The concept of tariffs is something many of us learned about in school, often linked to the study of the Great Depression. Intended to protect American industries during those difficult times, tariffs instead worsened the crisis by stifling trade and deepening the economic downturn. Since then, many economists and policymakers have debated their effectiveness. Despite this historical lesson, tariffs have once again become a central policy tool, driving market volatility and reshaping global trade dynamics.
However, it's not just the US focused on tariffs. Several recent trade disputes have significantly impacted global trade dynamics. For instance, did you know that last October Canada imposed a 100% tariff on Chinese electric vehicles and a 25% tariff on Chinese steel and aluminum products, citing concerns over unfair competition due to Chinese government subsidies? In response, this month, China announced retaliatory tariffs including a 100% tariff on Canadian rapeseed oil, peas, and oilcakes, and a 25% tariff on Canadian fish and pork.
Additionally, following Australia's call for an independent investigation into the origins of COVID-19 in 2020, China imposed tariffs on various Australian exports, including barley (80.5%) and wine (up to 212%). And since 2017, India has raised tariffs on several electronic products and "non-essential items" imported from countries like China and South Korea, aimed to promote its "Make in India" initiative and address current account deficits.
But, of course, the debate over the impact of tariffs is growing since the Trump administration has taken assertive action. Critics warn that imposing tariffs could spark a trade war that will have far-reaching economic consequences, while supporters argue they are a necessary step to address trade imbalances and pressure other nations to reduce their own protectionist policies. What we can all agree on is that the shifting trade landscape reflects a broader geopolitical realignment that is only gaining momentum.
Tariffs: A Tool for Protection, Negotiation, and Power
To help make sense of it all, let’s consider this carefully. First, to be clear, tariffs are essentially taxes on goods imported from other countries, used to help protect domestic producers from foreign competition, among other purposes.
There are four primary motivations for tariffs today and each has its own impact on the investment environment, highlighted in the chart below provided from our friends at the Capital Group. (1) Decoupling, which is shifting supply chains to reduce reliance on certain countries, such as China. (2) Rebalancing, which is about reducing trade deficits and boosting domestic production. (3) Negotiation is using economic pressure to acheive Trump's goal for policy outomes, and (4) Funding, which is about generating revenue to fund government budgets. Each are independent issues and will influence how the story plays out. For instance, tariffs used for negotiating purposes are unlikely to persist over long periods of time while those that are part of a larger decoupling process could be here to stay.
The base case assumption is that the United States can weather changes to trade policies, though higher tariffs would likely dampen economic activity and raise import prices. Let’s not forget that the U.S. has the advantages of size, economic resilience and consumers with money to spend. Fortunately, the supply chain disruptions since Covid has compelled businesses to already ramp up investment in the US, with both domestic companies as well as international firms that are eager to maintain access to the world’s largest economy.
Nonetheless, the ambiguity caused by these shifting trade policies is already affecting business and consumer confidence, which could ultimately have potential negative consequences for the U.S. economy and markets.
The fallout for other countries also remains uncertain, particularly those that rely heavily on the U.S. for trade, such as Mexico and Canada, where exports to the U.S. account for around 20% to 25% of their GDP. For most European economies, exports to the U.S. make up approximately 2% to 3% of their GDP, by comparison.
If the U.S. imposed tariffs result in lower exports and economic growth for these countries, then we are likely to see looser macroeconomic policy to counter the negative effects. Some governments are responding decisively. Germany, for example, has relaxed its fiscal policy dramatically and laid out plans to increase spending for infrastructure and defense, in part to reduce reliance on exports for growth.
America’s $1.1 Trillion Trade Gap: Strength or Vulnerability?
If there’s one number to know about tariffs, it’s the U.S. trade deficit for goods. That figure hit $1.1 trillion in 2024 as Americans bought imported products, and a strong U.S. dollar weighed on exports. In fact, the U.S. has run a trade deficit every year since the 1970s.
