Brad Setser on the Damage From Trump's Gigantic Tariff Shock
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Hello and welcome to another episode of the OutLots Podcast. I'm Traci Alloway. And I'm Joe Weisenthal.

Joe, another day, another emergency podcast. We're going to do a lot. This is a fact. I should just resign myself to this inevitability, right? The story of the tariffs, the market reaction, the global reaction is the central story of our time. One of the biggest stories of our entire career. I think perhaps, depending on how things could go, a bigger story than the past two big stories of the great financial crisis is

and the COVID shock, we're going to be doing a lot of episodes about what this all means. This is what is mind-blowing to me because when 2008 happened, I remember thinking this was the biggest thing that had ever happened in modern finance and the modern economy. And then in 2020, I remember there was a very vibrant debate about whether or not the pandemic and the market sell-off would end up being the central crisis for a new generation. And I think in retrospect,

It certainly was. A lot more people remember 2020 than they remember 2008 now. And here we are, you know, just five years later, having another discussion about how big this is inevitably going to be. So on that note, we are recording this on Friday, April 4th. The market is selling off yet again. We had Trump's new tariff announcements. Those were released on Wednesday, April 2nd, Liberation Day. Investors have been...

I mean, I would say pretty much panicking since then. And what's more, overnight, coming into Friday morning, we've started to see some reaction from other countries, notably China, one of the U.S.'s biggest trading partners. And they say they're instituting a 34% reciprocal tariff on U.S. goods. So things seem to be escalating.

Totally. You know, I'm just going to make one short comment here, which is why I think this might be end up being a bigger story than the great financial crisis potentially. And that is banking crisis happen. They happen around the world. They've happened in the U.S. They've even happened in the U.S. between massive crises. And there is a playbook and there is a response and you try to reflate the economy and your stuff like this.

This is different because this is a policy choice purposely aimed to completely reorient America's relationship with the rest of the world and reorient the internal economy. And so it's very different than sort of like, oh, you have a run on the bank, which happens for we had one in March 2023. We had a run on the bank. You know, this is very different in terms of the entire relationship of both the internal and the external economy. And it may end up being more consequential for

for better or worse than the great financial crisis. I don't disagree with you, but I'm just going to say one thing. Number one, that's not a short comment. Number two, you're right. This is an entirely self-inflicted own goal, basically, by the Trump administration. Like, it is their decision to do this. Yes. And they...

presumably knew what the results were going to be, right? They decided not to hold the tariff press conference while the markets were open. They knew that coming out was something that was worse than a lot of professional economists and analysts had expected was going to have this impact on the market. And here we are. So this is something that the administration has chosen to do. Obviously, there's lots going on.

Obviously, we have a lot of questions. Who do we turn to when we have trade questions? We do, in fact, have the perfect guest. We're going to be speaking with Brad Setzer, Senior Fellow at the Council on Foreign Relations and a longtime trade expert, one of our favorites to talk to. The last time we saw him was actually at our pre-election event at a live show in New York. And Brad, I

I remember speaking to you there. There were a lot of concerns about what Trump could do on trade. How has the reality shaped up to expectations here? Well, look, Trump did campaign on an agenda that was tariffs and more tariffs. He campaigned on a 10% across the board tariff and prohibitive tariffs on trade with China. And at times he did suggest that 10% was the minimum.

That said, a lot of people close to Trump, a lot of people who found their way into the administration, were sending different messages privately to people in the financial markets. People like Scott Besant were talking about how Trump's plan was escalate to de-escalate. The tariffs were a negotiating tool. They weren't a tool to upend the global economy. I think what the announcement on Wednesday showed is that

The decision of the administration, not surprisingly, was to follow President Trump's instincts, not the instincts of his more moderate advisors.

to go all in and that the goal really is to, as you guys suggested at the beginning, to radically restructure the US and global economies using tariffs as a tool with some flexibility perhaps to negotiate at the edges. But fundamentally, this is a test of what you can and cannot do with tariffs. And there was very little restraint, I would say, apart for, strangely enough, Canada and Mexico, USMCA,

on the level of the tariffs. So the tariffs are set at levels which are just going to frankly be painful.

