Financial markets are in a high-volatility moment, triggered by the Trump administration’s attempts to use tariffs to re-order America’s global trading relationships. By far the most unexpected early move has been the announcement of 25% tariffs on Canada and Mexico, slated to go into permanent effect on April 2. Markets don’t like the seeming randomness of these trade wars, selling off U.S. equities into correction territory. But the moves aren’t random. The administration is pursuing policies that produce short-term volatility in a gambit to end an unsustainable status quo. What may look like unnecessary trade wars are part of a rebalancing effort that, if it works, will justify the pain.
Decades of bad trade policy have produced deeply unequal relationships between the U.S. and its trade partners, in which foreign exporters enjoy far freer access to the U.S. market than U.S. producers have in foreign markets. The result has been American deindustrialization. The Trump administration, seeking to end this arrangement, has made reciprocal tariffs the centerpiece of its trade agenda. However, reciprocal tariffs won’t work effectively if tariffed countries can simply export through, or offshore production to, third countries that enjoy duty-free access to the American market. That’s the situation with Canada and Mexico, which have a free trade agreement, the USMCA, with the U.S. That agreement has led to deep supply-chain integration across the three countries, but now it prevents us from successfully reordering our relationships with non-reciprocal trading partners. The agreement needs to be renegotiated, and that means we need leverage. Cue the announcement of 25% tariffs—and the scrambling of Mexican and Canadian to accommodate U.S. demands.
The U.S. has long accepted large and persistent trade deficits, producing less than it consumes from the rest of the world. This condition is not the result of any inherent competitive weakness in American producers or the voraciousness of American consumption. Rather, the dollar’s status as the world’s reserve currency makes it artificially strong, boosting our purchasing power but making dollar-denominated American goods more expensive on global markets. The overvalued dollar means that it is cheaper for American consumers to purchase imports rather than domestically produced goods. International demand for dollars to structure payments and hold as reserve assets acts as a penalty to American producers, who must compete against artificially cheap imports that result from the strong dollar. That penalty is significant: most economists believe that the dollar is overvalued by about 25%, which effectively acts as a 25% tax on American producers and a 25% subsidy for American import purchases.
However, in a normal market, sending out more dollars in purchases than we take in from sales—that’s the trade deficit—would weaken the dollar, naturally correcting the trade deficit by allowing producers to sell at more competitive prices and diminishing the purchasing power of importers. That hasn’t happened. The dollar’s strength has been mostly unaffected by 30-plus years of growing trade deficits. This is because our trading partners use state-directed policies to subsidize their exports, weaken their currencies, and discourage the purchase of American goods. These distortive policies range from traditional barriers to trade, like tariffs and producer subsidies, to less-visible measures, like the use of “financial suppression,” in which consumers are blocked from accessing credit so that banks instead lend to and invest in exporters. The result is that our trading partners purchase less from us than their wealth indicates they should, allowing trade deficits to persist at levels that would be impossible in a free market.
The cost of this persistent trade deficit is deindustrialization. Due to factors that have nothing to do with American producers’ inherent competitiveness, we are rapidly losing market share in the critical industries of the future—semiconductors, batteries, biotech, aerospace, and more. We tell ourselves that we can continue to innovate while others manufacture our products, but the truth—highlighted in a recent speech by Vice President JD Vance to an audience of venture capitalists—is that if we lose production, we will eventually lose innovation too because R&D and production exist in a feedback loop in which R&D reaps efficiency gains from locating next to the factory floor. That process is well underway. Take a look at China’s share of highly-cited biotech research or the panic occasioned by the arrival of China’s DeepSeek AI platform. By losing our productive capacity, we risk the basic underpinnings of the American economy—as well as our capacity to fight and win wars, which depend on the ability to both manufacture and innovate in the world of atoms.
What’s more, to finance the gap between what we produce and what we consume, we pay for imports by selling off ownership of the American economy. Since we don’t produce enough to pay for imports with exports—a process that would create jobs by generating demand for American labor—we pay by selling debt, equity, and real estate to our trading partners. Optimists call this “investment,” but it very rarely builds anything new. Greenfield investment is just a few percentage points of foreign investment in the U.S. The remaining “investment” is more often an ownership transfer, such that the dividends of American growth go to foreigners. As Warren Buffet once noted, it’s no different from a farmer selling off pieces of his farm and mortgaging the rest in order to consume more in the short term. It’s a suicidal economic strategy.
