Today I’d like to discuss the United States’ provision of what economists call “global public goods,” for the entire world. First, the United States provides a security umbrella which has created the greatest era of peace mankind has ever known. Second, the U.S. provides the dollar and Treasury securities, reserve assets which make possible the global trading and financial system which has supported the greatest era of prosperity mankind has ever known.
Both of these are costly to us to provide. On the defense side, our men and women in uniform take heroic risks to make our nation and the world safer, preserving our liberties generation after generation. And we tax hardworking Americans mightily to finance global security. On the financial side, the reserve function of the dollar has caused persistent currency distortions and contributed, along with other countries’ unfair barriers to trade, to unsustainable trade deficits. These trade deficits have decimated our manufacturing sector and many working-class families and their communities, to facilitate non-Americans trading with each other.
Let me clarify that by “reserve currency,” I mean all the international functions of the dollar—private savings and trade included. I’ve often used the example that when private agents in two separate foreign countries trade with each other, it’s typically denominated in dollars because of America’s status as the reserve provider. That trade entails savings housed in dollar securities, often Treasurys. As a result of all this, Americans have been paying for peace and prosperity not just for themselves, but for non-Americans too.
President Trump has made it clear that he will no longer stand for other nations free-riding on our blood, sweat, and tears, whether in national security or trade. The Trump Administration has already, in its first hundred days, moved forcefully to reorient our defense and trading relationships to place Americans on fairer ground. The President has promised to rebuild our broken industrial base and pursue trade terms that put American workers and businesses first.
I’m an economist and not a military strategist, so I’ll dwell more on trade than on defense, but the two are deeply connected. To see how it works, imagine two foreign nations, say China and Brazil, trading with each other. Neither country has a currency that is trusted, liquid, and convertible, which makes trading with each other challenging. However, because they can transact in U.S. dollars backed by U.S. Treasuries, they are able to trade freely with each other and prosper. Such trade can only occur because of U.S. military might ensuring our financial stability and the credibility of our borrowing. Our military and financial dominance cannot be taken for granted; and the Trump Administration is determined to preserve them.
But our financial dominance comes at a cost. While it is true that demand for dollars has kept our borrowing rates low, it has also kept currency markets distorted. This process has placed undue burdens on our firms and workers, making their products and labor uncompetitive on the global stage, and forcing a decline of our manufacturing workforce by over a third since its peak1 and a reduction in our share of world manufacturing production of 40%.
We need to be able to make things in this country, as we saw during Covid, when many of our supply chains could not survive without being reliant on our biggest adversary, China. We clearly should not rely on our biggest adversary for equipment essential to keeping our population safe and secure. Nor should our biggest adversary be allowed to benefit so much from an international security and financial architecture we finance.
There are other unfortunate side effects of providing reserve assets. Others may buy our assets to manipulate their own currency to keep their exports cheap. In doing so, they end up pumping so much money into the U.S. economy that it fuels economic vulnerabilities and crises. For example, in the years running up to the 2008 crash, China along with many foreign financial institutions, increased their holdings of U.S. mortgage debt, which helped fuel the housing bubble, forcing hundreds of billions of dollars of credit into the housing sector without regard as to whether the investments made sense. China played a meaningful role creating the Global Financial Crisis. It took almost a decade to recover, until President Trump got us back on track in his first term.
In my view, to continue providing these twin global public goods, there needs to be improved burden-sharing at the global level. If other nations want to benefit from the U.S. geopolitical and financial umbrella, then they need to pull their weight, and pay their fair share. The costs cannot be solely borne by everyday Americans who have already given so much.
The best outcome is one in which America continues to create global peace and prosperity and remain the reserve provider, and other countries not only participate in reaping the benefits, but they also participate in bearing the costs. By improving burden sharing, we can enhance resilience, and preserve the global security and trading systems for many decades into the future.
Moreover, it is critical not just for fairness, but for capacity. We are under siege by hostile adversaries trying to erode our manufacturing and defense industrial base and disrupt our financial system; we will be able to provide neither defense nor reserve assets if our manufacturing capacity is hollowed out. The President has been clear that the United States is committed to remaining the reserve provider, but that the system must be made fairer. We need to rebuild our industries to project the strength needed to protect reserve status, and we need to be able to pay our bills to do so.
