Tariff Talk

Thursday, February 6, 2025

Although tariffs were absent from the flurry of executive orders in January, February brought new developments, with Canada, Mexico, and China now in the spotlight. While the situation remains fluid we’ll take this is as an opportunity to put tariffs into context and examine their potential impact.

A Historical Perspective

President Trump is not pioneering new territory here. While modern tariffs, including those implemented in 2018 and 2020, have played a modest role in economic policy, tariffs have had a more prominent role historically. In the past they have been used to attempt economic fairness (with “fairness” being subject to interpretation), protect domestic industries and generate government revenue.

Recent tariff supporters who face criticism of inflation often dust off history books and point to the Smoot-Hawley Tariffs of the 1930s as evidence that tariffs alone are not inflationary. It is true that the taxation of over 20,000 goods, leading to an effective tariff of roughly 20%, coincided with flat or even moderating CPI levels. But let’s not forget the broader economic backdrop: the U.S. was in the depths of the Great Depression, with the economy contracting sharply. Hardly the definitive proof one might hope for.

Fast forward to modern times. The tariffs imposed during Trump’s first administration in 2018 and expanded by President Biden in 2020 coincided with inflation surging from multi-decade averages of approximately 3% to over 9% by 2022. Other prevailing economic factors were also at play during that period. The government responded to the COVID-19 pandemic by dramatically expanding the money supply, keeping interest rates at historic lows, continuing quantitative easing until March 2022, rolling out massive fiscal stimulus and running up deficit spending (which continues today). Tariffs were just one piece of a much larger inflationary puzzle.

The Economic Punchline

Basic economic principles suggest tariffs are inherently inflationary. Why? Even without retaliatory tariffs—which we think are likely—companies facing higher input costs will pass those increases on to consumers. That translates to higher prices and, in effect, is policy-manufactured inflation. However, the actual inflationary impact depends on broader economic conditions, as demonstrated by history.

What This Means for 2025

• Tariffs Raise Inflation Risks, But Aren’t the Only Factor - The risk of accelerating inflation has increased for numerous reasons. If tariffs are enacted, the extent and scope will likely add upward pressure on prices. However, they won’t be the sole driver of inflation.

• Tariff Impacts Tend to Be Temporary, Not Structural – Just as tariffs can be imposed quickly, they can be reversed just as fast. Long-term investors are likely to see greater success by focusing on fundamental drivers—valuations, earnings growth and diversification to name a few—rather than short-term policy moves.

• Expect Noise – Tariffs are often used as a bargaining tool rather than purely an economic policy. Take Colombia, for example. In a recent headline-grabbing episode, the new administration sought to deport migrants back to their home country. When Colombia initially resisted, a brief standoff ensued, involving tariff threats. After a few deportation flights landed, the tariff threats disappeared. The new administration has shown far greater willingness to use these tactics than in the recent past. We expect more of these episodes which could create short-term market volatility. For long-term investors, such moments often present opportunities rather than fundamental shifts.

As always, please reach out with any questions; we would be happy to discuss our thoughts on these events in further detail with you.