous year, the Trump administration imposed a steel an aluminum tariff to address product dumping. It remained in place for a year before being lifted. Juan Carlos Baker, who helped Mexico negotiate the current trade deal with U.S. and Canada, said, I'm feeling a lot of deja vu. While Trump has never been shy, clearly, about using the threat of tariffs to achieve policy goals, there is also a clear

escalation here. 25% is a massive levy, and to apply it generally across all products is unprecedented in the modern era of global trade. China, Canada, and Mexico combined make up around 40% of U.S. imports. If imposed, they would likely cripple the economies of both nations and drive U.S. inflation much, much higher. But the general read from policy experts is that this is the opening gambit of a negotiation rather than an intended policy. Trump in this telling, likely doesn't want to impose these tariffs. He wants the neighboring countries to address issues at the border in a hurry. And there are already signs that foreign leaders are getting to work. On Wednesday, Canadian Prime Minister Justin Trudeau told the press, there's work to do and we know how to do it.

Mexico President Claudia Scheinbaum took a different tack, calling the tariffs unacceptable due to the job loss than inflation they would cause. She said, one tariff will follow another and so on until we put our common businesses at risk. Dialogue is the best path to achieving understanding, peace and prosperity for our two countries. I hope our teams can meet soon. So while maybe slightly tougher talk from Mexico's leader, both are clearly heading for the negotiation. table. For policy experts, the analysis is pure game theory. Daniel Tenenbaum, a partner at consulting firm Oliver Wyman said, making these announcements two months before you're in power is certainly signaling that you're ready to begin negotiating. We'll have to see what the new

administration team actually does as they get on board. Daniel Uxo, a senior trade lawyer at law firm Thompson Hein said, the tempo of this will be fast. He called the tariff announcements on Monday night, quote, tactical and transactional, designed to achieve targeted results. And this for many is the point. In the past, Trump hasn't used tariffs as a revenue-raising scheme. They've always been threatened as a way to gain leverage in negotiations. It's a form of economic brinksmanship, but the negotiation tactic worked during his first term. One big question that's new, however, will be how to think about the tactical threat of tariffs and a broader policy goal of shifting the tax burden away from income and towards tariffs. Jan Hatsy, as chief economist of Goldman Sachs said it's important not to

conflate the two. On the campaign trail, Trump promised the 60% tariff on China and a 10-20% tariff on the rest of the world. That policy seems to be less about tactics and more about long-term strategic goals. The aim appears to be a global realignment, rebalancing trade towards the U.S., and beginning to charge for access to the world's largest consumer base. Newly selected Treasury Secretary Scott Besson has spoken at length about this tariff strategy. He is in favor of a gradual approach and said he's willing to negotiate with Trump on the final numbers. But that doesn't mean he's in favor of maintaining the status quo. In a January interview, Besson compared the use of tariffs to sanctions, stating, I think tariffs for the sake of tariffs aren't interesting, but there's an old

Soviet nuclear strategy called escalate to de-escalate. I think with tariffs you can escalate, you can put on tariffs with the idea of getting rid of the tariffs. Tariffs are like sanctions. Why does the U.S. imposed sanctions? Because our financial might and the widespread use of the U.S. dollar, we are able to put on sanctions. We can tell the French you can't trade with Iran because we control this, but over time people can leave the dollar if you keep firing that weapon too much. What we're trying to do is make China rebalance. China over-manufacturers and they deprive the household sector. They under-consume. So if you push them to rebalance, the identity of that is more U.S. manufacturing. This is a 10-year project. You've got two patients the U.S. and China.

350-pound, two-pack-a-day smokers up on the table, and you're not going to throw them on the treadmill. Let's do this slowly, but you want to start moving towards equilibrium, and I think rebalancing could be good for everybody. So is that the right view? Looking at tariffs as a more fine-tuned version of sanctions. To continue the analogy at a nation-state level, sanctions are akin to the death penalty. Because they are only used in severe cases, once a country hits that threshold, sanctions are rarely removed. For example, Cuban sanctions are still in place more than 30 years after the end of the Cold War. They also, frankly, have a very poor track record of encouraging meaningful change. Tariffs could theoretically be used as a lighter-touch version of sanctions.

A 10-20% tariff doesn't cripple a nation, but it certainly provides a strong incentive to undertake trade rebalancing. Besant has played with the idea of a tiered system where tariffs are stratified into red, yellow, and green. This would be used to drive policy outcomes and encourage nations to adhere to American values and interests. For example, India might rethink their decision to buy Russian oil if the cost includes an increase in tariffs. Another strategy he has discussed is using the sale of U.S. Treasuries as a roundabout way to charge for use of the U.S. umbrella. Besant noted that Japan recently increased their defense spending, following through on a pledge made to the Biden administration. However, the devaluation of the yen meant spending remained flat

in dollar terms. Forcing allies to purchase long maturity to U.S. debt could be a way of paying up front for the defense guarantee. It could also have the side effect of allowing the U.S. to more easily refinance the debt to a longer maturity. Today's episode is brought to you by Bitkey, the hardware wallet built for Bitcoin. Made by the team behind Square and Cash App, BitKee makes securely managing your Bitcoin absurdly simple. BitKee is integrated with partners like Cash App, Coinbase, Robinhood, and Blockchain.com, so you can easily compare prices across exchanges before you buy or sell. And their app works like the money apps you already use because simply,

