Following President Trump’s announcement of tariffs on April 2, Vice President JD Vance faced backlash for his remarks emphasizing the necessity for major US trade protectionism. Vance expressed on Fox News, “We borrow money from Chinese peasants to buy those things that the Chinese peasants manufacture. That is not a recipe for economic prosperity, it’s not a recipe for low prices and it’s not a recipe for good jobs in the US.”

This comment, laden with implicit bias, drew sharp criticism from Chinese authorities and inspired numerous retaliatory memes across Chinese social media platforms. Although Vance has since refrained from reiterating this viewpoint, the statement encapsulates the administration’s perspective on the global economy, particularly regarding how trade and capital flows adversely affect American labor.

Two months after the tariffs announcement, Trump’s focus on rebalancing the global economy hinges largely on trade policies and tariffs. Recently, however, an unexpected ruling from the US Court of International Trade dealt a significant blow to this approach by invalidating most reciprocal tariffs, viewing them as an excess of executive authority. While the injunction is temporarily suspended pending a White House appeal, it complicates Trump’s reliance on tariffs as leverage in negotiations with over 120 trading partners.

With tariffs potentially losing their effectiveness as a tool for economic rebalancing, attention shifts to alternative strategies. Reports indicate that the White House is exploring different legal avenues to implement tariffs, though these paths appear to be less straightforward than the initial application of emergency powers.

Reflecting on Vance’s statement regarding Americans “borrowing money” from foreign sources, another significant aspect of the trade war emerges: the need to recalibrate not only the US current account (trade of goods and services) but also its capital account (financial transactions).

Vance’s comments provide a simplistic and inaccurate depiction of the dynamics of savings and investment between the US and China. The US current account deficit signifies that it imports more than it exports, with the shortfall financed by borrowing from foreign nations, thus creating a surplus in the capital account—a relationship that mirrors similar trends in the UK.

Conversely, China enjoys a substantial current account surplus, with savings exceeding domestic investments; this excess capital is frequently diverted for international investments, including US treasury securities. Vance’s assertion underscores the US dependency on foreign investments to sustain its deficits.

While restricting trade could sever this financial linkage, the administration is also exploring other measures: penalizing foreign holders of US assets.

The initial steps toward this approach are evident in Trump’s proposed budget bill currently under consideration in Congress. Investors are particularly focused on Section 899, which would allow the administration to impose “revenge” taxes on foreign entities if they maintain discriminatory tax policies against US businesses.

Primary targets include digital services taxes in nations such as the UK, France, Italy, Spain, and India, as well as the global minimum corporate tax rate agreed upon by numerous countries under the OECD framework. The administration has criticized both as “non-tariff” barriers that it aims to eliminate. Although the UK government retained its digital services tax amidst limited tariffs discussions, significant pressure may arise on the Labour party regarding this issue.

The draft budget stipulates that the revenge tax could potentially reach 20% on passive income—like interest and dividends derived from US investments—held by foreigners. If enacted, this could effectively introduce capital controls within the world’s largest economy, further reflecting the broader strategy to leverage US assets and the dollar against international trading partners, as suggested by the Mar-A-Lago accord authored by Trump’s economic advisors.

Should tariff strategies fail to immediately reduce the US trade deficit, a pivot towards constraining capital inflows seems probable, aligning with Vance’s depiction of American financial interdependence with foreign elements. This also explains the ongoing decline in US bond prices and the dollar’s value, as foreign stakeholders, already impacted by tariff measures, may divest from dollar-denominated assets due to concerns over Section 899.

The ramifications of enforced capital rebalancing pose risks that could surpass those of the current trade war. For instance, if Trump’s budget bill passes, it could inflate the national deficit by an estimated $5 trillion to $7 trillion, a precarious scenario for a country that should be encouraging foreign investment rather than driving it away.

This exodus from the dollar and the reevaluation of its standing as a reserve currency have led global players to reconsider their positions. Last week, Christine Lagarde, the president of the European Central Bank, viewed the emerging uncertainty as a chance for a “global euro moment.”

However, attaining the status of a global reserve currency involves more than just displacing the current framework; it comes with its own set of challenges. The euro is unlikely to replace the dollar, as it faces similar surplus issues that contribute to existing economic disparities. Recent data indicates that Germany has overtaken Japan as the largest creditor nation for the first time in 34 years, solidifying its position as Europe’s primary surplus country—dynamics that complicate the euro’s potential to assume the dollar’s dominant role.

Mehreen Khan is the economics editor.