We need to break out and tariffs are critical to doing so. Leading figures in the Trump administration, like Treasury Secretary Scott Bessent and Council of Economic Advisors chair Stephen Miran, have strenuously advocated for enabling American industry to compete by rebalancing our relationship with our trading partners. The goal is to use tariffs against countries that maintain manipulative policies that discourage American production and keep their currencies artificially weak. In an international negotiating format that Miran calls the “Mar-a-Lago Accords,” countries could agree to either end these policies or accept high tariffs.
But there’s a vulnerability with this approach: the USMCA free trade agreement with Canada and Mexico. This means that any broad, global tariff can be immediately undermined by transshipping or transferring production to either of our neighboring countries and exporting duty-free to the U.S. Indeed, China has already had success in circumventing high tariffs on its U.S. exports by relocating its factories to Mexico. In the international trading system, tariffs are applied based on the country of manufacture, not the corporate nationality of the manufacturer, so a car made in Mexico by a Chinese corporation gets treated as a Mexican car—meaning, under USMCA, the U.S. can’t tariff it. Secretary of State Marco Rubio drew attention to this problem in a September letter to then-President Biden, writing that “Congress passed a free trade deal with Mexico—not China” and calling for “immediate action … to prevent the Chinese Communist Party from exploiting USMCA and weaponizing this important trade deal.”
If the U.S. wants to be able to punish trading partners that refuse to drop manipulative policies that harm American producers, it badly needs to alter its relationship with Canada and Mexico. Otherwise, attempts to close the trade deficit by tariffing manipulators will incentivize those countries to transship and offshore through Canada and Mexico, undermining the effort to close off U.S. market access to trade cheats.
The administration’s rhetoric has focused on illegal immigration and fentanyl as the reason for the tariffs. However, lurking in the background is the USMCA. The agreement is up for re-negotiation in 2026, and Trump has suggested moving up the date to this year, indicating that USMCA is top of mind. The agreement can no longer serve as a “backdoor” to the U.S. market if we want to end the doom-loop of trade deficits, deindustrialization, and the loss of American competitiveness and innovation.
America has considerable leverage. Canada and Mexico have trade surpluses with the U.S. and their economies are far more dependent on trade with the U.S. than we are on trade with Canada and Mexico. As Stephen Miran explained in a recent interview, American purchasers are flexible, with a large domestic market and many eager sellers, while Canada and Mexico, smaller economies that are highly dependent on the U.S., are more constrained, and therefore more likely to bear the impact of U.S. tariffs. For example, trade represents 67% of Canada’s GDP, and the U.S. is the destination for 77% of Canada’s exports. No other country accounts for more than 5% of Canadian exports. The dynamic is similar in Mexico, where trade is 73% of GDP and over 80% of its exports go to the U.S. Meanwhile, total trade is only 24% of U.S. GDP.
The Trump administration is taking advantage of this leverage by imposing 25% tariffs on steel and aluminum and threatening 25% tariffs broadly on Canadian and Mexican exports. These tariffs are an existential-level threat to our trading partners but merely painful to the U.S. Mark Carney, the new Canadian Prime Minister, has called the threat of these tariffs “the most significant crisis of our lifetimes”—hardly the reception they’ve gotten stateside.
With tariffs, we’ve taken hostages. Now it’s time to negotiate. The Trump administration has created an opportunity to rethink USMCA, such that it can no longer serve to undermine our reciprocal tariff strategy.
Critically, the administration has provided that goods that are USMCA compliant will be exempt from the tariffs, at least until April 2, when the tariffs are slated to become permanent. Goods become USMCA compliant when they are “substantially transformed”—essentially, manufactured—in Canada, Mexico, or the U.S. This requires a certification process that is usually too much of a headache for exporters to undertake because baseline tariff rates outside of USMCA are so low (often in the low single-digits) that USMCA compliance doesn’t make a difference. Unless, of course, baseline tariffs become 25%. All of a sudden, USMCA compliance, and certifying that goods have been manufactured in North America, is essential.
The U.S. is now in a position to make this exemption permanent, but should do so only if Canada and Mexico cooperate in the plan to reorder America’s global trading relationships. The first item on the negotiating agenda is for Canada and Mexico to match the U.S.’s tariff policy against manipulator countries, namely China. This would turn USMCA into something closer to a customs union, closing the backdoor to the U.S. market because tariffs for imports to enter Canada and Mexico would be the same or similar to tariffs imposed for entering the U.S. market directly. This is already happening naturally—Mexico and Canada, suffering their own abusive trade dynamic with China, have recently adopted high tariffs on Chinese goods just as the U.S. did during the first Trump administration. They are now offering additional tariffs to appease the Trump administration. Indeed, Secretary Bessent has called for tariff-matching to produce what he calls “fortress North America.” USMCA should start digging the moat.
