Tariffs Explained

Tariffs—the taxes countries impose on imported goods—are without a doubt a hot-button issue. Some might say it’s a nuclear hot political issue. With that acknowledged, nothing in this blog should be interpreted as a political narrative, stance nor endorsement. This is designed to educate, inform and add context to you as an investor.

Tariffs can have a direct impact on our everyday lives, influencing everything from the price of our morning coffee to the availability of our favorite gadgets. Let’s break down the concept of tariffs in a straightforward way, using relatable examples to illustrate their various purposes.

Let’s start with four key factors—decoupling, rebalancing, negotiating, and funding—and see how each one shapes the bigger picture.

Decoupling

Rethinking Where Our Products Come From

Imagine you’re a business owner who relies heavily on a single supplier for essential components. If that supplier faces disruptions, your entire operation could be at risk. Similarly, countries sometimes impose tariffs to reduce dependence on specific nations, encouraging businesses to diversify their supply chains. This strategy, known as “decoupling,” aims to enhance economic resilience by shifting supply sources.

Rebalancing

Striving for Fair Trade

Consider a scenario where you and a friend regularly exchange goods, but you consistently give more than you receive. Over time, you might feel the need to address this imbalance. Countries use tariffs in a similar fashion to correct trade deficits—situations where they import more than they export. By imposing tariffs, nations aim to encourage domestic production and reduce reliance on foreign goods, seeking a more balanced trade relationship.

Negotiating

Leveraging for Better Deals

Think of tariffs as a bargaining chip in international negotiations. Just as you might use incentives or penalties to influence a business deal, countries impose tariffs to apply economic pressure, aiming to achieve favorable policy outcomes or trade agreements. This tactic is akin to using leverage in a negotiation to secure better terms.

Funding

Generating Revenue

At their core, tariffs are taxes collected by governments on imported goods. This revenue can be used to fund various public services and initiatives. For instance, the U.S. government has historically utilized tariff income to support infrastructure projects and other national priorities.

Why Does the U.S. Have Such a Massive Trade Deficit?

If there’s one big number to know about tariffs, it’s $1.1 trillion—the U.S. trade deficit for goods in 2024. That’s how much more the U.S. imported than exported, as Americans kept buying foreign-made products and the strong U.S. dollar made U.S. exports less competitive. The U.S. has been running a trade deficit every single year since the 1970s.

The Trade Deficit: A Sign of Strength or a Problem?

A big trade deficit isn’t necessarily a bad thing. Economists argue it can signal a strong economy—after all, Americans have the purchasing power to buy a lot of goods. President Trump has long viewed the deficit as a problem and made tariffs a key part of his economic strategy, aiming to shift the balance in America’s favor.

To put things in perspective, the U.S. relies on imports far less than many other nations – but we are not independent from global trade. That said, countries like China and Germany are deeply tied to global trade, while the U.S., with its massive consumer-driven economy, has more room to maneuver. This is why Trump’s trade policies have focused on using America’s economic weight as leverage in trade negotiations.

The Flip Side: What Happens When the Deficit Shrinks?

The U.S. also runs the largest current account deficit in the world—meaning foreign investors keep pouring money into U.S. assets, like stocks, bonds, and real estate. If the U.S. were to shrink its trade deficit, those capital inflows would likely slow down, which could lead to a weaker dollar and higher interest rates. In other words, fixing one imbalance could create a whole new set of challenges.

Tariffs, Emergency Orders, and Market Jitters

Unlike past administrations, Trump has used emergency orders to quickly impose or remove tariffs, often catching markets off guard. Previous presidents also used tariffs, but under laws that required in-depth analysis, allowing businesses more time to adjust. This fast-moving, unpredictable approach has made markets uneasy, as companies struggle to anticipate potential disruptions.

At the core of it all, tariffs represent a shift toward a more protectionist trade policy—one that could have long-term consequences for investors, businesses, and everyday consumers. Whether that’s a good or bad thing depends on your perspective, but one thing is clear: tariffs aren’t just abstract economic tools; they directly impact the cost of goods, corporate profits, and the global investing landscape.

Do Tariffs Make Prices Go Up? 

The short answer? Yes—but it’s complicated.

If a one-time tariff is imposed, prices might spike a little but eventually level out as markets adjust. The real concern is a trade war, where tariffs keep increasing year after year. That’s when you start seeing long-term inflation, which can lead to higher interest rates—and that affects everything from mortgage rates to credit card bills.

Who Pays for Tarrifs? 

While it may sound like tariffs only affect foreign companies, U.S. consumers and businesses end up footing the bill. Studies estimate that 30% to 50% of tariff costs are passed on to consumers, and for products without good alternatives, that number can be even higher.

