Trying to distill policy to its essence, the Trump economic game plan is to eliminate the trade deficit on goods while bringing manufacturing back to the United States. The two goals are often in conflict with each other. One cure for a trade deficit is for the dollar to weaken, thereby making exports cheaper and imports more expensive. A complementary or alternative method is to erect barriers using tariffs that make foreign goods more expensive. But a weak dollar chases capital away. Capital flows toward strength. A strong dollar attracts investment capital both for investment and capital spending purposes. Thus, on one hand, Trump wants a weaker currency that will help reduce trade deficits but he also wants to create incentives, whether using a carrot or a stick, to reshore manufacturing to our shores. He believes he can have both. Time will tell. But if the gambit fails, if tariffs raise prices and a weaker dollar pushes capital away, the consequences wouldn’t be appealing.
To eliminate the trade deficit, the administration has built a tariff wall intended to limit imports. Implementation to date has been erratic. We have seen 10% across-the-board tariffs on virtually everything, secular tariffs on steel, aluminum, cars and auto parts, and, for about 24 hours, reciprocal tariffs that weren’t reciprocal at all. Financial markets have reacted in a highly volatile fashion. That goes for stocks, bonds, and the dollar. The actual impact of tariffs has yet to be felt in a significant way as most were only recently imposed. The larger set of “reciprocal” tariffs have been deferred until July subject to negotiation. Thus, the economic consequences of tariffs are still unknown. We know it will be negative, at least initially. The stock market has sent that message loud and clear. But we don’t know if tariffs will merely stunt growth and create a price spike for a period of time or lead to a recession.
While consumption accounts for roughly 70% of GDP, future growth requires investment. Reshoring will require significant investment. There isn’t sufficient idle manufacturing capacity in the U.S. to suddenly build another two million cars or two hundred million smartphones. Those investments would have to be made by both U.S. and international companies.
The lynchpin to all this is the value of the dollar on world markets. As noted above capital moves toward strength. One wants to invest in strong markets not weak ones. If a European nation is considering building a manufacturing plant in the U.S., it would hesitate doing so if the dollar weakened. Why? Because any profits earned would translate back into fewer euros.
Currencies are strong when a nation has a competitive advantage. Perhaps its markets are growing faster than elsewhere. Maybe its governance is more secure. Maybe the dollar is stronger that it would otherwise be because it is the world’s reserve currency. Having the reserve currency elevates the value of the dollar. That may hurt trade imbalances. But that cost is offset by a series of advantages. Most importantly, when a nation has a deficit-to-GDP ratio of 7% or more, as we have, it can be funded cheaply because the reserve currency attracts capital as the safest harbor.
When Trump announced his reciprocal tariffs on April 2, not only did the stock market quake, but so did the dollar. The dollar is now down close to 8% since Inauguration Day. That strongly suggests a flight from the dollar to elsewhere. Elsewhere can be euros, yen, gold, crypto or whatever. Each has disadvantages versus staying in dollars, but uncertainty creates movement away. To keep dollars here there has to be an economic incentive. That incentive is higher interest rates. The yield on 10-year Treasuries spiked in the wake of the April 2 Liberation Day announcements while the value of the dollar was tanking. Needless to say, higher interest rates are not an administration goal. The spike in rates and dollar weakness clearly caused a rapid about face on reciprocal tariff implementation.
Over the past two weeks, markets have tried to stabilize. Treasury yields and the dollar’s value have traded in a rather narrow range. Is that a sign of a bottom? It’s much too early to say. Tariff negotiations are ongoing. We haven’t seen any tangible results yet. Washington says the 10% tariffs already in place are non-negotiable but with Trump anything is negotiable. China, of course, is the bigger problem requiring resolution. It is one of our top three trading partners. Tariffs each direction of over 100% are obviously not constructive and likely to be altered. But no one should expect a robust deal with China within 90 days. Any serious negotiation will have to not only cover what level of tariffs is acceptable but also broader topics like currency manipulation, state sponsored manufacturing subsidies, intellectual property theft, the rights of American companies to manufacture within China, and even the future of Taiwan. So far, no substantive talks appear to be taking place. Tariffs might be lowered if substantive talks begin. But they could yo-yo up and down should talks show frustrating progress.
Many companies have announced plans to invest billions, even hundreds of billions of dollars in the U.S. over the next four years. We have read this script before in Trump’s first term. To make a serious amount of reshoring happen, however, several things are needed. First and foremost, American manufacturing would be built to meet American demand. That’s a good start. Certainly, there is enough demand here to justify Apple# building an iPhone plant in the United States. But what about all the pieces? How many of them will be made here? What about cost differentials? U.S. workers get higher salaries. What about our red tape? Trump wants to cut that substantially but he isn’t going to eliminate it. States have their own set of regulations. The bottom line is that even if Apple could assemble phones here, including with parts made elsewhere, the price of an iPhone made in the U.S. would almost certainly be substantially higher than one made in Asia.
