ON July 9, a reader named Chai emailed me asking, is there any limit on tariffs?
Of course, clearly there are limitations to using tariffs.
Most economists would agree that for a large economy, imposing tariffs can be welfare-enhancing up to a point.
The reduced demand depresses domestic prices of imported goods.
But once the quantity imports have declined sufficiently large, the benefit from lower prices falls and there is a point where the net benefit turns negative.
Next question the F&B business owner asked, what is this “optimal tariff” point?
There is credible model done by our team and I think it is reasonable to believe this optimal tariff rate for the US is around 20 per cent — although it will be impossible to have any form of consensus opinion.
Crudely put, tariff rates at 10 per cent is a tax on imports, at 25 per cent and above is more about encouraging import substitution or the reshoring that Donald Trump wants.
Anything above 40 per cent will lead to a breakdown in trade flows.
Reading my previous write ups, you will understand why it is not important to be precise on this “optimal rate” as it is only for an interim purpose, so long as you understand that tariffs can be wealth-enhancing, up to a point.
And since the US’ effective overall tariff was at 2 per cent before April 2, Trump can impose tariffs aggressively to below an aggregate of 20 per cent and yet, Americans will be better off overall.
This is exactly why Trump is rolling out tariffs aggressively now.
It is also a fact that any gains from imposing tariffs disappear when the tariffed nations retaliate by imposing their own tariffs on US exports.
The breakdown of global trade will lead to lose – lose outcome for both nations.
And since the US is the richer country, the marginal pain for Americans can be worse than for others.
Therefore, tariffs are only a means to an end.
And the people in the Trump administration (led by 40 year-old Stephen Miran, a Harvard-trained mathematician and chair of the Council of Economic Advisers and Peter Navarro, senior counselor for trade and manufacturing) are fully aware and have articulated so.
Yet, we have seen many superficial and shallow articles written, repeating the common mainstream media narrative of how silly tariffs are, as if Trump is stupid.
They need to look in the mirror.
Third question he asked, why Trump thinks tariffs now can be effective to extract concessions.
I have four reasons.
One, a quick and large tariff on its biggest trading partners, China, Canada and Mexico will have the biggest gains on government revenue which can be used to reduce personal tax that will alleviate any rise in prices due to the tariff.
It will also support corporate tax cuts that can increase investments and improve productivity, making US exports more competitive, to better help the US sustain a trade war.
Two, the environment is also right for the US dollar to go up, offsetting any potential increase in the price of imports due to the imposition of tariffs, ensuring currency offsets will be effective.
US Treasuries spread against the euro and others are significantly positive.
US inflation is on a downtrend and economic growth projections are on an uptrend.
Its capital markets are supercharged to attract more capital inflows.
And as we have discussed, an effective currency offset against tariffs puts the cost of the tariffs on the tariffed nations, not on the American people.
US inflation will only rise marginally, allowing interest rates to fall, further stimulating investments and asset values, and not damage the housing sector.
Three, coordinated with the aggressive execution by DOGE to reduce government spending and deregulate the economy, the tariffs will improve productivity and America’s relative competitiveness, and expand exports.
This gives the US an edge on its trading partners to throw a bigger punch, or makes it able to take a bigger hit when foreign nations retaliate with imposing their tariffs on US exports.
Four, the total debt to GDP in China now exceeds 350 per cent.
Should imposing a large tariff on Chinese goods cause a currency offset, where the renminbi falls by a large magnitude, capital outflows from China can potentially cause an asset price and financial crash.
This is especially the scenario now when the property market in China is in a precarious situation.
These costs would exceed the cost to China of a US tariff itself.
Meaning, the cost for China to retaliate on tariffs imposed by the US would be extremely high in the current economic and financial environment.
To make tariffs more palatable and cause less volatility to the financial markets, the strategy would be first to make public announcements of intentions to impose the tariffs and to impose gradually, slowly ramping up the tariff percentage.
This is what Trump has done so far — many tariffs’ proclamations, and at high rates, only to see lower rates imposed and critical sectors with supply chain impacts on the US itself deferred.
The financial markets have at times adjusted well to the expectations, but there are also recent occasions where they did not — causing equity and bond markets to fall sharply.
Clearly, this president is concerned with the capital markets and he has reacted in response, tamping down the tariffs and even walking back (such as the tariffs imposed on Canada and Mexico recently).
This graduated approach also has the advantage in that the tariff itself is not the end game, but to get a predetermined set of concessions.
With a clearly-set-out path of escalating tariffs, the ball is in the court of the tariffed nations to yield to concessions demanded.
Although not in trade, we saw this played out recently in the way the US dealt with Ukraine.
Extracting economic concessions on minerals in return for support and concessions to make peace with Russia, as the US turned up the heat on Ukraine.
It’s transactional, making deals for immediate outcomes.
At this point, Chai raised a critical observation: isn’t a currency offset mechanism, by design, unsustainable in the long run?
I agreed.
This is why I repeatedly said that tariffs clearly cannot be a policy instrument to rebalance trade over time.
Why? Because it requires the US dollar to keep appreciating each time it imposes more tariffs.
But the overvalued US dollar (or undervalued foreign currencies) is the very reason the US feels taken advantage of.
The undervalued foreign currencies caused imports to be cheaper in US dollars in the US and therefore replace local production and US jobs.
In a tariff or trade war, with escalating tariffs by all parties, the US would have inflicted major harm to the world and to itself.
Can Trump stop or dissuade other nations from retaliatory tariffs against the US by threats? Or can the US force the rest of the world to only use the US dollar as the sole currency, with the US Federal Reserve the only central bank capable of printing money?
Argentina voluntarily opted for this route recently, but it will never be acceptable to most sovereign nations.
Critically, is it possible to retain the hegemony of the dollar as the world’s only reserve currency, and yet improve its trade and fiscal balances, making US exports more competitive, without an overvalued dollar, with US inflation and interest rates staying low?
Can it reindustrialise and rebuild US manufacturing capacities?
Can it boost government revenue at the expense of other nations?
The data I’ve gathered so far suggests that, yes, it can. Not only that, such a strategy can also reduce the US trade deficit.
In short, can the US deliver every pillar of the MAGA agenda all at once?
Inevitably, it will involve a high degree of coercion, threats, deal-making — and a high degree of risk to the world.
I have tried to simplify the totality of the views and brought them all together into a simple-to-understand and comprehensive narrative for a wider newspaper audience.
Some technicalities and model references are intentionally left out for this reason.
The views expressed here are those of the columnist and do not necessarily represent the views of Sarawak Tribune. The writer can be reached at med.akilis@gmail.com
