Economics of a Global Market Mudpit
Julia Friedlander, CEO of Atlantik-Brücke, at the Munich Economic Debates. Credit: CES Ifo.
Our CEO Julia Friedlander was a guest at the Munich Economic Debates of the ifo Institute for Economic Research in Munich on March 24th. She spoke about the tension between US President Trump’s tariff policy and economic sanctions in the interest of national security.
By Julia Friedlander
Democrats and Republicans find little common cause, but both parties have one idea in common: economic statecraft. From sanctions to export controls to investment screening, the toolkit soared to new heights under the first Trump administration and continued into the Biden years, mostly targeting China. Europe was a free-rider, but ultimately a likeminded party to be brought on-side when facing Beijing—friendshoring was the explicit goal, whether by nudge or by force. Now, Donald Trump is taking matters lightyears further – and using tariffs not as trade remedies, but as a form of sanction-like coercion, against the world. And in doing so, instead of building a ring of fire around China, America risks forcing one against itself
Sanctions vs. Tariffs
When the president announces tariffs on Mexico and Canada because of drug flows and immigration, and then turns around and threatens BRICS countries with tariffs because they are “de-dollarizing” he is reaching far beyond trade platitudes – he is seeking concessions or revenue or both. Two week before the implementation of “reciprocal tariffs,” no one seems to know what he means, or stranger yet, he doesn’t seem to know what he means, either. For decades, politicians of all persuasions have threatened financial sanctions on many things and people in a “don’t-do-this…or” format—from small-fry Balkan agitators to entire nations, so Trump-ist modalities are not as unfamiliar in American policy vernacular as many believe. But sanctions and tariffs are apples and pears—mostly because physical things and money (now rarely a physical thing) move about the world differently. And America will ultimately be ill-suited for a standoff based on the latter.
I have always argued that unprecedented measures against Russia beginning in February 2022 risked crossing the boundary between economic penalty and economic war. The sanctions—and particularly the blocking of sovereign assets—could have shattered the Russian economy or sent it into uncharted economic survivalism. The US and its partners acted with such resolve that the actions of 2022 tested whether sanctions could steer the course of live military conflict or sever a major global economy from its financial lifelines.
While the Russian economy has undoubtedly suffered and the government reaches further into emergency economic measures, western policies forced Moscow towards a new form of creative resilience. It has done so through the worst set of bedfellows including Iran and North Korea. But more importantly, it has elevated a broad set of third parties, close partners of the US such as India and the United Arab Emirates, who are happy to generate trade diversion tactics and alternative patterns of trade settlement to their benefit. Russia’s war economy cannot churn forever: it is massively inflationary, but Putin’s military has more capacity than it did before the war.
Still, the massive sanctions escalation on Russia was worth risking. For all its complications, the collective G7 showed it was willing to deliver the heavy hammer. The move was a strategic success because it surprised Putin – and President Xi – while the risks to Western markets were low—and especially low for the United States.
But that rationale does not apply to China, or to trade barriers more broadly deployed as a form of coercion in the US national interest. Building economic resilience requires prioritizing trade challenges, building alliances and offering incentives to emerging markets and industrial competitors alike. The sarcastic quip at the US Treasury has always been: don’t sanction everything at once so you have something left to sanction. That is, choose your targets wisely.
In the new administration, prudence may not advise the tariff onslaught, and the risks of a backlash are real. Donald Trump and a subset of his economic team seek a wide swath of tariffs on the world, as well as steeper investment controls on China. They are pursuing a theory—hence untested in the modern era—that the purchasing capacity and consumer market of the world’s biggest economy have amassed enough leverage to force a reindustrialization of the country, and to charge a premium for those seeking to buy US debt, effectively reducing what the US currently owes the world in interest. However, even before the shots have been fired, countries have quickly begun to question: just how indispensable is the US market—and for how long?
