Posts tagged ‘tariff’
Tariffs & Free Trade by Wade
Tariffs and trade have dominated the media headlines since the beginning of the year, creating a volatile rollercoaster ride in the financial markets and broader economy. What were screams of fear just last month turned into cheers of optimism after a trade deal between the U.S. and the U.K. was announced earlier this month.
This agreement—combined with hopes for future trade deals and the absence of runaway inflation or economic collapse—sparked a rally in stock prices. The minimum 10% baseline tariff in the U.K. agreement has fueled optimism that a simplified framework might extend to other international trade pacts. For the month, the S&P 500 surged by +6.2%, the Dow Jones Industrial Average climbed +3.9%, and the tech-heavy NASDAQ soared by +9.6%.
However, tariffs and trade haven’t faded into the background. In fact, just this week, a federal court ruled that the president’s tariff policies were illegal, citing misuse of emergency powers under the International Emergency Economic Powers Act (IEEPA) of 1977. Subsequently, the same court has granted the Trump administration a reprieve pending appeal—potentially escalating the issue to the Supreme Court. Even if the ruling stands, the president has alternative avenues to impose tariffs through other legal mechanisms.
So, what is all this fuss over tariffs and trade really about? I’ve previously written extensively on the topic (“Tariff Sheriff”), but some fundamental economic concepts still get lost in the tariff chaos noise.
It’s true that many countries engage in unfair trade practices against the U.S.—including subsidies, currency manipulation, non-tariff barriers, dumping, quotas, complex permitting, and value-added taxes (VAT). However, the powerful benefits of free trade are often underappreciated or poorly explained by the pundits.
Tariffs and Free Trade 101: China & France Experiment
To illustrate, let’s reference an example drawn from an op-ed by Princeton economist Burton Malkiel, author of the legendary finance book A Random Walk Down Wall Street.
Every country enjoys a comparative advantage in producing certain goods. For example, China historically benefits from low labor costs, making it a global manufacturing hub. Meanwhile, the U.S. leads in technological innovation, and countries like Brazil leverage vast land resources to dominate agricultural exports—such as being the world’s top coffee exporter. Let’s consider a simplified example using two countries: China and France, each with 100 labor hours available, and only able to produce T-shirts and wine.
China’s Output (see graphic above) – China’s comparative advantage in making more T-shirts than bottles of wine results in the following:
- 50 hours = 50 T-shirts
- 50 hours = 10 bottles of wine
France’s Output (see graphic above) – France’s comparative advantage in making more bottles of wine than T-shirts results in the following:
- 50 hours = 50 bottles of wine
- 50 hours = 20 T-shirts
Combined Total (China + France): 70 T-shirts + 60 bottles of wine = 130 total units of goods.
Example #2: Production Plan #2 (Each country specializes in their comparative advantage)
China’s Output (T-shirt specialization):
- 100 hours = 100 T-shirts
France’s Output (Wine specialization):
- 100 hours = 100 bottles of wine
Combined Total: 100 T-shirts + 100 bottles of wine = 200 total units of goods.
But here’s the challenge: the Chinese still want wine, and the French still want T-shirts. That’s where free trade comes in – see next example (graphic below).
Example #3: Production Plan #2 + Free Trade
Through free trade, each country can specialize in what they do best and then trade for other goods wanted or needed. If China trades 50 T-shirts for 50 bottles of wine with France, both countries end up with:
- China: 50 T-shirts + 50 bottles of wine
- France: 50 bottles of wine + 50 T-shirts
This plan produces 54% more total goods than the original production plan (200 vs. 130 – Example #1), with no increase in labor hours. China gets 300% more wine, and France gets 150% more T-shirts—a clear win-win.
Today’s Tariff Reality
In 2024, the U.S. trade deficit stood at $918 billion. President Trump’s aggressive tariff strategy aims to reduce this gap by incentivizing domestic manufacturing, increasing exports, and reducing imports. The challenge is that tariffs also raise prices for consumers and disrupt the benefits of free trade.
If the administration succeeds in establishing fairer rules for a level trading field, increasing government revenue, and narrowing the trade deficit, then history will likely view President Trump’s tariff policy favorably. But if tariffs lead to higher prices, inflation, and a weaker economy, the tariff policy may be judged as a costly misstep. The stock market, voters, and time will ultimately serve as the principal judges.
Looking ahead, two key dates are on the calendar:
- July 9 marks the end of the 90-day reciprocal tariff pause. Without new trade agreements, tariffs will spike on imports from many countries — raising costs for consumers.
- July 4 is not only Independence Day, but also the target date for Senate Republicans to pass the “One Big Beautiful Bill”, which packages several of President Trump’s top priorities: tax cuts, welfare reform, energy expansion, and border security. While the bill could stimulate growth, critics warn of its potential to balloon the national deficit.
Most Americans support the idea of fairer global trade. The question is whether aggressive tariffs across the globe are the right tool to achieve that goal — and whether trading partners will agree to new deals. Regardless of the outcome, this crash course in Tariffs & Free Trade 101 underscores the enduring value of specialization and free trade, even amid today’s turbulent tariff battles.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (June 2, 2025). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on the IC Contact page.
Animal Spirits to Animal Hibernation
Investor mood or sentiment can change rather quickly. Immediately after the 2024 presidential elections, positive animal spirits catapulted the stock market higher due to hopes of stimulating tax cuts and deregulation legislation. However, those warm and fuzzy feelings soured last month, as investor focus shifted to on-again, off-again tariff talks, and stagflation concerns, which have converted animal spirits into gloomy feelings of hibernation.
