The Tariff Recession?

Low-Tech Imports, High-Tech Exports

My last letter made the simple (at least to me) point that persistent trade deficits are an inescapable aspect of issuing the global reserve currency. The US is not like others. Our chief exports are dollars, which the rest of the world uses for central bank reserves, investing in our stock market and trade settlements. This system, while it has flaws, keeps the global economy moving with much less friction than was historically normal.

I was also careful to explain free trade has limits. Governments sometimes must intervene to protect their national security or domestic interests. I’m not against all tariffs; I just think they should be rare and, when necessary, applied with great caution.

Nonetheless, some readers took that letter to mean I am Mr. Globalist. I am not. Some countries like China are clearly abusing the system. We need specific targeted plans for dealing with problems while retaining what works.

I’m often told our trade deficit is “unsustainable.” Seriously? The US has been running them almost every year for a half-century now, during which the economy grew substantially, American companies invented many innovative technologies, and living standards rose. Of course we have problems. Trade deficits didn’t necessarily cause them.

The US is a huge exporter of a wide variety of goods, not just basic commodities. Here’s a graphic showing our 2024 goods exports by category.

Oil and related products are the largest box, but add up the other large categories and you’ll see various industrial and manufactured goods account for about half of our goods exports. You can view the full list here.

Yes, we import a lot of manufactured goods, too, the dollar value of which exceeds our exports. But there is an important qualitative difference. Our imports are generally inexpensive, low-tech goods while our exports are more sophisticated technologies and equipment. That’s exactly how “comparative advantage” works. We don’t make our own furniture and T-shirts because our demographically shrinking labor force has better opportunities. A little humor:

The US economy has issues. But the idea that our manufacturing base resembles war-ravaged Japan or Germany is simply false. American entrepreneurs (many of them immigrants) routinely build amazing things, much of which is exported. A trade war will make their jobs harder, not easier.

Progress Is Good

Many readers talked about the loss of US manufacturing jobs in recent decades. I share their frustration. We all—both business and government—got overly excited in the early 2000s about opening trade with China and forgot to plan for the inevitable side effects. This wreaked havoc on former factory towns.

But it’s also wrong to blame the trade deficit. The reality is that many of those jobs would have gone away regardless as new technologies made manufacturing more efficient and consumer demand shifted. Trade deficits are part of the equation, but not necessarily the biggest part.

Germany, for example, shows how running a trade surplus doesn’t necessarily boost manufacturing employment. A recent Wall Street Journal editorial explained:

“Between 2000 and 2024, Germany’s trade balance as a share of its gross domestic product grew from a deficit of 1.5% to a surplus of 5.8%. During this same period, the country’s share of factory jobs fell from 20% to 16%. A 2021 study found that the decline in manufacturing job shares was similar in both US and German industrial hubs despite the stark differences in national trade balances.”

That trend actually goes back much farther. German manufacturing employment, as a percentage of the labor force, has been falling despite a growing trade surplus.

The WSJ piece adds another important point. And note that last part (my emphasis):

“It’s also important to recognize that about 45% of US imports are inputs that go into our own manufacturing production. An import tax on these inputs hurts domestic manufacturing. Why have American car manufacturers pleaded with the administration not to impose tariffs on steel? And why has Alcoa, the largest US aluminum producer, sought a waiver from tariffs?

“Even if US-manufactured exports increased enough to close the trade deficit—an extremely unlikely event—and if employment grew proportionately, our manufacturing-workforce share would climb only from 8% to 9%. Not exactly transformational.”

Just as the world now produces more food with fewer farmers, we also manufacture more goods with fewer workers. This is called “progress” and it’s generally a good thing.

Progress has side effects for sure; that’s why we talk about “creative destruction.” Being on the destructive end isn’t fun. Ideally, progress happens slowly enough for everyone to comfortably transition into better opportunities. It unfolds faster now, which is a problem we need to address. But again, I don’t understand how tariffs help. Driving up the cost of foreign inputs for our manufacturing industry makes US exporters less competitive. That will reduce exports, not increase them.

