To a geopolitical crisis and an economic crisis we must now add a financial crisis, one capable of making the others much, much worse. President Donald Trump’s sudden retreat from the worst version of his tariff policy, a retreat any normal leader would have considered humiliating, came because he and his Wall Street backers could see that by midweek US financial markets were on the edge of disaster, a disaster capable of rivalling or even exceeding the crash of 2007-08.
That danger has been averted, for the time being, because Trump was persuaded to step back a few meters from the cliff’s edge to which he had taken America and the world. But the danger has not gone away, and the cliff is crumbling every day. The biggest danger lies not in the wild movements in equity markets that Trump’s trade war has caused, but in a loss of faith in US government debt.
It is looking much like the euro sovereign debt crisis of 2010. As with European government bonds at that time, US Treasury bonds have been seen as the safest of all financial assets, as they have been backed by the most trustworthy of governments. With that trust now shattered, attention has turned
- to America’s $36 trillion public debt – a debt 12 times as large as Italy’s, or four times as large as Japan’s;
- to the impact of a likely recession on that debt;
- to the associated rise in interest costs; and
- to whether the Trump administration might consider using US public debt and the US dollar as bargaining tools.
Moreover, as China is one of the biggest foreign holders of US Treasuries, the fact that Trump has now in effect declared a full blockade against imports from China by imposing a 125% tariff must increase the chances that China will dump its US Treasuries in response, even if it would take a big loss in doing so. Beijing has said it is willing to fight the trade war “to the end,” so the $759 billion of US Treasuries it held at the end of 2024 represent an obvious weapon.
Trade tariffs are bad enough, but this financial destabilization is extremely dangerous. Markets depend crucially on confidence in the resilience and good faith of the counterparties with whom business is done, many of whom have looked strong because of their holdings of US Treasuries. When safe assets start to look unsafe, calculations about the riskiness of all financial institutions start to change, and everyone’s financing costs rise.
Just as in 2008 the collapse of the Lehman Brothers investment bank led to a series of other crises, a similar phenomenon could unfold in America now. Fortunately, the US Federal Reserve Board can still be relied upon to support the financial system by buying Treasuries, as the European Central Bank also did by promising to buy European debt after 2010 – but the chaotic state of government in America means that the US Treasury and the White House cannot be relied upon in the same way.
Some basic facts about Trump need to be borne in mind. As a businessman he has filed for bankruptcy four times to default on his debts. He knows nothing about international trade and economics, but he is a world expert at vindictiveness and at using power for self-advancement.
Sad to say, he is capable of deciding that it would be smart for America to force a renegotiation of its debts – and capable of overruling advisors who might warn against it.
This leaves America and the world facing three harsh realities: about trade; about trust and uncertainty; and about how the way countries now deal with each other is becoming at least as important as their dealings with the world’s leading superpower, the United States.
On trade, Trump’s tariff retreat has simply changed the label on his policy from “disastrous” to “hugely damaging.” The 10% tariff on imported goods that will now apply for the next 90 days to virtually all countries except China still represents a tax that is three times as high as before he took office, and the extra tariffs he has left in place for steel, aluminum and cars still mean that the overall barrier he is building against imports is higher than America has had for a century.
What is still disastrous is the uncertainty that the policy is creating. No big business, whether American or foreign, can comfortably plan long-term investments in the United States while knowing that major factors could be changed by Trump at a moment’s notice.
Just days after declaring that tariffs on Chinese goods would not be lowered during the 90-day “pause” he suddenly announced that all imports of smartphones and other electronic goods – 80% of Apple’s iPhones are built in China – would, after all, benefit from the pause, before then confirming that this tech exemption would be temporary. No one knows where they stand.
The erosion of the rule of law through attacks on judges and on major law firms also adds to the growing risk of doing business in America. Trump may think that his trade policy is going to induce hordes of companies to build factories inside his tariff wall, but the uncertainty and loss of trust is acting as a big discouragement
In both political and commercial terms, the rest of the world is becoming estranged from America, previously a close ally to many and a valuable market to all. As in a marriage, an estrangement is not necessarily permanent – but it alters behavior fundamentally and leaves long-term damage behind it.
The third reality is that this estrangement must be dealt with by forming new relationships with others. Countries need to seek ways to create and sustain multilateral institutions that do not rely on America.
In trade, that is relatively easy, as blocs such as the European Union, Mercosur in Latin America and the Trans-Pacific Partnership in Asia already exist and can negotiate among themselves. China will not be taken into those blocs as a full member – but negotiations with it will be more straightforward than they now are with Trump’s United States, for common interests will be easier to find.
In finance the task is harder and will take more time, because the role of the US dollar as the world’s main reserve currency and the centrality of American banks will be hard and costly to shake off. The immediate task must be one ensuring that our own financial institutions are robust enough to survive a crisis. But for the longer term, countries will need to find ways to become less dependent on the US dollar and less vulnerable to American financial bullying.
This was previously just the domain of countries like China, Russia and Iran that felt threatened by US sanctions. We are truly in a new world.
Formerly editor-in-chief of The Economist, Bill Emmott is currently chairman of the Japan Society of the UK, the International Institute for Strategic Studies and the International Trade Institute.
Updated by the author, this article, which originally appeared in La Stampa in Italian on April 12, is republished with kind permission.
