Tackling the Trade Deficit with Tariffs
As it stands, Americans import more than they export. Donald Trump is not happy about this and believes that American jobs are unfairly lost to foreign production. This ignores the benefits of trade – the ‘comparative advantage’ for any economics students reading – which are lower costs, greater consumption, and a more prosperous economy overall. But Trump doesn’t see it this way and therefore wants to bring the US trade deficit down to zero, balancing the value of exports and imports in goods.
In his speech from the White House Rose Garden on Wednesday, the President announced that nearly all imports to the US will be subject to a 10% baseline tariff from April 5, and that further ‘reciprocal’ tariffs would be applied to a long list of countries from April 9. Of America’s largest trading partners, the EU will face total tariffs of 20%, Japan 24%, while Chinese imports will face total tariffs of 54%. These measures will run alongside the 25% tax on steel and car imports which had already been announced.
The levels of these tariffs are likely to change over the coming months as negotiations and countermeasures develop. The US has said that where countries do not retaliate, these numbers reflect the high-water mark, while those countries that do will face additional measures. Investors, politicians, and business leaders had been waiting for the announcement from Trump’s ‘Liberation Day’, hoping that greater certainty would be provided, but with such an aggressive move it is impossible to predict how tariffs will look once the dust settles.
The UK – Getting Off Lightly?
The UK has not been singled out for the additional tariffs and therefore looks like it is in the less-bad scenario of the two. This could have potential benefits for our economy, with UK goods getting a 10% discount for US consumers relative to European competition. Yet, this is likely not cause for great celebration. Even though we face the less onerous challenge, it will still be a worse trading situation than before. In addition, on the latter point regarding a UK advantage over Europe, if this materialises then it is likely to create tensions with the EU, complicating Keir Starmer’s plans, who has been trying to build better relations with our European neighbours.
Geopolitical Realignment
While the US is purposefully taking an isolationist direction, an undesired consequence of this could be greater cooperation between America’s traditional allies and its adversaries. With the rise of China over recent decades seen as a threat by Washington, successive US presidents have sought to build a coalition of like-minded democracies to contain Beijing’s power. Yet, with the US now moving away from its allies, they are reappraising their global relationships. In anticipation of this week’s announcements, economic officials from Japan, South Korea, and China (all historic enemies) met to discuss their responses, opening the door for greater cooperation. The EU and Canada are also reported to be warming to China in expectation of cooling relations with the US.
Increased Chance of Recession
Geopolitics is being reshaped by Donald Trump’s second presidency. The shape of the global economy and its prospects are also being rewritten. Tariffs are taxes on imports. This will lead to lower profits for producers and higher costs for consumers. This is a stagflation effect in that it will lead to higher inflation and lower growth. An estimate from JPMorgan suggests that the tariffs will increase inflation by 1-1.5% in the US. This significantly raises the possibility of an American recession, which, should it occur, would have damaging spillover effects for other countries.
Trump appears aware of the risk of recession his actions create, yet so far seems unfazed, believing that the ultimate effect will be the reshoring of production to the US, reducing their imports. This would be a long-term benefit for the country, but only after significant disruption has been experienced.
Market Reactions
Unsurprisingly, equity markets have reacted negatively, fearful of the growth implications of the tariffs announcements. The FTSE 100 is down by 1.3% at the time of writing, European markets are down around 2.3% on average, and the US S&P 500 is down by 3.3%, with the tech-heavy Nasdaq 100 down by 4.4%. These losses aren’t the first downward shift either, with investors already nervous in the days leading up to the announcements.
For investors with multi-asset portfolios, it is not all bad news, however. Government bonds across the US, UK, and Europe are rallying, as lower growth forecasts bring expectations of further interest rate cuts from central banks. The diversification traditionally expected between equities and bonds is working well today.
In the currency markets, the US dollar has fallen by approximately 1-2% against major trading partners. At many times over recent decades and especially so over recent years, the dollar has done well at times of crisis, with the stability of the US economy and the sound legal and trading systems affording American assets ‘safe haven’ status. Yet, in a reversal of this trend and in reflection of the expected economic self-harm of these policies, global investors’ confidence in the US is now fading. This has been happening since Trump’s inauguration in January, but the latest developments are compounding it. The calculations behind the announced tariffs levels appear crude and lacking in logical theory, which raises the question of credibility in the approach of the US government and, as with many of Trump’s actions so far, damages trust in the US economy.
Where markets go from here will depend on how countries retaliate and how negotiations develop in the coming weeks, but volatility is likely to remain heightened over this period. The path of economic growth will have to be monitored closely as tariffs start to bite, and central banks will be vigilant to signs of a slowdown. With interest rates at relatively high levels, there is plenty of room to cut should this be needed, but with tariffs likely to be inflationary this does complicate the situation. As this unfolds, there will be challenges, but opportunities too. US equity markets seem the most vulnerable given their high valuations, while lesser-loved areas with lower prices could provide shelter on a relative basis.