Putting Tariffs and Turbulence into Historical Perspective

Speaker: Erik Weisman, Ph.D., Chief Economist

Erik Weisman:

All right. Let's talk about tariffs and let's put it into a little historical perspective to begin with. So drawing from Douglas Irwin's tome, Clashing over Commerce, there have, basically, been three periods in American history with regards to tariffs. The first period is from 1791 until the Civil War where tariffs really are used as a means of raising revenue. Then we hit the Civil War and the government needs a lot more money. They introduce the excise tax and revenue from tariffs is no longer nearly as important, and the focus shifts to protection, restriction. So we're going to try and protect northern industries from European competition. And that pretty much reigns until we get to the Great Depression and everybody's favorite tariff bill, Smoot-Hawley, which was a big mistake, raising tariffs at the beginning of the Great Depression, which resulted in a great deal of retaliation. And after World War II, tariffs moved into a different paradigm, that of reciprocity.

So rather than making the mistakes after World War I, where we pitted everyone against one another, after World War II, the United States incentivized everybody to bring their tariff levels down in a reciprocal nature in the hopes that that would win the peace. And thus, over the course of the next many decades, tariffs declined to very low levels. So we go from revenue to restriction to reciprocity, and there are two major paradigm shifts, in the entire history, really, of the United States. There are a couple of episodes that are noteworthy and they're viewed as mistakes. So there's the Tariff of Abominations, which is an awesome name, in 1828, where there was a free-for-all. Everybody wanted to raise tariffs. They raised it very high. And the ramifications were that South Carolina threatened to secede from the union, and President Jackson threatened to bring troops down to keep South Carolina in the Union.

So be careful what you wish for. You can get these negative ramifications. And then, of course, Smoot-Hawley, where those who proposed the bill were oblivious to the notion that there could be retaliation, and indeed there was. And this is one of the factors that resulted in the Great Depression being as bad a situation as it became, so two paradigm shifts over the course of more than 200 years.

And the question is, are we entering into another paradigm shift where tariffs will be used as a different kind of tool? What is President Trump trying to do with tariffs? Well, he's trying to raise revenue. So that sounds a little bit like the early part of American history. He's talking about reciprocity, but not in the same way as post-World War II — will raise tariff levels as opposed to lower them. And he wants to use tariffs as a means of restriction so that we might bring jobs, manufacturing, back into the United States by creating a tariff wall around the country and incentivizing more production in the US.

Can you do all this stuff at once? History would suggest, you can't. You need to choose one of these two pillars, revenue, restriction, reciprocity. So I think it's going to be very difficult for the president and the administration to move on all fronts. How might it work, in theory? So you create this moat around the United States. How do you do that? So fine, you raise tariff levels and that makes it hard for the rest of the world to export their products and the US to import those products. You lower corporate tax rates to very low levels. So there's an advantage to producing in the United States. You lower the regulatory burden to very low levels, undo what occurred during the Biden administration and the Obama administration. So it's easy to set up a company and easy to run a company without all of the burden. And we already have very low energy prices. So if you are producing steel, if you're in manufacturing, you need energy. You get it at cheap levels. All of that's very attractive.

What are we missing? So, we're missing a few pillars here. One is that we will need an abundance of skilled labor. So the unemployment rate is relatively low and the kind of labor that we need, we probably have to import. So we need to issue a lot more of these H-1B visas to bring people from overseas to the United States, who have the skill set to do the manufacturing, to do the construction, to build the chips, to produce the ships, the naval ships, that we'd like to bring back to the United States. So we're missing that. We're also missing visibility, right? So if you are a company, whether you're a domestic or you're a foreign company thinking of producing in the United States, you'd like some level of certainty that you can understand the rules of the game and that they're not going to change every other day.

We're not seeing that right now. And the Trump administration, I think, likes to keep people guessing. So that's not particularly inviting. And then there's this notion of the rule of law, where some would argue, that again, the rules of the game are changing, and it's a little bit unclear what that landscape will look like. If you want to build a chip factory, if you want to build manufacturing to build naval ships, you need visibility out many years. And right now, we don't really have that. A couple of issues, in addition, I think that are very important to note. Global trade today is very different than it was in 1929 and 1930 when we had Smoot-Hawley. At that time and prior to that time, global trade was, mostly, in finished goods. Today, about 70% of trade in goods is intermediate goods. So these are the pieces that are needed to build the final product.

And the reason that this is really important is, if the US is going to build these tariffs around our country and make it more expensive for those inputs to production to get into the United States, it may be very difficult to create that end product. So as an example, you could imagine an airline company, they use a lot of inputs into production that we source from overseas. If the tariffs make the inputs to that production much more costly, it might not be profitable to be importing all of those pieces from overseas. And you can imagine that for so many different products. Automobiles come to mind as well. So this global value chain has taken us the better part of three decades to put together. And we are now calling it into question in a matter of months. So that won't just reverberate domestically in the United States, but it's also a problem internationally.

Another issue to be, I think, aware of is, the Trump administration, they're looking to address the weakness of manufacturing in the United States, the weakness of things like shipbuilding, national security issues. But the President hates the idea that the United States is constantly running a trade deficit. But the other side of that account, the other side of the capital of the current account, is the capital account.

So why do we have a trade deficit? Some of the reason that we have a trade deficit is because capital flows into the United States as a very inviting place to build, to produce. So you have capital flows coming from all over the world that are supplying us with international savings that we don't produce ourselves in the United States. So if we're going to ameliorate that trade deficit, almost by default, we're going to wind up seeing that our capital account surplus diminishes as well.

And if we want to have the same level of investment, but we're getting less savings from overseas, we in the United States will have to produce that savings ourselves. So that can come from the consumer who will save more and consume less. That's not necessarily a good thing. It could be growth depleting. It could be corporations that save more, but that means they're not investing. Or it could mean that the government is running smaller deficits that also would be equivalent to some fiscal austerity. That's also not great for growth, at least in the short term. So be careful what you wish for. If we bring the trade balance closer to zero, we'll also have to be producing a lot more national savings domestically. We won't be getting it from overseas.

And I think what we're seeing right now in the markets, currently, is a question around the safety and the value of using the dollar and US Treasuries as a hedge, and whether they should still be considered the global numeraire. Are they the safe haven? When things become very uncertain, when volatility rises, does the rest of the world still see the dollar as the safest place to hide during that turmoil? Does the rest of the world still see Treasuries as a great place to hide while the turmoil is going on? And similarly, as the United States has been the exceptional equity market with very high valuations historically, are those valuations warranted in a world where the United States may be pulling back from trade markets and from capital markets? So these are the things I think that the market is wrestling with right now.

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