Seth Wenig/AP Photo
A screen displays financial news as traders work on the floor at the New York Stock Exchange in New York, April 3, 2025.
As we’ve been covering at the Prospect, the American economy is looking distinctly shaky. The financial markets are down about 15 percent, the labor market is softening, and consumer balance sheets don’t look great. Delinquency rates on credit card debt and auto loans are higher than they’ve been in years. Inflation expectations are soaring, and estimates of a coming recession are ratcheting up.
But we might now be in for something worse: a full-blown financial crisis. And this one might be even worse than 2008, because a senile madman is president, and nobody can count on an even halfway competent government response. As a result, America’s most powerful weapon against financial disaster—the safe-haven status of dollars and dollar assets—is coming into question.
Trump’s deranged trade war against the entire planet is unleashing economic chaos, as many before the election predicted. The biggest current fight is with China, which recently announced a 34 percent tariff in response to Trump’s original attack, which led Trump to retaliate with another 50 percent, putting the overall tariff rate on China at 104 percent.
As I was writing this article, Trump abruptly announced a 90-day pause on his “reciprocal” (they aren’t) tariffs, but kept the global 10 percent duty, and escalated further on China to 125 percent. Markets rallied on the news.
But if just the China tariffs hold (or rise even further), that might cause a recession by itself. It will mean an instant, near-total halt of trade between China and the U.S. That trade was worth $582 billion in 2024, making it the sixth-largest bilateral trade volume in the world (depending on how you count the European Union). It’s not that large a share of either economy, but all manner of American businesses depend on Chinese imports, many of which can’t be easily sourced elsewhere. For instance, the bicycle industry gets 40 percent of its bikes from China. Moreover, 10 percent is still quite a sizable tariff, and in 90 days we are going to go through this ridiculous farce all over again.
Worse, the wildly erratic way Trump has imposed and removed these tariffs has cratered business confidence. As Paul Krugman points out, economists don’t generally think of tariffs as causing recessions by themselves, but Trump throwing up tariffs based on a totally nonsensical formula announced at the last second, as well as yanking them up or down on his random whims, makes it impossible for businesses to plan anything. Trump is creating recessionary conditions through his malignant personality alone.
The wildly erratic way Trump has imposed and removed these tariffs has cratered business confidence.
Trump’s lunatic incompetence has in turn deeply spooked financial players around the world. Many big institutions are pulling back from risky investment and running for liquidity. Previously, if a crisis hit, you would see the interest rate on U.S. government debt crash and the value of the dollar increase as everyone scrambled to buy up these safe-haven assets. That is not happening this time—interest rates on Treasury bonds are increasing while the value of the dollar falls.
Indeed, late on Tuesday, the interest rate on Treasurys (that is, government bonds) soared to the highest level in years, before abruptly falling again. This may have to do with the “basis trade.” As Adam Tooze explains, this is when financiers (most commonly, hedge funds) conduct arbitrage on the Treasury market. For instance, if you spot a discrepancy between the price of a bond and its futures market (that is, a contract to buy the bond in the future at a particular price), you can make an easy profit, thought to be nearly risk-free because Treasurys are so safe. Because the margins on such a trade are small, hedge funds commonly borrow 50 or even 100 times their own money on the trade, to maximize profits.
The problem with this much leverage, of course, is that it only takes a small miscalculation to create giant losses, and clearly the hedgies refused to believe that Trump would actually blow up the global trading system. This same thing happened in March 2020, as the effects of the pandemic ripped through the markets and the hedgies all tried to wind down their basis trade positions at once, forcing the Federal Reserve to step in and buy trillions of Treasurys to stabilize the foundation of the financial system. The Biden administration’s SEC actually investigated this problem, but ultimately nothing came of it, and the hedge funds raced back into the market as soon as the coast was clear.
At this moment, it’s not clear yet what exactly is happening in the Treasury market, but at a minimum these recent price spikes are radical moves in a $28 trillion market that is typically very sleepy. Panicked liquidations, if they’re large enough, can destabilize even a market this big, leading to wild gyrations that can cause knock-on problems. That instability would be worsened by the fact that buyers have to absorb large new issues of Treasurys every few days—and worsened still more by how the quantity of regular debt issuance has increased because of DOGE’s illegal cuts to the IRS, resulting in an estimated $500 billion loss of tax revenue this year. Debt issuance will increase yet more if Trump’s plans to abolish the IRS office that audits the wealthy, and pass large new tax cuts for the rich, go through.
And that brings me to the potential worst-case scenario. Back in 2020, we saw a flight to dollars, which helped backstop the Fed’s rescue of Treasurys with trillions in printed money. But what if this time everyone decides to flee from dollars, too? Then if the Fed rescues the Treasury market, the value of the dollar would plummet, leading potentially to the worst currency crisis in history. The dollar’s “exorbitant privilege” would become a curse overnight, as everyone tried to dump trillions upon trillions of dollars and dollar assets at the same time. Hyperinflation and a Great Depression–scale collapse would not be out of the question.
America would certainly deserve it for electing a senile madman to the presidency, again. But it wouldn’t be great for the rest of the world either. Neither the European Union nor China—the only two entities that could possibly do it—are set up to replace America as the global economic hegemon. The EU would have to create trillions in euro assets overnight, and be prepared to lend freely to half the planet, while China would have to give up its vaunted capital controls. More likely, nobody would replace the Fed as the world’s lender of last resort. But I pray officials in Brussels and Beijing are at least considering this possibility. America can’t be trusted to act rationally anymore.
The swing voters who delivered the election to Trump last year were, by and large, low-information people who hated inflation and wanted it to be 2019 again. I hope this inspires some introspection about voting Republican in the future.
