Viewpoints

Trump's tariff theory suggests that by placing substantial costs on imports, it can alter the competitive dynamics in manufacturing, especially in the automotive sector. However, he and his economic team are mistaken. The transition from being a net exporter to a net importer is a typical evolution of a mature industry like the automotive business. American prosperity has historically been fueled by creating new products and technologies and importing other goods that others produce more cheaply. Trump's tariff policy will not lead to better balanced growth or an increase in manufacturing jobs; instead, it will raise costs and harm American companies and consumers.

Half a century ago, US companies dominated the motor vehicle industry, with General Motors, Ford, and Chrysler, the big three, making up about 70% of total sales. Currently, only two of these companies remain, and their market share has dropped to less than one-third, despite significant direct and indirect support from the federal government over the past several decades.

The US experiences a trade deficit in motor vehicles with both high-wage countries like Germany and Japan, as well as low-wage countries such as Mexico and South Korea, including those with which it has a free trade agreement.

The transition to becoming a net importer of U.S. motor vehicles aligns with the product life cycle theory proposed by economist and Harvard Business School professor Raymond Vernon. His theory suggests that products are initially developed in countries with capital, demand, and income. Eventually, as production and technologies become standardized, they are adopted or replicated in other regions, leading the country that originally created the product to become a net importer. This is a common outcome—consider the product life cycles of cars, computers, televisions, textiles, and so on.

Attempting to reverse this strong trend would lead to economic disruption, be extremely costly, and possibly the greatest disappointment is that it won't generate additional manufacturing jobs.

In the early 2000s, I published a study on global manufacturing employment in the largest 20 largest economies. My research discovered that from the mid-1990s to the early 200s over 22 million manufacturing jobs were lost, and the biggest decline occurred in China, with a net loss of 16 million manufacturing jobs. Since that study was published the US lost another quarter of its manufacturing jobs but so did other countries.

The study on manufacturing employment should send a straightforward message to Trump's economic advisors: improving the manufacturing sector is done by increasing production and quality with new technologies, rather than by elevating costs. Over the past 20 years, manufacturing output has grown by more than 40% with fewer jobs.

Trump's tariff policy is expected to increase costs and raise the prices of both new and used vehicles, without necessarily boosting production or job creation. In essence, it will do more harm than good, and if fully implemented, it could certainly end America's exceptionalism.

Private credit involves nonbank financial institutions direct lending to private firms. It is a rapidly growing sector of the financial markets. According to McKinsey & Company, private credit “totaled nearly $2 trillion by the end of 2023, roughly ten times than it did in 2009”. Private credit increased in popularity following the Great Financial Crisis after which commercial banks came under increased regulation. But US commercial banks have steadily become involved in the private credit market indirectly. Banks have done this by increasing their lending to nonbank financial institutions, the institutions that make the direct loans to businesses.

Chart 1 shows the steady growth in commercial bank lending to nonbank financial institutions starting in 2015 (when the series first became available form the Federal Reserve). In January 2015, commercial bank loans to nonbank financial institutions were 4.2% of commercial banks’ total loans and leases. By February 2025, this percentage had risen to 9.4%.

State labor markets were generally little-changed from December to January, but were arguably a bit on the soft side. Four states (Georgia, Indiana, Missouri, and West Virginia) had statistically significant declines in payrolls; moves in all others were not significant., though in some cases were up or down by more than 10,000 (very remarkably, California’s job count was reported at 18,032,400 in both December and January).

Pennsylvania was the only state to report a statistically significant change (up .1 percentage point) in its unemployment rate. The highest unemployment rates were in Nevada (5.8%), California (5.4%), DC (5.3%), Kentucky (5.3%) and Michigan (5.3%)—due to the annual revisions, in some cases the rates look substantially different than the initially reported ones for December (Michigan, for instance, its December rate changed from 5.0% to 5.2%, while the December rate in Illinois moved from 5.2% to 4.9%). Montana, Nebraska, New Hampshire, North Dakota, South Dakota, and Vermont had unemployment rates under 3.0%, while South Dakota’s 1.9% was the lowest in the nation.

Puerto Rico’s unemployment rate was unchanged at 5.4%--unusually, lower than the state rate--while the island’s job count moved up by 2,800.