You know, Tracy mentioned that we talked to you the night before the election. And one thing that's interesting about talking to you is you're not a sort of naive, you know, all traded fine. Armchair economist. Yeah, or just like, you know, everything was fine in the global trading system. And you've been talking for years that like this is an unhealthy relationship that the U.S. has with China specifically. And that night that we talked to you before the election, you're like the answer is,

It's to really deepen the trading relationship with our allies, our friends. So that would be Europe, Canada, and so forth, and really build up a coherent open trading block that would stand as something different to China, which, as you've said, has had unfair trade practices for a long time. Trump says the same thing. We haven't. So what are the consequences of closing, fragmenting what you saw as the potential open trading block to counter China?

Well, obvious point is elections do have consequences. Look, I do think that trade with China is very difficult for most countries that aren't just commodity exporters. If you look at China's pattern of trade over the last six years, China's imports of manufacturers increased on average by $15 billion, $1.5 billion a year, essentially nothing.

China's exports of manufacturers over the last six years increased on average by $175 billion a year, 10 times as much. So China became an economy, particularly because of the way it responded to COVID, because of the real estate crisis that was exporting but not importing when it came to manufacturers. And China's trade surplus surged.

to being about a trillion, it's a little over a trillion dollars now, about a percent of world GDP. Its manufacturing surplus is 2% of world GDP. These are really unprecedented numbers.

And so, you know, my view was that, hey, we don't have to abandon all the benefits of trade. We can maintain the benefits of relatively integrated trade amongst like minded. I guess that's not I don't like that term, actually, amongst countries that have similar economic systems, similar politics.

And that was a better way of both putting pressure on China, because the pressure is really on China, and also avoiding the costs that come from fully disengaging from the world economy. I think the choice was made, was essentially an American to go with an America alone policy, where we're going to give up a lot of the benefits of trade with our neighbors and with longstanding friends.

And I think the net effect of that, yes, it's going to put a lot of pressure on China, the tariffs on Vietnam, or in some ways, tariffs on indirect Chinese exports as well. But it does so at a very, very high cost. And it sort of gives up the benefits that I thought the U.S. had from being at the center of a much bigger block than China was going to be at the center. We've kind of, the vision here is at least shrinking to within North America and maybe shrinking to within the United States.

That's just fundamentally a different vision, and I think it's a more costly form of disengagement. KPMG makes the difference by creating value, like developing strategic insights that help drive M&A success, and embedding AI solutions into your business to sustain competitive advantage, or deploying tech-enabled audits to deliver more accurate and transparent insights.

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where money means more. So you mentioned Vietnam there, and I think this is one of the big differences between tariffs this time around and tariffs in the first Trump administration. So we did see a lot of production that basically circumvented the China tariffs post-2018 that increased production in places like Vietnam, lots of Chinese components going into Mexico and then finding their way into the U.S. from there.

Is there any wriggle room left in the current constellation of, you know, the new export limitations, the new tariffs? Is there any wriggle room to kind of reorient potentially American imports that way? Or are there ways maybe to, I don't know, figure out lower tariff bans by like arbitraging between one country and another? Or are they so sweeping that a lot of that ability has just been wiped out?

There are two potential arbitrages that have opened up if Wednesday night is maintained. So the first is there are a set of countries, generally countries which have now relatively balanced trade with the U.S. that only got the baseline 10 percent tariff.

So if you reoriented your supply chains and took the increase in shipping costs and found a bunch of, say, workers in Brazil, you could employ those workers in Brazil to put together components from China and send them to the US and only pay a 10% tariff.

