This week we talk about taxes, reciprocity, and recession.

We also discuss falling indices, stagflation, and theories of operation.

Recommended Book: The Serviceberry by Robin Wall Kimmerer

Transcript

Stagflation, which is a portmanteau of stagnation and inflation, is exactly what it sounds like: a combination of those two elements, usually with high levels of unemployment, as well, that can cause a prolonged period of economic sluggishness and strain that slows growth and can even lead to a recession.

The term was coined in the UK in the 1960s to describe issues they were facing at the time, but it was globally popularized by the oil shocks of the 1970s, which sparked a period of high prices and slow growth in many countries, including in the US, where inflation boomed, productivity floundered, and economic growth plateaud, leading to a stock market crash in 1973 and 1974.

Inflation, unto itself, can be troubling, as it means prices are going up faster than incomes, so the money people earn and have saved is worth less and less each day. That leads to a bunch of negative knock-on effects, which is a big part of why the US Fed has kept interest rates so high, aiming to trim inflation rates back to their preferred level of about 2% as quickly as possible in the wake of inflation surges following the height of the Covid pandemic.

Stagnant economic growth is also troubling, as it means lowered GDP, reduced future outlook for an economy, and that also tends to mean less investment in said economy, reduced employment levels—and likely even lower employment levels in the future—and an overall sense of malaise that can become a self-fulfilling prophecy, no one feeling particularly upbeat about where their country is going; and that’s not great economically, but it can also lead to all sorts of social issues, as people with nothing to look forward to but worse and worse outcomes are more likely to commit crimes or stoke revolutions than their upbeat, optimistic, comfortable kin.

The combination of these two elements is more dastardly than just the sum of their two values implies, though, as measures that government agencies might take to curb inflation, like raising interest rates and overall tightening monetary policy, reduces business investment which can lead to unemployment. On the flip-side, though, things a government might do to reduce unemployment, like injecting more money into the economy, tends to spike inflation.

It’s a lose-lose situation, basically, and that’s why government agencies tasked with keeping things moving along steadily go far out of their way to avoid stagflation; it’s not easily addressed, and it only really goes away with time, and sometimes a very long time.

There are two primary variables that have historically led to stagflation: supply shocks and government policies that reduce output and increase the money supply too rapidly.

The stagflation many countries experienced in the 1970s was the result of Middle Eastern oil producing nations cutting off the flow of oil to countries that supported Israel during the 1973 Yom Kippur War, though a sharp increase in money supply and the end of the Bretton Woods money management system, which caused exchange rate issues between global currencies, also contributed, and perhaps even more so than the oil shock.

What I’d like to talk about today is another major variable, the implementation of a huge package of new tariffs on pretty much everyone by the US, that many economists are saying could lead to a new period of stagflation, alongside other, more immediate consequences.

—

A tariff is a type of tax that’s imposed on imported goods, usually targeting specific types of goods, or goods from a particular place.

Way back in the day these were an important means of funding governments: the US government actually made most of its revenue, about 90% of it, from tariffs before 1863, because there just wasn’t a whole of lot other ways for the young country to make money at the time.

Following the War of 1812, the US government attempted to double tariffs, but that depleted international trade, which led to less income, not more—gross imports dropped by 71%, and the government scrambled to implement direct and excise taxes, the former of which is the tax a person or business pays that isn’t based on transactions, while the latter is a duty that’s paid upon the manufacture of something, as opposed to when it’s sold.

Tariffs resurfaced in the following decades, but accounted for less and less of the government’s income as the country’s manufacturing base increased, and excise and income taxes made up 63% of the US’s federal revenue by 1865.

Tax sources have changes a lot over the years, and they vary somewhat from country to country.

But the dominant move in the 20th century, especially post-WWII, has been toward free trade, which usually means no or low tariffs on goods being made in one place and sold in another, in part because this tends to lead to more wealth for everyone, on average, at least.

This refocus toward globalized free trade resulted in a lot of positives, like being able to specialize and make things where they’re cheap and sell them where they’re precious, but also some negatives, like the offshoring of jobs—though even those negatives, which sucked for the people who lost their jobs, have been positive for some, as the companies who offshored the jobs did so because it saved them money, the folks who were hired were generally paid more than was possible in their region, previously, and the people consuming the resulting goods were able to get them cheaper than would otherwise be feasible.

It’s been a mixed bag, then, but the general consensus among economists is that open trade is good because it incentivizes competition and productivity. Governments are less likely to implement protectionist policies to preserve badly performing local business entities from better performing foreign versions of the same, and that means less wasted effort and resources, more options for everyone, and more efficient overall economic operation, which contributes to global flourishing. And not for nothing, nations that trade with each other tend to be less likely to go to war with each other.

