Damage Done

by Ryan Shea

One of the most popular speculations among the chattering classes after Trump won the 2024 presidential election was whether he would try to run for a third term, something that would require circumventing the 22^nd amendment introduced in 1951 that established “No person shall be elected to the office of the president more than twice”¹. Fueling such speculation were comments made by Trump himself, when he stated that there were methods² by which he could become only the second US president in history to remain in office longer than two terms – the other being President Roosevelt during the rather unusual circumstances presented by World War II. Of course, this was grist-to-the-mill for those on the left politically, especially those suffering from acute TDS (Trump Derangement Syndrome). However, judged on the basis of his actions, it is hard to see much evidence of Trump settling in for such a prolonged stint in the White House.

Why do we say this?

Look at his actions; this is a man in a policy hurry.

Having set a world first by establishing a US strategic crypto reserve in March – a subject we discussed at length in the previous monthly update – Trump followed up last month by announcing the imposition of reciprocal trade tariffs on all countries exporting goods to the US³. Even though digital assets were not the primary focal point of this policy announcement, the impact it had on the asset class (indeed pretty much all asset classes) was substantial. Not only that, but for reasons we will outline, the Trump tariffs stand to have a profound and lasting impact on digital assets so it is worth spending some time analyzing what occurred.

US Manufacturing Re-up

Nicknamed Liberation Day by the administration, the aim of reciprocal tariffs is to re-prioritize US manufacturing, a sector Trump judges to be critical from a national security perspective (“if you don’t have steel, you don’t have a country”). The expectation is that, by skewing financial incentives, tariffs will provide a domestic growth boost (although it is debatable how many American jobs on-shoring will generate given the increasing adoption of AI/robotics technology) as well as help eradicate the large and persistent US trade deficits that have emerged over recent decades.

In terms of specifics, a blanket 10% tariff was imposed on all countries who export to the US. However, countries deemed by Team Trump to be the worst offenders (read: greatest contributors to the US trade deficit calibrating for the size of their economy) saw even higher tariffs applied – see image below.

“Liberation Day” Tariffs

Source: Daily Telegraph

One of the worst hit, due to the size of its economy and dominance in global manufacturing, was China. Its exports had a 34% tariff slapped on top of the 20% tariff previously announced – meaning a combined tariff of 54%!. (NB: This turned out to be just the opening gambit. Both countries embraced the tit-fot-tat strategy and as a result export tariffs between the two countries now exceed 100%.)

To appreciate the economic significance of Liberation Day one needs to understand that the aggregate level of the tariffs proposed by the Trump administration takes the US back in time to the 1930s – effectively reversing 90 years of liberalizing global trade – see image.

Back To The 1930’s

Source: Tax Foundation and Fitch Ratings

As we noted in a recent monthly update, the 1930s were not an especially positive period economically or financially. To wit,

“tariffs constitute a negative aggregate supply on the economy, which is economic speak for saying they have have detrimental – potentially very detrimental – impact both on real economic activity and inflation.

One of the most famous examples of such policies being implemented was the 1930 Smoot-Hawley Tariff Act. It introduced 900 tariffs on goods imported into the US, and just like now, this protectionist trade policy triggered a wave of retaliatory measures from many of the nations targeted by the US tariffs. In the view of most mainstream economists the Smoot-Hawley Act significantly exacerbated the economic tailspin we have come to call the Great Depression.

For those of you unfamiliar with economic history, US equity prices tumbled more than 80% peak-to-trough in the first few years of the Great Depression between 1929 and 1932, while US house prices slumped 67%.”

Obviously, cryptocurrencies did not exist back then, but one does not have to be an investment genius to figure out that how digital assets would perform if such dire economic conditions were to be repeated.

Unleash The Bears

Indeed, investors were quick to draw parallels between then and now and Liberation Day had a large and immediate negative impact on the performance of risk assets. As evidenced by the 15% decline in our flagship large cap Top10 Crypto CTI, digital asset prices slumped on the news, but so too did stock prices. Indeed, most equity markets mirrored the performance of cryptocurrencies, witnessing double digit falls as investors attempted to price-in a possible recession (or worse!).

