What’s going on with trade policy?
One perspective on what’s happening with tariffs
Author’s note: Most of my writing focuses on leadership, purpose, and meaning at On Purpose. But in my day-to-day work, I’m an investor. A number of people have asked my opinion on what the current U.S. administration is seeking to accomplish with tariffs, so I drafted the following. For some readers this may not be of interest so please skip this one if not relevant to you! As noted below, my purpose here is to be descriptive rather than prescriptive about what I believe the administration is seeking to accomplish and how, and how that might impact markets.
President Donald Trump deemed April 2, 2025 “Liberation Day,” and on that day he announced sweeping tariffs on almost every country in the world. The administration has termed these “retaliatory” tariffs, though the way in which they were calculated indicates they are more about trade deficits than existing tariff rates or economic barriers. Those new tariff rates are slated to take effect April 9th.
Since that time, global markets have plummeted. In U.S. markets, the S&P500 is down ~11% since April 2nd, and global markets have been hit as hard or worse, with the Chinese stock market, Japan’s Nikkei, markets in the EU, and many other indexes falling as much or more as those in the U.S. The fear seems predicated on the disruptive way in which these tariffs were rolled out and the likelihood that an overall trade war could cause a global recession, reignite inflation, and slow long-term growth.
Briefly, in what follows I will describe what I believe is happening. Here I am trying to be as descriptive as possible based on my current understanding of the issues without passing judgment one way or the other. I think it worthwhile to seek to understand the administration’s point of view to predict potential outcomes in markets and underlying economic activity.
First, president Trump seems to have a long-term set of beliefs that drive the decision-making around tariffs that should be considered:
1. Trade deficits are bad: For decades President Trump has been talking about trade deficits, which occur when a country imports more goods and services than it exports. The U.S. has been able to sustain these deficits by issuing the world’s reserve currency and soliciting a great deal of foreign investment. But the President sees trade deficits as a long-term problem for the U.S. and sign of economic weakness, harming domestic industries.
2. Tariffs are an underutilized mechanism for tax and industrial policy: The President and his advisors have also voiced consistently the idea that prior to the early 1900s, when there was no income tax, the U.S. paid for much of its federal government through tariffs and that they are a neglected form of tax revenue that can provide for a more balanced form of taxation.
3. Budget deficits are bad when above 2-3%: Several members of the administration have voiced concerns about U.S. deficits and long-term debt, and that current levels (6.3% of Gross Domestic Product for fiscal 2024) are an existential threat to the continued political and economic function of the United States. Cutting deficits to 2-3% of GDP annually or balancing the federal budget entirely and paying down long-term debt are a key priority.
4. The lower and middle classes in the U.S. have lost in the era of global trade: A key theme of President Trump’s three runs for office has been “making America great again” for all Americans, particularly those in the lower and middle economic classes who are being disadvantaged on a number of fronts including stagnating wages, deindustrialization, offshoring, the inflow of harmful drugs, competition from immigrant labor, and other topics.
Given these suppositions, the current tariff policies in combination with other policies of the administration might be seeking to accomplish:
1. Raising revenue to decrease deficits: One of the most detailed discussions of the approach to trade was Howard Lutnick’s appearance on the “All-In Podcast” two weeks ago. A key policy of the administration he spoke to was balancing the U.S. budget by cutting $1 trillion from the budget through DOGE (targeting waste, fraud, and abuse) and raising $1 trillion in tax revenue, primarily through tariffs. Calculations here can be complex, but some estimates indicate an average tariff rate of 25% or more would be necessary to approach this goal.
2. Re-industrializing America and re-onshoring critical industries: COVID, in particular, made many policy analysts more aware of the U.S.’s vulnerabilities to foreign supply chains in certain critical industries, particularly pharmaceuticals and medical devices. In addition, there is concern about our reliance on Taiwan for chips and various foreign supply chains for defense technology and other critical inputs (like rare earth minerals). A targeted tariff approach on those industries would be one part of shifting those supply chains over the long-term. In addition, the administration seems to believe in a larger strategy of reindustrializing America and restoring American manufacturing. This also fits with the new Trump Republican voting coalition which is focused on the working class.
3. Restructuring tax policy away from income: The president has announced several goals to lower income taxes, particularly for the lower and middle class (“no tax on tips,” eliminating income tax below $150,000 in income), which is concordant with a broader push among some economists to shift from taxing productive activity (e.g., income) to taxing consumption. Typically a VAT is discussed for the latter but tariffs might accomplish the same goal in a different way (though typically with broader-ranging distorting effects).
4. Applying pressure to global adversaries: The administration views China as the U.S.’s primary threat and seems to believe that the Chinese economy is in a vulnerable position. Applying economic pressure to the Chinese Communist Party (CCP) through tariffs and other policies could then be used both to heighten its internal economic pressures weakening the CCP’s ability to engage America abroad and to force the CCP to the negotiating table on a broader array of geostrategic priorities.
5. Shifting U.S. imports from foes to friends: Higher tariffs on countries hostile to the U.S. (like China) will naturally move production to near-shore countries with lower tariffs (like those in Latin America). The U.S. could use tariff policy not just to bring supply chains back to the United States but to accelerate their movement from China, specifically, to friendlier European / Asian nations or those more proximate to the U.S. in the Western Hemisphere.
6. Restoring fairness to global trade for the U.S.: The administration has pointed out that many U.S. allies and adversaries alike—including Canada, Israel, the EU, China, Vietnam, and others—already have tariffs and other trade or business hurdles targeting American businesses and products. The U.S. originally allowed this as a way to rebuild the global economy post-WWII and seek other benefits of global economic and political leadership. But the administration would now like to remedy this by restoring more fairness to those barriers. Whether that is by negotiating deals that lower overall trade barriers globally or simply raise American trade barriers to global standards is an outstanding strategic question.
