Trump’s Tariff Tsunami: Brad Setser Unpacks China, Trade Wars, and Dollar Policy

The Trump administration's aggressive tariff rollout has fundamentally altered global trade dynamics, with China's manipulated surplus data masking unprecedented economic disruption.

Key Takeaways

• Trump implemented tariffs faster and more aggressively than experts anticipated, using emergency powers instead of conventional trade tools
• Current tariffs are three times larger than first-term China tariffs, representing 1.25-2.5% of GDP impact
• China manipulated trade data methodology in 2021-2022, artificially lowering reported current account surplus by 1-1.5% of GDP
• Chinese goods bypass tariffs through Southeast Asian final assembly, maintaining trade flow resilience despite higher costs
• Europe faces 20% base tariffs with potential escalation to 30%, threatening comprehensive retaliation measures
• Currency appreciation, particularly for Asian economies, offers more effective trade rebalancing than complex tariff structures
• Re-industrialization requires targeted sector policies rather than broad-based tariffs that penalize American manufacturers
• Tax code incentives still reward offshore production, undermining stated re-industrialization goals

Timeline Overview

• Early 2025 (Inauguration-March) — Trump escalated China tariffs to 145%, China retaliated with rare earth export controls, bilateral trade nearly halted in affected sectors
• March-May 2025 — Administration backed down from peak tariffs, negotiated unilateral rollback to 20-30% levels, expanded focus to global tariff implementation
• May-July 2025 — European negotiations intensified with 20% base tariff threats, pharmaceutical and auto sector tensions escalated, retaliation lists prepared
• Current Period — Markets show resilience despite underlying structural disruption, inventory effects mask true economic impact, currency intervention debates emerge

Trump's Unprecedented Tariff Strategy

The administration's approach defied conventional trade policy wisdom. Brad Setser, senior fellow at the Council on Foreign Relations, emphasized the administration's radical departure from normal procedures: "I did not think he would move as quickly and as forcefully to put in place tariffs."

• Trump bypassed traditional Section 301 and 232 national security cases, relying heavily on the International Emergency Economic Powers Act for broad tariff authority
• Emergency powers concentration allows rapid tariff escalation without standard documentation processes or Congressional oversight constraints
• Current tariff magnitude reaches three times the scale of first-term China measures, creating unprecedented trade friction levels
• Base 10% across-the-board tariffs generate bulk revenue while sector-specific rates target strategic industries like automotive and steel
• Administrative speed caught businesses unprepared, forcing immediate supply chain decisions without adequate planning time
• Legal challenges mount against emergency authority usage, potentially threatening the entire tariff architecture if courts rule against executive overreach

The administration's willingness to use sanctions authority for trade policy represents a fundamental shift in executive power application. This approach eliminates traditional checks and balances that historically constrained tariff policy through Congressional involvement and WTO compliance requirements.

Economic Impact Delays and Market Disconnect

Stock markets reached record highs despite tariff implementation, creating a puzzle for economic observers. The disconnect reflects timing lags and inventory effects that mask underlying disruption.

• Companies avoided proactive price increases due to uncertainty about tariff permanence and negotiation outcomes
• Second quarter goods sales relied heavily on first quarter imports purchased before tariff implementation
• Pharmaceutical sectors built enormous stockpiles ahead of expected tariffs, delaying price transmission to consumers
• Government tax revenues increased as tariff collections boosted federal income, providing clear evidence of policy impact
• Q1 weakness attributed partly to tariff front-running behavior, while Q2 performance reflects inventory unwinding rather than genuine strength
• Third quarter expectations remain subdued as true tariff costs work through supply chains and reach end consumers

The tariff impact operates as "a modest drag on the economy" rather than triggering recession, according to Setser's analysis. This measured effect occurs because tax cuts partially offset tariff costs, creating a complex fiscal balance that complicates economic interpretation.

China's Data Manipulation and Surging Surplus

China fundamentally altered its trade accounting methodology during the pandemic, obscuring the true scale of its growing trade imbalance. These changes coincided with a dramatic expansion of Chinese manufacturing exports that now exceed historical German and Japanese surpluses combined.

• China switched from customs-based to survey-based balance of payments accounting in 2021-2022, reducing reported current account surplus by 1-1.5% of GDP
• Real effective exchange rate depreciated 20% over three years, driving record export volumes when adjusted for prices
• Current account surplus climbed back to 3-4% of GDP using Chinese data, but likely reaches 6% when properly measured through customs goods data
• Manufacturing surplus now represents 2% of world GDP, surpassing the combined peak surpluses ever achieved by Germany and Japan
• Net exports contributed two percentage points to China's growth in 2024, representing the majority of actual economic expansion given inflated official growth figures
• Export dependence reached unsustainable levels for a large economy, generating inevitable international backlash

Setser rejected the premise that "China's current account surplus has come down and stayed down. It came down and it's now shooting back up." The methodology change created a statistical illusion that masked China's return to massive surplus levels comparable to pre-global financial crisis peaks.

Trans-shipment Networks and Trade Rerouting

Chinese manufacturers developed sophisticated workarounds to maintain market access despite escalating tariffs. These strategies exploit legitimate final assembly rules while maintaining Chinese supply chain dominance.