That's better than Vietnam's 45% tariff and the 55% tariff ballpark that China, that any good from China faces with some goods facing higher tariffs. So opportunity number one is basically move China

or at least final assembly to countries that already have balanced trade with the U.S. and thereby only have a 10% tariff. Note the irony that if these countries become centers for final assembly, bilateral trade will no longer stay balanced. It'll quickly shift. The other big issue

exception, again, for now, and it doesn't apply to autos, and it doesn't apply to steel, and it doesn't probably won't apply to pharmaceuticals, and it probably won't apply to some other sectors, is that for now, and I mean, I do find it a bit shocking given how much emphasis President Trump has placed on Canada in the first two months of its administration. For now,

Most trade with Mexico and Canada outside of autos is still relatively low tariff. It has to be USMCA compliant. You can generally achieve that. The USMCA compliance, a lot of people weren't doing it because there was no advantage in, say, electronics, because electronic tariffs were zero inside USMCA and zero for Vietnam. Now there's a huge incentive to be USMCA compliant.

So if you can do USMCA compliant production assembly in Mexico, there's no really right now, but it'll probably change over time. Limits on how many Chinese parts can be included in that operation. For now, you get around the tariff. Now, I think there will be a renegotiation of USMCA that will make some of this a bit harder over time. But that at least is the opportunity that would be open now.

For now, if nothing more changes, but it doesn't feel fully consistent with the president's intent either. You know, you've been talking about trade for your entire career, etc. You know, on that Wednesday announcement, every country got a tariff slapped on it. And it was basically a strict function of the amount of surplus trade.

then divided by exports and then divided by, yeah. So China, for instance, trade surplus of 295 billion last year on exports of 438 billion, a ratio of 68%. And then they divided by two and that's how they got 34%. And that's how they did it every country down the line. And the theoretical idea here seems to be that if we run a bilateral trade surplus with you, any country in the world, then that must be some proxy for the amount that you're cheating.

either through tariffs or non-tariff trade barriers or currency manipulation or something like that. This seems to be the intellectual logic. And what I'm curious from you is, in all your knowledge of sort of the theory of world trade, is this something that people have talked about as a reasonable way or a reasonable proxy to measure the amount with which a country, quote, cheats in the rules of free trade?

The simple answer is, as you know, Joe, no. This felt like a group of economic advisors who had put off doing a term paper until really late at night and were scrambling to come up. And then use chat GPT, right? Perhaps. But I mean, essentially, it certainly seems from the TikToks

that the president himself asked for tariffs on not just 15 countries, but 70 countries or something. And people had to come up with a formula because it was clear that USTR and others didn't have the capacity to do true assessments of all of the countries that were covered by this announcement. But it does feel like a term paper that went horribly wrong because it was written at four in the morning and it had to be submitted at six. There are some obvious reasons

weirdness that comes from this formula. The most significant of which, in my view, is that small Asian economies that generally have current account deficits, their trade deficits overall, often run surpluses with the United States because they're relatively poor, they can't afford many of our goods, and they can still produce clothing, more or less, for the US markets.

So hence, we put really quite heavy tariffs on a country like Sri Lanka, on a country like Bangladesh, you know, countries where I don't think there was any significant concern about the pattern of trade.

Sure, there were some concerns about sweatshops and labor rights and so forth and so on. But no one was sort of in the U.S. economy was, you know, hey, hey, ho, ho, competition from Sri Lanka has to go. This was just a function of a formula applied without thought.

And so you end up having heavy tariffs on countries that are just producing clothes, which realistically won't be produced in the U.S. So there's an element of pure pointlessness that comes out of this formula.

Now, I will say that there is some value in looking at bilateral trade patterns. I mean, I've certainly learned a lot from trying to understand why the U.S. runs such a large deficit with Ireland. I think the answer is not that Ireland is an unfair trader. I think the answer is we have a tax policy that incentivized American companies to produce in Ireland to reduce their U.S. tax rate significantly.

from 21% to 10.5%. And so in some cases, you can learn from the pattern of bilateral trade. I certainly think you can learn something from looking at global trade surpluses, not bilateral trade surpluses. And the global surplus is pointing to a problem with China. And China really has been growing on the back of net exports.

for the last four or five years. China's trade surplus with the world really is big. And in a sense, the bilateral deficit with China now understates our reliance on Chinese supply because of all this rerouting through third countries. But just using this simple formula produced some obviously absurd results. And you know it was done late at night because we ended up terrifying islands that only produce penguins. Yeah.

