As policymakers around the world struggle to keep up with US President Donald Trump’s tariff announcements, they seem to struggle more with determining the appropriate policy response. So far, they have leaned towards imposing trade restrictions of their own. This is an own-goal approach that reduces growth, raises inflation and places an unnecessary burden on domestic households and businesses.
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Trump is often credited with thinking outside the box. It is time policymakers elsewhere did the same. An alternative to imposing tit-for-tat tariffs is to match US tariffs with a similarly scaled reduction in central bank holdings of US Treasuries.
For example, if the US announces 25 per cent tariffs on Mexico and Canada, they can announce their intention to sell 25 per cent of their US Treasuries held as official foreign exchange reserves. Funds can then be redeployed into other highly rated sovereign or supranational bonds, or they buy more gold or even highly rated corporate bonds, as some central banks have already done. Sector-specific tariffs could be approached similarly, by reducing Treasury holdings proportionate to the share of exports to the US affected.
There are several benefits to this approach. Most important, virtually every central bank holds US Treasuries, about US$3.8 trillion in sum, making the collective threat of selling their holdings a meaningful one from the perspective of US bond market stability.
Some observers believe that while Trump is unmoved by arguments that tariffs are disruptive and costly for US allies – not to mention the US itself – he is likely to be much more attuned to the potential for financial market turmoil. Up to now, financial markets have largely shrugged as tariffs are rolled out, but foreign central banks can more directly bring financial markets into play.
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In addition to targeting an area that should have Trump’s attention, central banks swapping out of US Treasuries should see fewer negative effects on their domestic economies. Compared with imposing tariffs, selling US bonds would have no direct impact on growth or inflation. In fact, it is not obvious that there would be any negative macroeconomic impact, at least in the first order.