Now that’s a massively simplified version of the argument, but again, that’s been the outline for how things are meant to work, and aside from some obvious exceptions—like China’s protection of its local tech sector from foreign competition, and the US’s protection of its aviation and car industries—it’s generally worked as intended, and the world has become massively wealthier during this period compared to before this state of affairs was broadly implemented, post-WWII; there’s simply no comparison, the difference is stark.

There are renewed concerns about stagflation in the United States, however, because of a big announcement made by US President Trump on April 2, 2025, that slapped substantial and at times simply massive new tariffs on just about everyone, including the country’s longest-term allies and most valuable trading partners.

On what the president called “Liberation Day,” he announced two new types of tariff: one is a universal 10% import duty on all goods brought into the US, and another that he called a reciprocal tariff on imports from scores of countries, including 15 that will be hit especially hard—a list that includes China, EU nations, Canada, and Japan, among others.

The theory of these so-called reciprocal tariffs is that Trump thinks the US is being taken advantage of, as, to use one example that he cited, the US charges a 2.5% tariff on imported cars, while the EU charges a 10% tariff on American cars imported to their union.

The primary criticism of this approach, which has been cited by most economists and entities like the World Trade Organization, is that the numbers the US administration apparently used to make this list don’t really add up, and seem to include some made-up measures of trade deficits, which some analysts suspect were calculated by AI tools like ChatGPT, as the same incorrect measures are spat out by commonly use chatbots like ChatGPT when they’re asked about how to balance these sorts of things. But the important takeaway, however they arrived at these numbers, is that the comparisons used aren’t really sensical when you look at the details.

Some countries simply can’t afford American exports, for instance, while others have no use for them. The idea that a country that can’t afford American goods should have astoundingly large tariffs applied to their exports to the US is questionable from the get-go, but it also means the goods they produce, which might be valuable and important for Americans, be they raw materials like food or manufactured goods like car parts, will become more expensive for Americans, either because those Americans have to pay a higher price necessitated by the tax, or because the lower-price supplier is forced out of the market and replaced by a higher-price alternative.

In short, the implied balance of these tariffs don’t line up with reality, according to essentially everyone except folks working within Trump’s administration, and the question then is what the actual motivation behind them might be.

The Occam’s Razor answer is that Trump and/or people in his administration simply don’t understand tariffs and global economics well enough to understand that their theory on the matter is wrong. And many foreign leaders have said these tariffs are not in any way reciprocal, and that the calculation used to draw them up was, in the words of Germany’s economic minister, “nonsense.” That’s the general consensus of learned people, and the only folks who seem to be saying otherwise are the one’s responsible for drawing these tariffs up, and defending them in the press.

Things have been pretty stellar for most of the global economy since free trade became the go-to setup for imports and exports, but this administration is acting as if the opposite is true. That might be a feigned misunderstanding, or it might be genuine; they might truly not understand the difference between how things have been post-WWII and how they were back in the 1800s when tariffs were the go-to method of earning government revenue.

But in either case, Trump is promising that rewiring the global order, the nature of default international trade in this way, will be good for Americans because rather than serving as a linchpin for that global setup, keeping things orderly by serving as the biggest market in the world, the American economy will be a behemoth that gets what it’s owed, even if at the expense of others—a winner among losers who keep playing because they can’t afford not to, rather than a possibly slightly less winning winner amongst other winners.

This theory seems to have stemmed from a 1980s understanding of things, which is a cultural and economic milieu from which a lot of Trump’s views and ideas seem to have originated, despite in many cases having long since been disproved or shown to be incomplete. But it’s also a premise that may be more appealing to very wealthy people, because a lot of the negative consequences from these tariffs will be experienced by people in lower economic classes and people from poorer nations, where the price hikes will be excruciating, and folks in the middle class, whose wealth is primarily kept in stocks. Folks in the higher economic echolons, including those making most of these decisions, tend to make and build their wealth via other means, which won’t be entirely unimpacted, but will certainly be less hurt by these moves than everyone else.

It’s also possible, and this seems more likely to me, but it’s of course impossible to know the truth of the matter right now, that Trump is implementing a huge version of his go-to negotiating tactic of basically hurting the folks on the other end of a negotiation in order to establish leverage over them, and then starting that negotiation by asking what they’ll do for him if he limits or stops the pain.