When USMCA was negotiated during Trump’s first term, it innovated over its predecessor agreement, NAFTA, by introducing product-specific “Regional Value Content” rules in order to qualify for preferential USMCA treatment. Cars, for example, need 75% of their value to come from North American inputs, and 70% of automakers’ steel procurement must originate in North America. This prevents a company from simply importing auto parts from China, putting them together in Mexico, and getting duty-free treatment under USMCA. Further, 45% of the value of the car must come from factories where workers earn a minimum of $16 an hour. This acts as a proxy for a national content requirement, ensuring that low-wage Mexico can’t take auto manufacturing away from higher-wage America and Canada.
The thinking behind these rules was simple: they ensured that foreign producers couldn’t get preferential treatment for goods that weren’t really produced in North America. However, the current penalty for non-compliance with these requirements is a mere 2.5% tariff—the baseline non-USMCA rate. For many automakers, it’s cheaper to pay the measly sum rather than comply with rules that would benefit American producers. That must change, and these rules should be expanded to cover other high-value manufactured goods to ensure that China and other trade-distorting countries can’t benefit from the USMCA.
Further, USMCA must look beyond the country of manufacture in assessing the nationality of products for tariffs purposes. It must tariff goods based on the corporate nationality of the manufacturer to prevent China—or other manipulator countries that are not party to USMCA—from gaining U.S. market access by offshoring to Canada or Mexico. This approach has already been called for in a bill sponsored by Sen. Josh Hawley, which would increase the base tariff on Chinese autos to 100% and apply the tariff to all imported cars made by Chinese automakers irrespective of the country of manufacture. USMCA must codify Sen. Hawley’s idea and likewise apply it to high-value manufactured goods beyond autos. Indeed, Trump’s U.S. Trade Representative, Jamieson Greer, explicitly endorsed this approach in congressional testimony last year.
All of this points to a counterintuitive fact that much of the reporting on the U.S.-Canada-Mexico trade war has missed: the tariff threats will have the likely effect of binding Canada and Mexico closer to the U.S. Because Canada and Mexico need our export market more than we need their imports, these countries simply do not have the option of walking away from USMCA. At the same time, the U.S. needs USMCA renegotiated if it wants to re-order its global trading relationships with reciprocal tariffs that punish trade manipulators. Clearly, there is a deal to be made.
The administration needs to land the plane. Trump has opened negotiations with typical bombast by declaring that Canada should become the 51st state, creating risk that Canada will attempt to dig in its heels. Further, the timing and structure of the tariff rollout have been subject to frequent changes, causing more market volatility than necessary. There is no guarantee that the program will be executed effectively, and there will be costs if it isn’t—many U.S. manufacturers have deep supply chain integration with Canada and Mexico, and a failure to sustainably improve our trade terms with these countries could invite retaliation and destabilize key American firms without providing any benefit in return.
However, much of the discourse on the Canada/Mexico tariffs operates on the assumption that there is no strategy and that the tariffs are instead a gratuitous manifestation of Trump’s bullying cruelty. Ezra Klein recently devoted an episode of his New York Times podcast to why the tariffs won’t work, describing them as “momentary bullying” while his guest, Kimberly Clausing of the Peterson Institute, agreed that the tariffs on Canada and Mexico “defy explanation.” In the Atlantic, Roge Karma recently compared the idea of the Mar-a-Lago Accords to QAnon and mocked the notion that tariffs on Canada and Mexico were anything but “an incoherent, inconsistent, self-destructive mess.” After all, Canada and Mexico aren’t major dollar holders. What role could they possibly have to play in global trade rebalancing, he asks?
A look at the details reveals that they play a major one. The U.S. won’t be able to reverse its deindustrialization trend if USMCA can serve as a duty-free export and offshoring conduit to the U.S. market. Tariffs—and the volatility they create—have triggered an all-hands-on-deck moment in Canada and Mexico to renegotiate USMCA. This is a highly welcome development.
The tariff threat is thus a key measure in the most important task this administration has: the restoration of American dominance over production and innovation in the industries of the future. We cannot do this if American manufacturing is kneecapped by our trading partners’ distortive trade and currency policies, and we cannot effectively combat those policies if we continue free trade with Canada and Mexico in its current form. The administration’s shock-and-awe approach to altering our relationship with these countries is risky—but the object it aims at is essential.