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for one of the first time since the Cold War. The ideology of insisting allies pay for the benefits they receive from the U.S. and incentivizing enemies to yield to U.S. policy is dramatically different to the Lazi Fair Free Trade era that began in the 90s. However, for many, it's difficult to claim that the free trade era has been a complete success, it is, of course, impossible to ignore its disintegration over the past decade. It might be useful to understand, not only the policy plans, but the person who's proposing it, and I mean specifically the implementation version. Besson is largely seen as a macrogenius on Wall Street, and while the plan is unorthodox

compared to the last 30 years of free trade, it doesn't appear to be unconsidered. In other words, tariff policy could have a clearly defined strategic goal. At a June event, Besson said, we are going to have some kind of grand global economic reordering on international trade and relationships. I'd like to be a part of it. I've studied this. Some have suggested that Bessent could seek to moderate Trump's tariff policy. Judging from his policy statements, Bessent was likely the architect of the policy during his time as chief economic advisor to the campaign. Bessent then doesn't seem to want to moderate the tariff policy so much as harness it to bring about a new global order. During a speech last month,

entitled to make the international economic system great again, Besson said, President Trump is right that actual free trade is desirable. It might seem counterintuitive from a free market perspective, but he's also right that in order to actually create a freer and more extensive trading system over the long term, we need a more activist approach internationally. Michael Pettis, a senior fellow at the Carnegie Endowment and renowned China expert seems to agree with the logic. After reading Besson's speech, he tweeted, Bessett is right. Those who believe that U.S. trade intervention is introducing distortions into a world of global free trade are completely befuddled. For one thing, a world of global free trade is incompatible with large persistent beggar-thy-neigh-neigh-tray

surpluses. In a well-functioning global trading system, surpluses couldn't persist because they would unleash automatic adjustments that would eliminate imbalances in the surplus economies, thereby reducing the downward pressure their surpluses put on global demand. The fact that policies in the surplus countries prevent these adjustments from happening is prima facie evidenced that major surplus economies have been indirectly intervening in trade for decades, while also undermining the global benefits of comparative advantage. This suggests that there are two very different trade strategies for the U.S. One is to hamper global trade and to turn large economies into our Tarkik trading blocks. The other is to break up the current global trading system and force it closer

to the ideals of free trade. That seems to be Besson's plan, but the fact that economists often can't see the difference between the two strategies shows just how befuddled most of them are on the subject of trade. In other words, escalate to de-escalate. The other key piece of logic underlying Besson's plan to use tariffs to bring about global change is that the design is that the pain shouldn't necessarily be borne by the U.S. consumer. Most reporting is assuming inflation is the clear outcome of tariffs. But during an interview last week, Besson said, tariffs can't be inflationary because if the price of one thing goes up, unless you give people more money, then they have less money to spend on the other thing so there is no inflation.

The inflation comes through either increasing the money supply or increasing the government spending. Still, that signal is a little mixed. Back in January, Bessent wrote to his hedge fund investors, tariffs are inflationary and would strengthen the dollar, hardly a good starting point for a U.S. Industrial Renaissance. Wickening the dollar early in his second administration would make U.S. manufacturing competitive. A weak dollar in plentiful cheap energy could power a boom. The current Wall Street consensus is for a strong dollar based on the tariffs. We strongly disagreed. A strong dollar should emerge by the end of his term if the U.S. reshoring effort is successful. So what we have here sounds like an order of operations problem. Bessent will be faced with a choice.

Weaken the dollar early to promote domestic manufacturing, or strengthen it to put pressure on the Chinese manufacturing base. There's also a slight contradiction in Besson's thinking in the January note, which might explain the change in later comments. Tariffs might well be inflationary, but a strong dollar would be disinflationary, especially when combined with a boost to oil production. Either way, the point is that it's not as clear a one-to-one correlation between tariffs and inflation as it might at first seem. Ultimately, we don't know what Trump and Besson will do once they take office.

What does seem clear is that this will likely be the highest-stakes policy the U.S. Treasury has attempted in several decades. It evokes ideas of the fourth turning thesis and Zoltan Pozars' Breton Woods three. To carry out this grand scheme, Besson will need to carefully balance policy. He will need the consent of the bond market. We could see currency interventions unlike anything since the 1985 Plaza Accords. Energy policy may need to be deployed as a break on inflation. Right now, the reporting is assuming that the Trump tariffs are the actions of an angry politician lashing out at the world, that Trump is breaking things just to break them.

Seems clear when you dig into Besson's comments that, agree with it or not, there is a coherent strategy being deployed intentionally to reshape the global order. If that is the case, which appears to me to be clear, the much more productive comments, that is a very important, conversation is about how it will work in practice and what the tradeoffs and risks really are. I'm sure that is something that we will continue to cover on this show, but for now, hopefully you have a better sense of what's going on and what's going into this policy. Like I said, I hope you're in the middle of a great little holiday weekend. And until next time, be safe and take care of each other.

Peace.