The Status of the World Reserve Currency

I am a participant in several active chat groups. Last night and this morning one focused on how this will affect the status of the US dollar as the world reserve currency. David Rosenberg wrote: “I sense this is the first step towards America relinquishing the reserve currency status…” That was in the context of these tariffs actually sticking. I don’t think they can.

The US supplies the currency the rest of the world uses for trade. It is a mathematical certainty that the world’s reserve currency must run a deficit. It is an exorbitant privilege and the US really, really, really needs it. All those dollars that we export return to the United States in one form or another. Much of it goes to buy our debt, but also all sorts of goods and services, including stocks. If you are wondering why the stock market is not having a particularly good week, this is part of the equation.

As of Q4 2024, overseas investors owned $16.5 trillion, or 18%, of US equities—the highest share on record, according to Federal Reserve data. That's up from 8% in 2000 and just 2% in the 1950s.

Rather than seeing it as a “trade deficit,” we should realize those dollars come back to the national account which mathematically must balance. The US benefits, massively, because we have the exorbitant privilege of being the world’s reserve currency and the recipient of those dollars back into our markets.

And no, I’m not arguing that some countries and some businesses are not cheating and need to be sanctioned. There are some countries that are clearly hostile to the United States and need to be sanctioned. But Vietnam and Switzerland are not a problem.

Strange Formulas

Now, let’s look at “Liberation Day.” I will assume you read the news and know the basic facts. The president is adding minimum 10% and sometimes much higher tariffs on almost every country in the world. The amounts come from a rather strange, if not economically perverse, formula that purportedly reflects the barriers each country imposes on US exports. The stated intent is to achieve “reciprocity.”

From Strategas, a true and favorite go-to source:

“President Trump announced his tariff proposal today, which is near the worst-case scenario. We estimate the proposal will generate roughly $500bn of tariff revenue on top of the $150bn that has already been enacted. Trump said he wanted $600bn and he got it. This represents 2.2 percent of GDP and twice the size of the largest tax increase in modern US history.”

Make no mistake. Tariffs are a tax increase on the American people and business just like a sales tax increase.

The new policy assumes trade deficits in and of themselves are bad and that the world economy is a zero-sum game. Setting tariff rates by algorithm at least puts everyone on a level playing field, I suppose, but it misses many details and distorts reality.

Vietnam, for example, has a monster trade deficit with the US. Vietnamese exporters sent goods valued at roughly $137 billion to the US in 2024, while importing only $13 billion in US goods. This produced a $124 billion trade deficit. Vietnam’s GDP was approximately $476 billion, so trade with the US is obviously crucial. The tariff proposal is almost 10% of Vietnam’s GDP.

The White House’s formula claims Vietnam charges 90% tariffs on the US. That is untrue. They do have some small import duties. The trade deficit exists not because Vietnam throws up unfair barriers, but because Vietnam’s low-wage workers make a lot of stuff Americans want to buy (like Nike shoes and T-shirts). Meanwhile those same workers (because of their low wages) can’t afford many American goods. Nevertheless, we are now imposing a 46% tax on their exports to the US. To the extent this reduces exports, it will make Vietnamese workers even less likely to buy US goods—not to mention devastate their economy.

There is some irony here. Both the Trump and the Biden administration encouraged businesses to leave China and to manufacture elsewhere. Vietnam was a large recipient of those companies going “elsewhere.” And now we are penalizing them for it.

The same is true, more or less, in numerous other countries. This is so nonsensical I have to think it is a negotiating ploy. But for what? Vietnam doesn’t have much to give. They don’t control the inputs to the formula which produced that 46% tariff rate, so nothing they do will improve it. Can they offer to sell us T-shirts at a lower price? Sure, they could remove those minor import duties, but it’s de minimis in the grand scheme of things.

If the idea is to force these other countries to offer concessions, then it might work in some cases. Vietnam can probably drop some taxes and let Trump claim victory. But that will have to be individually negotiated with dozens of different countries, which will take time. Meanwhile the damage will mount.

In my chat group the consensus seemed to be that the tariffs are a negotiating ploy. What my longtime Trump fan wife calls, “He’s just doing the art of the deal, John.” I think I replied something like, “Then he understands as much about economics as you do.” Thankfully she laughed and I got to sleep in my bed. True love and all that.