The iPhone is a price sensitive consumer product. Logically, one shouldn’t expect it to be made in the U.S. But the problems may be less for auto manufacturers given a different economic model. Many European and Asia car producers already have plants in North America. And more would come but only if demand here warranted construction. But once again, a weak dollar would also inhibit incremental capital spending on our shores.
Back to the dollar dilemma. Tariffs create barriers that chase international producers of goods to explore whether there might be alternative end markets for their products. They are a tax borne collectively by producers, importers and consumers. Reasonable tariffs used in a targeted way can correct economic imbalances. Tariffs to prevent dumping goods here below cost are one example. But a 10% tariff on coffee and avocados is simply a tax, a burden. Moreover, with tariff policy seemingly changing constantly, businesses are likely to defer investment until they better understand the costs of doing business in the United States. The actual flight of dollars means less money for capital spending. It means a higher cost to reshore. It means foreign buyers of U.S. debt will command higher interest rates.
Within Trump’s inner circles there is a tension, a disagreement on policy that still needs to be resolved. You have the Peter Navarro camp that, simplistically said, believes that all our global economic woes center on an unfavorable balance of trade for goods which can best be resolved by tariffs. If we make imports expensive enough, the only logical recourse would be to make everything ourselves, an ideal situation in the Navarro camp. One the other side, led by Treasury Secretary Bessent, a weak dollar and higher borrowing costs will lead to a flight of capital, capital we need to support the development of infrastructure needed if the U.S. is to see significant reshoring. Few economists align themselves with the Navarro camp. But the ultimate decision maker will be Trump. He has often described tariff as one of the most beautiful words in the dictionary. But as April 3rd showed, less than 24 hours after Liberation Day, Trump is not ignorant of market reactions. He does listen.
Where do we go from here? We are in the middle of earnings season. So far, results in the first quarter give little hint as to what’s to come. Anecdotal data suggests that Americans are booking fewer flights and buying fewer homes. Retail sales data continues to be robust but those numbers reflect a rush to buy large items to beat the tariffs plus some weather variations. May and June will give us a better read on consumer spending. Weekly jobless claims remain muted. Government terminations still haven’t hit in great numbers because many announced terminations start as paid leave. It is likely that within 2025 roughly 200,000 Federal jobs may be lost. But 200,000 is a tiny percentage of the U.S. workforce of approximately 170 million. What will be more telling are changes in employment within the private sector. So far, public sector employment remains solid.
Normally, investors focus on the natural forces affecting economic growth and balance. Growth was slowing before tariffs and is likely to slow further, at least in the short term. Balance focuses on inflation. Inflation spikes when demand exceeds supply. Balance leads to stability, ideal for investors. What is different this time is that political forces are much more critical than normal. And moreover, most investors are having a hard time factoring in the costs related to political decisions than normal. Today, including the tariffs on China, the overall “tax” on imports is over 20%, the highest in a century. And that doesn’t factor in the reciprocal tariffs put on 90-day hold. What we see today is almost certainly what we will see 30 or 90 days from now. A lot of the near-term economic future will be impacted by the direction in coming months of the dollar and the 10-year Treasury yield. There are sidebar considerations such as future steps to be taken by the Federal Reserve. But tell me where the dollar will trade in 9 months or what the 10-year Treasury yield will be at year end and I can give a more logical estimate of where markets are headed in the short run.
It is also important to remember that tariffs are only a part of the Trump game plan. He wants to extend and expand the 2017 tax cuts. He wants to cut Federal spending although doing so without dealing with the rises in interest, Social Security and Medicare costs will be a daunting task. One item he isn’t focused on is the Federal deficit. Fully implemented, his initiatives will add to the deficit and could raise the ratio of deficit to GDP even higher than 7%. Financing that debt at reasonable cost will be critical to successful implementation of the Trump agenda.
Until resolution, good or bad, becomes more apparent, I would expect volatility to remain high. That’s not necessarily a negative. Trump moves quickly and resolutions could be positive. Despite his rhetoric, he doesn’t want a bear market or a recession. Neither help his cause. Meanwhile, don’t underestimate the abilities of corporate managements to continue to succeed and grow despite the unsettled political environment. Obviously, the political and tariff barriers will be more or less severe company to company. These are unusual times. But looking back on Trump’s first term, at least up until the onset of Covid-19, it turned out to be a pretty good time economically. This time tariffs and other bold steps have come at a faster pace. That increases uncertainty. It also suggests looking for safer harbors until more resolution is apparent.
Today, Andie MacDowell turns 67. Tony Danza is 74
James M. Meyer, CFA 610-260-2220