Trade and Capital at the Crossroads of War

Global imbalances and the forces that may soon reshape them

Apr 06, 2025

The Fight Between Carnival and Lent - Pieter Brueghel the Elder. It represents the clash between a period of feast and indulgence (Carnival, the fat man on the barrel) and one of austerity and penitence (Lent, the pale woman on the chair).

The events of this week will probably pass as one of the most iconic moments in recent economic and political history, comparable with the Nixon-Mao meeting, or the collapse of Lehman Brothers.

It is now undeniable that the US has decided to push for a global reorganization of trade (and consequently finance) not seen since the 1970s. In the background, decades of economic decision-making frameworks are buried under the specter of looming war.

And yet, despite the market reaction and media frenzy, we are only witnessing the opening minutes of a story that could unfold over decades. Even the rough outlines of the new global order are still unclear, even to those shaping it. Let alone the final economic configuration that would allow us to pick winners and losers inside specific countries and industries. Trying to make big macro calls in this context is not futile but pretty hard, and this article is not about that.

Rather, this article expects to provide the historical and theoretical framework to understand how the world got here, and where it might go next, in broad strokes. It explains some tacit assumptions behind global trade that are generally ignored, how the trade/capital balance mechanism works, why the US has a special status in that mechanism, and why it might want to relegate that status. It also reviews the fundamental sources of the trade imbalance between the US and other advanced economies, and the options and costs involved in trying to close it.

If you were back in 1970 or 1945, would you care about which stock will do well in the next six months, or about understanding the structural forces that would define the decades to come? This year might be one of the most important of the next 30, and starting with a good structural framework to understand it may help us look at ‘where the puck is going’.

How we got here

Trade integration and the balance of payments

When countries trade and allow capital to flow, with any degree of openness, their economies start to integrate. Changes and decisions made in one country reverberate in another. A decision to raise interest rates in the US makes the cost of capital for a Malaysian producer higher; a decision to lower the cost of electricity in a Chinese city affects the competitiveness of a steel producer in Brazil. Interdependence is not a side effect of globalization—it is its very mechanism.

This global integration of goods, capital, and ideas made innovative production models possible and transformed financial systems, laying the foundation for the modern economy. But it came at a cost: globalization built a global market without a global political authority. No mechanism to coordinate, arbitrate, or absorb the shocks of these deeply interconnected but separate decisions.

One of the key consequences of this setup is that internal economic decisions—about how much a country saves, invests, or consumes—end up shaping global imbalances. Some countries—for example, manufacturing powerhouses like China, Germany, Japan, and South Korea— orient their economies toward high savings and investment. Over time, this makes them more competitive in global markets and leads them to run persistent trade surpluses.

These surpluses are not accidental, they result from domestic economic policies. However, the policies are not always directed towards generating a surplus, but rather reflect society’s preferences on the domestic economy. These include low taxes on retained earnings, subsidies for industry or energy, weak labor protections, and foreign exchange intervention. Even long-term investments in infrastructure or education can tilt the economy toward competitiveness. These are not trade policies per se, but they affect trade outcomes.

The problem is that these internal decisions do not happen in a vacuum. In an integrated global economy, persistent surpluses on one side imply persistent deficits on the other. If some countries consistently invest more, their goods become cheaper and more competitive over time. Other countries (those with lower savings and higher consumption), gradually lose competitiveness. Their industries shrink, their imports rise, and their external accounts deteriorate.

For deficit countries, this poses a conundrum. They can either avoid trading with surplus countries, copy their policies that ‘penalize’ households (for example, via lower salaries) or try to maintain their trade deficit against these economies through capital deficit. This is, countries that import more than they export can finance the gap either by issuing debt, selling assets, or drawing down reserves. But deficit countries cannot simply run external deficits forever. Over time, creditors tighten, assets run out, and the external position becomes unsustainable. At that point—sometimes after a crisis, sometimes through policy—the adjustment comes. And most often, it comes by lowering the relative income of households, usually via currency depreciation.

One underlying idea in all of this, often left implicit, is that trade integration puts pressure on factor prices to converge, adjusted for things like capital availability and legal frameworks. If your country becomes “too expensive in dollars,” you’ll run a trade deficit. You can finance that for a while, but not indefinitely. At some point, you face a choice: either align your prices—typically wages—to those of more competitive countries, or restrict trade to protect domestic imbalances. But trade restrictions reduce the benefits of openness. This is the reality for most countries—except the United States. The U.S. can sustain wages and costs above its productivity level because the world demands its financial assets, allowing it to finance current account deficits indefinitely. No other country has that privilege. Until, maybe, now.

