Trade tariff policies are currently generating considerable uncertainty in financial markets. The fluctuations of stocks, bonds, and the dollar seem to hinge on the daily statements of Team Trump.
Are the severe tariff policies merely strategic maneuvers in President Trump’s ‘art of the deal’, or is a seismic shift occurring in the global economy and its financial systems?
This week, the stock market focused on preventing further damage. Treasury Secretary Scott Bessent, speaking at the Institute of International Finance Global Outlook Forum, stated that “America First does not mean America Alone.” This clarification followed his previous remark that the ongoing tariff conflict with China is “unsustainable,” and he anticipates a “de-escalation” of the trade war.
When you play with fire, you’re bound to get burned. Consequently, the initial damage has already occurred, but more may still follow.
Recent data from Port Optimizer indicates that scheduled import volumes for the Port of Los Angeles experienced a week-over-week drop of 28.53 percent for the week ending May 3. Projections suggest a staggering 34.54 percent decline year-over-year for the week ending May 10.
Could this signal the onset of a protracted global trade contraction?
Over the past 200 years, world trade cycles have frequently expanded so extensively that many have come to perceive them as a permanent state. This extended growth phase has led to the mistaken belief that global trade is an inexorable linear trend, destined to continue without end.
For instance, the share of trade in global gross domestic product rose from about 25 percent in 1970 to 63 percent in 2022. Shouldn’t this upward trend in trade continue indefinitely?
Rise and Fall
To find someone with direct memory of a global trade contraction, you would have to look back to pre-1960 in the United States, Japan, and Western Europe. China’s significant trade growth began in the 1970s, while Eastern Europe entered a similar phase in the early 1990s.
However, a glimpse into the first half of the 20th century reveals a starkly different narrative. From the onset of World War I through the 1960s, global trade as a proportion of total economic activity actually declined. This 50-year period saw a contraction of global trade.
Geopolitical upheavals, like the crumbling of the classical gold standard with the onset of the Great War, coincided with this downturn. Eastern Europe experienced rampant hyperinflation in the 1920s, while in the USA, inflation fueled a monumental stock market bubble.
As these forces unraveled, the world was plunged into the Great Depression. The introduction of the Smoot-Hawley Tariff Act of 1930 and the retaliatory tariffs that followed decimated whatever was left of international trade, setting the stage for World War II.
Only well after WWII did international trade experience a resurgence. While initially cautious, it flourished in the latter part of the 20th century. Nonetheless, this does not guarantee continued growth indefinitely.
Geopolitical shocks have historically disrupted or reversed long-term trends in expanding global trade. Currently, the risk of multiple shocks—ranging from trade tariffs to currency chaos, and including both cold and hot wars—threatens to disrupt the global trade expansion established since the 1960s.
Indeed, it is quite plausible that we have already entered another protracted global trade contraction.
Economic Metamorphosis
The current trade contraction is politically motivated, stemming from President Trump’s trade tariffs. The damage control efforts unfolding this week do not signal an end to the trade war, but rather mark the beginning of a broader transformation.
To put it plainly, this trade war is set to have significant repercussions for the economy, supply chains, and the way goods and services are produced and distributed.
This environment suggests that the world is on the brink of a significant transformation from what people have historically known and expected. You will observe noticeable changes in your daily shopping experiences, perhaps feeling the impact in your wallet as well.
Trump believes this transformation will favor working Americans by providing fair wages, but we remain skeptical.
What remains clear is that both the USA and its trading partners are entering an economic metamorphosis. Like a caterpillar engaged in the process of forming a chrysalis, the perpetually fluctuating trade tariffs and threats to impose them are diverting economic activity inward.
Within this new framework shaped by trade barriers, a transformation is occurring. Long-standing relationships cultivated over decades are eroding, while new specialized domestic producers are emerging.
Will this chrysalis yield a beautiful butterfly ready to soar? Or will it result in an ugly moth drawn to flames and its own destruction?
Generally, a trade war triggers a disruptive economic transformation. Initially, price spikes for imported goods emerge, leading to a gradual disappearance of these items from store shelves.
This environment may provide a competitive advantage for domestic producers seeking to enter the market. However, this advantage comes at the cost to American consumers, who face higher prices and fewer choices. Consequently, American consumers effectively subsidize domestic production.
Moreover, producing goods domestically that could be manufactured more cheaply abroad leads to a misallocation of resources. Capital is used in industries that receive artificial protection rather than being efficiently deployed elsewhere.
While government intervention may generate certain jobs, these roles are often ones that should not exist in the first place.
Make Depressions Great Again
The evolving economic landscape is further complicated by the intensification of the trade war. Retaliatory tariffs imposed on American exporters jeopardize their businesses as foreign markets shy away from American-made goods priced above market norms.
Subsequently, American exporters will be compelled to adjust their operations, scaling down and laying off workers. They may also encounter rising costs for imported raw materials, further complicating production and increasing prices for both domestic and foreign consumers.
This creates a distorted framework for production and consumption. Artificial incentives redirect resources from efficient global suppliers to less competitive domestic manufacturers, ultimately diminishing overall productivity and reducing living standards for everyone involved.
Additionally, the uncertainty spawned by a trade war discourages long-term capital investments. Businesses often take a ‘wait and see’ approach, delaying projects while the rules of international trade are in a constant state of flux, hindering innovation and economic growth.
Trade wars essentially compel economies to adapt to an artifice rather than responding to genuine market-driven supply and demand shifts. This inefficient restructuring stems from government intervention rather than natural economic evolution.
Ultimately, this metamorphosis results in a less productive, less efficient, and weaker economy compared to one driven by voluntary and free exchange. Any benefits to select domestic sectors are overshadowed by the increased costs borne by consumers and other non-favored domestic producers.
President Trump, with his Liberation Day tariff initiative, has ignited a transformation that may be beyond his control. The economic metamorphosis—a division between east and west—is already unfolding, and global trade is contracting. Supply chains are fraying.
This outcome aligns with Trump’s intentions, yet it contrasts sharply with the interests of his wealthy supporters and their thriving stock portfolios.
This week’s damage control might generate favorable headlines and potentially lift stock market indices—at least temporarily. However, it cannot reverse the ongoing metamorphosis.
It may, however, slow it down, elongating the process of transformation. This is a crucial distinction.
Political indecision, as evidenced now, is how recessions evolve into depressions…and how we ultimately “make depressions great” again.
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Sincerely,
MN Gordon
for Economic Prism
