So as I’ve mentioned before Donald Trump plans on imposing a 20% tax on Mexican imports in hopes to force Mexico to pay for a border wall. Trump is playing with fire and here is why.
Trade Deficits 101
Trade deficits are the results of the United State buying more goods than it sells to a particular country. In theory, these can’t last forever as the deficit will cause your local currency (U.S. Dollar) to go down in value, which will make goods in the United States more appetizing to those in the other country.
Despite this, the US has been able to maintain large trade deficits with many of our trading partners like China and Mexico for quite a while. The reason for this is that the governments of both these countries took the mercantilist view that a prolonged trade surplus is how you grow your economy (a mistake the US made in the early 1900s contributing the bond bubble that led to the 1929 market crash).
How did they do this? They spent the dollars back in the US to push the dollar back up. Instead of buying goods or investing in US assets (companies, real estate), the vast majority of that capital came back to the US in the form of loans to the government by purchasing government bonds. Through the purchase of large amounts of government bonds, the trade deficit is turned into a boost for the U.S. dollar and lower interest rates, making it easy for Americans to continue buying foreign goods.
Mexico Has an Ace Up Its Sleeve
If any of these countries were to dump these government bonds, it would result in a huge spike of interest rates in America, choking the economy and the governments budget. The reason China and Mexico would not want to do this is because they are dependent on selling goods to America, so maintaining the status quo may seem (at least in the short run) in their best interest.
If Trump pretty much sets the stage to kill trade with Mexico, Mexico could just offer to pay for the wall by selling off some its holdings in US Debt, which will result in essentially blowing up the governments budget with interest cost as rates rise.
According to this article from 2012, Mexico owns over 50 billion in US Debt more than enough to pay for that 20 billion dollar wall, but at what cost?