How Liberation Day will be America's Brexit plus other disasters

Thoughts on America's emerging market tendencies, bracing for a USExit, Britain's wasted crisis, and the perilous position of the Baltics in Trump's new Yalta

Photo by Miltiadis Fragkidis on Unsplash

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In the meantime, I look forward as always to your comments and feedback.

In this newsletter:

• America’s Fiscal Crisis: A troubled emerging market

• Liberation Day: Worse than Brexit?

• Britain’s Wasted Crisis: How to seize the moment

• Baltic Independence: Trump’s New Yalta

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1. America’s Emerging Market Tendencies

Despite the flurry of Truth Social posts in the middle of the night, the daily newsbombs and the relentless assaults on opponents and allies, there is an internal consistency to the Trump administration agenda that often gets overlooked in much of the media commentary. Much of what it is doing both at home and abroad appears to be motivated in large part by the same goal: to enable the Republicans to roll over Trump’s first term tax cuts without worsening a federal debt and deficit situation that risks becoming unsustainable.

Hence Elon Musk’s desperate search for “government efficiencies”, Trump’s promise of “trillions of dollars” of tariff revenues, and the administration’s plans for deregulation, particularly of the banking sector, by which it hopes to engineer a “deleveraging of the public sector by releveraging the private sector”, as Treasury secretary Scott Bessent put it in a recent podcast interview.

Hence too, the assault by JD Vance and other cabinet ministers in the extraordinary leaked Signal chat on “pathetic European freeloaders”. Anything that can be monetised is to be monetised, including America’s security guarantees, whether that be forcing Europeans somehow to pay for maintaining freedom of navigation in the Suez canal, extortionate demands on Ukraine for a revised minerals deal, or demanding Greenland cede its sovereignty to allow America an unimpeded right to exploits its putative mineral resources.

The Bessent interview is well worth listening to for an explanation as to how the administration’s economic agenda hangs together. Indeed, it is easy to see why the former macro hedge fund manager is so concerned about US fiscal risks. Last week the Congressional Budget Office forecast that the US’s debt-to-GDP ratio would reach 107 per cent during the 2029 fiscal year — exceeding the 1940s era peak — and continue rising to 156 per cent by 2055. The debt-to-GDP ratio is forecast to be 100 per cent for the 2025 fiscal year.

Yet the reality is that the way that the administration is going about its agenda risks making those fiscal pressures worse. As Desmond Lachman, a senior fellow at the American Enterprise Institute, wrote in a piece for Project Syndicate, America is starting to look like a troubled emerging market economy.

It is not just that America’s debt and deficit could soon far exceed the typical emerging market, if Trump delivers on up to $11 billion worth of proposed tax cuts. Nor the rampant protectionism, a sure sign of an emerging market in trouble. “Such policies stifle competition, increase inflation, inhibit economic growth, and fuel widespread corruption by giving government officials the power to grant exceptions to tariffs on a case-by-case basis.”

It is also outsize political influence of a handful of oligarchs and the way that the government seems to go out of its way to undermine confidence in public institutions in general and the central bank in particular. Meanwhile the Trump administration’s highly erratic approach to economic policymaking, which creates an atmosphere of heightened uncertainty that undermines investor and consumer confidence, is also reminiscent of an emerging market.

America’s two main trading partners are threatened with 25% tariffs one day, only to be granted a one-month reprieve the next. Government workers are fired en masse by Musk’s Department of Government Efficiency (DOGE) and then rehired, because it turns out that they performed essential functions like overseeing the US nuclear-weapons stockpile. No wonder the stock market has been swooning: investor and consumer confidence is tanking.

Until recently, America’s great advantage over most emerging-market economies was that investors could have full confidence that the rule of law prevailed, and that there was a level playing field for all market participants. Yet here, too, America seems to be in the process of squandering its advantage. The executive branch’s public challenges to legitimate court rulings are becoming commonplace, and those wielding political power no longer bother to hide egregious conflicts of interest.

The danger for America - and the world - is that the further America continues down this path, the harder it will become to deliver the fiscal consolidation that Bessent recognises is needed. Moody’s last week warned that America’s “fiscal strength is on course for a continued multiyear decline”, having already “deteriorated further” since the rating agency assigned a negative outlook to America’s triple A credit rating in November 2023. And unlike with an actual emerging market, there will be no IMF bailout to repair the damage.

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2. An American Brexit?

At least we should get some clarity on one of the biggest uncertainties hanging over the global economy on Wednesday when Trump unveils his plans for “reciprocal tariffs”. Or as the president put it in a post on Truth Social at 1:39 a.m. on Thursday. “LIBERATION DAY IS COMING. FOR YEARS WE HAVE BEEN RIPPED OFF BY VIRTUALLY EVERY COUNTRY IN THE WORLD, BOTH FRIEND AND FOE. THOSE DAYS ARE OVER.”