Yeah, make the penguins sign up for better trade terms, certainly. Okay, so on this note, I mean, this is actually the thing that I find most depressing slash disturbing about all of this. It's the arbitrariness with which some of these seem to have been designed. And I know

I wrote about it in the newsletter yesterday, so Joe's aware of this, but like the example I've been reaching for is NARU. So, you know, 30% tariffs on this tiny island state in the middle of the South Pacific Ocean. And they, you know, they export like

one to two million worth of pig meats and some computer parts every year to the U.S., I just cannot fathom what the U.S. wants from a country like Nehru or in what way the U.S. economy is at all threatened by a country like Nehru. And as you point out, Brad, it's not like

Like the Islanders are suddenly going to be buying a bunch of Fords from the US, right? Like they have 12 miles worth of road. What exactly are they going to be buying from America? That disturbs me a lot. But beyond that, you know, you might've realized already, Joe certainly has that. I'm a little bit cranky and tired this morning. Joe's very exhilarated by watching a history change in real time. I just got kind of, kind of sad and tired, but

For my benefit, can you maybe describe, is there any path where you see this going reasonably well or at least not completely terribly?

Well, there is a path to de-escalation. The path to de-escalation is one where, you know, in some sense, the Trump administration decides not to make history. Joe's going to be a bit bored. This doesn't turn out to be the repeat of the global financial crisis. It turns out to be a more ordinary trade war, maybe with a few Trumpian flourishes and maybe with a bit more revenue collection. But if you...

If the administration concludes that it overshot, that they are worried about throwing the U.S. economy into a self-induced recession, that they don't have political support for this particular trade war, and they want to back off, they've left a little space to do quote-unquote phenomenal deals. And so if there are phenomenal deals done with China, with Europe, with Japan, if there's some

agreement that is reached with Mexico and Canada that rolls back some of the auto protection, which is actually significant in its own terms, even if the rest of, well, not the rest, but even if the consumer goods and non-metal based part of North American trade is still relatively on tariff. If you reach deals with them, reach deals with Southeast Asia, reach deals with the UK, you

you could generally perhaps fall back to something that's closer to a 10% tariff.

across the board, which is significant, but not as disruptive. And then whatever your deal with China leaves you with, you kind of play a trade war out with China using the 301 tool, and you really just focus on China. So that is the most plausible path towards de-escalation. I think right now, though, Joe's in luck. We're on a path where the president does seem fairly committed to

changing the fundamental structure of the U.S. and North American economies. And if you want to achieve that deep change through policy, you have to impose policies that are disruptive and painful. And so, and other countries are going to react.

The U.S. basically is taking policy steps that on one hand risk throwing the U.S. into recession and are almost certain to throw some of our major trading partners into recession. And countries generally don't want to be pushed into recession by policy choices made abroad. So the natural reaction is going to be to try to

Reduce your dependence on the US market. Now that's really hard because the US is the only big, big, big country that runs really big deficits, I guess along with the UK. So it is just really hard for all the surplus countries to find an alternative source of demand. The US has really been supplying a lot of demand to the global economy.

But if Trump is determined to close the trade deficit and willing to do so by shrinking the U.S. economy and has more or less given up on the idea of growing exports as a way out, then I think, A, we're making history because we are tearing apart something that has grown up organically over 80 years, something that the U.S. actually helped create.

It's a trite statement, but it is true. It's a system the U.S. after World War II more or less created. And then the cost of that system, in Trump's view, eyes got to be too big. And so he made a decision to radically step away from current trade patterns and trade policies. I mean, this is a real break. It's a much bigger break than just doing a targeted action.

against China, which is his term one trade policy. I'm not sure it's going to be bigger than the global financial crisis. I was unfortunately around then. And I remember the panic in New York when the big institutions were on the edge of going bust and the 5% fall in the US economy and the very, very slow recovery. You just do normal economic analysis. You maybe get a shock

of a third of that size from what we're doing now. We're not so integrated into the global economy. We haven't stopped all trade. We've just taxed at a very high rate. But yeah, it will play out over a much longer period of time. A financial crisis, you know, risk disaster, but it forces you to respond quickly. This is a more slow moving. And as you indicated, it's a result of a conscious policy choice.