The US is expected to suffer greatly from these tariffs, but other countries, especially those that rely heavily on the US market as their consumer base, and in some cases for a huge chunk of their economy, their total GDP, will suffer even more.

There’s a good chance many countries, in public or behind closed doors, will look at the numbers and decide that it makes more sense to give Trump and his administration something big, up front, in exchange for a lessening of these tariffs. That’s what seems to be happening with Vietnam, already, and Israel, and there’s a good chance other nations have already put out feelers to see what he might want in exchange for some preferential treatment in this regard—early reports suggest at least 50 governments have done exactly that since the announcement, though those reports are coming from within the White House, so it’s probably prudent to take them with a grain of salt, at this point. That said, this sort of messaging from the White House suggests that the administration might be hoping for a bunch of US-favoring deals and will therefore make a lot of noise about initial negotiations to signal that that’s what they want, and that the pain can go away if everyone just kowtows a little and gestures at some new trade policies that favor the US and make Trump look like a master negotiator who’s bringing the world to heel.

There’s been pushback against this potentiality, however, led by China, which has led with its own, very large counter-tariffs rather than negotiating, and the EU looks like it might do the same. If enough governments do this, it could call Trump’s bluff while also making these other entities, perhaps especially China, which was first out the door with counter-tariffs and statements about not be cowed by the US’s bluster, seem like the natural successors to the US in terms of global economic leadership. It could result in the US giving away all that soft power, basically, and that in turn could realign global trade relationships and ultimately other sorts of relationships, too, in China’s favor.

One other commonly cited possibility, and this is maybe the grimmest of the three, but it’s not impossible, is that Trump and other people in his administration recognize that the world is changing, that China is ascendent and the US is by some metrics not competing in the way it needs to in order to keep up and retain its dominance, and that’s true in terms of things like manufacturing and research, but also the potential implications of AI, changing battlefield tactics, and so on. And from that perspective, it maybe makes sense to just shake the game board, knocking over all the pieces rather than trying to win by adhering to what have become common conventions and normal rules of play.

If everyone takes a hit, if there’s a global recession or depression and everything is knocked asunder because those variables that led to where we are today, with all their associated pros and cons, are suddenly gone, that might lead to a situation in which the US is hurt, but not as badly as everyone else, including entities like China. And because the US did the game board shaking, the US may thus be in a better position as everything settles back into a new state of affairs; a new state of affairs that Trump and his people want to be more favorable to the US, long-term.

There’s some logic to this thinking, even if it’s a very grim, me-first, zero-sum kind of logic. The US economy is less reliant on global trade than the rest of the G20, the wealthiest countries in the world; only about 25% of its GDP is derived from trade, while that number is 37% for China, 63% for France, and a whopping 88% for Germany.

Other nations are in a relatively more vulnerable position than the US in a less-open, more tariff-heavy world, then, and that means the US administration may have them over a barrel, making the aforementioned US-favoring negotiations more likely, but also, again, potentially just hurting everyone, but the US less so. And when I say hurting, I mean some countries losing a huge chunk of their economy overnight, triggering a lot more poverty, maybe stagflation and famines, and possibly even revolutions, as people worldwide experience a shocking and sudden decrease in both wealth and future economic outlook.

Already, just days after Trump announced his tariffs, global markets are crashing, with US markets on track to record its second-worst three-day decline in history, after only the crash of 1987—so that’s worse than even the crashes that followed 9/11, the Covid-19 pandemic, the debt crisis, and many others.

Foreign markets are doing even worse, though, with Hong Kong’s recently high-flying Hang Seng falling 13% in trading early this week, and Japan’s Nikkei dropping 8%.

Other market markers are also dropping, the price of oil falling to a pandemic-era level of $60 per barrel, Bitcoin losing 10% in a day, and even the US dollar, which theoretically should rise in a tariff scenario, dropping 0.1%—which suggests investors are planning for a damaging recession, and the US market and currency as a whole might be toxic for a while; which could, in turn, lead to a boom for the rest of the world, the US missing out on that boom.

There are also simpler theories, I should mention, that tariffs may be meant to generate more profits to help pay for Trump’s expanded tax cuts without requiring he touch the third-rails of Medicare or Social Security, or that they’re meant to address the US’s booming debt by causing investors to flee to Treasury bills, which has the knock-on effect of reducing the interest rates that have to be paid on government debt.

That flight toward Treasuries is already happening, though it seems to be primarily because investors are fleeing the market as stocks collapse in value and everyone’s worrying about their future, about stagflation, and about mass layoffs and unemployment.