Nonetheless, it seems that even now, just days before a key policy announcement with momentous implications for the global economy and America’s relationships with the world, no one, including the president and his closest advisers, know what will be announced. According to Politico:

“No one knows what the fuck is going on,” said one White House ally close to Trump’s inner circle, granted anonymity to speak freely. “What are they going to tariff? Who are they gonna tariff and at what rates? Like, the very basic questions haven’t been answered yet.”

Indeed, Trump is still debating with his advisers whether “to go bigger”, according to the Washington Post. Treasury secretary Scott Bessent had proposed imposing tariffs on products from the 15 percent of countries that it deems the worst U.S. trading partners, which between them account for almost 90 percent of imports. But Trump is still pushing the idea of a universal tariff that would apply to most imports regardless of country of origin. Apparently he thinks he made a mistake in allowing advisers to talk him out of bigger tariffs during his first term.

One of few things one can say with certainty is that whatever tariffs he announces, there will be nothing reciprocal about them. As the WSJ noted:

Some Trump advisers and friends have peddled the line that he merely wants a level tariff playing field. But the average U.S. tariff rate (2.7%) on foreign goods is higher than the average rate in Canada (1.8%), Japan (2%) and Europe (2%), and roughly the same as in Mexico, according to the World Bank. While other countries impose non-tariff barriers, so does the U.S.

Andy Laperriere of Piper Sandler estimates that Mr. Trump’s auto tariffs, when combined with his levies on China, steel and aluminum, will raise the effective U.S. tariff rate to nearly 8%, the highest in 75 years.

Another thing that is clear is that Trump’s tariffs will be economically damaging. That is why stocks around the world fell last week when he announced a 25 percent tariff on the import of cars and car parts. Yet as Tracy Alloway noted in Bloomberg’s Odd Lots newsletter, the response in other markets to Trump’s over-turning of the global order has been “weird”: there has been very little volatility in recent weeks in junk bonds, foreign exchange, emerging markets, or government bonds, all of which are exposed to sweeping world changes.

That could be because investors are too complacent. Or it could be simply that no one knows what will happen and have no framework by which even to judge such momentous changes to the global order. As one Fed official put it last week, a dense fog has fallen: “It’s not an everyday “forecasting is hard” type of fog. It’s a “zero visibility, pull over and turn on your hazards” type of fog.”

Nonetheless, once the fog clears, Bank of America reckons that the long-term implications of a substantial increase in US protectionism to be negative for the US economy and the dollar. Indeed, it reckons Trump’s Liberation Day is likely to be America’s Brexit:

The academic literature on the negative impact of trade tariffs on economic growth is vast. As we have recently argued, the argument that the US economy may not suffer as much because it is less dependent on trade is not valid when the US has a trade war with the rest of the world. For the rest of the world, only exports to the US are subject to the new high tariffs, while for the US most of its exports could be affected.

A comparison of a "USexit" with Brexit is illustrative. Although the US is much less dependent than the UK on trade, its total trade share compares with that of the UK exports to the EU. High US tariffs against the rest of the world could be a shock for the US economy that could be compared with Brexit. It may even be worse, as the UK share of exports to the EU has not changed much after Brexit.

Given that Brexit was followed by eight years of political chaos and deteriorating economic conditions in Britain, the comparison should worry everyone.

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3. Britain’s Wasted Crisis

Hardly anyone in the British media had a good word to say about Rachel Reeves following her Spring Statement last week. She may have succeeded in restoring her headroom under her fiscal rules, but the left-wing press attacked her for doing so on the backs of the poor by cutting welfare benefits, while the right-wing press blamed her for the Office for Budget Responsibility’s growth forecast being halved this year to 1 percent, making the cuts necessary.

Both attacks are unfair. It is impossible to look at Britain’s soaring sickness benefits bill, which almost uniquely among developing countries has continued to rise since the Covid pandemic, and not conclude there is something seriously amiss. And given the dire economic inheritance from the Tories, I don’t think Reeves has done too badly. Taxes needed to rise and whichever ones she chose, the right-wing media would have attacked her for them.

Nor do I have much truck with those who say she should simply junk her fiscal rules and borrow more as Germany has done. She already changed the fiscal rules last year to allow her to borrow more, and indeed she was able to sneak through another increase in borrowing in her spring statement by classifying some defence spending as investment. But the reality is that she is planning to issue £299 billion of gilts in the next financial year, the second highest total since the pandemic. The fact that gilt yields fell in relief that the gilt mandate was not £300-320 billion as many had expected suggests that the real constraint on Reeves is not the fiscal rules but the willingness of the market to absorb higher issuance.