So therefore, it has a very different dynamic.

Lots and lots and lots and lots and lots of trade episodes to come in our future. We'll talk to you next week, Brad. Yeah, Brad, thank you so much. Let's talk about capital flows and Canadian pension funds and why the dollar has rallied into the trade war in Taiwan. Taiwanese life insurance. The good old days. They are still interesting, Joe. They are still interesting.

The good old days of Taiwanese life insurer mysteries. All right, Brad, thank you so much. Really appreciate it. My pleasure. Thank you. Joe, I guess, I guess on the plus side.

We are making history. All of it is very interesting from an economic intellectual perspective. So there is that. Can you tell I'm trying to make myself feel better? Tracy, we're the best business in the world. This is why we get up in the morning. But I'm just going to say one comment. There's not really much for me to add. I don't have much to add to Brad. But when he said that comment...

About how the formula for the tariff announcement reminded him of turning in a very bad economics term paper at 4 a.m. Yeah. The only thing that I could remember...

was the time that I interviewed for a job with Rubini Global Economics in 2007, and Brad Setzer was my interviewer. And I completely flopped that interview by basically talking about the Argentine economy with the sophistication that he described the tariffs, and I did not get that job. And so when Brad says this is bad economics, I have personal experience with hearing that from Brad.

That's all I'm going to say. I mean, yes, it does seem to be bad economics in terms of the tariff rollout. But this is the thing that, you know, OK, yes, it's exhilarating. It's interesting to watch. But this is the thing that actually bothers me, because as Brad points out, there are some legitimate grievances involved.

over US-China trade. And you could go about trying to fix those in a cohesive and potentially effective manner. And instead, we've chosen this weird wish list of things that we want that don't seem to be based on anything rational. Here are some numbers that we pulled out at 4:00 AM in the morning as we were cramming for this announcement or whatever. And we're also targeting countries from which

There can't be anything we want from like Kiribos or, or Nehru. Like why exactly are they even included in this thing? What are we doing here? Well, this actually is one thing you're right. That drives me crazy, which is there's this whole game that gets played where it's like,

well, we need more manufacturing and, you know, what are we going to do? Be reliant on China for all of our like semiconductors and batteries and stuff. That's actually really not great. And we had a policy put in place by the last administration that was specifically targeted. And look, I'll be very clear. Like I'm totally fine with disagreeing with like how the chips act rolled out. And I think there's reasons to think

Like that is totally like to my mind ground for debate. But the idea that no one was talking about the national security implications of heavy reliance on China for manufactured goods up until Wednesday, that part is complete nonsense.

No, it's crazy. And also, I mean, we know that central to Trump's world vision or his economic vision of America is the centrality of private capital, right? Yeah.

build all these strategically important industries for the U.S. like semiconductors. But at the same time, the magnitude of what he's trying to attempt all at once seems very obviously going to scare a lot of private capital away from building anything in the U.S.

Like, I don't really see why it has to be this shock and awe approach to reorienting U.S. trade when you could be something that's much more strategic and done perhaps like much more in coordination with a bunch of different constituents, I guess, of the American economy. Don't ask me. I'm going back to bed. Okay. Okay.

This has been another episode of the All Thoughts Podcast. I'm Traci Allaway. You can follow me at Traci Allaway. And I'm Jill Weisenthal. You can follow me at The Stalwart. Follow Brad Setzer, Brad underscore Setzer. Follow our producers, Carmen Rodriguez at Carmen Arman, Dash O'Bennett at Dashbot,

Kale Brooks at Kale Brooks. For more Odd Lots content, go to Bloomberg.com slash Odd Lots, where we have all of our episodes and a daily newsletter. And you can chat about all of these topics 24-7 with fellow listeners in our Discord, discord.gg slash Odd Lots.

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