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Perspectives Trade and capital flows – emerging patterns
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The global impacts of US trade policy and tariffs continue to ripple through the global economy. Renowned economist and Senior Fellow at the Council on Foreign Relations, Brad Setser, joins Janet Henry, HSBC’s Global Chief Economist, to discuss the outcomes so far and the implications ahead. Their wide-ranging conversation also covers new patterns in investment allocations and trade flows, the impacts on the US dollar, China-US trade relations, and how Emerging Markets are faring.
Watch or listen to find out more.
This episode was recorded on the sidelines of the HSBC Gulf Cooperation Council (GCC) Exchanges Conference in London on 17 June 2025. Read more about the GCC conference here https://www.business.hsbc.com/en-gb/campaigns/hsbc-gulf-cooperation-council-conference-gcc
Disclaimer: Views of external guest speakers do not represent those of HSBC.
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Transcript
Introduction to HSBC Global Viewpoint
00:00:01
Speaker
Welcome to HSBC Global Viewpoint, the podcast series that brings together business leaders and industry experts to explore the latest global insights, trends, and opportunities.
00:00:13
Speaker
Make sure you're subscribed to stay up to date with new episodes. Thanks for listening, and now onto today's show.
Introduction of Economists Janet Henry and Brad Setzer
00:00:24
Speaker
Hello, I'm Janet Henry, HSBC's Global Chief Economist, and welcome to this latest edition of the HSBC Perspectives series. I am delighted to be joined by Brad Setzer, renowned economist um with a stunning CV, um having worked at various high-level US institutions, currently a senior fellow at the Council of Foreign Relations. Brad is an expert on global imbalances, capital flows, the US, China, and and pretty much everything in between.
00:00:55
Speaker
So
Welcome to the GCC Exchanges Conference
00:00:56
Speaker
um Brad, um welcome to this conference and and to this podcast. ah Thanks for inviting me. ah Now, we're sitting here um on the sidelines of the GCC Exchanges Conference that HSBC is holding um here in London.
00:01:10
Speaker
um But
Unexpected Developments in US Trade Politics
00:01:11
Speaker
actually, um um want to start with the US because last time that I saw you speak at a conference of ours in New York, um it was just before the US election.
00:01:21
Speaker
A lot has happened over the last six or seven months. um I think probably you anticipated a lot of it. But what do you think actually surprised you the most in terms the functioning of government, the policy announcements? What what really has made you think, I did not expect this?
00:01:39
Speaker
I think compared to many in the market who thought that Trump wasn't serious about a trade war, I got the basic idea that Trump really was quite serious about a trade war correct.
00:01:52
Speaker
ah But even within that context, I was surprised at precisely how he conducted the trade war and how quickly he went to some of the most escalatory trade measures in the U.S.
US Trade Policy Focus on China and Personnel Changes
00:02:09
Speaker
trade and international economic policy arsenal.
00:02:13
Speaker
I frankly expected at that time ah Bob Lighthizer, the first term U.S. trade representative, to be involved in the second Trump term. So one big surprise was that he wasn't.
00:02:26
Speaker
My expectations, in some sense, were would were very much centered around a trade policy that Bob Lighthizer would be comfortable with. Lighthizer is a careful lawyer.
00:02:36
Speaker
He tends to do things in sequence. So I was expecting, in a sense, that the second Trump administration would pick up where the first Trump administration left off. It would initially focus on China with a Section 301 case.
00:02:51
Speaker
And then I thought the administration would move forward with a lot of sectoral Section 232 tariffs, certainly in autos, ah steel, maybe in pharma, and that that would be their broad trade agenda for the first six months.
00:03:07
Speaker
What did that leave out? Well, it
Focus on Trade Disputes with Canada and Mexico
00:03:11
Speaker
left out the, I think, inexplicable initial focus on fentanyl and Canada and Mexico, which now has kind of died down. But the first two months of the administration, it felt like we were going to fight a trade war with Canada ah over the question of whether Canada was it going to become the 51st state or not.