But back to the chat—the real question is how does Trump walk this disastrous tariff policy back. My friend David Bahnsen said, “Trump doesn’t do mea culpas. He does off-ramps.”

Perhaps getting concessions from countries like Vietnam will give Trump an off-ramp. Lesotho? Nauru? Get in line.

Our larger trade partners have more options. China and the EU can apply targeted leverage against US customers while stimulating domestic demand to replace lost imports. I woke up this morning to China imposing a 34% tariff on US goods. Neither policy will help restore trade balance. China and Europe will feel some pain, but it should be manageable for a while. If they don’t come to the table, then what? Is Trump going to tighten the screws even more? I don’t see the endgame here.

If forcing negotiation isn’t the goal, there’s another possibility. Maybe the goal is to raise revenue in McKinley-like proportions. The president has hinted at this many times.

Last weekend Peter Navarro, (possibly the most dangerous man talking to the President), told Fox News, “Tariffs are going to raise about $600 billion a year, about $6 trillion over a 10-year period.”

Really? Based on total imports of $4.1 trillion last year, this implies a 15% average rate on imported goods and services. But that’s probably low because much of the total is Canada and Mexico which will apparently get more favorable rates. That would mean more like 20% on everything else.

Americans, not foreigners, will pay most of this via higher prices, lower profit margins, and lost jobs. The thinking may be that tariff revenue will enable other offsetting tax cuts, like the campaign promises to make tips, overtime, and Social Security benefits tax-free. But that would still leave a mismatch; the tariff impact will fall on everyone while only selected groups get tax cuts.

Worse yet, the tariffs are happening immediately. The tax cuts, if they happen at all, will come later this year and in 2026. We are getting the stick first and the carrot later.

Moreover, will that much tariff revenue even happen? Only if Americans keep buying imported goods at higher prices. Again, really? We just went through one round of inflation which no one liked at all. It’s hard for me to believe people will just shrug off 10-20% higher prices on almost everything they buy at Walmart. If their paycheck doesn’t increase, and it isn’t going to, then that means they buy fewer products.

If the tariffs do produce significant revenue, it will mean they aren’t drawing manufacturing back to the US. We will remain import dependent, with only the financial terms changing. From that point forward, the political incentive will be to encourage more imports so the government can keep cutting taxes and raising benefits.

The hope may be that reshoring will happen over time. How long is hard to say. Building a new manufacturing plant, or expanding an existing one, isn’t a quick decision. You have to first gain confidence that someone will buy your products, then go through all the design, financing, permitting, and other steps to actually build it. Maybe a year for simple products, several years for more sophisticated items. Large factories typically take 5–7 years. Ideally, these would add more tax revenue as they come online while tariff revenue diminishes.

Something like that may be Peter Navarro’s thinking. And make no mistake, I think he has Trump’s ear and is the one driving all this. I was a little relieved back in December when it looked like he would have only a minor role in the administration. That now looks overly optimistic.

We haven’t even talked about how other countries may retaliate. China imposed a 34% tariff this morning. Others may choose differently. Japan and South Korea, for instance, depend on US security guarantees. Will they push back and risk Trump’s wrath? Currency adjustments are also possible. We are in a highly fluid situation that could go many directions.

What we know is that these tariffs, if implemented, will be a large, regressive tax increase on American consumers while inflation is going up, GDP growth is falling, and unemployment rising. It may not reach recession level, but we are certainly looking at a slowdown. The Fed may not be much help, either. Rate cuts have a limited impact on this kind of shock.

Final Thoughts on Tariffs

In no particular order.

