Author: Ray Dalio
Translated by: TechFlow
Tariffs are a tax with the following effects:
1) Increasing revenue for the country imposing tariffs, with the tax burden shared by foreign producers and domestic consumers (the specific proportion depends on their relative elasticity), making tariffs an attractive tax type;
2) Reducing global production efficiency;
3) Having a stagflation effect globally, with a more deflationary effect on the tariffed producing countries and a more inflationary effect on the importing countries imposing tariffs;
4) Protecting domestic companies from foreign competition in the domestic market, but also reducing their efficiency; these companies are more likely to survive if domestic aggregate demand is maintained through monetary and fiscal policies;
5) Ensuring domestic production capacity is necessary during periods of international power conflicts;
6) Reducing imbalances in current and capital accounts, in other words, decreasing dependence on foreign production and foreign capital, which is particularly important during global geopolitical conflicts or wars.
These are the direct effects (first-order impacts) of tariffs.
Subsequent impacts depend on the following factors:
How the tariffed countries/regions respond to the tariffs;
Changes in exchange rates;
How central banks adjust monetary policies and interest rates;
How governments adjust fiscal policies to address these pressures.
These constitute the indirect impacts (second-order effects) of tariffs.
More specifically, regarding these impacts:
1) If the tariff response is reciprocal retaliatory tariffs, the result will be broader stagflation;
2) If monetary policy is relaxed, real interest rates decrease, and currency depreciates in countries with the most deflationary pressure (a typical central bank response); or if monetary policy tightens, real interest rates increase, and currency appreciates in countries with the most inflationary pressure (another typical central bank response);
3) If fiscal policy is relaxed in areas with deflationary weaknesses or tightened in areas with strong inflationary pressures, these adjustments can partially neutralize deflationary or inflationary impacts.
Therefore, tariff policies involve many dynamic factors that require extensive measurement to assess the market impact of significant tariffs. These impacts go beyond the six first-order effects I mentioned earlier and are significantly influenced by second-order effects.
However, the current context and future trends can be clearly outlined as follows:
1) Production, trade, and capital imbalances (especially debt issues) must be resolved in some way, as these imbalances have become dangerous and unsustainable from monetary, economic, and geopolitical perspectives (thus, the current monetary, economic, and geopolitical order must change);
2) These changes may be accompanied by sudden and unconventional adjustments (similar to the scenarios I describe in my new book 'How Countries Go Broke: The Big Cycle');
3) Long-term monetary, political, and geopolitical impacts will primarily depend on the degree of trust in debt and capital markets as wealth storage, countries' productivity levels, and whether political systems make countries suitable for living, working, and investing.
Additionally, discussions are currently very heated about:
1) Whether the US dollar as the primary global reserve currency is more beneficial or detrimental;
2) Whether a strong US dollar is a good thing.
Clearly, the US dollar as a reserve currency is beneficial (as it increases demand for its debt and other capital, otherwise the US would not be able to abuse excessive borrowing without this privilege). However, as this phenomenon is market-driven, it inevitably leads to abusing this privilege, excessive borrowing, and debt issues, which is the predicament we currently face (needing to address the inevitable reduction of goods, services, and capital imbalances, take unconventional measures to reduce debt burden, and reduce foreign dependence on these aspects, especially due to the geopolitical environment).
More specifically, some suggest that the RMB should appreciate, which might reach a consensus during a trade and capital agreement between China and the US, ideally during a meeting between Trump and Xi Jinping. Such an adjustment and other non-market, non-economic adjustments will have unique and challenging impacts on the relevant countries and trigger some of the second-order effects I mentioned earlier to mitigate these impacts.
I will closely monitor future developments and update you on my views of first-order and second-order effects at any time.
