Ray Dalio, The Impact of Tariffs: How It Works

Tariffs are a type of tax with the following effects:

1. Increase revenue for the implementing country: Foreign producers and domestic consumers jointly pay this tax (the specific proportion depends on their relative elasticity), making tariffs an attractive form of taxation.
2. Reduce global production efficiency: Tariffs interfere with the optimal allocation of global resources.
3. Create a stagflation effect on the global economy: Overall, they cause stagflation for the world, with a deflationary effect on the countries subject to tariffs and an inflationary effect on the importing countries.
4. Protect companies in the importing/tariff-imposing country: These companies are shielded from foreign competition in the domestic market. Although efficiency may decrease, they are more likely to survive if domestic aggregate demand is maintained through monetary and fiscal policies.
5. Necessary during periods of major power conflicts: Tariffs can ensure domestic production capacity, especially during tense international situations.
6. Reduce current account and capital account imbalances: In simpler terms, they reduce dependence on foreign production and foreign capital, which is particularly important during global geopolitical conflicts or wars.

These are the first-order consequences of tariffs.

What happens next largely depends on the following factors:

• Response of the targeted country/region;
• Changes in exchange rates;
• Central bank adjustments to monetary policy and interest rates;
• Central government adjustments to fiscal policy to address these pressures.

These are the second-order consequences. More specifically:

1. If the targeted country responds with reciprocal tariffs, it will lead to a broader stagflation effect;
2. If monetary policy is relaxed, with real interest rates falling, the currency of the country experiencing the most deflationary pressure will depreciate (a typical central bank response); or if monetary policy is tightened, with real interest rates rising, the currency of the country experiencing the most inflationary pressure will appreciate (also a typical response);
3. If fiscal policy is loosened in deflationary weak areas or tightened in areas with strong inflation, these changes will partially neutralize the deflationary or inflationary effects.

Therefore, the market impact of tariffs involves many variables and requires extensive data to determine its specific consequences. These effects are not limited to the six first-order effects I mentioned but are further influenced by second-order effects.

However, as background and a clear future fact:

1. Production, trade, and capital imbalances (especially debt) must be reduced in some way, as they have become dangerous and unsustainable at monetary, economic, and geopolitical levels (the current monetary, economic, and geopolitical order must change).
2. These changes may occur suddenly and in unconventional ways (as I describe in my new book "How Nations Go Broke: The Big Cycle").
3. Long-term monetary, political, and geopolitical effects primarily depend on: people's trust in the quality of debt and capital markets as a safe store of wealth, countries' productivity levels, and the political systems that make a nation a desirable place to live, work, and invest.

Moreover, there are now many discussions about: 1) whether the US dollar as the world's primary reserve currency is beneficial or harmful; 2) whether a strong US dollar is a good thing. Clearly, the dollar as a reserve currency is beneficial (because it increases demand for its debt and other capital that would not exist without this privilege). However, as markets drive such things, this inevitably leads to abusing this privilege, over-borrowing, and debt issues that have brought us to the current situation (namely, the need to reduce goods, services, and capital imbalances, take extraordinary measures to alleviate debt burdens, and reduce foreign dependence on these aspects due to the geopolitical environment). More specifically, some suggest that China's RMB should appreciate, which could be part of a trade and capital agreement between the US and China, ideally reached when TRON and Xi meet. Such non-market, non-economic adjustments will have unique and challenging impacts on the countries involved, triggering some of the second-order consequences I mentioned earlier to mitigate these effects.

I will continue to monitor future developments and update you on my views of first-order and second-order consequences.