Tariffs and Balance of Payments

With the recent strike down of the legality of US Tariffs, there is significant back and forth on the impact of tariffs on both domestic prices and the US’s income statement.

Tariffs are a tax. Like all taxes, tariffs hurt both the producer and consumer through payments of the tax, reducing production and consumption to benefit the omnipotent government’s coffer.

Reduced foreign consumption has positive benefits on the current account (trade balance). Unknown to most, the trade balance is rolled up into the Balance of Payments, which comprises of the current, capital, and financial accounts. As the capital account is negligible in developed countries, it is commonly neglected in analyses.

The Balance of Payments always sums to zero. If not, a country buys or sells reserve assets to stabilize.

As the current account covers trade, the financial account balances it out encompassing foreign investments in treasuries, equities, and direct investment (South Korea funding a smelting facility in Tennessee).

Historically, this was settled with countries exporting gold reserves to trade partners. To bolster those reserves, countries would raise their interest rates to gain foreign investment on a global competitive scale. Vice versa, countries could lower interest rates, which would reduce the value of their domestic currency, making goods more competitive on the global market. This competitiveness would increase their trade balance, offsetting the loss in foreign investment from reduced rates.

The US has been running a trade deficit since 1975. Every year, foreign investment has offset the deficit.

Knowing this, we can derive the impacts of tariffs on the equities market; this was the cause for the April 2025 tariff tantrum in the US market. The strikedown of tariffs allowed the US equity and treasury market to continue going up and to the right unabated.

Beginning in 2022, foreign countries have been reducing holdings of US treasuries and equities. As this continues, the US will have reduced ability to expand its trade deficit without supplementation of reserve assets. The US does have over $250B in foreign reserves, which would last momentarily before structural change to the accounts would be needed…or we would be forced to remove the gold from Fort Knox.