• These tariffs are enacted under something called the International Emergency Economic Powers Act (IEEPA). There are literally hundreds of sections of this act. It is extremely technical. The first legal challenge was filed before I woke up this morning by the same conservative law firm that successfully overturned the Chevron case. There will be more. I can understand making the case that China or (pick a country) requires an emergency response. But Switzerland and Vietnam? Lesotho? Mauritania? I am not a lawyer nor the son of a lawyer, but it will be interesting to see how the Supreme Court deals with this when it reaches them. I have no idea at this stage how they will rule.
• I know for a fact that Congressmen and Senators are getting lots of very unhappy calls. The margins in both chambers are razor thin. Trump absolutely has to get his tax extension through Congress. Not just for him, but for the country. Not extending that tax increase is a guaranteed recession. We would get through it but the temporary pain will be, well, painful. All it takes is five House members and a couple of senators to dig in their heels over the tariff policy to slow things down. I truly hope that’s not the case, but just saying…
• This is Game Theory 101. The world was in a trading equilibrium, for good or bad, but it was an equilibrium. Trump’s tariffs are game changing for everyone. Game theory says that every other player on the table will try to protect their own interests. China already imposed 34% tariffs this morning. Some will capitulate. Others will negotiate.
• China’s first reaction was to issue a response that sounded like a full-throated defense of free trade. Honestly, I read it and laughed. Only Trump can make China sound like a free trade advocate. But I have read several China-related letters, from serious China hands, and this is a serious and massive blow to their economy. Their 34% tariff is posturing as both sides can’t seriously not negotiate through this. Pay attention to whatever US-China talks occur.
• Quick calculations indicate this will increase inflation at least 1-1.5 percentage points. What does the Fed do? Last week I was arguing that the Fed needs to cut at least three or four times this year, but can they do that with 4% or higher inflation? Can they argue the tariffs are a one-time phenomenon like then-Fed chair Arthur Burns did in the 1970s? That didn’t work out very well. And today’s employment numbers offer little reason to cut all that much.
• At least four services that I follow have raised their recession odds overnight. I talked with Ed Yardeni who is raising his recessions odds to 45%. I told him I thought that if these tariffs are still in place in two months, that is a guaranteed recession. He agreed. Which means neither of us believes they will still be in place.
• I am not certain what the off-ramps will look like, but they will come. As I write, the market is continuing to drop significantly. A 20% correction is very possible. Every time we get an off-ramp where an agreement is reached between countries to forgo the tariffs for whatever reason, I expect the market will rally. And then if nothing else follows soon the market will fall further until the next offramp. This too will pass.
• The good news is that our biggest trading partners, Canada and Mexico, are more or less unaffected, with a few exceptions. And our job market still is strong.
• The proposed tariffs are significantly higher than Smoot-Hawley, which caused the Great Depression. We will see retaliatory tariffs proposed as part of the negotiations. This is serious.
• I know that hope is not a strategy, but Trump has actually appointed some very serious economic and market-oriented minds to policy positions. I can’t believe they would go along with these policies long-term. That’s why I think this is all part of negotiations, which Trump believes will work. I and every other American should be hoping that it works and that we can get back to dealing with reducing government waste, getting a workable immigration policy, and so on.

All this will, however, make for an interesting Strategic Investment Conference next month. Our online event will, as always, feature an all-star faculty to help you through the turbulence.

A quick note: volatility creates opportunities. My friend and fellow Mauldin Economics writer, Jared Dillian has created The Options Masterclass. It is quite an achievement—a real education without drowning you in arcane math, a practical guide without endorsing Robinhood-esque gambling, a deep, deep dive into the options world without numbing you with theory. Until April 20, you can get the Masterclass at a 50% discount—that’s $299 instead of $599. I can assure you it is worth far more than that. You can learn more here.

Dallas, DC and an Abbi Update

I will be in Washington, DC, April 21–24 at a conference hosted by The Alliance for Longevity Initiatives, where I, Dr. Mike Roizen, Dr. Mehmet Oz, and others will speak with staff and members of Congress focusing on health and longevity policies. If you would like to participate as a sponsor, more information is here.

I will then go to Dallas to open our new longevity clinic with Mike the next week. And then West Palm Beach and Columbia, Maryland shortly following.

I want to thank everyone for their well wishes for my daughter Abbi, who had double bypass open heart surgery last Friday. When I left Tulsa earlier this week, she was active and doing well. The doctor told us that she probably didn’t have more than a month or so to live as her arteries were blocked badly. Now everything is good. I was blown away by the technology. The world has improved so much.

It is time to hit the send button. We will visit this topic more next week as things will surely change. Interesting times. You have a great week!

Your not understanding what’s going on analyst,

John Mauldin

A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out some of our webcasts.

© Mauldin Economics

Read more commentaries by Mauldin Economics