Donald Trump has had his first Liz Truss moment

Greetings. For our American readers, are you tired of winning yet?

Much has been said about President Donald Trump’s “reciprocal” tariffs: how they are not reciprocal, how they will make Americans poorer and how they will harm the global economy — especially the ones that are allowed to come into force. This changes by the day, as shown by the sudden “pause” announced just in time for this column to note.

Instead of going over common ground, I want to talk about the economics of the manner in which the indisputably harmful tariffs were decided and announced. Trump’s methods (if they can be called that) cause harm in their own right, perhaps harm as significant as that from the tariff levels themselves, and certainly as relevant for how other countries should think about their response.

To paraphrase my colleague Robert Armstrong’s nice weekend column, it’s not the cost but the uncertainty that’s going to kill you. He was talking about markets’ dislike of unpredictability — but it is a point that applies more broadly and should inform policymaking in the countries now bearing the brunt of Trump’s policy vandalism. More below on why the lesson from a certain shortlived UK prime minister is that when a leader believes their own ideology to the point of dismissing reality, it’s time to take cover.

Let’s recap. Nobody had any idea until “liberation day” what the tariffs would be — not the general level to expect, and not how they would be differentiated between countries or types of goods. In particular, there was no attempt here to help businesses — American businesses — to prepare themselves as well as possible to the shock that was coming, or mitigate any downsides.

Then, once the tariffs were announced, it turned out that the method for setting them made no sense at all, was nothing like what Trump and his team had said they were going to do, and was not seriously designed to achieve any intelligible economic goal. (Even if your goal was to reduce America’s goods trade deficit, this would be an awful way to go about it, compared with, say, just a high uniform tariff, or a broad manufacturing subsidy.) There was no attempt either to let people know a pause was in the offing.

And finally, the administration has evinced no shame when it has been pointed out that its reverse-engineered formula to get tariff rates out of trade deficits is a piece of junk or looks plucked from a cheap artificial intelligence chatbot. What it has said, though, is that the tariffs could quickly change depending on what offers other countries make. As my colleague Alan Beattie likes to point out, when it comes to Trump tariffs nobody knows anything.

There is one (well, two) words for this: policy uncertainty. Policy uncertainty is the defining feature of Trump’s trade policy and may even be its primary purpose. At the very least, the uncertainty is rooted in a total neglect, even scorn, of two essential things: maths and facts.

And this is why “liberation day” is the Trump administration’s Liz Truss moment. Like the former UK prime minister’s “mini” Budget in 2022, Trump’s trade policy reveals that the people at the top don’t care if their policies add up, make sense, or will actually work. Belief is all. So as with the market reaction to Truss, which reflected less that she was increasing the deficit than that she was giving up any pretence to reality-based policymaking, the market reaction to Trump has as much to do with the sheer dumbness of how the tariffs were chosen as with the damage they will cause (wherever the tariffs end up).

To summarise any sensible person’s reaction to “liberation day”: the people in charge have drunk their own Kool-Aid, so God help us.

For now, how can we help ourselves? By recognising three important things to remember about policy uncertainty.

First, it can be measured and is a real quantity with real effects on hard economic activity. And the measures we have show it soaring. Here is the policy uncertainty index charted by my colleague John-Burn Murdoch:

Relatedly, Morning Consult’s daily index of US consumer confidence has just registered its steepest two-day fall since the onset of the Covid-19 pandemic.

Second, we have good knowledge of the economic effects of uncertainty — that is to say, the evidence confirms that those effects are bad.

The theory is clear enough: the standard economic view is that people dislike volatile outcomes, and will therefore retrench as uncertainty increases, by spending less and avoiding risky investments. So a rise in uncertainty reduces aggregate demand (both on the consumption and the investment side). That’s an immediate brake on growth. In the medium to long run, the supply side will be depressed by the lower investment (which comes on top of the immediate supply-side obstructions from tariff costs).

Is this born out empirically? It is. Here is one study finding that increased uncertainty about future inflation — even for a constant expected average inflation level — makes households postpone durable goods purchases, de-risk their investments and increase their work effort. This other study shows that increased uncertainty about future growth in GDP has similar effects.

Businesses, too, react to more uncertain GDP growth forecasts with lower prices, employment and investment, and by becoming less likely to adopt new technology or develop new facilities. And there is evidence that investors require higher returns — a greater risk premium — when macroeconomic uncertainty is more severe.

It makes perfect sense, then, that the dollar and US risk assets have been falling since the Trump tariffs were announced. A realisation that policymaking has gone crazy is a realisation that there is less money to be made, and more downside risk. Spenders and investors retrench. One difference between Trump and Truss is that US Treasuries are the ultimate risk-off assets, which UK gilts are not — so, initially, US yields fell after the tariff announcements, in contrast with how UK borrowing costs jumped on Truss’s “mini” Budget. But it seems like Trump has even managed to strip US Treasuries of their haven status — or caused investors to expect a recession big enough to outweigh that attraction. Whatever the reason, the US government’s borrowing costs reached their highest levels in weeks, after the initial fall.

Another difference is that in the UK system, Truss could be pressured to resign. Trump is staying. That means that despite Wednesday’s U-turn of most of his latest tariffs, the uncertainty remains. Indeed, who can know whether even the announced 90-day pause will stick?

This leads to the third point: what policies should other countries choose against this uncertainty? Here we come to the reason for emphasising that the damage from uncertainty is a separate and different one from the cost of the tariffs themselves. Try as you might to “do a deal” and negotiate down the tariffs on your country — and you may even succeed — you will not remove the uncertainty. Just look at Mexico and Canada.

That implies that different — and possibly incompatible — policies are required to protect from the two distinct types of damage. As far as the cost of tariffs is concerned, the remedy is of course to get them lowered — that is to say, to play Trump’s “dealmaking” game in order to restore or sustain your country’s trade with the US. But to minimise the damage from uncertainty, you have to do the opposite: reduce your exposure to Trump’s decisions by scaling down the US share of your country’s foreign trade.

This is the stark choice countries face: reduce the cost of tariffs but keep suffering the damage from uncertainty; or eliminate the damage from uncertainty but pay the cost of extracting yourself from your US relationships.

The world in which the former choice makes sense is one in which you think US policy uncertainty will fall — in other words, Trump’s policymaking to become more normal. Countries that don’t believe Trump will change, however, should look to free themselves from their vulnerability to his policy choices. If that were the long-term effect of Trump’s Truss moment, it would be a “liberation day” worthy of the name.

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