Trump's trade war is essentially a conflict between his economic team and American businesses. This is because the Trump economic team, along with the president, holds an out-dated perspective on international trade. The "old" way of analyzing foreign trade with an export being a "win" and an import representing a "loss" for an economy is too simplistic nowadays since companies operate without national borders and many times are on both sides of the transaction. Compelling U.S. multinationals to relocate their operations domestically would cause major disruption, higher prices, considerable losses, financial market turmoil, and ultimately make U.S. companies less competitive globally.

The Bureau of Economic Analysis (BEA) constructs an ownership-based trade account, which incorporates the role multinational companies play in international trade. This framework adds the direct investment income and receipts that are associated with international transactions. The ownership-based trade account reduces the traditional trade measure by "Half". Is the Trump economic team even aware of the existence of this statistical measure of international trade? In politics, one can create a misleading narrative, but when developing economic policy, it's crucial to base decisions on "facts."

The ownership-based trade measure offers a more accurate modern-day account of international trade, largely due to the substantial overseas investments by US companies over several decades. For example, US majority-owned foreign affiliates have $3.4 trillion in physical assets like property, plants, and equipment, with 50% of these investments in Europe and another 16% in Canada and Mexico. These assets have helped generate $6 trillion in gross sales and $300 billion in net income, according to the most recent data from 2022.

US trade agreements have been crucial in encouraging American companies to grow internationally. Currently, the US has trade agreements with 20 countries, the most significant being the North American Free Trade Agreement with Canada and Mexico. Despite these agreements, the Trump administration intends to impose tariffs of up to 25% on a wide array of manufactured goods, even in cases where trade agreements are in place, to incentivize companies to manufacture products within the US.

The reasoning behind Trump's tariff strategy is suspect. First, it implicitly recognizes a significant cost gap between domestic and international production that isn't solely to do unfair trade practices. Second, it does not acknowledge that higher product prices are inevitable, as producing goods in the US would be unprofitable without tariffs. Third, it overlooks the costs involved in creating a new manufacturing "ecosystem," including who will bear these costs and the time required to establish it. Fourth, it places US companies with global manufacturing operations in a situation where they may need to sell or cease some activities. Lastly, it overlooks the fact that simply having a trade surplus does not ensure a strong economy (as shown by Japan and Germany), nor does it necessarily lead to a better standard of living.

The Trump tariff approach is 30 years behind the times. It may have yielded certain economic and financial benefits when exports and imports were associated with specific country names, but that world no longer exists.

Nowadays, the economy, workers, and companies would benefit more if the Trump administration collaborated with US businesses to create a forward-looking manufacturing plan and invested in educating the youth or future workforce. Regrettably, the administration intends to prolong the 2017 tax legislation, which advantages high-income earners, prioritizes consumption over investment, leads to massive budget deficits, and simultaneously dismantles the education department.

"Has the Era of American Exceptionalism Ended?" If Trump's tariff strategy is fully implemented, it raises the probability that it has.

Historically investment has gone where economic incentive and returns are best, which in turn has driven specialisation, innovation and trade.

Venice, the richest and most successful European economy from the 11th to the 16th century, used economic incentives to attract foreign investment. Venice created the institutional foundations for commercial capitalism by guaranteeing property rights and the enforceability of contracts. This combined with an efficient fiscal system that was favourable to merchant profits encouraged capital accumulation and specialisation while keeping costs low.

The Dutch Republic’s ascent in the 14th century was underpinned by the same model as Venice’s, as was the industrialisation of countries that followed. Each became a magnate for FDI. In early 1500 England adopted the Dutch economic model of industrial specialisation supported by a sound legal, financial and tax system.

Historically, foreign capital and entrepreneurs have played crucial roles in transferring technology and in helping drive local innovation. Britain is credited as the father of the industrial revolution but all the major innovations that drove the initial British industrial expansion came from the technically more advanced countries at the time - Germany, The Netherlands, Italy and France.

In the United States, the rapid transfer of technology from Britain, along with expanding trade and inward investment—coupled with America's abundant land and mineral resources—accelerated its industrialisation. By 1913 it was the US not Britain that operated closest to the technological frontier.

