Tariff Wars and Net Foreign Assets

This note addresses whether and when a trade war that imposes balanced trade (or even zero trade) can be consistent with initial non-zero net foreign asset positions. Using a bilateral trade model, we exploit insights from the classic literature on the Transfer Problem to characterize when gross asset or liability positions and tariff policies generate an endogenous terms-of-trade effect that ensures the value of assets and liabilities balance. As long as gross positions denominated in different goods differ in sign, there exists a continuum of bilateral tariff policies that ensure balanced trade and that satisfy the contractual financial obligations. If the new terms-of-trade do not reverse the initial direction of trade, balanced trade is consistent with non-zero exports and imports. In general, high enough bilateral tariffs lead to an autarkic outcome where no trade occurs and the net foreign asset positions rebalance to zero.