00:03:32
Speaker
which was outside of the scope of my expectations. And then I certainly did not expect that the International Economic Emergency Powers Act, the sanctions authority, in some sense the most powerful international economic tool available to the U.S. president, would be rolled out to...
00:03:52
Speaker
introduce the base tariff and to introduce the so-called reciprocal tariffs, which are basically tariffs on everyone at the levels kind of picked by the president. I didn't expect that that would be rolled out so quickly.
00:04:04
Speaker
And then I never anticipated that that would be the basis for going after China. I thought it would be a much more structured case built around 301, built around a set of concrete demands.
00:04:16
Speaker
So I didn't expect the, you know, oh, you retaliated, therefore we're going to 145, and we suddenly have a freeze of trade.
Trump's Tariffs and Historical Comparisons
00:04:24
Speaker
So in ah essence, everything escalated ah way more rapidly, and the tariffs covered threatened to cover way more trade more quickly than I ever expected.
00:04:35
Speaker
The question that i ask myself is how much is this broad braced approach with with all trading partners um about the the revenue raising um element? Obviously, um President Trump ah constantly talked about President McKinley and how much ah Revenue was raised from tariffs and talked about, you know, cutting household taxes, corporate taxes, if you have more in the way of tariff revenues.
00:04:59
Speaker
So do you think it is that revenue approach or is it just a bargaining tactic or why do you think he took that route? I mean, the administration, I think, views tariffs and I think it was coming directly from the president as the all-purpose tool that can do pretty much everything.
00:05:16
Speaker
um probably including things they cannot do. And the way I like to think about it is that if you go back and look at what happened in the first Trump trade war with China, those tariffs, first of all, they did generate a certain amount of revenue.
00:05:32
Speaker
ah The 25% tariff on roughly half of 2017 trade generated some money. Those tariffs generated a certain amount of negotiating leverage.
00:05:44
Speaker
Trump threatened to bring those tariffs, ah apply those tariffs to all trade rather than just half of trade. um And by threatening to apply them to all trade, he got a deal, the phase one deal, that where China made certain commitments to buy U.S. goods, something that Trump felt he could sell, and he did sell.
00:06:05
Speaker
And then ah they did also serve the third protective function. ah In those areas, we trade less with China. ah In general, a 25% tariff reduced trade by about 50%, so a factor of two.
00:06:21
Speaker
Now, most of that trade shows up in Vietnam, shows up in Malaysia, shows up in India. It doesn't generally show up in US production, but it did reorient patterns of trade.
00:06:32
Speaker
So we achieved multiple goals. And I think the way to think about Trump's trade policy now, setting aside the inevitable chaos, is that he is pursuing multiple goals.
00:06:43
Speaker
He wants a base tariff that gets revenue. He wants some tariffs that are protective and lead to reshoring. And he wants some tariffs, which are just threats, where he is willing, at least in principle, to give up the tariff for concessions.
Impact of US Trade Policies on Global Trust and Investments
00:07:00
Speaker
but But going back to what you were saying about um the unlawful, um in the views of the trade court, um use of the Emergency Powers Act um ah for the US, that we're waiting to see how the whole appeal or process rolls out.
00:07:15
Speaker
ah To what extent do you think that that that is undermining trust um in US institutions? Obviously, you know, when I travel around the world talking to investors, you know, there was a time when everyone was overweight, everything in the US, the S&P, the US Treasuries, etc. Everyone's talking about the the investment reallocation um trade.
00:07:36
Speaker
Is your sense that this is just they're talking about it, we're only seeing it around the edges? um Is it still you think they're very overweight? Or do you think that gradually we are seeing this this undermining of the US institutions that that is leading to some countries to reallocate their investment elsewhere? There is, i think, very little doubt, ah to use a French expression, which is very fitting, that Donald Trump's conception of the state is that of Louis XIV, l'état, c'est moi.
00:08:08
Speaker
um He believes in direct presidential authority. um And if the president wants to spend on this... item, he should be able to. And if he wants to not spend on something that Congress has authorized, he should be able to.