As a result, the advancing bull market took a breather and transformed into a weary bear during March. For the month, the S&P 500 (-5.8%), NASDAQ (-8.2%), and the Dow Jones Industrial Average (-4.2%) all fell significantly in the wake of tariffs, inflation, and recession worries.
Lovely Liberation Day or Tariff Trouble?
Since the President took office in January, he has announced, reversed, and implemented tariffs across a wide range of countries and sectors, including China, Canada, Mexico, the EU, Colombia, Venezuela, steel, aluminum, oil, automobiles, digital services taxes, and more.
The day of reckoning begins on April 2nd, designated Liberation Day by the president. This is when the president and the White House officially announce global reciprocal tariffs on foreign countries in an attempt to reverse the nation’s large trade deficit (see chart below) and bring manufacturing back to the United States. For example, if Germany subsidizes BMW cars sold in the U.S. while simultaneously placing tariffs (i.e., additional taxes) on American Ford Explorers sold in Germany, the president wants to impose equivalent reciprocal tariffs on those same BMWs sold in the U.S. in an effort to level the trading playing field. On the surface, a $131 billion trade deficit sounds very significant, but when compared to a $30 trillion economy (Gross Domestic Product – GDP), this negative trade balance represents less than 0.5% of GDP – effectively a rounding error. I have previously written how tariffs represent more of a molehill than a mountain (see Tariff Sheriff), in part because consumer spending and services make up the vast majority of our country’s economic activity, whereas trade and manufacturing are relatively smaller segments.
Source: Trading Economics
Driving home the point that tariffs are more bark than bite, Senior White House trade and manufacturing counselor Peter Navarro recently stated the 2025 tariffs could add $700 billion annually to U.S. revenues, including $100 billion from the recently announced 25% auto tariffs. Many economists believe this collection estimate is too optimistic. However, even if this target is achievable, $700 billion only represents a measly 2% of overall GDP.
Tariffs = Recession or Stagflation?
With the recent stock market downdraft and growing concerns related to tariffs, some economists and pundits are raising the probability of a recession and the possibility of inflation accompanying an economic downturn (i.e., stagflation).
Economic data should clear some of the fog. Fresh employment numbers will be released this Friday, which should shine some light on the health of the economy. Irrespective of this month’s results, the most recent 4.1% unemployment rate (see chart below), though slightly higher over the last two years, does not strongly indicate a recession.
Source: Trading Economics
Other “hard” data, such as GDP, also suggest a slowing economy rather than a recession. For instance, a recent survey of 14 economists estimates the economy is growing at a paltry +0.3% rate in Q1 – 2025 versus +2.3% in Q4 – 2024. Data is continually changing, but if a looming recession were imminent, corporate earnings would likely be trending downward, not upwards, as evident in the chart below.
Source: Yardeni Research
Tariff Inflation Has Yet to Arrive
There is no doubt tariffs function as a tax hike on consumers because U.S. companies that pay the tariffs on imported goods are eventually forced to raise prices to maintain profit margins or limit margin degradation.
Nonetheless, inflation did not spike under President Trump’s first term. Even if the president’s new policies result in more aggressive tariff actions this go-around, inflation will likely remain in check due to the point mentioned earlier – imported goods represent a small percentage of overall consumer and business purchases.
Tariff implementation is just beginning, so only time will tell how pervasive inflation will become. However, what we do know now is that inflation has declined dramatically over the last couple of years and has not yet spiked (see Consumer Price Index chart below).
Source: Calafia Beach Pundit
Where Could I Be Wrong?
I have explained how some of the lagging “hard” data does not signal recession or stagflation, but what could I be missing? For starters, some of the leading “soft” data (e.g., surveys) indicate various cracks in the economic foundation are forming. Take the recent Consumer Confidence data (see chart below), which has weakened dramatically from pre-COVID and even post-COVID levels.
Source: Trading Economics
It’s not just consumers who are feeling uneasy about the economic environment; businesses are as well. Another soft data point flashing red is the NFIB Small Business Uncertainty index, which recently reported its second-highest reading in 48 years (see chart below). Even if my argument that tariffs are too small to materially impact the economy holds, if the psychological effects of tariff uncertainty paralyzes consumer and business economic activity to a standstill, then tariffs could indeed become a substantial factor.
Source: National Federation of Independent Business (NFIB)
What Comes Next After Liberation Day?
Liberation Day is unlikely to trigger an immediate and sustained V-shaped recovery in the stock market because international trading partners will be forced to announce retaliatory tariffs in response to President Trump’s reciprocal tariffs, potentially leading to additional reactionary tariffs by the U.S.
Additionally, the reciprocal tariffs announced on April 2nd will likely serve as a starting point for subsequent negotiations with trading partners. Without a comprehensive resolution, investor sentiment will likely remain somewhat unresolved and unsettled. Regardless of your views on the size and impact of tariffs, Liberation Day will at least bring some clarity and reduce the uncertainty surrounding the current murky and chaotic environment.
The multi-year bull market continued its charge after the presidential election, but investor sentiment has weakened the bull run due to tariff uncertainty. In response, the excited bull has temporarily turned into a sleepy bear. Depending on how these tariff events unfold, we will soon find out whether Liberation Day will awaken the bear to hunt for bulls or send it into deep hibernation.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
This article is an excerpt from a previously released Sidoxia Capital Management complimentary newsletter (April 1, 2025). Subscribe Here to view all monthly articles.
DISCLOSURE: Sidoxia Capital Management (SCM) and some of its clients hold positions in certain exchange traded funds (ETFs), but at the time of publishing had no direct position in F or any other security referenced in this article. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on the IC Contact page.
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