Economists say that a high trade deficit might indicate a strong U.S. economy because it reflects consumer spending. However, this large deficit is also why tariffs play a central role in Trump’s economic plan. Many other countries depend more on global trade than the U.S., so this administration is leveraging America’s strong economy to negotiate better trade deals.
The fact is, the U.S. has the largest trade deficit in the world, meaning it brings in a significant amount of money from other countries. If the U.S. attempts to lower this deficit, it could result in reduced foreign investment, potentially weakening the dollar.
Trump’s unusual use of emergency orders to add or remove tariffs has made markets uncertain. Previous presidents have used tariffs too, but they followed stricter laws that required more research and gave businesses time to adjust. However, the unpredictability of current trade policies adds another layer of risk, making it crucial for investors to stay vigilant. No matter how they’re used, tariffs could signal a shift toward a more isolated economy, which may have long-term effects on investments.
With markets reacting sharply to policy changes, we believe now is not the time to be complacent. Economic conditions can shift quickly, and portfolio adjustments may be necessary to navigate these evolving challenges. Investors close to or in retirement should be especially prepared for heightened volatility, inflationary pressures, and sector-specific disruptions. It’s critical to assess exposure to trade-sensitive industries, broad markets, and assets other than cash that may benefit from uncertainty to ensure portfolios remain resilient and aligned with retirement needs.
The Tariff Effect: How Trade Policies Shape the Economy
Do tariffs cause inflation? The short answer is yes, but the full impact is more complex. A one-time tariff may cause prices to rise slightly before stabilizing. However, if a trade war escalates, with tariffs increasing year after year, it could lead to long-term inflation.
It could also lead to higher interest rates. If inflation rises significantly, the Fed may respond by raising interest rates to slow down spending in an attempt to keep prices under control. A prolonged trade war with escalating tariffs could create a compounding effect on inflation, forcing central banks to tighten monetary policy even further. This cycle could potentially slow economic growth, which is why you may be hearing more about stagflation—a period of high inflation and slow economic growth. While it might be premature, all eyes are yet again to be on the Fed who will be meeting this week to consider its next steps. Investors and economists alike will be watching closely for any signals regarding future rate hikes, balance sheet adjustments, or changes in the Fed’s policy stance.
Tariffs can also disrupt supply chains and further drive up costs, keeping inflation elevated despite the Fed’s efforts to control it. If inflation remains stubbornly high while economic growth slows, the result could be stagflation—an especially challenging economic environment. While it is too early to predict the outcome with certainty, one thing is clear: investors must be prepared for a shifting economic landscape. Proactively assessing portfolio allocations and ensuring resilience against inflationary pressures and market volatility will be key to navigating the uncertainty ahead.
A Stronger U.S. Dollar: A Partial Inflation Buffer
Inflation isn’t the whole story, though. In the short term, tariffs can lead to a stronger dollar by shifting capital flows, which may help offset some inflationary effects by making imports cheaper. American buyers can purchase foreign goods at a better exchange rate, reducing the impact of price hikes on imports.
The value of the dollar also affects commodity prices, since goods like oil, metals, and raw materials are priced in U.S. dollars. When the dollar is strong, these goods become cheaper, keeping production and transportation costs lower. That could help contain inflation. Additionally, non-tariffed goods from foreign markets may become more affordable, further balancing out some of the inflationary effects.
However, a stronger dollar may not fully offset the impact of tariffs, and its strength could diminish over time with continued tariffs. Tariffed products will still see price increases, and domestic industries, now shielded from foreign competition, may raise their own prices, as seen in the past. A well-known example is Trump’s 2018 tariff on imported washing machines. Even though dryers weren’t tariffed, U.S. manufacturers still raised their prices to match competitors, taking advantage of the situation to increase profits. No matter how you slice it, tariffs are a market disruptor – with some good and bad consequences.