It may be that all or most of these things are true, too, by the way, and that this jumble of events, pros and cons alike, are seen as a net-positive by this administration.

For what it’s worth, too, the US Presidency doesn’t typically get to set things like tariffs—that’s congress’ responsibility and right. But because Congress is currently controlled by Republicans, they’ve yet to push back on these tariffs with a veto, and they may not. There are rumblings within the president’s party about this, and a lot of statements about how it’ll ultimately be good, but that maybe they would have done things differently, but there hasn’t been any real action yet, just hedging. And that could remain the case, but if things get bad enough, they could be forced by their constituents to take concrete action on the matter before Trump’s promised, theoretical positive outcomes have the chance to emerge, or not.

Show Notes

https://www.everycrsreport.com/files/20060925_RL33665_4a8c6781ce519caa3e6b82f95c269f73021c5fdf.pdf

https://en.wikipedia.org/wiki/Tariff

https://www.washingtonpost.com/business/2025/03/31/tariffs-affect-consumer-spending/

https://www.wsj.com/tech/exempt-or-not-the-chip-industry-wont-escape-tariffs-a6c771db

https://www.wsj.com/economy/central-banking/goldman-sachs-lifts-u-s-recession-probability-to-35-ce285ebc

https://www.axios.com/newsletters/axios-am-9d85eb00-1184-11f0-8b11-0da1ebc288e3.html

https://apnews.com/article/trump-tariffs-democrats-economy-protests-financial-markets-90afa4079acbde1deb223adf070c1e98

https://www.wsj.com/economy/trade/trade-war-explodes-across-world-at-pace-not-seen-in-decades-0b6d6513

https://www.mufgamericas.com/sites/default/files/document/2025-04/The-Long-Shadow-of-William-McKinley.pdf

https://x.com/krishnanrohit/status/1907587352157106292

https://www.nytimes.com/2025/04/04/business/trump-stocks-tariffs-trade.html

https://www.nytimes.com/2025/04/05/opinion/trump-tariffs-theories.html

https://www.nytimes.com/2025/04/06/world/asia/vietnam-trump-tariff-delay.html

https://www.nytimes.com/2025/04/06/world/europe/trade-trump-tariffs-brexit.html

https://marginalrevolution.com/marginalrevolution/2025/04/why-do-domestic-prices-rise-with-tarriffs.html

https://www.foxnews.com/politics/how-we-got-liberation-day-look-trumps-past-comments-tariffs

https://www.pbs.org/wgbh/frontline/article/trumps-tariff-strategy-can-be-traced-back-to-the-1980s/

https://www.nytimes.com/2024/12/12/us/politics/trump-tv-stock-market.html

https://www.hudsonbaycapital.com/documents/FG/hudsonbay/research/638199_A_Users_Guide_to_Restructuring_the_Global_Trading_System.pdf

https://economictimes.indiatimes.com/news/international/us/over-50-countries-push-for-tariff-revisions-will-donald-trump-compromise-heres-what-the-white-house-said/articleshow/120043664.cms

https://www.nytimes.com/2025/04/06/business/stock-market-plunge-investment-bank-impact.html

https://www.wsj.com/livecoverage/stock-market-trump-tariffs-trade-war-04-07-25

https://www.wsj.com/world/china/china-trump-tariff-foreign-policy-6934e493

https://www.wsj.com/economy/in-matter-of-days-outlook-shifts-from-solid-growth-to-recession-risk-027eb2b4

https://asia.nikkei.com/Business/Markets/Asia-Pacific-stocks-sink-from-Trump-s-tariff-barrage-Hong-Kong-down-13

https://www.reuters.com/markets/eu-seeks-unity-first-strike-back-trump-tariffs-2025-04-06/

https://www.washingtonpost.com/politics/2025/04/07/trump-presidency-news-tariffs/

https://www.nytimes.com/2025/04/07/world/asia/china-trade-war-tariffs.html

https://www.bloomberg.com/news/newsletters/2025-04-07/global-rout-carries-whiff-of-panic-as-trump-holds-fast-on-tariffs

https://en.wikipedia.org/wiki/Stagflation

https://finance.yahoo.com/news/economists-fed-recent-projections-signal-120900777.html

https://en.wikipedia.org/wiki/1973_oil_crisis

https://en.wikipedia.org/wiki/Economic_stagnation

This is a public episode. If you'd like to discuss this with other subscribers or get access to bonus episodes, visit letsknowthings.substack.com/subscribe

MM#150: How to Keep Your Money Safe, Where Money is Being Invested, & Bitcoin's Rise