The tariffs announced two weeks ago by President Trump kicked in last week and survived contact with reality in their original form for about twelve hours. Had they persisted – and of course they could yet be revived – the impact of this trade-weighted 21% tax on all US imports would have been profound, and profoundly negative, for both the US and the world economy.

The markets breathed a huge sigh of relief, following the abrupt reduction of most tariffs to a 10% baseline tariff for a 90-day period[1]. Markets recovered nearly 2/3 of the c. 15% fall suffered since the original announcement. Yet, as things stood on Thursday, a straightforward analysis[2] would suggest the trade-weighted average tariff was even higher than the 21% initially announced, given the punitive increases on imports from China.

Thus, the markets’ collective sigh of relief might reflect more the reassurance that Trump is prepared to back down, rather than a ringing endorsement of the current set of tariffs.

Indeed the climbdown over the weekend on China’s single biggest export to the US – smartphones – validates this hypothesis. Expect further changes.

Such is the speed of events, it can feel hard to keep up. Yet governments, exporters and investors alike need to keep up because they must make impactful decisions in response to these chaotic changes. To do that, it helps to understand Trump’s real motives.

Trump’s Tariffs: Economic Strategy or Power Play?

Trump’s objectives

So what is Trump doing? Most analyses assume that the tariffs are an attempt to boost, revive or protect the US economy. And they conclude (correctly) that they would fail in such an objective. Why? Well, let’s consider the Trump Administration’s stated goals:

It turns out these three objectives are trivially – mathematically – incompatible. Every dollar sold must be a dollar bought. There is no way to enjoy long run capital inflows except by running a trade deficit and vice versa.

To understand why, let’s imagine a world with no money at all: simply goods and services being exchanged for one another. It should be clear that in such a world, a country’s voluntary imports and exports would have to be of equal value, by definition. You couldn’t convince a country to send you more stuff, except by sending them stuff of equivalent value in return.

Introducing money into the equation allows for a country to swap current imports for an IOU to supply exports in the future. This makes a short term trade deficit or surplus possible, dictated by differential savings rates in trading partners. One country’s households could be saving more for the future – thus running a trade surplus, while another’s might be spending more now – thus running a trade deficit.

But could this situation persist indefinitely? Only if people really believed their IOUs would be redeemed. Otherwise the exchange rates between goods would have to change. If, say, for a sustained period of time, America demanded more goods from the rest of the world than the rest of the world demanded from it, then the terms of trade would change. Instead of one Harley Davidson motorcycle being worth 1000 bottles of Scotch, it might become worth 800 bottles. That’s just supply and demand – no different in international trade than in any other market.

Floating exchange rates just make those relative price adjustments less painful to manage. It is the price of dollars that changes in response to international supply and demand rather than the price of each individual good or service.

So why has the dollar exchange rate not adjusted to reflect the persistent trade deficit the US has run for fifty years? Why has the dollar not devalued so that the value of imports and exports become equal in monetary terms?

Quite simply, because to offset the relative lack of demand for US dollars to buy exports, there has been a corresponding net demand for US dollars to fund investment in the US and to hold dollar-denominated Treasuries – the logical consequence of the dollar being the world’s reserve currency.

Tariffs don’t help consumers…

Every voluntary trade is, by assumption, beneficial to both counterparties. American consumers choose to buy their whiskey from Scotland, their cars from Germany or their oil from Canada because it is in their interests to do so. Obstructing these choices does not make Americans better off.

…They don’t help exporters

And because American exporters rely on the sale of American imports indirectly to put dollars in the hands of their customers, it does not, in aggregate, benefit American business either.

Protectionism simply erodes the collective benefits of comparative advantage. Driving Americans to buy goods made in America is – at a nation state level – the equivalent of pushing individuals to build their own house, cut their own hair and do their own accountancy. It is hard to be good at everything at once.

…And they are inflationary

Across-the-board tariffs at the originally proposed trade-weighted average rate of 21%, if enduring, will have an inflationary impact of c. 2% on the US economy, other things being equal.

Other things would not be equal because there will be a counteracting income effect, whereby Americans – with less money in their pockets thanks to higher prices – spend less. But for a given level of economic growth an increase in inflation of 2% is serious.

But what if it’s not about economics?

If the economic arguments don’t stack up, what else could Trump be trying to achieve? Could it be about power and leverage, rather than textbook economics? Here are four more plausible motives:

1. Geopolitics and strategic security

   With some justification, Trump fears that the USA is dependent on potentially unfriendly powers for strategic industries necessary to wage war, such as steel and aluminium production. Reshoring these capabilities is a matter of national security, rather than national prosperity[3].

   However, this does not explain the broad application of tariffs across all sectors and to friend and foe alike.

2. Shifting the burden of taxation to foreigners

   Most economists claim that it is US consumers who will pay the tariffs. There is a lot of truth in that, but in reality, some portion of the taxes are likely to be absorbed by suppliers attempting to remain competitive[4].

   Of course, if reciprocal tariffs are levied, the reverse will be true – costing US exporters – but on the basis that reciprocal tariffs are unlikely to match US tariffs, there would be a small, but non-negligible, net contribution from foreigners to the US tax take.

   But certainly not enough to compensate for the damage inflicted to the economy.

3. Extracting concessions from foreign powers

   In a game of chicken, where the player to blink first loses to the other, it is advantageous to convince your opponent that you are determined enough to follow through on a threat to ‘cut off your nose to spite your face’. If your threat is unconvincing, it does not work. Your opponent must believe that you believe in your cause, rational or not. Thus, if the objective were to persuade other countries to offer concessions on trade or otherwise, the theatre over the supposed injustice of America’s bilateral trade deficits would all be part of an act to convince negotiating partners that the US is serious.

   Perhaps. But could any bilateral concessions, on trade barriers or otherwise, be enough to compensate for the damage caused by tariffs to the US economy?

4. Obtaining fealty from businesses

   With livelihoods depending on the swipe of Trump’s pen, businesses that are vulnerable to tariffs – either directly or because of reciprocal tariffs – will now be beholden to Trump should he grant them relief. We have seen this weekend meaningful exemptions for computers, smartphones and memory chips. Whether these have come with conditions for the likes of Apple and NVIDIA we do not know. But there are few other ways to exert such power over the titans of the US economy.

So what happens next?

If this analysis is correct, these tariffs are not designed to stay in their current form. And even if they were designed to stay in their current form, they probably will not anyway. Whether Trump’s primary objective is the US economy or not, he is not immune to its performance. As we have seen this week, it is hard to ignore a tumbling stock market, still less a tanking bond market.

How, then, to respond?

It is hard to predict exactly what will happen next. Responses should be rapid, but not knee-jerk.