Transcription
When I compared President Trump's reciprocal tariffs that he announced on April 2nd, Liberation Day, with COVID-19, I wasn't being disparaging. I was just noting that it was a comparable shock to global supply chains.
If you think back five years, one of the effects of COVID was to cause a breakdown in international trade and, of course, also in international travel. If you look at the immediate aftermath of the Liberation Day announcements, you saw comparable declines in passenger traffic to the United States from abroad, especially from Canada, but not only from Canada, from Europe, too. If you look at the effect of Trump's tariffs, not only the reciprocal tariffs, but the tariffs he'd already imposed on China, there's been a really quite drastic decline in Chinese exports to the United States.
Now, unlike COVID-19, which it was impossible to stop spreading and against which there was no vaccine until the very end of 2020, President Trump can dial back and has dialed back his tariffs since April 2nd. In fact, on April 9th, just a week after he announced them, he introduced a 90-day pause in response to the kind of financial shock that he had caused. So the analogy isn't exactly the same because we've already seen a significant reduction in the tariffs that he announced, or at least a postponement in the tariffs that he announced on April 2nd. But at the moment he announced those reciprocal tariffs, the world economy was facing a shock as big as that which COVID unleashed five years ago.
But what is interesting is that in each case, you're administering what economists like to call a supply-side shock that very suddenly changes everything that is happening in the world economy and forces businesses everywhere to alter their plans. And it also has an impact on consumers because the disruption to supply chains will manifest itself in shortages or higher prices, or some combination of the two. So I don't want to overdo this. I think it's now clear that the shock is less than the COVID shock, but that's because President Trump has deferred or reduced the tariffs that he initially announced.
Well, it amounts to turning the clock of economic history back. For most of our lifetimes, the direction of travel was for average US tariffs to decline. The United States was a protectionist country for most of its history up until the Second World War. And after that, the US embarked on a policy of trade liberalization which was bipartisan and took the average tariff rate down below 2% by the time of the global financial crisis. President Trump's first term involved tariffs, but the increases were significantly less than the ones that he's now talking about.
So, let's assume, as I think a lot of people in markets currently assume, that when all is said and done, many, if not most, of the reciprocal tariffs will be negotiated away, and we'll end up in a world where the US charges a 10% tariff on just about all its imports. And it probably charges a higher tariff on Chinese imports because it's pretty clear that the administration's drawing a distinction between its friends and allies on one side and China. And so we'll end up in a world in which the average tariff rate is probably around 10 times what it was last year, maybe a bit less. That's a pretty big change in American trade policy. That takes us back perhaps to the period before World War II. Certainly, it takes us back to before I was born in terms of the level of protection.
What's the consequence? Well, part of it depends on who pays. Most economists expect that US consumers will absorb a pretty big part of the increased cost. And so one way of thinking about this is just as a tax, and therefore it's the biggest tax hike that we've seen in our lifetimes, with some percentage of GDP, maybe two, maybe one, but a big tax hike on consumers of imported goods. I imagine some of the costs will be absorbed by the companies doing the importing who don't want to price themselves out of the US market, and some may be absorbed by the exporters abroad. President Trump says it's all going to be paid by the foreign exporters, and that's just not borne out by what happened last time.
So we enter a world in which things jump in price, particularly things imported from China, but it's a one-off shock to the price level. It doesn't necessarily turn into persistent inflation, but it means for a period we'll see prices rising. Some people think you could see an inflation rate that goes up from 2-point-something to 4-point-something, but you'll be told, and I expect to be hearing, that it's transitory. Remember that word? It was a popular word back in 2022, too. Anyway, so there's an inflation effect.
But I think the most interesting question, Consuel, is really how do the supply chains of the world reconfigure themselves? You have to think of the global economy as this incredibly complex network of supply chains in which products like an iPhone, for example, in fact, consist of components and processes from multiple countries. China's only one of them. The lesson of the first Trump term was that if you went after China and made it more expensive to buy stuff from China, the same goods just arrived in the United States via third countries: Vietnam, Mexico. And this will be a problem for President Trump if he really wants to decouple the US from the Chinese economy because we still import a lot of stuff that originates in China. In some areas, China is the dominant source of US imports. So I think the real question is how quickly did the supply chains reconfigure themselves? And is the Trump administration going to go after things that originated in China even if they appear to be imports from Mexico? Rules of origin are going to become a talking point, and it's going to turn out to be quite difficult to establish.
Well, there are two separate questions. The first one: Who's hurting more? And the answer has to be China, because the United States is less reliant on imports than most economies. It's a pretty large, self-contained economy. And China is more reliant on exports relative to its gross domestic product. But the second question is: Who is more politically sensitive to economic pain? And you don't need me to point out that one of these players is a democracy, has things like midterm elections to think about next year, and the other is not. And Xi Jinping has already demonstrated during COVID that he can inflict a lot of social and economic pain on the Chinese people, and it was the longest and tightest lockdown in the world that he was able to impose. And that, I think, is the key here. I have no doubt that there are meaningful economic consequences playing out in China, and there may even be some social unrest, but the Chinese Communist Party has got an iron grip over the population through systems of digital and other surveillance. It is very difficult indeed to engage in any kind of protest in China without very quickly being clamped down on.