For instance, tariffs have disrupted the market positions of companies like Weber, the world’s leading barbecue brand, resulting in a 42% loss in market share and ultimately leading to the 70-year-old company being bought out by private equity. Traeger, known for its wood pellet grills, reported a 24% decrease in grill sales largely due to tariffs but has since rebounded through successful promotions. The financial strain from tariffs changed the market as U.S. competitors seized the opportunity to lower their prices. Looking ahead, some companies like Traeger will emerge stronger through these changes, but others will not. Regardless, the market conditions are changing enough, thus future winners and losers will also change.
What Is Trade Reciprocity and How Does It Work?
At its core, trade reciprocity means charging other countries the same tariffs they charge us.
The Trump administration aims to adjust tariffs so that they are more balanced and equal between the U.S. and its trading partners. This approach marks a major shift from 75 years of U.S. trade policy, which has focused on multilateral agreements under organizations like the World Trade Organization.
This shift has happened because the U.S. government believed American industries are at a disadvantage due to foreign trade barriers. A key example is the auto industry. The European Union charges a 10% tariff on U.S. cars, while the U.S. only charges 2.5% on European cars. This imbalance has fueled arguments for tariff adjustments.
But Americans should know that some of these tariff imbalances have been in place for decades. For example, Canada’s longstanding protectionist policies allow a predetermined quantity of dairy imports at minimal or zero tariffs. However, once this quota is exceeded, tariffs can soar to approximately 245% on imported cheese and up to 298% on butter. These measures were implemented to shield Canadian dairy farmers from international competition and maintain stable market conditions within Canada. But in the U.S., American taxpayers support its farmers, subsidizing over $30 billion annually to help manage production costs.
One unresolved question is whether Trump’s definition of reciprocity would include value-added tax (VAT) rates used by many countries. Unlike U.S. sales tax, which is applied only at the final sale, VATs are added at multiple stages of production. Some economists argue that VATs could effectively raise the EU’s trade barrier to around 25%. But, of course, the VAT is collected by the government of the country where the product is sold whereas the tariff is collected by the country that imports the goods.
Why Trade Negotiation Details Matter.
Since these trade negotiations happen one-on-one, every detail is important. Tariffs on major trading partners, such as China, the EU, Canada, and Mexico, can help reduce the U.S. trade deficit and encourage more domestic production by making locally made products more competitive against imports. However, tariffs can also lead to retaliation from other countries. For example, Canada has responded to US tariffs by removing U.S. liquor from its shelves. China could take even stronger measures, such as banning exports of critical minerals to the U.S., cutting back on airplane and agricultural purchases, or putting U.S. companies under more scrutiny. This could affect major businesses like Apple, Starbucks, and Tesla, which rely on the Chinese market.
What impact did tariffs have during the first Trump administration?
The first Trump administration pursued a similar goal of reducing the trade deficit by imposing tariffs. That move sparked a trade war that whipsawed markets and dominated the news, much like now. But it was temporary. In hindsight, the impact on inflation was muted in the aggregate, with the annual Consumer Price Index ranging from 1.50% to 2.85% in 2018 and 2019. The S&P 500 Index declined in 2018 but rallied sharply in 2019, both years driven by many factors other than tariffs.
However, today’s economic landscape is far more complex. The lingering effects of the pandemic, geopolitical conflicts in Ukraine and the Middle East, and the most significant inflation shock in decades have created new uncertainties. Tariffs, combined with potential federal spending cuts, could have a different and less predictable impact this time around.
The Lesson
The real lesson here isn’t just about tariffs; it’s about managing uncertainty effectively. While we can’t control policy decisions or global events, we can control how we invest. This serves as a reminder to stay focused on time-tested investment principles, such as diversification, maintaining a rational perspective, and preparing your investment strategy for unexpected market shifts, especially as you approach retirement. Avoiding reactionary decisions during market swings is critical. These fundamental rules are essential for navigating uncertainty and staying on track to achieve your financial goals.