• Solar panel production exemplifies the pattern: Chinese polysilicon, wafers, and cells get assembled into panels in Southeast Asia for US market access
• Electronics components flow to Vietnam, Thailand, and Malaysia for minimal final assembly before US export
• Taiwan serves as higher-cost final assembly location for premium computer products, leveraging technical expertise and established relationships
• Mexican auto market displacement rather than direct Chinese trans-shipment, with China selling domestically while Mexico increases US exports
• Final assembly constitutes legitimate "substantive transformation" under WTO rules, making enforcement extremely difficult
• Southeast Asian economies benefit from investment and employment while serving as trade conduits for Chinese manufacturing

The scale of rerouting demonstrates both tariff limitations and supply chain adaptability. Companies with advance warning established alternative production networks that maintain Chinese content while avoiding direct tariff exposure.

Policy Framework for Global Rebalancing

Effective rebalancing requires China to implement fundamental domestic reforms rather than simply facing external tariff pressure. The current approach lacks the coalition-building and targeted focus necessary for lasting change.

• China needs direct income support systems like earned income tax credits to boost low-wage worker purchasing power
• Tax system reform should reduce regressive consumption taxes and social security burdens on lower-income workers
• Social insurance centralization would reduce household precautionary savings and increase consumption propensity
• Currency appreciation represents the most powerful rebalancing tool, affecting all Chinese exports rather than just those facing specific tariffs
• Coalition building with Europe and other major economies would amplify pressure on China's surplus-generating policies
• US fiscal deficit reduction remains essential for global demand rebalancing, though current policy moves in the opposite direction

Industrial policy support for strategic sectors like semiconductors and batteries makes economic sense, but requires sustained commitment and protection from tariff uncertainties. The Chips Act demonstrated effective results before political changes disrupted implementation.

European Trade War Escalation

US-Europe negotiations have reached a critical juncture, with both sides preparing for potential trade war escalation. European willingness to accept limited tariffs conflicts with American demands for comprehensive concessions.

• Current US offer demands 20% base European tariffs plus 25% auto and 50% steel tariffs in exchange for avoiding 30% across-the-board measures
• Europeans reject the premise that their luxury auto exports or steel production constitute national security threats requiring punitive tariffs
• Digital services tax disputes center on European sovereignty versus American corporate interests, with Google and Facebook profit-shifting creating legitimate tax base concerns
• European retaliation preparation includes €25 billion steel tariff response list and €100 billion comprehensive tariff package
• Anti-coercion instrument represents "heavy artillery" allowing regulatory changes targeting US digital giants' profit engines
• Pharmaceutical trade recycling through Ireland creates complex tariff calculation challenges given integrated American corporate structures

Europe's willingness to accept 10% tariffs with concessions on sectoral issues suggests negotiation space exists, but American demands appear to exceed European political constraints.

Re-industrialization Contradictions

The administration's re-industrialization rhetoric conflicts with actual policy implementation. Broad tariffs often penalize American manufacturers while tax incentives continue rewarding offshore production.

• Brazil and Canada tariffs harm American manufacturers who export to these markets and import complementary commodities
• Canadian aluminum represents efficient, ally-produced inputs for American industry dating to World War II bomber production
• Tax code maintains 14% offshore rate versus 21% domestic rate, incentivizing pharmaceutical and technology companies to produce abroad for US market sale
• Applied Materials and Lam Research report Singapore and Malaysia profits respectively, demonstrating semiconductor equipment tax avoidance strategies
• Generic pharmaceutical production capacity degradation threatens medicine supply security without long-term tariff commitment guarantees
• Auto industry faces existential threat from Chinese overcapacity without targeted protection, justifying sector-specific tariff walls

Coherent re-industrialization requires eliminating perverse tax incentives, providing targeted sector support, and maintaining access to complementary inputs from allied nations. Current policy fails these tests while creating new obstacles for American manufacturers.

Currency Policy as Strategic Tool

Exchange rate adjustment offers the most comprehensive approach to trade rebalancing, affecting all bilateral flows rather than requiring complex rules of origin enforcement. Asian currency weakness has reached extreme levels that invite correction.

• Taiwan intervenes massively to prevent appreciation, creating clear currency manipulation that will trigger Treasury designation
• Chinese state banks conduct large-scale intervention using PBOC guidance, accumulating $40-50 billion monthly in recent periods
• Japanese yen weakness reduces purchasing power and creates domestic political pressure for policy change
• Coordinated intervention approach could mirror historical yen depreciation campaigns in reverse, with Secretary Bessent's trading background providing technical expertise
• Currency deals could trade tariff relief for intervention cessation, creating win-win outcomes for all parties
• Dollar strength undermines re-industrialization goals by making American production uncompetitive regardless of tariff protection

Trade negotiations that exclude currency issues miss the most powerful policy lever available. Currency appreciation affects all Chinese exports while eliminating complex enforcement challenges around trans-shipment and embedded content rules.

The Trump administration's tariff strategy has created unprecedented trade tensions while failing to address underlying global imbalances. Effective policy requires targeted approaches, coalition building, and currency realignment rather than broad-based tariff wars that harm American interests. Current trajectory threatens further escalation without achieving stated rebalancing objectives.