The US exorbitant privilege becomes an exorbitant liability

Most countries can’t escape the above logic. Trade deficits can only be financed via capital deficits for so long: eventually, an adjustment is needed. But since 1971, the US has defied this rule. Despite running massive and growing trade deficits, it has never faced a balance of payments crisis. This ‘advantage’ arises from the world’s insatiable demand for US financial assets, especially the US dollar.

For most of the 20th century, the US had been a surplus country, but by the late 1960s its surpluses had shrunk and turned into trade deficits. Under the Bretton Woods system, the dollar was pegged to gold at $35 per ounce, so as deficits grew, the system was becoming unsustainable. In 1971, the US broke the peg and allowed the dollar to float against all other currencies. The expectation at the time was that a freely floating dollar would depreciate and help restore the trade balance.

However, this never happened. The dollar never really depreciated much. Thanks to the US’ deep capital markets, legal stability, and investor-friendly institutions, the country became a primary destination for financial savings, with an insatiable demand for dollar-denominated assets (treasuries, bonds, mortgages, equities).

The ‘dollar advantage’ meant the US never had to adjust: they could import products and services from the rest of the world and, in exchange, return pieces of green paper and debt that never decreases in value despite growing massively. In the meantime, the US also got the fastest-growing stock market in the world, the cheapest cost of capital, and the largest and healthiest consumer market.

Over time, the US became great at exporting financial assets —at the expense of its ability to export almost anything else. In particular, it lost ground in manufacturing sectors with high labor cost components. Today, across nearly every industry, US wages are substantially higher than in other developed economies, especially the surplus countries.

For decades, this imbalance seemed sustainable. Despite mounting concerns over the size of US deficits (particularly the fiscal deficits tied to trade deficits), the system seemed to have no end in sight. Anti-deficit rhetoric only resulted in more deficit, and global markets kept absorbing US financial assets.

But eventually, tensions surfaced. The first was internal. The deindustrialized interior, the so-called ‘Rust Belt’, had not shared in the benefits of persistent deficits as regions like the Northeast, Florida, or California had. A consensus started to build that foreigners were ‘stealing’ American jobs and the country’s wealth. The result was Donald Trump’s election in 2016.

Then, the tension became external, and much more pressing, with the growing prospect of a geopolitical conflict with China. Military strength is inseparable from industrial strength, and dollars do not shoot bullets. Suddenly, the logic shifted. Industry had to return to the US, and the trade deficit had to close, so that the country was prepared for a potential large-scale conflict.

Where do we go from here?

Closing the massive imbalance between the US and the manufacturing economies will be a titanic task, involving a tectonic shift in global trade, consumption, and capital patterns. There are different ways this could play out, each tied to the sources of the imbalance (the US and the surplus countries) and the mechanism that sustains it (Wall Street).

Different theorists assign blame and responsibility differently. Some argue the US must correct its excesses; others see the root of the problem in the export-led strategies of surplus countries. Ultimately, who adjusts (and who pays) will depend on the kind of deal that gets made, and the power dynamics behind it.

The contested equation

The balance of payments equation looks like this.

Y - C - G - I = CA = KA

The current account deficit/surplus (similar to the trade deficit) equals the capital account deficit/surplus, which equals the difference between what is produced (Y) in an economy and what is absorbed/consumed (C + G + I).

Put simply, if you consume more than you produce, you will sell financial assets, and if you do the opposite, you will buy financial assets. Further, the current account deficit of one country is the current account surplus of the rest of the world with that country, and the same is true for the capital account.

This is an accounting identity, meaning it always has to hold, and is therefore always true. Because it is a tautology, it doesn’t tell us much about the source or direction of the imbalance, and this is where the different views differ.

First vision: Foreign-focused

One side of the argument believes that the structural imbalance is generated by the surplus countries, and that therefore it should be them that adjust.

This is the view of the US government right now, and most famously in the theoretical world by the economist Michael Pettis (here is an article explaining these theories). It builds on previous debates like the Triffin Dilemma and the Saving Glut Theory.

