“There are weeks when decades happen”, Lenin famously said. The first two weeks of April this year have been such an event: major foundations of the global economic order have been shaken. The Trump Administration’s announcement of the so-called reciprocal tariffs package (which, notably, has nothing to do with reciprocal tariffs) are on par with huge post-war events like the Nixon shock in 1971. Then the US pulled out of the Bretton Woods system of gold-linked exchange rates and introduced new tariffs on US imports. The world economy entered a long decade of high inflation and recessions, exacerbated by stop-go monetary policies and general unpredictability in economic policy. Unless economic and monetary policy are carefully managed in the coming months and years, the scale of the Trump chock may become bigger.
The level of average tariffs in the US has been radically raised – even above the levels introduced with the infamous Smoot-Hawley Tariff Act in 1930. The EU, for instance, is now faced with an average tariff of 10 percent, the new baseline US tariff. After the reprieve from the “reciprocal tariffs” that was announced on April 9 – which is due to last for 90 days – the additional ten percentage points of announced new tariff rate on imports from the EU are paused for the time being. But President Trump talks about adding additional tariffs in a next round of tariff hikes, including tariffs on pharmaceutical products, which were exempted in the first package. China, on the other hand, has not been spared at all: Trump’s tariffs and China’s responses have taken bilateral tariffs between to such levels that most trade between them is just going to stop.
The Smoot-Hawley Tariff Act contributed to prolong the economic depression in the 1930s. Along with tight monetary policy, and retaliatory trade actions, they spurred an international development of banking collapses and an environment of seemingly permanent economic slump. The key lesson then, as with the Nixon shock in the 1970s, is that new trade protectionism cannot be separated from the general global macro-economic environment. While the history is rich with episodes of small-scale tariffs actions and minor trade wars, huge trade actions by major economic powers will affect global capital markets and the ability of companies and governments to fund themselves. Ultimately, the status of currencies, and the systems of relations between currencies, get affected too: governments, central banks and companies will no longer be able to trust established monetary arrangements and they need to reduce their own exposure to the financial risks.
It is such concerns exactly that spurred the very strong market reactions to Trump’s tariffs. Estimates that had been done prior to the announcement of the tariff package had pointed to moderate negative effects on the economy. Gross Domestic Product was estimated to go down for 2025 with some percentage points while the price of imported goods was going to go up, adding some new inflation pressures on the economy and making it less likely that the US Federal Reserve would cut their policy rates. Recession risks, however, were still seen as moderate. The basic assumption was that the US economy is strong and can weather temporary effects from new tariffs. The US dollar would appreciate, if it would be affected at all.
These estimates turned out to be wrong. In fact, they were badly wrong. While it is true that pre-announcement estimates had not assumed a very large increase in the US global tariff rate, their major fault was to discount the scenarios in which markets would start losing trust in the US economy and in US economic leadership. The US is a strong and important economy, but its trade sector is integrated just not in complex global production networks but also in a much broader financial economy. Trust in US institutions is a fundamental reason why the US dollar is the preeminent world currency and why global investors use US financial institutions disproportionally. The 10-year US treasury bond has been an anchor for global debt markets for a long time – and in the first weeks of April its yield increased a lot. With a shambolic fiscal policy and fiscal deficits in the region of 5-plus percent of GDP in the past years, despite having a good business cycle, the Trump administration was pushing the economic to the brink. Total government debt has surpassed 100 percent of GDP and debt service now exceeds total US spending on military defence. Unfunded liabilities in the social security and Medicare systems are astronomical. This situation alone is an accident waiting to happen.
Growing distrust in the US economy is exacerbated by expectations that notable voices in the Trump administration wants to engineer a change in the global macro-economic order. No one really knows the thoughts of President Trump. He has long favoured US mercantilism and policies that would raise tariffs. Yes, he’s called himself the “Tariff Man” and even elevated tariffs to the most beautiful word in the English dictionary. But others view him as transactional and thinks he wants to cut trade deals: the tariff assault is just the extravagant opening bid in a negotiation process that will result in reduced tariffs. Those who have read The Art of the Deal, Donald Trump’s 1987 book, will nod and say there is a method in the madness. They will also say that, more than anything else, Trump ties himself to US power and a strong dollar: he won’t risk the country’s silverback status by throwing the global economic order overboard.
