America’s Faustian Trade Bargain
US President Donald Trump clearly likes the idea of using tariffs to wrest concessions from America’s trade partners. But the pursuit of short-term advantage often proves catastrophic in the long run, especially if countries running trade surpluses with the US retaliate by deploying an overlooked weapon.
Kenneth Jacobs
NEW YORK – On a recent trip to Germany – where I gave a talk on the state of the mergers-and-acquisitions markets and what it implies about business confidence – I stumbled upon the house of Johann Wolfgang von Goethe, the towering writer who produced the most influential interpretation of the legend of Faust.
It was a serendipitous development.
In that story, a magician and alchemist bargains away his eternal soul to the devil for short-term power and riches.
Last week’s tariff announcements could be viewed as America’s Faustian bargain.
Among CEOs and board directors on both sides of the Atlantic, confidence was already shaky.
M&A markets are a good barometer for business’ appetite for long-term investment, and in the first two months of this year announcements were the lowest they have been in the past 20 years.
It is not difficult to see why.
Confidence is inseparable from predictability, and over the last month, US President Donald Trump’s administration has initiated broad-based tariffs, thrown economic commitments into doubt, disrupted the work of federal agencies, and issued a series of policy pronouncements that could upend global geopolitics.
But the problem runs deeper than unpredictability.
When your decision-making framework amounts to Faustian bargaining for short-term benefits, you often won’t recognize the long-term consequences of your actions until it is too late.
Tariffs are a case in point.
The Trump administration believes that the US would have the upper hand in any trade war, because exports of goods and services are far less important to the US economy than they are to most of its trade partners.
So, while tariffs would disrupt the US economy, they would harm China, Canada, or the European Union – among other targets – far more.
Today, foreign countries hold nearly one-quarter of US government debt.
They raise the money to purchase this debt – thereby financing America’s chronic budget deficits and offsetting its low savings rate – partly by running trade surpluses with the US, which enable them to build up dollar reserves.
They are in no way required to invest the proceeds of their trade surpluses in US debt, but they often do.
But what if America’s major trading partners introduced a tax on the purchase of dollar-denominated securities issued by the US government or US firms?
A significant source of funding for Treasury auctions would evaporate, and the US government’s borrowing costs would rise.
As more domestic capital flowed toward Treasury auctions, investment in other sectors would be crowded out, spreads would widen, and the cost of capital would increase.
Mortgage interest rates, credit-card interest rates, and borrowing costs for businesses would rise, generating powerful market and economic headwinds.
Even the threat of such a tax would affect US bond yields.
It is not hard to imagine more subtle foreign dollar-reserve strategies that accomplish the same outcome.
Some might argue that America’s trade partners are unlikely to take such a step, since it would also carry high costs for them, from lost earnings on their US dollar reserves to higher risks from shifting investments to other economies.
But the costs for the US would be far greater, and they would emerge much faster.
It is a lot easier to shift financial investments than it is to establish new trade relationships.
Even if a tax or other policy that discouraged the purchase of US securities led to a kind of “mutual assured destruction,” America’s trading partners might decide it is worth it, not least because they have few other options to push back against tariffs effectively.
The more aggressively trade is weaponized, the more tempted they will be to use this tool and “go nuclear.”
The politics are certainly appealing: “If the US taxes our goods, we will tax its debt” would be a compelling rallying cry for the leader of an economy under pressure from US tariffs.
The Trump administration clearly likes the idea of using tariffs to wrest concessions from America’s trade partners.
But the bargain the administration appears poised to make in service of its short-term goals creates enormous risks for America’s economy.
Kenneth Jacobs is Senior Chairman of Lazard.
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