00:08:25
Speaker
And obviously, the president believes that he should be granted enormous authority or has been granted enormous authority to change tariffs and change U.S. international economic relations ah more or less without any consultation or due process.
00:08:42
Speaker
That's what the International Emergency Economic Powers Act provides. And that is a new context. And what I think was particularly significant is that the International Emergency Economic Powers Act, which historically has been used for financial sanctions against countries that are adversaries of the United States, but broadly adversaries of all of America's allies, Russia,
00:09:06
Speaker
Iran modestly against China, that this power was used not against adversaries, geopolitical rivals, but against allies. And yes, it was only used for trade, but it's at its core financial sanctions authority.
00:09:22
Speaker
And I think that some countries and and big institutional investors in those countries have started to wonder if the International Emergency Economic Powers Act could be used against them.
00:09:36
Speaker
It sounds crazy. But if the president is serious about Greenland being a necessary addition to the United States for U.S. national security, that he could make a case that if Denmark doesn't give up Greenland, that's an international economic emergency.
00:09:53
Speaker
And we could apply the full sanctioning authority that has been used against Russia and Iran to Denmark. And I think that has to be something that Danish institutional investors now at least consider.
00:10:08
Speaker
And I think it does factor into some decisions. yeah You can't be zero invested in the US, but do you want to be as invested in the US? Should you be reducing your your allocation?
00:10:21
Speaker
um And if you think of the countries, ah where the president has, mean, in his, without great popular support, I would say, threatened the territorial integrity of U.S. allies.
00:10:33
Speaker
That includes Denmark, that includes Canada. Should the Canadian pension funds be as invested in the dollar in the U.S. equities? So I do think that that is eroding one of the foundations of the U.S. s exceptionalism trade.
00:10:48
Speaker
I think the other foundations of the US exceptionalism trade ah arguably were getting a little long in the tooth. um The US exceptional trade had been going on for a long time.
00:11:01
Speaker
Everybody was pretty much overweight, overweight equities and under hedged. um And the dollar had gotten to be quite strong. So you were in a position where if you're going, putting new money into the US, you were buying into market that was very highly valued, a market ah where very few people were hedged, and a market where in standard economic terms, unless there's an adjustment in the value of the currency, the trade deficit would keep getting bigger.
00:11:33
Speaker
So you're taking a meaningful set of risk because you're buying in at a very high price. You're betting on exceptionalism squared. And I do think what has happened is that the foundations of exceptionalism squared eroded.
00:11:49
Speaker
I do think you're seeing some important pools of institutional money reconsider and maybe start to hedge and maybe eventually reduce their allocations to U.S. assets.
US Deficit Financing and Global Capital Flows
00:12:00
Speaker
and And in terms of the global implications of this, as you say, if you've got some erosion of trust in US institutions combined with some some growing macro balances, what does that mean for the future of capital flows?
00:12:14
Speaker
is Is this a temporary situation, do you think? Which are the bigger regions? Will it be the advanced economies, some of the emerging economies that see some of this shift in capital flows and in in, I suppose, the next couple of years?
00:12:26
Speaker
And what does it mean for the dollar? Sorry, a lot of questions in that list. A questions. So the the basic equilibrium condition in a world where by far the largest external deficit in dollar terms is run by the United States, ah the external deficit is now $1.2 trillion.
00:12:45
Speaker
two trillion dollars And if the US s is going to run an expansionary fiscal policy or even a just keep the fiscal deficit at its current 6% to 7% of GDP level and American consumers sort of remain willing to spend,
00:13:02
Speaker
ah the US will continue to run a large external deficit that needs external financing, even with a modest set of tariffs.
00:13:13
Speaker
So I think if you throw 10% tariffs on that, you'll get some revenue. You maybe won't expand the deficit as much, ah but you're not going to shock the economy in a way that leads to a contraction.