Perhaps it’s right that Trump is playing four-dimensional chess and that his aggressiveness is just a covert strategy for actually expanding trade opportunity. I doubt that very much, however. In the first place, the one constant in Trump’s political life since the 1980s is his dislike of trade deficits. He thinks trade deficits are the result of other countries ripping the US off. That view on trade deficits also sits comfortably with the grander macroeconomic strategies of Scott Bessent, the US Treasury Secretary, and Stephen Miran, Trump’s chair in the Council of Economic Advisers. They want a new global macro accord – what has been dubbed a Mar-a-Lago accord – that appreciates other world currencies against the US dollar and push the trade deficit down. At least Miran thinks tariff hikes are part of the toolbox to achieve such a result. It is true that he and Bessent do not want to challenge US financial primacy – or risk having to pay much higher interest rates on all the US public debt that needs to be rolled over every year. But their bigger vision for US macroeconomic performance confirms the expectation: the US now wants change rather than stability in the global economic order.
What speaks even more in favour of a lasting US change – and that the 90-day reprieve on tariffs won’t result in many new trade agreements – is that tariffs play to the monarchical, Machiavellian essence of Trump’s political personality. He is centralising power and side-lining the US Congress: the big tariff package was decided only by the President because he had declared a national emergency. In his position now, Trump can cut some smaller deals and exchange some favours with companies that dance to his tune. Even if Wall Street does not like the tariffs, the new system of oligarchy that is growing under Trump will reflect his ascending power. There is a name for the type of economic system that Trump seems to favour and that high tariffs produce: crony capitalism.
The character of President Trump, and his regime, is what makes it difficult for other countries to work out how to deal with him – or how to respond to the tariff assault. Fortunately, the EU has been careful and calm in its response, and made a point about not rushing to retaliation. Obviously, there are voices in Europe using irresponsible language, talking up muscular and impulsive responses. As always, there are many Europeans with anti-American instincts and a “superiority-inferiority complex” who now spot an opportunity to be aggressive. Notably, many of them are downplaying the risks that a Transatlantic trade war may pull the rug under the feet of Transatlantic defence cooperation. Sober heads, however, understand that Europe now needs to be cautious and not imperil out security by tit-for-tat trade protectionism.
The first principle for Europe’s policy should be to avoid as far as possible to import US financial turbulence into the EU. Trump is injuring the US economy and we should not respond by injuring the EU economy even more. The EU economy will of course be affected by the US tariffs: forecasts of growth for 2025 has already been revised downwards. But the direct injury would be a lot higher if Europe would respond in kind, and even open new fronts in a trade war by targeting services, intellectual property, and financial flows.
Additionally, such responses would also risk the credibility of EU institutions and their reputation for competent economic management. The peril of Trump-like protectionism is that they cause so much chaos and confusion that firms and consumers hold on to their money. This is the recession or even depression-like territory that, alarmingly, US indicators already started to show in the week following the big tariff announcement. Once the vicious cycle has started, companies and businesses spend less and rather prefer to improve their financial balances. In the process, they are also reinforcing downward pressures in economic activity. Europe stared into the same abyss during the Eurozone crisis. We should not repeat the experience.
A second response is to craft new forms of international trade collaboration with likeminded countries – especially countries in the Anglosphere and free-market democracies in Asia and Latin America. They, too, are fearing the consequences of a United States that is unplugging itself from global economic leadership. Nor do they think it is a desirable alternative to be pulled even more into the slipstream of China’s economic rise and succumb to norms and rules of trade and currency policy that Beijing demand. Now is therefore the time for new economic diplomacy and new forms of international economic collaboration – without US hegemony and unbound by the constraints of worldwide multilateralism.
A third strategy is to promote economic dynamism and growth in Europe. We have been a stagnating economic region for two decades. Productivity growth has been paltry. Investment is underperforming and inward Foreign Direct Investment have tanked in the past years. Some European economies are the frontier of technological change – embracing, for instance, the economic opportunities that artificial intelligence and quantum technology bring. Others, however, are stuck in an old industrial model and a mindset that is fearful of change they are not controlling. Unfortunately, Europe’s two largest economies belong to the latter camp.
Smaller and mid-sized economies in the Nordics, Baltics, Eastern Europe and now also Southern Europe are showing the benefits of structural economic reforms and being open to change. Better leadership for them can also lead the way for Europe. They have benefitted enormously from the Pax Americana and US economic leadership. Trump’s action may unleash Great Power conflict. He may also turn out to be a busted flush. Either way, smaller nations are the big casualties of a world order that is demoting liberal rules. In Europe, they now need to accept greater responsibility for recreating an order that generates greater prosperity and new security.