Tariffs & Q2 Growth Shock | Trade Maven Brad Setser on Trump’s Tariff Warpath, China’s Balance of Payments, and “Self-Induced Recession” Probabilities

Episode Summary

Executive Summary: Brad Setser argues that the Trump administration’s tariff plans are far larger, faster, and more chaotic than the 2018 China tariffs, creating major uncertainty, a likely near-term hit to growth, and inflationary pressure, with recession risk if broad reciprocal, sectoral, and North American tariffs all proceed. He also challenges claims of easy reshoring gains, warns the U.S. trade deficit is unsustainable, and says China’s surplus and accounting methods are more opaque than reported.

Main Topics: Scale and macro impact of new tariffs (Priority: 5/5): Setser says the announced and potential April 2 tariffs could amount to a shock of roughly 1% to 2% of GDP, materially affecting inflation, investment, and recession risk. Reciprocal tariffs and administrative complexity (Priority: 5/5): He explains that 'reciprocal' tariffs would be far more complicated than matching headline tariff rates because they could include VATs, non-tariff barriers, and currency undervaluation, producing uneven country-by-country rates. Short-term pain vs long-term reshoring claims (Priority: 4/5): Setser argues the immediate effect of tariffs is mostly negative, while any manufacturing reshoring benefits would lag by years and depend on policy permanence, exchange rates, and legal durability. U.S. trade deficit and external sustainability (Priority: 5/5): He contends the U.S. current account deficit, around 4% of GDP and possibly rising toward 5%, is not on a stable long-run path given the strong dollar and rising external debt. China’s trade surplus, accounting, and industrial policy (Priority: 4/5): Setser argues China’s current account surplus is understated by accounting changes and that China sustains surpluses through high savings, low consumption, subsidies, and buy-China preferences. Trump’s tariff strategy, Canada/Mexico, and foreign policy uses (Priority: 4/5): He says Trump likes tariffs as a discretionary power tool, but that using them against Canada, Mexico, Europe, or for non-economic goals like fentanyl and Greenland is unjustified and destabilizing. Policy alternatives: fiscal, tax, industrial strategy (Priority: 4/5): Setser favors narrower China-focused tariffs, fiscal consolidation, tax reform to reduce offshoring, and industrial policy such as CHIPS and the IRA rather than broad protectionism.

Key Arguments: The new tariff package could be much larger than the first-term China tariffs and large enough to trigger a recession if implemented broadly. Inflationary effects from tariffs can be close to the direct tariff burden because domestic producers may raise prices too, not just importers. Most gains from reshoring are delayed; immediate effects are higher prices, lower demand, and investment hesitation. Retaliation by trading partners is likely to reduce U.S. output and farm income, while being only modestly disinflationary. The U.S. trade deficit is tied to a strong dollar, large fiscal deficit, and elevated external debt; it is not on a stable path. China’s reported current account surplus appears understated, partly because of a methodology shift away from customs data and because investment income data look implausibly weak. China’s export strength is driven primarily by high savings, low consumption, industrial subsidies, state-bank financing, and buy-China preferences rather than just tariffs. Trump’s tariffs on Canada and Mexico are not grounded in a strong trade-fairness case; Canada in particular is the U.S.’s most balanced major trading partner in manufacturing. Tariffs can help against China, but broad tariffs on allies are counterproductive and undermine a broader coalition against Chinese trade practices. Tax policy and fiscal policy, not tariffs alone, are the most effective ways to reduce the U.S. trade deficit and reshoring distortions.

Data Points: Announced tariff impact on GDP: about 1% of GDP - Setser’s estimate of the 'just pay it' cost if all announced tariffs are implemented Potential impact with reciprocal tariffs: around 2% of GDP - Upper-end estimate if April 2 reciprocal tariffs and other sectoral tariffs are fully imposed China tariff first term GDP impact: about 0.3% of GDP - Setser compares the first-term China tariffs to the current proposed package Trump 1.0 China tariff aggregate change: about 15 percentage points - Average tariff increase on China in the first term, phased in over time U.S. 2025 real GDP forecast revision: 2.1% to 1.7% - Federal Reserve projection referenced in the discussion U.S. current account deficit: about 4% of GDP - Setser cites latest data on the U.S. external balance Possible future current account deficit: closer to 5% of GDP - His projected path if conditions persist U.S. net external debt: about 50% of GDP - Debt component excluding equity fluctuations U.S. net international investment position: negative 70% to 80% of GDP - Broad external position including equities China customs goods surplus: about $1 trillion - Setser’s reading of China’s reported trade goods surplus last year China current account surplus reported: about $400 billion to $420 billion - China’s reported current account figure in the discussion China current account surplus estimated by Setser: $750 billion to $800 billion - His estimate based on goods surplus minus services and skepticism about income data China services deficit: a little over $200 billion - Mostly tourism and travel spending abroad China reserves: over $3 trillion - Used to argue China should earn more investment income than reported China savings rate: above 40% of GDP - Explains persistent surplus and low import demand China imports for own use: about 4% of GDP - Imports of manufacturers for China’s own use after netting out re-export inputs China manufacturing exports net of imported parts: about 14% of GDP - Shows the scale of export intensity China manufacturing surplus: about 10% of GDP - Setser’s estimate after netting out imported parts Japan tariff example: 2.5% auto tariff in the U.S. - Used to illustrate how reciprocal tariffs could create big country-specific shifts U.S. pharma trade deficit: close to $100 billion with Ireland this year - Example of offshored production and tax-driven distortions U.S. trade deficit with Canada: about $50 billion to $100 billion - Setser argues this is relatively small and sensitive to oil prices U.S. trade deficit with China under first-term tariffs: about 30 to 40 basis points of GDP impact - His estimate of the first-term tariff package using a simple just-pay-it calculation

Pivotal Quotes: "If they go through with everything that could be done, actually quite large." — Brad Setser: On the potential scale of the tariff package and its macroeconomic importance "I think you're risking a recession, actually." — Brad Setser: On the likelihood that a maximal tariff package could materially damage growth "The short run, most of the effects of the tariffs is just going to be negative." — Brad Setser: On timing: pain arrives before any reshoring or factory-build benefits

Implications: Listeners should expect higher near-term inflation, weaker demand, and more policy uncertainty if broad tariffs proceed. The bigger message: trade deficits are tied to macro policy, the dollar, and tax structure—not tariffs alone.