00:13:24
Speaker
Now, if you go full reciprocal tariffs, 145% on China, fifty maybe a hundred on europe everything could change. We could have a recession and a contraction. But if we're in the 10% plus fisc ten percent on the tariffs fiscal, ah not a fiscal consolidation,
00:13:43
Speaker
um basically ah the equilibrium condition is someone has to add over a trillion dollars to their holdings of dollars. So in a global sense, the world has to get even longer the dollar.
00:13:56
Speaker
And as the question is just then at what price? At what price are investors willing to put in and buy in to this ah funding need? That generous equilibrium probably will be replaced by a less generous equilibrium, one where the US has to pay more or where people buying into US assets are only willing to do so at a lower value of the dollar.
00:14:21
Speaker
But the US s still has to be the net absorber of of capital from the world. the big sources of savings, and it does depend a bit on the oil price, but I think it is very interesting that right now the global funders are almost all in East Asia, mostly in China, little bit in Korea, a little bit in Taiwan, a little bit in Singapore, et cetera.
00:14:45
Speaker
So
East Asia's Role in US Deficit Financing
00:14:46
Speaker
the global flow of funds is basically from East Asia to the U.S. s and then more modestly to the U.K. I think the question is whether that is basically the price.
00:14:57
Speaker
ah Does the dollar have to adjust to keep that flow coming? And then also, is this a, as it has been, a private flow? Or does does the private flow pull back?
00:15:10
Speaker
In which case, in the past, ah Asian central banks have stepped in and acted as the financier lender of last resort to keep their currencies from going up, to keep the U.S. deficit game going.
00:15:25
Speaker
Now, that does run into some issues. ah You could characterize that as currency manipulation. You could characterize that as impeding the desired reduction in the U.S. trade deficit.
00:15:37
Speaker
um So it isn't clear if the U.S. will tolerate it. ah But I do think what we have seen over the course of this year is that—and it's not uniform across the Asian surplus countries— but in some of the surplus countries. What previously was a set of private investors thinking the dollar would go up, thinking U.S. rates are above Asian rates, thinking U.S. equities are going to shoot to the moon, Trump's deregulation will be good, reevaluating and saying, well,
00:16:11
Speaker
That dollar, it was pretty strong, maybe too strong, ah maybe ah five, four and a half, four, four and a half on long-term US treasury bonds.
00:16:24
Speaker
Maybe that's not a good price if you're going to put so many more bonds into the market. um So you see some of the traditional buyers pull back. ah which means, and you see some others who have big stocks starting to hedge, and then you see pressure on the currencies.
00:16:41
Speaker
And in Taiwan's case, you've seen the central bank come back and be very active in the market in the month of May. So we've seen at least in one case a return to an equilibrium where the flows are coming from the same place, going to the same place,
00:16:54
Speaker
But it shifted from being a private flow, a voluntary flow, a yield-seeking flow to being a defensive flow from a central bank that in Taiwan's case doesn't want its currency to strengthen.
00:17:06
Speaker
And then it becomes ah much more political intrinsically. So that's one dynamic. And then I think the the other dynamic is very much tied to the instability we've seen in the Middle East. If oil ends up at a higher price, then we would see a new equilibrium where Europe goes probably into deficit.
00:17:26
Speaker
The East Asian surplus falls and the the oil exporters, GCC and Russia, go back to being much more part of the game. Well, I guess, you know, to some extent, some of this is already happening.
00:17:39
Speaker
But actually, you touched on East Asia, um and we haven't got to China. You are an expert um on on China, particularly the external balances. um But, you know...
00:17:50
Speaker
You
China's Trade Surplus and Global Impact
00:17:51
Speaker
mentioned, and and actually I have a quote here, you said, Mr. g has a one-way vision of trade. Mr. Trump often sounds as if he doesn't believe in any trade. Between the two of them, the global economy is in for a rough ride. Well, you said that earlier the year. um Obviously, that was not a bad forecast. It already looks like things are already a little bit rough. But, I mean...
00:18:13
Speaker
but i mean How much of a complete severing do you think we see um on the trade side? But also, you know, what what are your broader thoughts um on China?
00:18:24
Speaker
Well, there are very different ways one can think about and measure China's trade. um You can certainly look at the shrinking share of exports to the US and say, OK, there's the beginning of some kind of decoupling.
