The U.S. markets are about to face one of their biggest policy shifts in decades.
According to the Tax Foundation, Donald Trump’s proposed tariff plan could push the average U.S. tariff rate to nearly 17.7% – a level not seen since the Great Depression of the 1930s.
This dramatic shift includes a 10% tax on all imports, 25% on Mexico and Canada, and a staggering 60% on Chinese imports.
The Double-Edged Sword of Tariffs
The primary goal of these tariffs is strengthening domestic manufacturing.
U.S. manufacturing employment has seen a massive decline over the last 40 years, coinciding with the meteoric rise in imports.
Many blame exporting of US manufacturing overseas for rising inequality in the U.S.
Since 1980, middle-class wages have grown only 73%, while upper-income wages have soared by 326%.
While tariffs might help reverse these trends, any positive impacts are unlikely to materialize immediately, just like globalization’s effects took time.
The second objective of tariffs is generating government revenue.
With the U.S. government running unprecedented deficits of about $1.5 trillion per quarter, tariff revenue could provide much-needed relief.
Previous tariffs under Trump and Biden administrations collected over $200 billion.
Now, the new proposed tariffs could generate an estimated $3.7 trillion over the next decade – approximately 10% of total national debt.
However, government debt remains a long-term theme and is unlikely to significantly impact markets or the economy in the short term.
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The Inflation Question
While government debt is a long-term issue, the short-term concern for markets and the economy is inflation.
Many economists worry these tariffs could reignite inflation just as it’s cooled to reasonable levels.
Historically, rising U.S. inflation has often preceded economic recessions and major stock market drawdowns, as seen in the 1970s and 2022.
On the surface, tariffs do in fact raise consumer prices.
When a company pays tariffs on imported goods, they have 3 options:
- Absorb the cost and reduce profit margins
- Pass the cost to consumers through higher prices
- Restructure their supply chain to find local manufacturers, which is typically an expensive process.
So all of these constitute a cost for either the consumer or the company.
We saw this play out in 2018 when Trump imposed a 20% tariff on Chinese washing machines, and later raised it to 50%.
U.S. washing machine prices immediately jumped by about 12% after the tariff implementation.
However, the inflation impact through tariffs is very likely overstated.
Academic research suggests each percentage point increase in effective tariff rates typically raises consumer prices by just 0.1%.
Even with Trump’s proposed 15% increase, this would translate to roughly a 1.5% one-time price increase – not sustained inflation.
This is significantly different from the type of inflation that typically concerns markets.
We can also see this through Trump’s first term…
While tariffs initially pushed inflation up, it quickly returned to almost 2%, the Fed’s target
That said, Trump’s proposed tariffs this time are much larger than before.
But if we zoom out and look at inflation data alongside tariffs, a pattern emerges:
In the 1930s, tariffs were also extremely high, but inflation wasn’t a problem during that period.
In fact, the 1930s were marked by deflation!
So, while tariffs can impact consumer prices, they don’t necessarily cause sustained inflation.
The Real Threat: Corporate Profits
The more significant concern from tariff actually lies in corporate profit margins.
U.S. corporate profits as a percentage of GDP have trended upward since the early 1980s, largely due to free trade and globalization.
In fact, there’s a clear correlation between rising exports and U.S. corporate profits.
Globalization has boosted US firm profits by providing access to cheap labor and foreign markets.
But Trump’s tariffs could disrupt this trend by forcing companies to bring manufacturing back to the U.S. at the cost of lower profits.
The New York Fed found that during Trump’s first term, firms with Chinese ties lost $1.7 trillion in market valuation due to tariffs.
With proposed tariffs now four times larger, the impact could reach $5 trillion – about 10% of the total S&P 500 market cap.
Wall Street’s record-high S&P 500 earnings forecasts haven’t yet factored in this potential impact.
This is where tariffs could have their biggest impact felt.
In fact, history shows that falling corporate profits often precede recessions as companies cut costs, lay off workers, and slow investments.
If by late 2025 these tariffs do take effect, then shrinking profit margins could become a real problem for the markets.
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