In the early 1980s Congressional leaders were lamenting our trade deficit with Japan and were calling for protective tariffs. President Ronald Reagan would hear nothing of it and he invoked the memories of the Smoot-Hawley Tariff Act of 1930, the Great Depression, and the dark side of protectionist trade policies. That was a half-century earlier back then and today it is almost as long since. As the key element of President Trump’s trade policy, tariffs have become a great debate over the impact they will have on the global economy, not to mention the market volatility of recent months.
Critics argue that these tariffs will start a new trade war that will hurt everyone. Supporters argue that it’s an attempt by the U.S. to reduce long-term trade deficits and compel other nations to reduce their own protectionist measures.
The American economy is very broad and diverse and can absorb changes to trade policies though higher tariffs would likely dampen economic activity and raise prices for a wide array of products. Also, foreign companies eager to maintain access to the American market are planning to invest more here. The uncertainty surrounding trade policy is impacting consumer confidence which may affect the economy and the markets.
However, the history of tariffs is very clear in that they always backfire. Tariffs always result in more pain to the country that imposes them than they do to those countries that have to pay them. Tariffs are a tax on the American people. We will pay more for those goods that we want and need. Tariffs are an attempt to reshape the American manufacturing base by forcing citizens to pay more for goods that we want to buy. This is the type of central planning that is practiced in socialist countries and is an anathema to free markets. Interestingly, economists consider our trade deficits a source of our economic strength! For example: China’s trade surplus has grown about $700 billion since 2007, but its stock market is about flat; total returns are only up slightly and that is due to dividends. The US trade deficit has grown about $400 billion during this time, and the S&P 500 is up about 450% with dividends!
This past April 2 was designated Liberation Day in a rather George Orwell 1984-ish kind of way. The markets responded accordingly with risk-off selling that we haven’t seen since the start of the Covid-19 pandemic in March, 2000. Trillions of dollars of investor wealth were lost. Fortunately, the administration took notice and announced a 90-day pause, enabling the markets to rebound. Markets are inherently apolitical. This clearly shows that markets will neither validate bad policy nor will they tolerate any politician’s attempt to re-arrange the global economy. Although the markets have rebounded, we should not get complacent. Markets are aware of what the administration is capable of and a risk discount will be applied at least for the near term.
Frédéric Bastiat (1801-1850) was a French economist and writer who developed the economic concept of opportunity cost. He was one of the leading advocates of free markets and free trade in the mid-19th century. One of the main points of Frédéric Bastiat's satire is to expose the folly and negative consequences of legal plunder, particularly in the form of trade protectionism and government intervention in the economy. He argued that such policies, while seemingly benefiting a specific group, ultimately harm the overall population and hinder economic progress. In one essay, he argued that the government should block out the sun in order to protect the livelihood of French candlemakers. He also quipped that “if goods don’t cross borders, soldiers will.”
Hopefully the administration’s tariffs are just a negotiating tactic and not an attempt to re-start low-value manufacturing here in an economy that now is dominated by service industries. It is unlikely that labor intensive industries will ever return to the US.
The U.S. trade deficit for goods was $1.1 trillion in 2024. As Americans bought more imported products and the strong U.S. dollar made our exports more expensive. The U.S. has run a trade deficit every year since the 1970s. Other nations rely on global trade more than we do and the Trump administration‘s goal is to achieve a more balanced relationship with our trading partners. Much of the dollars that foreigners have are reinvested in our Treasury securities and other markets. If the U.S. wants to reduce its deficit, it will likely mean smaller capital inflows, a weaker dollar, and higher interest rates.
Tariffs also can result in higher inflation depending on whether they are a one-time event, or if a trade war erupts leading to higher long run inflation and subsequent higher interest rates.
Conceptually, this means that we charge you the same tariffs that you charge us. The Trump administration believes that key American industries face steep barriers to selling their products abroad. The European Union (EU) imposes 10% tariffs on cars sold in their markets while the U.S. tariffs on European autos is only 2.5%.
Tariffs on our major trading partners may well boost domestic production and give local firms an edge over imports. However, this would likely invite retaliation such as Canada removing U.S. liquor from its stores and China withholding critical mineral exports to the U.S., buying more planes from Airbus and fewer from Boeing, as well as non-tariff actions including investigations of our largest companies that do business in China.
The first Trump administration’s tariffs on China sparked a trade war that caused stock market volatility. In 2018 China’s economy slowed and the S&P 500 Index fell 4.4% with a sudden bear market drop in December that year. As trade deals were announced in 2019, the index rallied 31%. Consumer spending remained steady and inflation stayed low. Events of the past few months mirror what happened then. However, there are differences today including the wars in Ukraine and the Middle east and the inflation shock starting in 2021-2022. As we’ve stated here before, the stock market is resilient, and focusing on diversification and remaining invested during volatile times will enable you to attain your investment goals.