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Recent developments in financial markets are leading people to ask an uncommon question: are global investors, both domestic and foreign, losing faith in U.S. dollar assets? The most prominent evidence for a loss of confidence is the post-April 2 simultaneous decline in the U.S. dollar, the U.S. equity market, and U.S. bond prices, accompanied by a surge in the price of gold. There also are signs of a rising risk premium on those U.S. assets (Treasury issues) that had long been viewed as the safest on the planet (see here).

Previously, when a global shock sharply boosted market risk, investors fled into Treasuries. This time really has been different. In this post, we explore the new risky pattern in U.S. asset markets and consider various explanations, including a change in relative inflation expectations and heightened pressure on intermediaries to deleverage.

The simplest hypothesis is the most troubling: that global investors are losing confidence in the United States and fleeing U.S. assets and the dollar. At this point, we lack hard data to confirm this bleak proposition. However, there may be little warning of an intensified shift away from U.S. assets. If that happens, it will be too late to find low-cost ways to “de-risk” exposure to chaotic U.S. policy developments.

Since his mid-January inauguration, President Trump has introduced tariff hikes that are unprecedented in scale, breadth, and speed. Even after the 90-day partial postponement announced on April 9, the Yale Budget Lab estimates that the average U.S. tariff rate is now 27 percent, the highest level since 1902! While the rate likely will fall closer to 18 percent as U.S. purchases of high-tariffed goods decline, that would still be the highest level since 1933.

Perhaps the most amazing thing about the tariffs is that no one outside the Administration knows why they have been applied. The fact that Administration officials are voicing numerous inconsistent rationales for the tariffs is a key reason for the financial market downturn and heightened volatility. The President’s erratic tariff changes are another. Keeping the tariffs in place likely will lead to stubborn inflation and lower long-term growth. Moreover, record trade policy uncertainty alone probably is sufficient to induce a recession.

In the remainder of this post, we try to correct a common misunderstanding about international trade policy: namely, that higher tariffs, by promoting import substitution, will reduce the U.S. external deficit. The primary mechanism by which tariffs can narrow the external deficit is by inducing a recession. Another, even more damaging, path to a lower deficit would be by reducing the attractiveness of U.S. assets to foreign investors. The danger in this case would be an abrupt loss of confidence that prompts a sudden stop of foreign acquisitions and a plunge of U.S. investment.