Sanctions are first and foremost the territory of financial markets, where the dollar governs all major global transactions. Trade flows and settlement are another matter —who moves what and where is a murkier target for US tariffs than financial flows are for the US dollar. With global supply chains morphing in the aftermath of the pandemic, new sudden jolts to the trading system will lead to fragmentation, higher costs for US consumers, and question the business models of many of the US’ most globally competitive companies. Trump and some advisors are starting to argue that a short recession is a necessary sacrifice for the longterm structural gain for industry, while other advisors look like they’ve been losing sleep. Leaving voter interests and the price of eggs aside, how long can this “economic detox” last before it becomes a structural loss? Or how long will the country hold out politically for this experiment to bear fruit?
Someone Else’s Trade Rules Now
From an eagle-eye view, creative thinking is welcome. Global trade rules are not working properly, and tariffs can have their usefulness. Both parties in Washington acknowledge that WTO rules do not suit the 21stcentury economy due to the rise of digital trade and because China has so glaringly abused its developing country status to the detriment of advanced industrials. Most parties in Europe agree but are not as eager to flaunt the rules in return, nor were they ever of the opinion that blocking the appointment of judges to the appellate body has ever helped.
But it is not only China poised to limit our range of motion. Miniature trade arrangements between emerging economies and developing regions are cropping up through a web of bilateral and trilateral ad-hoc arrangements. While this behavior, in time, might help force new international trade rules, right now it looks like growing economies around the world are carving out new advantages while the heavyweights who drew up the rules revisit their own history.
At the G20 in Brazil—a group heralded by the United States to navigate through the global financial crisis— the summit’s hosts avoided hot-button foreign policy issues such the Gaza War to account for country positions that starkly differ from those of the United States. Almost in parallel, Peru christened a Chinese-owned megaport on the heels of the APEC summit, which could bypass US trade routes entirely—no wonder Trump forced a US hedge fund into the ownership structure of the Panama Canal. Now, the US administration will not show up to South Africa’s meeting of the Group—citing mistreatment of white South Africans. That may sound like a gripe of Elon Musk, but to many others it sounds like the cry of a sore loser. No, the G20 isn’t just there to solve Western problems anymore, so it’s not worth showing up if it’s not our show.
Since the second half of the Obama Administration, Washington has tried various tactics to cope with the relative loss of economic power. With post-NAFTA globalization taking hold, in the aftermath of the financial crisis, the disaster of the Iraq War and neoconservative nation-building in Afghanistan—we witnessed an empire in overreach. Such empires have to pay it forward to maintain their status—and the US was ready to contribute the largest share of the UN, NATO, and recognize the developing country status of the WTO. But the US was also ill-prepared for the world that it propped up to begin asserting itself. Overestimating the staying power of Western economic advantage, we overlooked trade basics, that open markets create an overall increase of welfare for all participants, but also a convergence of wealth. There are of course easily parallels to be found in Germany’s expanded trade and investment relationship with China.
Unwinding the Unique American Problem
Given the predatory behavior by China, and to a much lesser extent, imbalances with the European Union and in the Western Hemisphere, there is understandable bipartisan consensus to address the disadvantages felt by the American workforce. There is nothing wrong with selective protectionism—every country has it—but it is worth understanding that these moves are risky business. Despite its market power, energy independence, and consumer base, the United States can still become an outsider. When countries try to work around US sanctions (and they do so all the time in very creative ways), we call it evasion. When countries work around the US market, it’s called trade diversification.
The core problem with accelerating a tariff standoff with the world all at once is that the US economy generates 25% of global GDP. This may come across as a massive point of leverage- or an indication of how intertwined the economic health is with the world. Cheerleading China’s economic slowdown as a chit for team America, which the Biden Administration often did to demonstrate that its chosen policies were working and Chinese GDP would never overtake the US, is misguided. Global GDP is not a zero-sum game.
Increasing barriers to entry will force some firms to reshore intermediate production to the United States, but also incentivize many to reduce their footprint in producing US exports. Discussions have already begun in earnest among traditional allies and competitors how to ringfence their trade flows around the United States. New York functions as the global financial center not only because of the depth of its capital markets but because of trade financing. And if there’s any comparative advantage the United States has over others for the foreseeable future, it is our broad and deep marketplace.