7. Lowering interest rates to refinance debt: U.S. Treasury Secretary Scott Bessent, in particular, seems keenly aware that the U.S. will need to refinance $9.2 trillion in debt this year at a much higher rate than it was originally financed several years ago. Every 100bps decline in the interest rate saves approximately $90bn in annual interest payments. Slowing economic growth (or signaling that growth will slow) is a way of forcing rates lower without Fed action.
8. Negotiating non-economic goals through the use of Tariffs: President Trump has explicitly made non-economic goals related to border control and illegal drugs a part of his negotiation with Mexico, as one example, and that will likely be a feature of many of the bilateral negotiations on Tariffs as the administration hopes to use an economic lever to negotiate both financial and political outcomes it views as favorable to the United States.
9. Rejuvenating the economy medium and long term through other measures: In combination with its tariff policy, the administration seems to believe it can create economic dynamism through a variety of other measures including deregulation, reductions in personal income tax, recruiting greater foreign direct investment in American production, re-shoring American manufacturing, selling green cards, and paring down government to reduce deficits and allow for more efficient spending.
The administration has also repeatedly and consistently stated that it does not care about the impact of these policies on stock markets and is solely focused on impacting the underlying economy for “main street” without much regard for the impacts of those policies on “Wall Street.”
If successful, the administration believes it can reduce inflation, reduce deficits, balance the budget, encourage more balanced U.S. economic dynamism, accelerate incomes for the lower and middle class, restore fairness in the global economic order, set back adversaries like China, and assure U.S. national security interests through domestic or allied production of critical inputs, goods, and services. These are bold ambitions which will be challenging and complex to achieve.
One of my longstanding beliefs about President Trump’s approach to topics like these is he operates through a combination of long-term strategy and short-term flexibility, with a penchant for “deal-making.” In that context, I tend to believe you need to wait a few weeks after the President makes a policy announcement to see what he is actually seeking to accomplish with that policy. The same holds true here, where I think we will find out whether the President is genuinely hoping to erect incredibly high tariffs across the board to re-industrialize or he will engage other countries in deal-making which will selectively lower overall tariffs across the board through a series of bilateral negotiations. The latter appears the most likely approach as Treasury Secretary Bessent has already announced negotiations with Japan and Prime Minister Netanyahu announced new efforts with Trump in the Oval Office. But some members of the Trump administration seem to have markedly differing views about the right approach, the the long-term strategy remains to be seen. Understanding this fundamental dynamic will be critical to understanding long-term market impacts as well as impacts on economic factors like inflation (given that tariffs are typically inflationary, as they raise the costs of goods and services).
In general, it is difficult to predict the future in markets or the economy right now. 2025 is likely to be a year of significant uncertainty. I’d make only a few observations:
1. Market participants should prepare for volatility: 2025 is likely to be one of the most volatile years in recent history (although COVID wasn’t so long ago). We’ve already seen massive declines in the markets year-to-date, with more declines possible. And I expect swings throughout the year in markets broadly and in particular companies and sectors as the dynamics of the new global trade discussion, among other topics (like recession, artificial intelligence, inflation, interest rates, and global conflict) evolve.
2. Market performance may begin to revert to longer-term norms: As a reminder, the S&P as one measure is still up more than 100% over the last five years, an historical bull run which might naturally revert to mean at some point. U.S. equity markets have dramatically outperformed long-term averages consistently since the Great Financial Crisis (GFC). Investors should not take that outperformance as a given moving forward, as it was predicated in part on the easy monetary policies initiated in the midst of the GFC and in the wake of the pandemic. Long-term returns have tended in the mid-to-high single digits not double digits. And periods of regression sometimes follow prolonged bull runs.
3. It will take time to understand the impact of the tariff regimes on specific industries and companies: Supply chains are complicated. Deal-making will happen this year. We will not be able to trace the specific impacts of what policies emerge from initial negotiation for months or longer. Companies themselves are all digging in now trying to analyze how they will be impacted. Investors will do the same for their portfolios. But clear pictures will take time, reinforcing the volatility mentioned above.
4. The risks of economic recession in the U.S. and abroad are much higher: Betting markets and global financial institutions are all raising their probabilities of a U.S. recession in 2025, often to greater than 50%. I think the chances of a global recession including both the developed and developing world are ticking higher depending on the outcome of the tariff negotiations and the speed at which they are resolved.
5. Large cap stocks are still highly valued, small and mid-cap stocks seem undervalued: The overall P/E ratio of the S&P500 (at 19x) is still above long-term averages (of 16x). And that is driven by mega cap stocks (led by the Magnificent 7) sitting well-above their long-term average P/E ratios. Small and mid-cap stocks historically have traded more expensive than large caps due to their higher growth, but came into this sell-off already trading at a discount to large caps. As a result, small and mid-caps are now valued well below their long-term P/E average. This would indicate upside opportunity in small and mid-cap stocks that doesn’t exist in large cap stocks, particularly high-quality, profitable companies with little tariff exposure. Although in periods of economic uncertainty, there is often a “flight to quality” in stocks—which would favor large, profitable companies like many of those in the Magnificent 7.
These are complex topics, and I haven’t even touched on things like U.S. dollar valuations, emerging geostrategic alliances between China and other nations, or the ongoing wars in the Middle East and Ukraine. But I wanted to offer brief thoughts on these issues as they unfold as I see them (very imperfectly) as an addition to how others are seeking to understand the current environment.