Given the slump in investor risk appetite, the knee-jerk response of government bond markets was to rally. However, in a very telling move, this bullish move was swiftly reversed. Indeed, after the initial drop, the yield on the 10 year US Treasury surged more than 50bp in less than a handful of days. For one of the world’s most important benchmark interest rates (a lot of global and US fixed income products are priced off the US Treasury curve), this constituted a very dramatic development; one that certainly caught the attention of the crypto investors because, as per the chart below, as US treasuries sold off crypto started to go bid⁴.

A Hand-brake Turn For Bonds and Bitcoin

Source: yfinance

The swift re-emergence of the bond vigilantes worried many influential people on Wall Street and in Washington, so much so that President Trump hastily announced a 90-day moratorium on the introduction of tariffs on all countries except one: China. The Middle Kingdom remained firmly in the US cross hairs because of President Xi’s decision to respond to US trade tariffs by imposing retaliatory tariffs on US imports (see above). Tempting as it is to think that the tariff moratorium was the reason why crypto turned up, the real answer is more complex for reasons we will now explain.

Shock And Awe

President Trump revels in being considered a tough and successful negotiator, so much so that he named his 1987 bestseller “The Art Of The Deal”. Given this, it is perfectly plausible to assume that by announcing large and widespread tariffs – at the risk of triggering Great Depression 2.0 – Trump deployed military style “shock and awe” tactics to bring other nation states to the negotiating table with the intention of getting them to remove the pre-existing trade impediments on US exporters in return for being exempt from US tariffs. Certainly, this is a more plausible explanation than the intellectually lazy option many took, which was to simply dismiss Team Trump as a bunch of economic imbeciles for announcing such draconian trade measures – see image below for a selection of MSM headlines.

Source: google

Were a negotiated outcome to materialise it would mean US tariffs considerably lower than announced and hence much more benign economic growth outcomes. In fact, US exports would, for instance, be expected to pick up as a consequence of better access to overseas markets providing a nice tailwind to growth. Of course, for countries that have grown – literally – to rely on US consumer demand they would be forced to stimulate domestic demand to offset the drag from a lower external GDP contribution or risk a recession.

That said, for this approach to work the US’s trading partners must be prepared to wean themselves off net exports as a growth engine – a structural change that is quite challenging and hence far from obvious it would happen even though globally the outcome is superior. They must also believe Trump is fully prepared to impose the tariffs.

Given the economically ugly precedent of the 1930s, the tariff threat would not be credible coming from most people, but we are not talking about most people, we are talking about Trump. This is a person who knowingly uses chaos, obfuscation and constructive ambiguity to get what he wants. Moreover, his administration is all too well aware that game theory confirms there are circumstances where behaving – or appearing to behave – irrationally is the optimal strategy (eg, during the cold war President Nixon avoided nuclear armageddon by convincing the Soviets he was unstable enough to push the red button his so-called Madman strategy). Such circumstances could certainly apply in the current trade negotiations given how much China in particular risks if US tariffs bring global trade to a shuddering halt (internal social stability – the top priority of all Chinese leaders – would be jeopardized).

Damage Done

Soon enough Trump’s intentions will become clear, but for now the only person who truly knows whether he is bluffing or not is Trump himself. The problem with this approach is even if it turns out he was bluffing and the tariffs never get imposed, there will still be negative long-term economic repercussions for the US. This is because brinkmanship may be an effective tactic in trade negotiations but it is toxic when it comes to international finance.

The smooth functioning of the global economy relies heavily on trust in order to support the billions of financial transactions that take place every single day. Given recent events, it’s highly likely that the US – under Trump’s leadership – is no longer considered a reliable and trustworthy economic partner by individuals, companies and other nation-states. Moreover, it’s not a stretch to think that countries with substantial foreign exchange reserves—many of whom have been targeted by the tariffs—may reconsider the US as a safe destination for their savings: capital flows that have supported the USD’s status as the world’s dominant reserve currency.

Lack of Alternatives

This is where things really get interesting from a crypto perspective.