Succinctly, it says that surplus countries have excessive pro-manufacturing, pro-investment policies that generate excess savings. These savings cannot be profitably invested within their economies (diminishing returns on capital) and are therefore shifted to the largest financial market in the world, the US. In this way, they avoid adjusting the exchange rates that would balance the trade and create an excess of capital in the US. That excess capital lowers the interest rate, incentivizing excess domestic borrowing and consumption, and the current account deficit.

Therefore, to solve the problem, the surplus countries should adjust their economic structures towards more consumption, lower savings, and less pro-industry measures.

Some of these include lower FX intervention (allowing their currencies to appreciate), higher salaries for workers, lower subsidies for industries, lower taxes for households, and higher government spending.

This would require deep structural changes in the surplus countries’ economies, —changes that demand significant political leverage. This is where this week’s tariffs aim to provide: leverage to steer the negotiation.

Second vision: US-focused

The other side of the debate says that this is a US-based problem because it consumes more than it produces. This excess consumption is tied to accommodative fiscal and monetary policy in the US.

This is the more classical economic view when dealing with US deficits. For example, the economist Maurice Obstfeld recently put out a paper criticizing the views of the foreign-problem camp and explaining the US-problem view.

In Obstfeld’s opinion, foreigners cannot buy financial assets that the US does not sell, and US agents are not obliged to borrow from foreigners. Therefore, the origin of the problem necessarily has to lie in the US excessive consumption.

At the core of this excessive consumption is the fiscal deficit and a long-term fear of recessions and deflation, which have led monetary and fiscal policy to be too accommodative.

Therefore, the US-focused view thinks this problem needs to be solved via austerity that reduces government deficits and reduces the capacity of households and companies to borrow. In this way, imports would decrease (along with other forms of consumption), and labor would become more competitive on a global basis. The downside of this option is that it would require the American people to carry the bulk of the cost of the adjustment.

Third vision: Capital account-focused

Another possibility is to let every country run its own domestic economic policy, but make the balance of payments constraint more binding for the US (automatically tightening it for the rest of the world as well) by limiting capital flows into the US.

At the core of persistent trade imbalances lies one key mechanism: the world’s seemingly infinite demand for US financial assets. Massive current account deficits have only been possible because foreigners have been willing to finance them through equally massive capital inflows.

To address this, some proposals focus on limiting foreign access to US assets: raising the cost of holding dollar reserves, imposing taxes or surcharge on foreign holdings of Treasuries, increasing reserve requirements on offshore dollar deposits, or even restricting foreign trading in US stocks.

The logic is simple: if holding US assets becomes less attractive, surplus countries will have less incentive to accumulate trade surpluses with the US. And for American households, firms, and the government, it would become harder to finance excess consumption with foreign capital.

This view gained visibility in a document by Chief Economic Advisor Stephen Miran, reportedly reflecting ideas supported by Secretary of the Treasury Scott Bessent. In

Either way, the American consumer is the most likely to suffer

A somewhat ignored or even outright denied point that emerges, implicitly or explicitly, from all three visions is that, one way or another, it’s the American consumer who stands to lose the most.

Reversing decades of imbalances during which the US consumed more than it produced will require recognizing a hard truth: the US economy is no longer as competitive as it once appeared. A key reason is that Americans have a much higher standard of living than their German, Japanese, or Chinese peers. In the words of Secretary Bessent in a recent interview: ‘Americans need to manufacture more, and the Chinese consume more’.

Under the foreign-focused vision, closing the gap mainly requires raising domestic consumption abroad, potentially through higher wages in places like China, Germany, or Japan. That is the scenario where Americans are spared a big part of the cost of the imbalance, because the US can expand its output via higher net exports to the current surplus countries. This is naturally the path that the current administration is trying to pursue.

However, if the adjustment needs to happen in the US, as the second view suggests, it would mean less consumption and an overall much tougher macro environment for the US. With over 70% of the US GDP being consumption, any move toward rebalancing—whether through tighter fiscal policy, higher taxes, lower credit availability, or the lower wages needed to make manufacturing competitive—would hit the consumer directly. This scenario raises serious questions for companies and sectors that rely on the strength of US consumption.

Finally, the capital account view seems to offer a middle ground, but even there, the costs aren’t easily outsourced. It would still put most of the cost on the American public via higher costs of capital, while also increasing the risk of a global shift away from the dollar.

Can we go to de-dollarization?

The issue of de-dollarization and currencies requires a separate article given the complexities involving not only trade but also business cycle management. However, given the relevance the dollar has had in the current trade imbalances, the potential challenges to the US capital account, and the general level of global conflict, it is important to provide an overview of the dollar's global standing.

