Transcription
Credit where credit's due, President Trump made a big bet that the US had a magnetic appeal and that would enable him to get a better deal from US trade partners and companies that want to do business in the United States. On the evidence of the last few months, that bet is playing out pretty nicely.
Did the economics profession get it wrong on tariffs or is the impact just delayed? Economists don't agree on much. One thing they do agree on is that free trade is good and that tariffs are bad. If we were to trace US tariffs over the last, let's say a hundred years or so, there's our axes, from the end of the 19th century into the start of the 20th, tariffs were on a declining trend. Get to 1930, and we get the infamous Smoot-Hawley Act, that most economists believe contributed to and deepened the Great Depression. From that point on, we have a continuous decline in the average US tariff rate till Trump started his second term. He's jacked it all the way up to around 15%. For a moment, Trump escalated US tariffs on China all the way to 125%.
If you plugged the US tariffs into a model of the global economy, what it said was that there was going to be a really significant drag on growth. And there was also going to be a significant upward impulse to prices. And low growth and high prices is a challenging state of the world, which economists call stagflation. Markets panicked. Let's look at the S&P 500. It looked like this. If we looked at a chart for economist's forecasts for inflation, we've got the COVID bump in inflation. We've got prices coming almost back down to target, but then, oh dear President Trump's introduced his tariffs and we get another inflationary bump. But when we look at what's happened to inflation over the summer, it's not come down, but it's not come up either. That inflationary bump from tariffs, that the Fed was focused on as a risk before they cut interest rates, it hasn't materialized, at least not yet.
We looked at lots of the different things, which people in the United States buy every day. If tariffs were being passed on to consumers, we'd see a pretty tight relationship. In fact, what's happening is there doesn't seem to be a very strong relationship at all. US firms are facing higher costs for their imports, so far though, they're not passing those higher costs onto consumers. Why is that? Well, it's because US importers and foreign exporters saw the Trump tariffs coming and they rushed to front load, shipping to the United States before the tariffs could come into force to build up cheap inventories that they could then sell down after the tariffs came into place. If we look at a chart of US imports, what we see is that in the first months of 2025, imports weren't exactly off the scale, but they were significantly higher than they had been in the same month in 2024 and the average of past years.
One thing that's happened is that we've gone from a lot of unexpected bad news concentrated on a single day to a series of country by country deals, some of which brought good news relative to the previous status quo. We have US allies like Japan and Korea, which are scrambling to make offers to the United States, promising hundreds of billions of dollars to help rebuild US manufacturing as a price to retain access to the US market. There's something of a Swiss cheese of exemptions and carve outs and smaller tariffs obviously have a smaller impact. The trade war is a drag, but it's not the only thing which is happening. We've got tax cuts with Trump's one big beautiful bill, and we've got a bonfire of regulations, which is stoking the animal spirits of US businesses. We've also got the artificial intelligence boom and a huge amount of investment going into data centers. AI and the trade war kind of point in opposite directions, and investors are paying much more attention to the potential for AI to be a significant profit driver. Certainly it seems like there's enormous potential with artificial intelligence. At the same time, the International Monetary Fund and other economists are warning that the markets have got a bit over ahead of themselves. There's irrational exuberance. If markets have a moment where they lose their confidence, that can only mean one trajectory for stocks- downward.
There are signs of weakness showing up in the US economy. We've gone from a labor market comfortably creating a hundred thousand or more jobs every month to barely expanding, and in some months the number of jobs shrank. So a concern here is that, well, when the tariffs do start to hit, they're going to be hitting an economy where the labor market's already weak and potentially amplifying that downward trend. China, which views itself more as a peer competitor to the United States, they've turned up with their own leverage. You impose tariffs on us, we are going to impose tariffs on you. You block our access to semiconductors, we'll block your access to rare earths. And we're seeing the impact of that really clearly in the trade data. China's exports to the United States are way down relative to where they were last year, way down relative to the historical trend.
So who pays for the cost of tariffs? We're seeing US firms absorbing tariffs in lower profit margins. Why might that be? I can think of two reasons. The first is no one wants to be the first to raise their prices and lose market share. The second, and this is more speculative, is no one wants a vengeful US president. But despite his well-known love of gold, the president is not an alchemist. He can't make something from nothing. That money has to come from somewhere. And if the US Treasury is looking forward to $3 trillion in tariff revenue over the next decade, all of the evidence so far suggests that in the end, the bulk of it is going to come from US businesses and US households.
One way of thinking about this second Trump presidency is that it's an innovative approach to managing the fading of America's imperial movement. America was the world's single superpower. In 2025, that's clearly not the case. Trump is attempting to use that last moment of strength to get a better deal. Will President Trump succeed in reigniting the flame of American preeminence or will he just hasten the end? I think on that question, the jury is still out.