Faisal Islam: The tariff wars have begun - buckle up
2025-02-06
Category: economic

Don't mess with Canada - that's the private message to the US from the very top of Ottawa's political system. Just like nearly a century ago with the infamous American Smoot-Hawley tariffs, Canada got its retaliation in to Donald Trump's import taxes very quickly.While the White House is claiming Canada's pledge to spend $1.3bn (£1bn) on a border protection plan has given it diplomatic victory in its battle over fentanyl traffic, there was very little conceded that was not already planned by America's northern neighbour.Crucially, both Mexico and Canada were undeterred by a clear threat in Trump's executive orders that any retaliation would lead to higher tariffs on imports into the US.After consulting each other, Canada and Mexico instead both negotiated a month's pause with Trump.The returning US president likes making threats of tariffs on most days, and in many directions.
Since his inauguration, these have also been directed at Denmark, Colombia, China, Taiwan, the European Union as well as all of the Brics countries which include Brazil, Russia and India.The rationale for his tariffs keeps changing and much about this situation defies logical explanation.So, Mexico, Canada and every other country facing tariffs or the threat of them have to decipher what Trump is really playing at.And when they've done that, the question for the whole world is whether what we are seeing is an attempt by the US president to rewrite the entire global monetary system - and at what risk to America?
The contradictions
Trump has claimed that fentanyl trafficking was the legal pretext for tariffs, allowing him to bypass Congress and use emergency powers to impose border taxes on Canada, Mexico and China, by declaring an "unusual or extraordinary threat".But while talking about the fentanyl trade, he also referred to Canada's goods trade surplus with the US (which means Canada sells more to the US than it imports), and introduced the idea that Canada should become the "51st state" of America.While any country might demand talks about both illicit and legal trade flows, it is difficult to see how to handle these conversations when there is a parallel threat of continental annexation of a free trade ally which is also part of Nato and one of the Group of Seven (G7) most advanced economies in the world.
A disputed surplus
Europe, meanwhile, seems unwilling to stir the pot as it attempts to work out the president's precise motivations and how this feeds itself into what he decides over Transatlantic tariffs.Trump's long-standing animus with the EU comes from the bloc's substantial goods trade surplus with the US, arising from areas such as high-end German car exports.Underlying all of this is a perceived unfairness that other markets are more restrictive against America such as when it comes to the prices paid for US drugs or fines placed on US tech companies.But if this really is about trade deficits, it is something of a mystery as to why Trump has not yet announced tariffs against the likes of Vietnam, Japan and South Korea - who have far bigger surpluses with the US.In any case, for Trump to focus solely on goods means that he is willingly ignoring the US's great export - services.
I put this precise point to the EU Trade Commissioner Maros Sefcovic last month.He told me: "Sure, we have a trade surplus in goods, but the US has a trade surplus in services."And on top of it, every year, €300bn (£249bn) is flowing across the Atlantic into the American companies from our pension funds, from the saving accounts of the European citizens because they're investing in the US. So I think that it's a pretty balanced relationship."As it happens, the UK trade position with the US is more balanced, a point made to me by the Trade Secretary Jonathan Reynolds. In fact, on some measures, the US has a surplus with Britain.Amid the fog of Trump's true intentions,  European negotiators have resorted to stressing co-operation, partnership and deals with the US and studiously avoided directly criticising even the extraordinary suggestion of using tariffs against Nato-ally Denmark over the fate of Greenland.
A negotiating tool
In November 2024, Stephen Miran, before becoming President Trump's White House chief economics advisor, authored a paper laying out further questions that could determine how much more the US should tariff specific countries.These ranged from an assessment of whether a country applies similar tariffs to the US, suppresses its currency, respects US intellectual property, pays its Nato obligations, votes against the US at the United Nations or its "leaders grandstand against the US in the international theatre".It also talked of forcing other nations "to choose between facing a tariff on their exports to the American consumer or applying tariffs to their imports from China", asking: "Which will they choose?"
The president himself was pretty clear in his video address to a stunned World Economic Forum in Davos, Switzerland in January."Your choice," he said to the assembled international executives. Build your goods in American factories with tax incentives, or import into the US from foreign factories and pay tariffs that would raise "hundreds of billions of dollars and even trillions of dollars" for the US Treasury."Most of the world has come to understand that Trump does use tariffs as a negotiating tool," Stephen Moore, a former Trump economic advisor who recently visited the president, told me.
Across the board
It may be that a part of Trump's logic is very simple: remodel the US tax system so that everything coming into the country attracts a levy but, in return, the public sees income tax rates slashed."By the way, I do think at the end of the day, there will be an across-the-board tariff imposed by Trump," says Mr Moore."He's talked about this, that if you're bringing something into the United States whether it's from Britain, whether it's Mexico, Canada, China, Europe, you're going to pay a little bit more but if something is made in the United States, he's going to lower the tax. And to a lot of Americans, that's a very attractive proposition."Mr Moore has suggested a 15% universal tariff on all imports from everywhere in order to fund a cut in income tax rates down to 15%.