00:18:40
Speaker
um I think that's actually somewhat misleading. um Chinese parts are just being assembled elsewhere in Asia. That is not true decoupling, nor has it meaningfully changed China's exports. You just don't see the direct trade.
00:19:00
Speaker
That is a function of a particular constellation of tariffs. If you have high tariffs on China and low tariffs on others, you will see more of that. And I think that is probably the most likely outcome. That is what Trump campaigned on.
00:19:16
Speaker
Another way of looking at ah developments is just to look at China's overall surplus and to think about China's overall surplus in relation to other big deficits.
00:19:27
Speaker
And if you think about trade that way, absolutely nothing has changed despite the apparent reduction in bilateral trade. China's monthly trade surplus is as high as it has ever been.
00:19:39
Speaker
it is now running about $100 billion a month, $1.2 trillion a year. It'll probably be above that this year. The US s trade deficit is over a trillion. there There is just no way those two variables are not linked in some ways.
00:19:53
Speaker
I think you can postulate three different futures. One is, in a sense, more of the same. Bilateral tariffs on China that are higher than tariffs on others.
00:20:08
Speaker
Easy, relatively easy to get around the tariffs by doing assembly in third countries. Europe takes on more of China's export surplus. The global economy does not adjust that much.
00:20:19
Speaker
The US actually doesn't just shut itself off from China in bilateral trade. It really closes down. In that world, Europe is faced with a vice.
00:20:31
Speaker
On one level, we'll see lower exports to the US. On the other hand, China will be exporting less indirectly to the US, have a lot more of its surplus to go to the rest of the world and biggest available market is Europe.
00:20:45
Speaker
And Europe has to choose about whether it remains open or not. And then the ability of Europe to kind of move into a current account deficit to absorb some of China's surplus becomes central, Europe and some of the commodity exporters, it's not just Europe, becomes central to the ability of China to run a big surplus without a big US deficit.
Gulf's Economic Ties with East Asia and the US
00:21:08
Speaker
possible, but it enormous strains on Europe. And then the third option is in response to this constellation, China finds it can't make up for the loss of the US market in other markets, and it is in some sense forced to adjust.
00:21:24
Speaker
It can't keep employment up just with its export sector, and so therefore it takes steps to stimulate, takes text take steps to support internal demand, or generally grows less.
00:21:36
Speaker
And that's, you know, a a world of both adjustment um and a world of ah ah big steps towards decoupling. Very hard to see how we the world will evolve because it a lot depends on whether the U.S. aggregate deficit comes down or comes stays the same.
00:21:56
Speaker
So I think it will be it ultimately becomes a test of how trump far Trump is willing to go and a test of how much ah the other parts of the global economy can re-equilibrate if the U.S. does change.
00:22:08
Speaker
so So just to to bring this all together, you know, we are sitting here on the sidelines um of the GCC Exchanges Conference that HSBC is holding. How do you see um the Middle East region, the Gulf region, faring in what are likely to be ongoing frictions in the whole US-China trade relationship in terms of what they seek to achieve when they've got their own domestic challenges, and even if they are still in a pretty strong position?
00:22:36
Speaker
um versus what they may want to do on the trade side and on the capital flows side. Well, i mean, one interesting thing about the the Gulf is that because the US s basically, I mean, to be perfectly precise, it's more like North America, Canada plays a role here, ah but the US is essentially self-sufficient in oil.
00:22:58
Speaker
All right, Trump, we don't have a trade deficit with the GCC countries because we're not buying their oil. That oil goes to China. And then, you know, they are willing to throw money at ah a Trumpian vanity projects.
00:23:11
Speaker
And you saw that how that, and buy U.S. s weapons, and you saw how that could be the basis for ah ah a relatively easy relationship with this president.
00:23:24
Speaker
It does, though, imply that the Gulf's economic interconnections so are increasingly with East Asia, which is the natural market for their oil. I'm pretty sure that the steel that is going to build the new cities is going to come from China, because why wouldn't you? It's the cheapest out there.
