Tariffs are Misdirection

The short term effects of tariffs are secondary to the long term goal of preserving the dollar as the global reserve currency.

Tariffs are misdirection away from what the new trade policy really aims to do — preserve the dollar as the global reserve currency. All other effects, i.e. the balance of trade, the crash in financial markets, and the near term damage to the US economy are subordinate to this primary objective.

There is too much dollar liquidity in the world, owing to uniformly easy US monetary policy since the Greenspan era of the Fed. If the BRICS countries succeed in moving more of their trade away from the dollar, then, to the extent that they succeed, ex-US dollar demand will fall. This will do two things; it will reduce the seigniorage the US is able to charge the rest of the world for the privilege of transacting in dollars (i.e. the US prints dollars and buys oil, other countries have to sell products to get dollars to buy oil), and it will reduce dollar demand which, ceteris paribus, weakens it. A weak dollar makes a weaker case for use as a reserve currency.

Basel III conferred tier 1 status to gold, which puts it on par with US treasurys when it comes to collateralizing a bank’s balance sheet. What that means is that gold is already in the running as a parallel global reserve asset. This is possibly why Russia, China, India, et al., have been stockpiling it for years and why, despite essentially no demand for gold in The West, gold continues to strengthen in dollar terms as it flows East and South.

That brings us to tariffs. They essentially do two things which provide support for the dollar. Tariffs reduce global dollar supply. Global dollar demand is relatively inelastic in the short run and so a reduction in supply will strengthen it. Tariffs are a tax and, as the saying goes, if you want less of something, tax it. Moving from a world with low and stable tariffs to one with high and rising tariffs slows global trade and therefore turns down the spigot of dollars flowing from the US to the rest of the world. Triffin’s dilemma demands the reserve currency issuer to export their currency, and therefore to run a trade deficit, so anything which closes that deficit fights against this dynamic. The second thing tariffs provide is a replacement for any loss of seigniorage income with an explicit tax. The US set into motion heavy international machinery to replace the dollar as the basis for international trade when it confiscated three hundred billion USD of Russian assets at the outset of the Ukraine War. Moving to a new monetary order is essentially inevitable at this point, it’s just a matter of when. Tariffs provide an income stream for the US which goes some way to replacing some of the loss of seigniorage.

If the US does not take a leadership position in the transition to the next global monetary order then it will have the new monetary order imposed on it. The only route for the US to retain its global monetary hegemony is to define the path to that new world order. If the US can do this correctly, it probably buys another couple hundred years as the global monetary superpower even as the BRICS nations inevitably develop a parallel trading regime that doesn’t rely on the US. Failure to achieve this could mean the US is subordinate to the BRICS nations as a monetary union even if it remains stronger than any one of the members individually.

In his interview with Tucker this past weekend, Bessent proclaimed himself to be a gold bug in his former life as a capital allocator. Combine this with Trump’s well known love of gold and global central banks stockpiling it, the new monetary world order could resemble a return to a gold standard. The current global monetary standard is based on credit. Credit is based on trust. Even the origin of the word credit, credere, means trust. In a low trust world, there is essentially nothing other than gold that can provide a basis for money. Why would you lend to (i.e. buy the sovereign debt of) a country which debases its currency and might confiscate your savings on a whim? Better to hold something which everyone recognizes as valuable due to its inherent physical scarcity that does not depend on any other nation for its value, not only something that holds its value in any given moment but which also holds its value through time.

I grant that I may be conferring too much 4D chess thinking to the current batch of US policymakers but I believe they are simply stewards of the inevitable. All currencies die. Ever heard of the solidus, denarius, or drachma? And, if you read carefully, the epic tome of money and credit, “A History of Interest Rates,” by Sidney Homer, one sad fact constantly emerges: all sovereigns eventually default, usually because of war, and this destroys their currency. Rather than explicitly default, policymakers seem content with sacrificing the market and the near term health of the economy for the long term continued global dominance of the currency. Tariffs are the opening salvo.