Tariff Wars and Net Foreign Assets

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Citation

Aguiar, Mark, Manuel Amador, Doireann Fitzgerald (2026): “Tariff Wars and Net Foreign Assets”.

Abstract

This paper examines whether and how international financial claims can be honored without default once a trade war erupts. Using a two-country two-good model, we study how tariffs revalue international assets and how ex-post indebtedness depends on ex-ante gross asset positions. When gross positions are strictly positive (each country has claims on the other), sufficiently high bilateral tariffs zero out any ex-ante net debt. Conversely, this net debt cannot be zeroed out when the debtor holds no claims on the creditor. When a country has liabilities indexed to the other country’s prices, as in the case of foreign currency debt, then a sufficiently large tariff levied by the lender can immiserize the borrower, generating multiple equilibria if both sides have such liabilities. We generalize the environment to an arbitrary number of goods, time, and uncertainty. In the dynamic version, under a severe trade war, domestic interest rates and the real exchange rate must decouple: interest rates align with their autarkic values, and international relative prices revalue net asset positions to zero. We calibrate a two-country model to the US net foreign asset position in 2023 and show that the welfare consequences of a tariff war that stops short of autarky depend critically on the US ex-ante gross portfolio composition.