A perfect example? The “washing machine tariff” of 2018. When the Trump administration slapped tariffs on imported washers (but not dryers), economists at the University of Chicago and the Federal Reserve studied what happened. Instead of absorbing the cost, U.S. manufacturers raised their prices to match their now more expensive, tariffed competitors.

Even dryers—untouched by tariffs—became more expensive, possibly because companies took advantage of the situation or spread price hikes between the two products.

Bottom line? Tariffs don’t just hit imports—companies often use them as an excuse to raise prices across the board.

The Dollar and Tariffs: A Two-Way Street

Tariffs don’t just affect prices—they also move currency markets.

Higher tariffs can strengthen the U.S. dollar because they reduce demand for imports priced in foreign currencies. A weaker dollar can result from limiting tariffs, as demand for foreign goods (and their currencies) increases.

This is similar to how a strong dollar benefits American tourists—when your money is worth more overseas, you get more bang for your buck. Likewise, a strong dollar can offset some tariff-related costs for consumers.

While tariffs might seem like a tool to protect domestic businesses, they often lead to higher prices for consumers and complicated ripple effects in the economy. Whether tariffs are worth the cost depends on your perspective, but one thing is clear: when trade policies shift, so do your everyday expenses.

What’s Trade Reciprocity, and Why Does It Matter?

At its core, trade reciprocity sounds pretty simple—if another country charges tariffs on U.S. goods, we’ll charge them the same in return. Sounds fair, right? But in reality, it’s a major shift in U.S. trade policy that’s shaking up decades of global trade agreements.

So why is the U.S. pushing for reciprocity? The Trump administration believes the U.S. has been getting the short end of the stick when it comes to international trade. Some American industries face high barriers when selling abroad, while foreign companies often get easier access to the U.S. market.

A great example? Cars.

Right now, if a U.S. automaker wants to sell cars in Europe, they get hit with a 10% tariff. Meanwhile, when European automakers sell cars in the U.S., they only pay a 2.5% tariff. That’s a big difference, and the administration wants to even the playing field.

However, trade negotiations aren’t a one-way street—if the U.S. raises tariffs, other countries won’t just sit back and take it.

Canada could respond by banning U.S. liquor from its shelves. China might stop selling key minerals to the U.S. (which are essential for tech and manufacturing). China could also buy fewer airplanes and farm products or even crack down on U.S. companies operating in China—think Apple, Starbucks, and Tesla.

What Happened the Last Time Trump Used Tariffs?

If it feels like we’ve been here before, it’s because we have. During Trump’s first term, tariffs were front and center, particularly against China, in an effort to shrink the U.S. trade deficit. The result? A full-blown trade war that sent markets on a rollercoaster ride and dominated headlines—much like today.

Did Tariffs Drive Up Inflation?

Surprisingly, not really—at least, not in a major way.

In 2018 and 2019, U.S. inflation (measured by the Consumer Price Index) stayed between 1.5% and 2.85%—pretty mild by today’s standards.

The stock market reacted, but not always in predictable ways. The S&P 500 dropped in 2018, but in 2019, it bounced back sharply—and that had more to do with other economic factors than tariffs alone.

Fast forward to today, and a lot has changed since Trump’s first round of tariffs.

A global pandemic upended supply chains, while wars in Ukraine and the Middle East reshaped energy and trade markets. All of which was followed by the biggest inflation spike in decades, prompting the U.S. Federal Reserve to respond with aggressive interest rate hikes.

With these factors at play, it’s even harder to predict what new tariffs might do to the economy. And with Trump’s policies still evolving, the long-term impact on growth and investments is uncertain.

Tariffs Are Just One Piece of the Puzzle

If history has taught us anything, it’s that tariffs come and go, but smart investing principles stand the test of time.

Yes, tariffs can rattle markets, disrupt industries, and make headlines—but they’re not the first, and won’t be the last, major economic policy shift investors have had to navigate. 

Take the Smoot-Hawley Tariff Act¹ of 1930, which raised tariffs on over 20,000 imported goods. It’s often blamed for worsening the Great Depression, yet markets and economies eventually recovered. Fast forward to the steel and aluminum tariffs of 2002, imposed by President George W. Bush. Stocks dipped, but when those tariffs were lifted in 2003, the S&P 500 surged over 26% that year. And let’s not forget Trump’s first round of tariffs in 2018—while markets wobbled initially, the S&P 500 ended 2019 up nearly 30% despite the ongoing trade war with China.

What’s the takeaway? Markets adapt, businesses adjust, and investors who stay the course tend to come out ahead – especially those with a plan that factors in these types of historic scenarios!

¹ Sound familiar? If so, you either remember it from economics class or Ferris Bueller’s Day Off. Bueller, Bueller?