It is true that the US also pays a price for protecting the world’s reserve currency. The capital markets contribute a predominantly large share of GDP compared to our closest partners, and our rising debt is financed by cheap interest rates. That sounds very advantageous at first. However, other countries have bought this debt to underpin their own export markets. At this point, Germany has always been a thorn in the side.
Because no one has provided a sufficient answer to address America’s entrenched vulnerabilities, creative, fringe theories gain traction. Combine the calculations of a few brainiac economists no one use to listen to, Musk’s penchant for creative destruction, Vance’s millennial-generation populism, and Trump’s ability to give concessions to his negotiating partners and call it his own victory, and here we are today.
Friendshoring without America
The evidence of diversification away from the United States is still anecdotal because it is still so fresh, but it is also happening fast. Canada is poised to join the EU’s new military funding mechanisms and call off its orders of F-35 fighter jets, right at the time when tariffs will damage American aerospace manufacturing. Chief economists at European banks are full of bright ideas how to leverage Germany’s massive spending bazooka to create new credit markets for European investment, and already have colorful graphs showing investment flows moving to Europe to avoid US whiplash and “buy European” before valuations rise higher. It is mid-March. Two months ago, I spoke at a conference in New York where I was met with skeptical glances when I encouraged investors not to ride off Germany entirely.
Again, tariffs can be a necessary measure, even when there are potential drawbacks. The debate last year over Germany’s refusal to back EU tariffs against Chinese electric vehicles felt like gazing into the funhouse mirrors at a carnival—every time you see an odd new reflection of yourself and you’re not sure which one is the real you. Was allowing China to flood the market with cheap electric cars worth the bet on a dwindling number of luxury diesels going in the other direction? It was the dregs of mercantilism. Two months later, deficit spending, defense, and industrial policy are clearly back, and at just the right time for industry. Biden’s justification for the Inflation Reduction Act had a three-pronged message: create jobs, accelerate the energy transition, and compete with China. Germany just passed its own version, and the prongs are: defend Europe from Russia, save German factories, and compete with the United States.
For the Biden crew, every policy was about friend-shoring, near-shoring, or ally-shoring. The tool of choice was export controls, which relied heavily on the participation of likeminded partners to be successful, despite the size of the America market. Admittedly, no one knew how “small” the “yard” would remain or how “high” the “fence” was to become. If the semiconductor industry was the core, high-end technology and dual use goods radiated out like a weird sun. The result was not to delay China where it might really matter, in artificial intelligence; the result was DeepSeek, so it’s fair game to say this wasn’t a watertight strategy.
For the Trump administration, round two, it’s not clear that it matters what goods are sold to the United States and what for, only that there is too much of them. This is a weakness. Once you are in dodgeball territory, friendshoring around the United States can be successful every time investment is diverted or prices rise. Everything becomes a Mexican avocado.
Conclusion
The tenor of political debate has become rough and frankly hard to listen to. I tell my team repeatedly that the louder a leader screams or threatens, the less power he or she will have. One rarely yells out of a position of strength, but out of a feeling of perceived loss. I’m not only talking about America, of course.
Trade relations between the US and the EU are going to get worse before they get better. I was part of the team that designed the meeting between Trump and Jean-Claude Juncker in July 2018 that led to a trade truce, and the European “price for peace” was low. A few months later Germany received a reprieve from automobile tariffs, also by not giving all that much. That’s the Trump surrounded by a more traditional set of advisors. Now we will see trade deficits, taxation and technology regulation thrown into one bucket and a taste for further escalation. But escalation creates vulnerabilities, and the global trading environment is not America-centric, is a free-for-all, global market mudpit. As an American, I see the problems with the status-quo with clear eyes and will hear out any theory that addresses entrenched structural problems in our economy. But as a European (or soon to be, at least) I see how disruption has given Europe much to gain.