Whereas the United States is now on track for an economy that will grow more slowly, may even enter recession, and there's going to be some increase in inflation. So, these things are going to have political consequences, and it won't be long before it shows up in the price data, and then it's going to show up in the labor market data, and then it's going to show up in the polls, and then there are going to be some very concerned Republicans on the Hill wondering, when the midterms come around, are we going to get a shellacking?
There will be a persistent uncertainty about US trade policy for some months to come, and that's going to impact behavior. We can already see it in the survey data. Consumers are concerned, businesses are concerned, confidence is down. It's going to then translate into investment decisions getting postponed, purchase decisions getting postponed. So I think we're looking at something a bit reminiscent of 2006-7-8. Do you remember the slow way in which the subprime mortgage resets of early 2007 fed into the financial system and did not produce the real breakdown of the financial crisis until September 2008? And that kind of chain reaction is typical in a large, complex economy. This is a different shock. I don't think it has quite such severe financial implications, but nevertheless, you should expect the trade policy uncertainty that President Trump unleashed on April 2nd to have enduring macroeconomic effects, feeding through into a slowdown, if not a recession, whatever he does from now on. You can't turn off this chain reaction. It's underway. And the only question is, what's the magnitude? How much do prices go up? And more importantly, how much does growth decline? I think it's a reasonable base case to expect our growth rate to be down around 1% by the later part of the year. But as I said, there's a probability of recession which is substantially higher even than we talked about two years ago. And you'll remember economists thought there was going to be a recession in 2023, and it didn't happen. And the economists are the problem of the boy who cried wolf. Right now, everybody who is talking about a recession is kind of being dismissed, and I think a lot of investors are in the kind of "it's going to be fine" mode. But I remember 2007, the same mentality was there in the stock market. And I think people who say to me, "Oh, look at the stock market. It's rallied somewhat since April." Say, "Yeah, sure." But the stock market is not a profit. It does not have foresight into all that's going to happen. That's an illusion. And as there's still uncertainty around so much that we're discussing, it's perfectly possible that we'll get a major correction at any time between now and the end of the summer. There's a lot of bad news that can still materialize that currently isn't priced in.
Well, our message, which is always historically informed, is that it's harder than it looks to turn back economic history. And you should expect there to be a meaningful cost in terms of prices, in terms also of employment. A lot of small and medium-sized businesses do not have the capacity to go to the Oval Office and say, "Please, can we have a carve-out?" You can do that if you're Tim Cook and you're running Apple. But all those small businesses that rely on China, say for toys or for apparel, they're really getting caught in a very heavy crossfire here, and we should expect there to be pain, and that pain will take months to manifest itself.
The second thing is the US-China relationship is the crux of the matter. We are in a game of chicken between the two biggest economies in the world, and it's a far more aggressive game than we saw in the first Trump term. This is different because President Trump has upped the ante. He feels emboldened. He feels vindicated by his re-election. He is far more self-confident than the President Trump of eight years ago. And therefore, you should expect this to be a much more dramatic negotiation.
Now, the final thing, and a very important one, is remember this administration is interested not just in tariffs. It is interested in a weaker dollar. It's very unusual for a Treasury Secretary, for a US administration, to say that it kind of wants the dollar to be weaker. That violates Bob Rubin's old rule that when asked about the dollar, the Treasury Secretary should say, "The policy of the United States government is a strong dollar, and only that." So, we're in new terrain here where the administration seems to want a weaker dollar to boost the competitiveness of US exports. I'd say buckle up, because it's a lot harder than it sounds to achieve the kind of depreciation of the currency that some members of the administration talk about.
You've got to get a bit nerdy here. You have to look at the effective exchange rate adjusted for trade. You want to know how the dollar stacks up against the currencies of our major trading partners. And if you do that kind of calculation, looking at real effective exchange rates, you see that the dollar has been quite strong. It strengthened in a pretty sustained way after the global financial crisis, and therefore we may be due one of those periods when the dollar gets weak again, as happened in the mid-1980s, for example, and has happened in the early 1970s. But that can be good. In the 1980s, we had a weaker dollar, '85 to '87. We also had lower interest rates because Paul Volcker had managed to deal with inflation, and markets boomed. But in the early '70s, it was a completely different story, because in the early '70s, the dollar was taken off its remaining link to gold. This was Richard Nixon's big shock. Tariffs were imposed. But guess what? Rates did not come down. Inflation pressures grew. Stagflation started to become a reality. And the stock market performed pretty dismally.
This is, from my vantage point, the most important question. Is it somehow going to be a rerun of the mid-1980s? In other words, is Donald Trump going to be the Ronald Reagan of the 2020s? Or does he run the risk of Nixon's fate and ending up being a president associated with stagflation and horrible stock market performance? And no one, I think, can be 100% certain about which of these scenarios it is.