The rest is history – the rise of Japan, starting 1868, the Asian Tigers and China in the late 1970s.

Foreign direct investment flows

Figure 1 shows that while global FDI tend to be volatile from year-to-year, FDI as a share of global GDP, has risen through recessions, crises, geopolitical tensions, trade battles and wars. The exceptions are the Global Financial Crisis, the worst financial market meltdown since the 1929 crash, and the pandemic, when economies ground to a halt.

In recent decades, the American economy has expanded more rapidly than other major economies, creating substantial wealth. This phenomenon is often called "American Exceptionalism." While the economic and financial results are not in dispute, the reasons behind them are. A deeper look shows that the period of "American Exceptionalism" was driven not only by fundamentals but also by large-scale and unconventional fiscal and monetary policies that were unprecedented in their reach and magnitude. The Trump administration, eager to extend America's exceptionalism, plans to impose taxes (i.e., tariffs) on our major trading partners. Will this strategy work or is the era of "American Exceptionalism" over?

Advocates of "American Exceptionalism" often overlook or downplay the most extensive fiscal policy in history that has bolstered the economy in recent decades. For instance, the US federal debt has risen from $7 trillion to $36 trillion over the past twenty years. Essentially, the federal government has spent, on average, over $1 trillion annually beyond what individuals and businesses paid in taxes. Consequently, the US economy reaped the benefits of government spending without imposing equivalent taxes on its citizens or businesses. No other nation globally could maintain this for such an extended period.

Unlike households, businesses, and other countries, the US government has a printing press that enables it to spend beyond its means. However, there are limitations to this ability. Niall Ferguson, a British historian, suggests that a government is no longer a great world power when it spends more on interest payments than on defense. The US surpassed this threshold last year, indicating that the story's script has already been written, with the conclusion possibly unfolding very soon.

Also, monetary policy had a significant influence on the economic and financial outcomes over the last 20 years. For example, in half of those years, policymakers kept official rates near zero, and in about one-third of the years, the Federal Reserve spent over $8 trillion on securities purchases to stabilize financial markets and support economic recovery. These direct asset purchases, called quantitative easing, lead to demand-pull asset inflation by pushing investors to swap risk-free fixed income assets for risky assets, typically equities. Consequently, the surge in wealth was partly fueled by monetary policy.

Although it may appear to be an obvious observation, if a nation increases its government debt five times over twenty years and its central bank follows a "crisis-type" policy for half of that period—spending a third of the time directly purchasing financial assets to artificially boost equity values—can this truly be considered an era of "American Exceptionalism"? Would it be more precise to call it a "folk tale"?

The Trump team aims to extend the real or fabricated narrative for as long as possible. Their primary goal is to make the 2017 tax cut permanent. The challenge they encounter is that by only partially offsetting the cost with spending reductions, they lock in significant fiscal deficits. This heightens the likelihood that the so-called "Ferguson Law"—which suggests that when governments spend more on interest payments than on defense, they lose their status as a major power—becomes a reality.

At the same time, Trump plans to increase federal revenues by implementing tariffs on a broad range of imports. Imposing tariffs on imports is seen as an easy way to raise revenue in the short run with the larger objective of increasing costs of imported products, thereby encouraging a shift in supply. This strategy aims to persuade importers to relocate production to the US or face the potential loss of sales.

However, establishing a new ecosystem will be neither simple nor inexpensive. This is because it would require a substantial and lasting rise in tariffs to force a change in production sites. Even so, success is not guaranteed due to concerns about cost and profitability. If people cannot afford the increased prices caused by tariffs and the higher production costs in the US, they will buy less, resulting in decreased sales and profits for businesses. Moreover, US companies might risk losing international markets as other nations retaliate.

Warren Buffett, a renowned investor, has consistently maintained the stance to "never bet against America." However, betting against "American Exceptionalism" is not the same as betting against America, particularly if the past was "exceptional" only because of unique and unrepeatable fiscal and monetary policy measures.

Investors ought to be concerned about the "Ferguson Law," as the narrative is already set. The conclusion may arrive soon as the Trump administration either misunderstands or disregards the repercussions. If "American Exceptionalism" unravels, revealing it as more myth than reality, it could lead to significant and swift changes in US financial markets. This is because the value of US financial assets, especially stocks, is based on a growth narrative that is neither accurate nor sustainable.

