What the crazy/genius Trump is trying to achieve

If you’re a Trump fan, he’s got a grand plan to Make America Great Again. If you’ve got Trump Derangement Syndrome (TDS) then he’s an imbecilic madman intent on destroying the world.

Only hindsight will give us the correct answer, so it’s not a debate I’m interested in having.

What is useful, though, is thinking through the implications of what he’s trying to do…assuming we know that much.

I’m sort of qualified on this front as I studied international relations as part of a post-graduate degree many years ago. I really enjoyed the subject and have loosely kept up my interest in the topic over the years.

After the GFC in 2008/09, I spent way too much time thinking the post-WWII financial system was coming to an end. I thought it was only a matter of time before it all blew up.

I was completely wrong. The system had plenty of gas left in the tank.

That was 15 years ago. Now, the tank is getting low on fuel. If the system keeps going in its current form, the US is speeding towards bankruptcy. Not in the traditional way, but in the form of a major crisis.

The Trump administration is creating a ‘mini-crisis’ now to try and prevent that from happening.

The US is the world's consumer of last resort

To explain, I first need to define what I mean by ‘the system’?

It’s the one where the US dollar is the world’s reserve currency. The US economy is the global consumer of last resort. It consumes the rest of the world’s excess production and pays for it with US dollars.

Those dollars pile up in foreign countries in the form of Treasury bonds, the result of taking the trade surpluses and lending them back to the US government.

The physical Treasury bond may sit in another country’s central bank vaults, but the ‘cash’ or capital that purchased it returned to the US to fund excess consumption.

This is why a trade or current account deficit equals a capital account surplus. In effect, producer nations finance US consumption.

US trade deficits started picking up after 1971 when Nixon took the US off the gold standard.

In the 50 years since, these deficits have resulted in outstanding US government debt of around US$36 trillion. Not to mention mortgage-backed security debt, corporate debt and private sector debt.

It’s now getting to the point where the US government’s interest bill alone is over US$1 trillion a year.

Paying the interest bill and funding a global defence budget is becoming increasingly difficult.

Trump says…enough is enough…

This is the backdrop to the current situation.

Trump wants to cure 50 years of excess US consumption, and the ‘exorbitant privilege/curse of having the global reserve currency, by raising tariffs on every country that the US has a trade deficit with.

Taken at face value, this is crazy.

Why?

Well, in 2024, the US trade deficit was around US$920 billion, while the current account deficit (which includes net income transfers like interest payments to foreigners on government debt) was US$1.13 trillion.

That outflow is a source of liquidity for the rest of the world. But it’s also a source of liquidity for US capital markets. While the liability from the deficits accumulates over time, foreigners reinvest the annual trade and current account deficits back into US capital markets, or the real economy via direct investment.

If they didn’t, their currencies would soar against the US dollar, making them less competitive. In other words, the US dollar would tank against other currencies, making the US more competitive.

But because of the US dollar’s reserve currency status, which provides uneconomic demand for US dollars, this doesn’t happen.

It's better to keep financing the consumer of last resort to buy your stuff, right?

Doing so is fine in the short term, but in the long term, it catches up with us…

And with the US having accumulated US$36 trillion in Federal debt (not to mention trillions in government-backed mortgage debt and corporate and private sector debt), Trump has said, ‘enough is enough’.

He knows that this system will completely bankrupt the country at some point. So he’s trying to engineer painful change now.

The magnitude of pain will depend on the timeframe. If Trump wants to shrink the trade deficit to zero, we’re talking a very deep global recession. You simply can’t shift a meaningful chunk of global production to the US in the short term.

So, the only way you get trade to balance is via a collapse in consumption.

Now, no one wants that. Not even crazy/genius Trump.

If I had to guess, the ridiculous tariffs levied, and Trump’s acceptance of related market volatility, is shock treatment designed to get countries to the negotiating table and quickly re-order the global trading system.

It’s also about isolating China. Levying a large tariff on China will put downward pressure on its currency and encourage capital outflows. That’s a big headache for the Chinese Communist Party trying to engineer an economic recovery.

This re-ordering of global trade will, over time, result in a structurally lower US trade deficit. This also means less inflow of capital to finance US consumption.

Now this is where it gets interesting…

Less foreign capital flowing into US capital markets means a weaker dollar, perhaps structurally higher interest rates, and lower asset prices.

Which is where the Fed comes into it.

The Fed will have to step in and provide liquidity to a US banking system that no longer receives an abundant inflow of foreign capital.

What I have just described is a very high level framework for how to think about the potential impact of what Trump is trying to achieve.

My guess is that this will be long-term beneficial for the US and global economy but short-term negative for what has become highly financialised capital markets.

Broadly then, I would favour real assets and quality businesses that sell enduring products over ‘financialised assets’, like banks, private equity and private credit.

I think that is where you want the majority of your capital to be as we head into this ‘new paradigm’.

The crucial point to understand is that this IS a ‘new paradigm’. What we’re witnessing now will go down as a momentous occasion in financial history.

But in the same way that Buffett has endured over the decades with a simple value investing philosophy, as value investors, so will we.

It doesn’t matter what the paradigm is. Good businesses bought at attractive prices will always do well over the long term.

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