My criticism of Reeves and Labour is that they are too timid. They are right that the world has changed, but they seem reluctant to rise to the level of events. As I wrote in a column for Byline Times, they are in danger of letting a crisis go to waste. Yes, they have taken some tough decisions that they might otherwise not have ducked, including raising defence spending to 2.5 percent of GDP by 2027 and making those welfare cuts. But the government gives every impression of bowing to events and making no attempt to master them.

The reality is that Reeves will almost certainly face further tough choices come the Autumn when she delivers her next budget. As the OBR noted, it would only take a small rise in interest rates, or continued weak productivity growth, to wipe out her headroom again. The central OBR forecast also doesn’t account for the impact of a Trump a trade war, which would crush growth. At the same time, defence spending will surely need to hit 3% before the end of this parliament. No wonder most City economists expect taxes to have to rise, so why does the government not seize the opportunity arising from a shifting of the Overton window to escape the straitjacket of its manifesto?

If taxes must rise, then why not grasp the opportunity for long overdue far-reaching reform of a tax system filled with incentive-crushing cliff edges at every level of the income scale? When better than now to slash electricity prices by shifting green levies onto general taxation, paid in part by finally raising fuel duties, frozen for over a decade?

Rather than footling around with a small-scale National Wealth Fund tasked with picking industrial winners, now is the time to create a vast Public Wealth Fund to manage all public assets on a commercial basis and improve their returns – as the US Government is considering doing.

Above all, why squander energy and political capital in desperate pursuit of a US trade deal, even at the possible price of altering the UK tax code to suit American corporate interests and sowing division with European allies, when far greater gains could be achieved by rejoining the EU customs union and single market? Indeed, there is no single policy that the Government could pursue that could at a stroke boost the economy, reassure the bond market and revive the desperately sagging stock market.

As Reeves says, the world has changed. Time to smash the emergency glass.

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4. Trump’s New Yalta

I reviewed a couple of timely new books on the Baltics for the Financial Times this weekend. Baltic: The Future of Europe by Times reporter Oliver Moody is a historical, political and military survey of the countries of the region and how they and the West can best defend themselves from the Russian menace. Rebooting a Nation: The Incredible Rise of Estonia, E-Government and the Startup Revolution by Joel Burke is, as its title suggests, a celebration of Estonia’s transformation into a tech hub and what the rest of the world can learn from it.

Having reported extensively from the region myself, I agree with both authors in their optimistic assessments of what these countries have achieved, what they can teach the rest of us and why it is vital that we defend them. Nonetheless, the truth is that the West has until relatively recently had an ambivalent attitude towards the independence of the Baltic states, even going so far as to oppose their quitting the Soviet Union in case it undermined Mikhail Gorbachev, the reformist Soviet leader. Today, more than a decade after Russia’s invasion of Ukraine, it is not clear that Nato could defend the Baltic states from Russian aggression, and certainly not, says Moody, without American involvement.

Perhaps it doesn’t matter. Russia’s military weakness has been exposed in Ukraine and America has said it is not planning to pull out of Nato. But that may not give the region much comfort, particularly now that America and Russia appear to fast be becoming allies with a shared contempt for Europe. For obvious reasons, the Baltic states have been the most steadfast supporters of Ukraine, fearing that a victory there would embolden Vladimir Putin.

Yet it seems possible, even likely, following the deal struck last week between America and Russia for a Black Sea ceasefire that Europeans could soon be put under pressure by America to relax sanctions on Russia, thereby handing Putin a massive win. Who would bet against America using its security guarantee as leverage over “freeloading Europeans” to help deliver such a concession?

Besides, as noted in last week’s newsletter, Trump doesn’t need European unanimity to agree to any relaxation of sanctions. He just needs one EU member state to refuse to roll them over when they come up for renewal every six months. As things stand, Trump can probably count on Hungary’s Viktor Orban. Meanwhile, as a new report by Vessela Tcherneva and Garvan Walshe for the European Council for Foreign Relations notes, there is a risk that American support for far right parties may lead other central and eastern European countries may come down on the wrong side of “Trump’s new Yalta”.

This point in the report seemed to me particularly worth highlighting:

Equally concerning is the Trump camp’s decision to halt enforcement of the anti-money laundering Corporate Transparency Act. Bringing corruption funds to light has been one of the most difficult policies in eastern Europe in the past decades; in a region where high-level corruption is endemic, the US Magnitsky Act and state department visa blacklists were among the few effective deterrents against oligarchical impunity.

Now, rather than targeting kleptocrats, there are whispers that it is anti-corruption activists who could end up on American punitive lists. In Romania, far-right presidential candidate Calin Georgescu has been banned from running in the country’s upcoming election due to illegitimate Russian interference. In response, Georgescu has openly welcomed the prospect of US sanctions on Romania’s current government, in order to reshape his country’s political landscape.

Trump and Putin now appear to have a shared goal to keep Europe weak and divided - and the Baltic states have the most to lose from it.