A fundamental change
Mr Miran's paper also contains a proposal that led to jaws dropping in global central banks and finance ministries: bring down the value of the dollar in order to boost US industry and exports.Arranging this would mean a fundamental change to the way the global monetary system operates. But Mr Miran suggests that punitive tariffs could be used as leverage to make reluctant trading partners like Europe and China "become more receptive" to the idea.
He suggests that in time there could be a summit of the world's economic powers, where allies and rivals thrash out the revaluation of the dollar, perhaps at the president's Florida residence. It could be known as the Mar-a-Lago Accord.Early discussions of the idea in international forums have been highly sceptical, recalling the history of similar attempts to manage global currency values.But it is the recently published concept of the top White House economic advisor. Tariff now, tariff hard and tariff everywhere in order to, in the future, get the world to help bring down the value of the dollar.
Show strength
Such a radical idea comes with risk and already simply with the tariffs, there is a danger for the White House that the US overplays its hand.Mark Carney, who is frontrunner to replace Justin Trudeau as Canadian Liberal Party leader, and as Prime Minister, at least until an election, has a rather unique approach. The former governor of both the Bank of England and the Bank of Canada decided to come out punching, ridiculing the fentanyl rationale and telling the BBC that Canada would retaliate "dollar for dollar" and that Canadians would "stand up to a bully".He said that the tariff move would rebound on the US economy itself by fuelling inflation, forcing the Federal Reserve to raise interest rates and crippling the ability of the US to sign trade deals, given they would have effectively ripped up their biggest  - the United States-Mexico-Canada Agreement (USMCA) - just a few years after the president had personally renegotiated it.Mr Carney then publicly suggested that Canada removes a subsidy from exports to the US of its oil, and stressed that Canada's green investments might need to be protected from US carbon emissions.For those countries like the UK trying to avoid tariffs, he had a simple message: "Good luck".The clear sense was that from his own experience of having dealt with Trump at the G20, the way to deal with him was to show strength.
The risk of retaliation
This is partly a calculation that the muted opposition to these policies within the US will not be sustained. Again, the harder, more strategic and more coordinated the retaliation, the more pause for thought it will give big US corporates and some in the competing courts around the President.Elon Musk, the normally prolific social media poster on his X platform and chief executive of electric vehicle-maker Tesla, was curiously largely quiet about the single biggest move from the president. He eventually reposted the news from the Mexican president that their tariffs had been delayed.
A leading US tech chief executive told me that his company was already making plans, assuming they would be on the receiving end of retaliatory tariffs.His hope was that Trump's focus on the rising value of the US stock market would create a natural restraint against excessive tariffs. Some saw the modest fall on the Dow Jones index on Monday as contributing to this week's pauses.Retaliation is standard procedure in trade wars.Indeed in the most famous of them all, when US Republicans passed the calamitous 1930s Smoot-Hawley tariffs, Canada was the first to hit back, doing so before the US had even finished legislating. History points to Henry Ford being one of those begging Herbert Hoover to veto the Smoot-Hawley tariffs in 1930.
An integrated industry
And, in 2025, the car industry is one obvious potential tariff loser."It's true to say that there is no such thing as a Canadian auto industry, an American auto industry and a Mexican auto industry," says Peter Frise, a professor of mechanical and automotive engineering at the University of Windsor."There are Canadian, American, and Mexican components of a North American auto industry and the integration among the three countries is absolutely foundational to how the industry works."
Not only are models like the Honda Civic, which is hugely popular in the US, manufactured in Canada - Prof Frise says "very few" cars assembled in the US will not contain some parts that come from across the border. And so, says he adds, tariffs "would drive up costs for everyone" - US consumers included.
Others diversify
Another risk for Trump is that as Mr Carney and Mr Sefcovic said, they are all now responding to the direction of US trade policy by diversifying with one another. The EU is busy doing trade deals with Latin America. "There is huge demand in the outside world for free and fair trade relationships," says Mr Sefcovic.The UK has also restarted trade negotiations with India and the Gulf countries. Reynolds says that the "challenging international position" means the UK has to push its "genuine competitive advantage" as the "most connected market in the world" with the US, the EU and China.
An extensive and surprising tariff war
The other issue here is that if the direction of travel is a universal tariff, as Trump and his advisors keep suggesting, is there much incentive to try to avoid it?There is some startling thinking circulating in Trumponomics circles. It is talk of that revenue grab of trillions of dollars that is spooking even allies who think they might escape the tariffs.It sounds like a wild economic gamble. But such talk is relative, at a time when the US president is putting tariffs on his closest economic G7 and Nato partner over fentanyl, while simultaneously claiming it should become part of the US.It could be an extensive and surprising tariff war. This week's trade dramas are just early skirmishes.Top picture credit: Getty Images
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