When it comes to the high and rapidly rising Federal debt, which is now $36 trillion, a lot of attention is paid to the increasing debt service costs, how they are impinging on spending programs, and potential implications for interest rates. Foreign holdings of US treasuries, which amounts to $7.5 trillion, or 31% of total publicly-held government debt, receive a lot of attention. And there’s a large amount of research on the Fed, which through its massive asset purchases, is the largest holder of U.S. treasuries, with $4.4 trillion. This note does not address any of those issues. Rather it addresses the dramatic rise in US treasuries owned by U.S. state and local governments.

The U.S. Treasury estimates that state and local government holdings of treasury securities have soared from roughly $750 billion prior to the Covid pandemic to a whopping $1.7 trillion in 2024Q3. That means state and local governments rank as the second largest holder of US treasuries behind the Fed, well ahead of foreign holders Japan, China and OPEC nations. This observation reflects the evolution of the U.S.’s structure of fiscal federalism and has far-reaching implications for the different fiscal roles played by the different layers of government. It also a central issue in the current initiatives that aim to streamline the government and reduce deficits.

Some of the biggest components of Federal government spending is distributed directly to individuals: Social Security and other income support programs, medical care providers for Medicare and Medicaid, U.S. treasury creditors for debt services costs, and defense contractors. A big chunk of Federal spending that has been authorized by Congress is disbursed to state and local governments for a wide range of activities—education, transportation and infrastructure, commerce and judiciary, etc. State and local governments hold these disbursements along with other savings that result from a surplus of receipts over spending in US treasury securities. All states maintain “rainy day” funds and use them for a variety of purposes.

Prior to the pandemic, as shown in Chart 1, state and local government holdings of US treasuries hovered around $720 billion. Their dramatic rise during 2020-2021 reflected primarily the surge in Covid-related Federal government fiscal transfers to state and local governments that culminated with the $350 billion disbursement as part of President Biden’s $1.9 trillion American Rescue Plan of March 2021. According to the official U.S. Treasury Fact Sheet, “The Rescue Plan will provide needed relief to state, local, and Tribal governments to enable them to continue to support the public health response and lay the foundation for a strong and equitable economic recovery.” (March 18, 2021).

By then, the economic recovery had strengthened significantly and was generating rapid growth and recovery in state and local tax receipts. At the same time, the Federal government was distributing additional Covid-related health care subsidies to state and local governments. State and local government finances quickly repaired, as tax receipts accelerated and health-related spending demands subsided. Unlike Federal taxes, most state governments do not index their individual and corporate income taxes to inflation, so their elasticities of tax receipts with respect to state income is far higher than for the Federal government’s tax receipt elasticities. Thus, increases in real personal incomes and soaring inflation boosted nominal incomes and tax receipts. The quick rebounds in retail sales as the economy reopened generated a big boost to state sales taxes. The soaring home prices generated an acceleration in local government property tax receipts in some states like California, this occurred with a short lag; in other states it unfolded with a longer lag.

Can it be that every geographic region of the World, save for South/Central America practices unfair trade with the US? Since 1976, the only geographic region of the World that the US has come close to running a trade surplus in goods is South/Central America. Are the other regions of the World practicing unfair trade practices with the US or might there be another reason why the US consistently runs goods trade deficits with them?

Of course, if I did not think there is another reason, I would not have posed the question. Consider the following identity:

Gross Domestic Production = Gross Domestic Purchases + (Exports – Imports)

Rearranging some terms, we get:

Gross Domestic Production – Gross Domestic Purchases = (Exports – Imports)

If Gross Domestic Purchases exceeds Gross Domestic Production, then imports must exceed exports. In simpler terms, if the households, businesses and government entities of a country, collectively, spend more than they produce, they must run a trade deficit. Collectively, the rest of the World is “lending” the trade-deficit country goods and services.

Let’s go to a chart. Plotted in the chart below are the annual trade deficits in goods the US runs (blue bars) along with the difference between annual US Gross Domestic Production and Gross Domestic Purchases (the red line).