00:23:41
Speaker
um And there is sort of then this a little bit of a gap between the structure of ah the Gulf's connections, trade connections with the global economy ah and their political relationship with the US. Within the emerging markets context um and a world where I don't think you've completely dismissed the idea of any kind of globalization or trade reconfiguration, which emerging economies would you say start from positions of of relative strength who could, you know, I guess, fare less badly than some of the others um in the next couple of years?
00:24:16
Speaker
You know, the
Vulnerabilities of Emerging Economies to US Policies
00:24:17
Speaker
the interesting thing about ah emerging economies is that they aren't really anything close to a homogenous group of countries.
00:24:28
Speaker
Mexico, its essential vulnerability is its trading relationship with the United States, and that's something that Donald Trump wants to a change. Otherwise, it's broadly speaking a well-run emerging economy. But if you could take away Trump,
00:24:44
Speaker
Mexico looks fine. The problem is you cannot take away Trump. If you look at, say, South America, the interesting thing about South America is that South America does relatively little trade with the United States. It primarily exports to East Asia, ah primarily exports commodities. Brazil's an iron soybean exporter. All of the others are copper exporters.
00:25:06
Speaker
Their risk is down tied to further downturns in China. They're actually relatively insulated from Trump's trade war because they don't run trade surpluses with the US, s they run trade surpluses with China.
00:25:17
Speaker
So Trump doesn't tend to see them as bad actors, doesn't tend to hit them with big tariffs. So they've got a different risk. Their risk is tied to the Chinese economic cycle, not to Donald J. Trump.
00:25:28
Speaker
Turkey, very insulated from the United States, doesn't trade that much with US, s trades with Europe. If Europe's on an upswing, that should be good for Turkey. ah But Turkey's also next door to Iran.
00:25:39
Speaker
An oil importer, it's exposed to some specific risk there. You could say India doesn't trade that much with the US, maybe is a little bit more insulated.
00:25:52
Speaker
But then when you hit East Asia, ah Many of the countries of East Asia are maybe not as exposed as Mexico, but quite exposed to the to Trump because, you know, the poor countries like Sri Lanka, like Bangladesh, they're too poor to buy much from the US.
00:26:11
Speaker
So, the US doesn't export much and they produce clothing for the US market. So, we run a trade deficit with them. They've gotten hit with some—threatened with some rather absurd tariffs, which would be quite devastating.
00:26:24
Speaker
So then ah in a strange way, because of the obsessions of Donald Trump, they're on the front lines. If you look at Southeast Asia, they are caught because their economies have evolved so that they take parts from China, they assemble them, and they ship them to the US s and to Europe.
00:26:41
Speaker
If the US really wants to decouple in a serious way, their business model doesn't work. I think Africa, frankly, the US s is turning us back to Africa, doesn't trade that much with Africa, doesn't look like it's gonna provide much financing to Africa.
00:26:56
Speaker
So Africa is gonna have to rely more on China. ah or Europe. I think the big picture is you got the countries that are exposed to commodity shocks. And now you have to layer that on to countries that are exposed to Trump trade shocks.
00:27:11
Speaker
And unfortunately, a lot of the countries that are protected from Trump trade shocks tend to also be exposed to commodity shocks. So it's a difficult period.
Conclusion on Global Trade Complexities
00:27:23
Speaker
But it's still a relative world. I think there were glimmers of relative optimism within there. And for me, I think it was Latin America, perhaps um a couple of Latin American countries that came out.
00:27:33
Speaker
um Brad, um thank you very much for covering our our globetrotting um tour in this very, very complicated world that we find ourselves in um currently is obviously going to be the still a highly uncertain time for US policymaking um and the implications will be felt um everywhere in the world and not least in terms of capital flows.
00:27:56
Speaker
um So thank you very much for sharing your thoughts. My pleasure. Thank you for joining us at HSBC Global Viewpoint. We hope you enjoyed the discussion. Make sure you're subscribed to stay up to date with new episodes.