The dollar is by far the single global currency. Despite losing some ground in central bank reserves, it still leads by far in trade invoicing, FX transactions, debt denomination, and depth and liquidity of markets. The reason is simple: there’s no real alternative. The global financial system is deeply inertial, built over decades on US-based institutions, norms, and legal frameworks.

However, if the US continues to weaponize the dollar (Russian asset freezing, sanctions to foreign entities, etc.), and especially if it imposes restrictions on foreign access to its assets, we could see a (hopefully not sudden) loss of US financial dominance.

It is not at all clear what new potential assets would be. The closest alternative is a more distributed system, with increased use of currencies like EUR, GBP, JPY, CNH, or SAR. This was the original promise of the post-Bretton Woods era: that currencies would compete on the basis of macroeconomic and institutional strength. This seems the most likely outcome from the current standing.

A second alternative would be to establish a global currency—something like Keynes’s Bancor or the IMF’s SDR. The advantage of a global fiat currency is that it would make sustained trade deficits or surpluses much harder. The disadvantage is that it would require a global money authority regulating issues like credit expansion, liquidity provision, etc. This seems unlikely in today’s geopolitical climate.

Finally, some imagine a return to hard currencies (gold, BTC, or a system backed by them). The challenge is that these systems lack the infrastructure and political backing to function at scale. Worse, they tend to be pro-cyclical: in downturns, their rigidity amplifies credit contractions, turning recessions into deflations. That might appeal to some people in theory, but it’s a hard sell in a complex, debt-based 21st-century economy.

In any case, any serious erosion of the dollar's role as global currency would be a direct blow to US power, the US economy, and the US consumer. Whether the US has used its exorbitant privilege for good (becoming the financial center of the world) or for bad (financing conspicuous consumption and an overleveraged economy), the truth is that the dollar’s power is a net benefit. Without it, the US is less powerful, and the adjustments it has to make to bring its trade back in balance will be more painful.

Final thoughts: Alea iacta est

One thing is certain after this week: the US government is willing to put a lot on the line to reach the outcome of closing the deficit and changing the global division of labor. Although there is a possibility that all of this is just rhetoric and inconsequential, at great expense to US credibility, I would not be surprised to see global-level discussions for a new trade and capital global order this year. The changes then defined will be as consequential as those that occurred in 1945 and 1971.

It is not possible to make reassuring conclusions now, with so limited information. We can only hope to wait for events to develop while we study the past and gain a better understanding of what’s coming. Below are some of my most concerning thoughts right now.

The imperative need to proceed cautiously

The speed and simplicity of financial reactions, social media, and policy decisions contrast with the massive inertia of the real economy and the impressive complexity of financial connections. Without care, value chains can break, causing inflation and shortages, and financial conditions can rapidly deteriorate.

Any of the solutions above requires moving massive objects like the national economies of the US, China, Japan, or Germany. It will probably also require a rethinking of the global financial piping. This will probably be unachievable in isolation by the US, and will require lengthy discussion tables. I hope the recent unilateral measures by the US were a signal of strength and determination with the goal of sitting the players at the table, and not the final move in the dance.

Don’t forget this is a preparation for war

In March 2025 Warren Buffett said that ‘tariffs are an act of war in some sense’.

We should not forget that the US feels it needs to be prepared for a potential direct confrontation with other powers, especially China. Although manufacturing strength can be a dissuasive element and not necessarily a sufficient condition for war, this is all indicative that traditional economics, business profits, happy consumers, and happy markets are a lower priority for war strategy than resiliency and production capacity.

We took off, where do we land?

Economies are incredibly more complex than macroeconomic identities like the balance of payments or national income. If the US puts a high tariff on Vietnamese footwear, what is the final equilibrium, which stocks benefit, and which ones suffer? On the supply side, it depends on how much of the tariff is absorbed by the Vietnamese manufacturer, the whole of Vietnam (say via currency depreciation), the US importer (Nike,) and the US retailer (Amazon or Famous Footwear). On the demand side, it depends, basically, how much higher are consumers willing to pay for footwear, which in turn depends on how much less other stuff (which may also rise in price) they are willing to consume.

We know where we are taking off from but we don’t know where the economy, the consumers, and the margins of companies will land. This calls for caution when making decisions, and especially trying not to act sentimentally during times of panic.