ExplainSpeaking: The economic repercussions of Trump’s presidency

It has been less than seven full weeks of Donald Trump’s second term as US president and not a day has passed when the US has not run into one or more of its allies threatening to take action in the shape of punitive tariffs.

Trump’s bet

Trump and his supporters firmly believe that over the past several decades the US has been cheated by its allies and trading partners, and that the only way to ensure that the rest of the world stops being a free rider, benefitting from US largesse, is by US reevaluating its role in every manner possible. As such, if European countries do not pay the US or benefit Americans via trade, the US will no longer provide protection or financial assistance to even its traditional allies.

Trump’s bet is that — given the strength of the US economy and its enviable record of sustained economic growth even against terrible odds (often referred to as US exceptionalism) — the threat of tariffs will quickly force foreign companies and countries across the world to set up shop inside the US , thus reducing trade deficit while boosting manufacturing within the US, creating jobs and unprecedented prosperity.

To be sure, for Trump’s supporters, this plan is working to a T. According to them, Trump is the first US president who is effectively using a carrot and stick approach to get the kind of co-operation from its allies and partners that it deserves.

The flip side

But many others point out that the US’s decision to impose tariffs is deeply counter-productive and the country may have already started drifting towards a recession; even more importantly, the US may not have many friends left to lean on if and when it falters.

Moreover, traditional US allies have decided to fight the US bullying by slapping their own tariffs — as Canada has done — and building up their own economies — as much of Europe is planning to do.

Earlier this week, Friedrich Merz, who is likely to become the next Chancellor of Germany, announced that Europe’s largest economy will raise hundreds of billions of euros in extra spending on defence and infrastructure. “In view of the threats to our freedom and peace on our continent, the rule for our defence now has to be ‘whatever it takes’,” Merz said.

Most of US allies have been witnessing stagnant economic growth since the Global Financial Crisis of 2008 (SEE CHART 1). This has led to falling per capita incomes and productivity, and fuelled social unrest. The remarkably counter-productive decision by the British to leave the European Union is one example of economic stress and social unrest leading to a reactionary and counter-productive decision.

CHART 1.

On paper, if US allies start building up their economies and growing fast, they can provide an alternative to the US for global investors.

The result till now

The first thing to note is that President Trump’s tariff actions have injected an unprecedented level of trade policy uncertainty in the markets across the board (SEE CHART 2).

CHART 2.

This essentially means that businessmen and businesswomen everywhere, especially on either side of the Atlantic, are completely clueless when a tariff will affect them or not, how much would their product cost after tariffs, what would be the demand at the higher price, do they need to fire some of their employees or hire some new ones etc. A similar confusion reigns in the minds of consumers.

The relative performance of the stock market is another good initial indicator of how firms and investors look at Trump’s tariff. CHART 3 show how the US’s benchmark S&P 500 index has performed relative to the Stoxx Europe 600 since the start of the year. While S&P 500 tracks the top 500 companies listed in the US, Stoxx 600 has 600 companies of large, mid and small capitalisation, spread over 17 European countries.

CHART 3.

The US benchmark index is below its level at the start of 2025 while Stoxx 600 as well as other European country specific indices — such as the CAC40 (the French benchmark), DAX (German blue chip companies) and IBEX ( Spain’s benchmark) — all have handsomely outperformed.

Another way to look at the US’s fortunes is to look at the US dollar’s exchange rate against other competing currencies.

For a while now, the US dollar has been strengthening against all currencies of the world. Partly this was because of the proverbial US exceptionalism; it was, for instance, the only major economy in the world that managed to register a genuine V-shaped recovery after the Covid pandemic. A genuine V-shaped recovery requires the absolute level of a country’s GDP rising back to where it would have been had there been no economic disruption.

But the US dollar strengthened even when Donald Trump first threatened to impose tariffs. That’s because 50% of all global transactions are invoiced in dollars, making it the default currency of the international order. Not to mention that it is the biggest economy by size and its policy choices have global impact. Trust in the dollar’s purchasing power during times of uncertainty is second only to the trust investors have in gold.

However, over the past week, be its Canadian cousin, or the euro, or the Japanese yen or the Chinese yuan, the US dollar has weakened against all its closest competitors (SEE CHART 4).

CHART 4.

There is a flip side though: There has been broad-based sell off in government bonds of Germany, France, Japan etc. As a result, yields of 10 year government bonds in all these countries have registered a sharp spike (SEE CHARTS 5, 6 and 7). Investors are selling these bonds because they anticipate the issuance of fresh bonds with better returns to be floated as these developed countries start borrowing billions of dollars to boost their domestic economies.

CHART 5.

CHART 6.

CHART 7.

Bond yields and bond prices move in opposite directions. That’s because every government bond carries a set amount of absolute return (called the coupon rate); yield is nothing but the size of the coupon as a proportion of the bond price. When there’s a sell off, bond prices fall and their yields go up even at the same coupon rate.

Typically, higher bond yields signal higher interest rates (borrowing costs) in the economy but in this case, they also signal higher rates of GDP growth in Europe in the short-term at least, fuelled by fresh borrowings.

Upshot

In life as in investing, it helps to remember the old adage: “Never keep all your eggs in one basket”. US allies are realising their historic mistake as the US, in their view at least, betrays their trust and goes back on its commitments. It is an open question whether the other developed countries will accept US leadership in a hurry.

Beyond the loss of global leadership, this can also cost the US economically if its former allies decide to trade among themselves and find new connections and solutions — such as invoicing their internal trade in a currency (or currencies) other than the US dollar.

Perhaps it is time for the US as well to pay heed to the wise adage and not place all its trust in one policy tool alone.

By repeatedly threatening tariffs on all, is Donald Trump doing the right thing from the point of view of the US economy? Share you views and queries at udit.misra@expressindia.com

Take care,
Udit