In an earlier research note we outlined why, despite long-standing predictions to the contrary, the USD remains the monetary foundation of the global economy. The key reason is because being the dominant reserve currency is not unambiguously positive as most people assume; the phrase “exorbitant privilege” is a bit of a misnomer. To understand why we need to introduce a national income accounting identity called the sector financial balances. It states that:

Current Account Balance = Net Corporate Saving + Net Household Saving + Government Budget Balance

Absorbing capital inflows from the rest of the world – as required by virtue of being the dominant reserve currency – means the issuer nation state is compelled to run a current account deficit. This external shortfall must (it is an identity not a theory so it holds in perpetuity) be matched by households, corporates and/or the government in aggregate running an equivalent sized deficit. The chart below shows how US sector financial balances have evolved over the past 30 years. The vast majority of the time it is the government budget deficit that absorbs the capital flows (in other words this foreign capital flows into the US Treasury market). Indeed, there have been only two occasions when the US private sector absorbed the capital inflows and in both cases recession swiftly followed: corporates in the dotcom boom and households in the 2007 housing bubble.

US Sector Balances (% GNP)

Source: https://fred.stlouisfed.org/graph/?g=pzlH#

Economic logic therefore dictates that abandoning the USD as the dominant reserve currency means another nation state(s) will have to start to running sizeable trade deficits to absorb the necessary capital inflows as well as (almost certainly) larger fiscal deficits. This is, naturally, in addition to the other prerequisites such as deep capital markets, an open capital account and reliable rule of law (so investors can be sure to withdraw their savings as and when required). Aside from the UK, whose external position is almost as bad as the US, all the other nation states issuing currencies that could be considered potential candidates – China, Japan, EU (read: Germany) and Switzerland- fall short in meeting these criteria. It turns out the obstacles to abandoning the US dollar as the dominant reserve currency are extremely high.

Of course, this is true only to the extent that one restricts oneself to the world of fiat currencies. Fortunately, this is not the world we inhabit. For nation states wishing to move away from the status quo because they no longer view the US as a reliable and trustworthy financial partner there are other alternatives. Historically, one reliable reserve asset is gold but since 2009 there is another player on the scene – crypto, specifically Bitcoin. As we have pointed our in prior research notes, these are the only two liquid forms of outside assets that exist with the ability to serve as a money (outside money is money that is not a liability for anyone “inside” the economy and hence its value does not rely on someone paying you back in full).

That is a key reason why the spot gold price has surged to a record nominal high last month and why Bitcoin – and crypto more generally – have also started to catch a bid in tandem with rising US Treasury yields.

Powell Under Pressure

It also didn’t hurt when Trump took to social media to say Powell’s termination as Fed Chair can’t come “soon enough” because of the central bank’s policy intransigence in the face of the proposed tariffs. By threatening the Fed’s monetary policy independence in such a blatant manner Trump and his team gave investors yet another reason to exit the US dollar and move into analogue and digital gold based on the assumption that if Trump succeeds in ousting Powell, US – and therefore global – liquidity conditions will become much more accommodative, a positive development for limited supply assets.

With Trump threatening to upend the world financial order by attempting to slay two of economics most sacred cows – free trade and central bank independence – further price gains for both of these assets are likely. Of the two though, in our view, it will be crypto rather than gold that offers the best returns for the reasons outlined in a recent tweet.

Source: X

1 The law was passed in Congress in 1947 but only ratified by the states in 1951. Prior to then, US presidents choose to follow the lead of George Washington – the first US President – who voluntarily chose to step down after two terms as it is seen as a key mechanism to stop the abuse of power and to ensure democratic competition.

2 Becoming the vice president in the 2028 election and having his presidential running partner step down after election being one such method – a political do-si-do not unlike Putin during the 2008 Russian presidential election when he became prime minister during Dmitry Medvedev’s Presidency, only to return in 2012.

3 This was in addition to the 25% tariff on all foreign car imports into the US.

4 As a consequence there was a decoupling between crypto and risk assets performance eroding the validity of one long-standing narrative.