2025 Q1 Market and Economic Update
The big topic this year has been international trade, and specifically tariffs. On “Liberation Day” when Trump rolled out tariffs on America’s trading partners, the US stock market initially crashed, expecting devastating economic contraction and inflation. I initially commented that it was too early to determine what would happen. I still think it’s too early. I don’t want to get into a political discussion, but I do believe that taxes and barriers to trade (both domestically and internationally) reduce wealth creation. This massive tax that was rolled out on the American consumer does threaten to raise prices domestically while slowing global economic growth, or even causing contraction. This is the logical outcome to large tariffs, but it doesn’t have to turn out that way. I’m still confused on the point of the tariffs. Are they to stop illegal Fentanyl imports, to raise taxes or to compel trade partners to reduce their unfair trade practices toward the US? Trump famously likes to negotiate. Sometimes misdirection and being unclear about what you are willing to settle with are effective tactics. It is too early to judge what the final outcome of the negotiations will be. The situation could still resolve favorably if negotiations end with trade partners giving the US more favorable treatment in exchange for the US dropping its new tariffs. It could also turn out poorly if both sides dig in and maintain or escalate protective trade policies that ultimately impoverish everyone by reducing comparative advantage trade. For instance, imagine the impossible example of California and Iowa engaging in a trade war. Iowa slaps a large tariff on California wine, so California retaliates by taxing Iowa corn. If this were enforceable, California would have to tear up vineyards to plant corn, while Iowa would repurpose cornfields toward homegrown wine. Iowa is perhaps the best place in the world to grow corn, and California is one of the best places to produce wine, but trade barriers would have each reducing what they do best to do what someone else does better. Practically, if the goal is to reduce trade deficits by taxing imports, the actual mechanics of how this works is the final price to the customer rises to a point that the either the customer doesn’t buy or a domestic producer makes the product for a higher price than the non-taxed import but a lower price than the all-in cost with tariffs. The point is, US consumers get less for their money, and stocks suffer. We do know that Trump is very concerned with the stock market, so he is likely to have limited patience with a strategy that is hurting stocks. We also know that elections happen every two years, while stock valuations are based on decades of future earnings. If the current plan doesn’t work, Trump is likely to change course, and if he doesn’t the next person will.
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