What forms can that burden sharing take? There are many options, here are a few ideas:
- First, other countries can accept tariffs on their exports to the United States without retaliation, providing revenue to the U.S. Treasury to finance public goods provision. Critically, retaliation will exacerbate rather than improve the distribution of burdens and make it even more difficult for us to finance global public goods.
- Second, they can stop unfair and harmful trading practices by opening their markets and buying more from America;
- Third, they can boost defense spending and procurement from the U.S., buying more U.S.-made goods, and taking strain off our servicemembers and creating jobs here;
- Fourth, they can invest in and install factories in America. They won’t face tariffs if they make their stuff in this country;
- Fifth, they could simply write checks to Treasury that help us finance global public goods.
Tariffs deserve some extra attention. Most economists and some investors dismiss tariffs as counterproductive at best and devastatingly harmful at worst. They’re wrong.
One reason the economic consensus on tariffs is so wrong is because nearly all of the models that economists use to study international trade assume either no trade deficits at all, or assume that deficits are short-lived and quickly self-correct through currency adjustments. According to standard models, trade deficits will cause the dollar to weaken, which reduces imports and boosts exports, eventually wiping out the trade deficit. If that happens, tariffs may be unnecessary, because trade will balance itself over time and, in this view, intervening with tariffs can only make things worse.
However, that view is at odds with reality. The United States has run current account deficits now for five decades, and these have widened precipitously in recent years, going from about 2% of GDP in the first Trump Administration to a high of nearly 4% of GDP in the Biden Administration2. And this has happened all while the dollar has appreciated, not depreciated!
The long run is here, and the models are wrong. One reason is that they fail to account for the U.S. provision of the global reserve currency. Reserve status matters and, because demand for the dollar has been insatiable, it has been too strong for international flows to balance, even over five decades.
More recent economic analyses3 allow for the possibility of persistent trade deficits that resist automatically rebalancing, which is more in line with reality in the U.S. They show that by imposing tariffs against exporting countries, the U.S. can improve economic outcomes, raise revenues, and impose huge losses for the tariffed nation, even with full retaliation.
In this sense, analysis of what economists call the “incidence” of tariffs indicates that a large share and burden of the tariffs are “paid for” by the country on which we’re applying the tariffs. Countries that run large trade surpluses are pretty inflexible—they can’t find other sources of demand to substitute for America’s. Instead, they have no choice but to export, and America is the largest consumer market in the world. By contrast, America has plenty of substitution options: we can make stuff at home, or we can buy from countries that treat us fairly instead of from countries that take advantage of us. This difference in leverage means that other countries end up bearing the cost of tariffs.
In 2018-2019, China bore the cost of President Trump’s historic tariffs through a weaker currency, meaning their citizens became poorer, with less purchasing power on the global stage. The tariff revenue, paid for by China, was used to finance President Trump’s tax cuts for American workers and firms. This time around, tariffs will help pay for both tax cuts and deficit reduction.
Lower taxes on Americans, financed in part by revenue provided from foreigners, will create economic growth, dynamism, and opportunity the likes of which our country has never seen, ushering in President Trump’s new Golden Age. Deficit reduction will help lower Treasury rates, and with them mortgage rates and consumer credit card rates, stimulating an economic boom.
It is important to note here that tariffs are not levied simply to collect revenues. For example, the President’s reciprocal tariffs are designed to address tariff and non-tariff barriers and other forms of cheating like currency manipulation, dumping, and subsidies to gain unfair advantage. Revenue is a nice side effect, and if it is used in part for lowering taxes, it can help turbo-charge competitiveness improvements that boost U.S. exports.
Burden sharing can allow the United States to continue leading the free world for many decades. It’s a must not only for fairness, but for feasibility. If we don’t rebuild our manufacturing sector, we will be strained in providing the security we need for our safety and to underpin our financial markets. The world can still have the American defense umbrella and trading system, but it’s got to start paying its fair share for them. Thank you, and I am happy to take some questions.
[1] https://fred.stlouisfed.org/series/MANEMP
[2] https://data.worldbank.org/indicator/BN.CAB.XOKA.GD.ZS?locations=US
[3] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5008591