Trade War
InsightsWe’ve known it was coming, but on February 1, President Trump made it official: The U.S. intends to levy a 25% tariff on imports from Canada and Mexico, plus a 10% tariff on imports from China.1 (This is on top of tariffs that were already in place.) The White House also announced that “energy resources” from Canada — essentially, oil — will have only a 10% tariff.1
In response, Canada announced their own 25% tariff on $23 billion worth of American imports, with an additional $125 billion later.2 Then, on February 3, it was announced that tariffs on Canada and Mexico will be suspended for thirty days after both countries agreed to make changes to their border security.3
On February 4, China announced their response: A 15% tariff on coal and natural gas imports from the U.S., and a 10% tariff on oil, machinery, and some automobiles.4 It’s a safe bet that further tariffs will follow unless the situation changes.
If you remember President Trump’s first term in office, you likely recall the “trade war” between the U.S. and China. (While media coverage on this decreased after COVID, it’s worth noting that President Biden continued and increased many of the same tariffs. In other words, this is a fire that’s been raging for a while.) These new tariffs, assuming they last, are likely to kick off another trade war — one that could be far more impactful than before. To be clear, this situation has been changing rapidly and will likely continue to do so. It’s possible that by the time you read this, things will have changed further. But to try and get a handle on what’s going on, let’s do a Q&A on tariffs. We’ll start with:
What are tariffs, exactly? Why is this such a big deal?
To put it simply, a tariff is essentially a tax on imported goods and services. Tariffs can be levied on almost anything: metals, food, appliances, lumber, you name it. Whenever a U.S. business buys goods from a foreign country with a tariff on it, they will pay that tax along with the cost of the product itself. So, when tariffs rise, it can have major implications for both businesses and consumers. And when countries slap tariffs on our products, it affects U.S. companies that export goods abroad.
So, what’s the argument for tariffs? Why is the White House doing this?
Traditionally, the main purpose of a tariff is to generate revenue. In fact, tariffs were once the country’s primary source of revenue until the creation of the federal income tax in 1913.
Another reason governments sometimes impose tariffs is to protect domestic industries from foreign competition. When you tax imports of specific goods, businesses may be more likely to buy from domestic producers instead.
While revenue and protectionism are the traditional arguments for tariffs, President Trump’s reasons have been more varied. In his first term, his stated objective was to decrease the trade deficit between the US and other countries, primarily China. On the campaign trail, Trump talked about tariffs as a way to ensure more products would be made in America. But in their announcement, the White House declared that securing the border and halting the flow of fentanyl was the primary objective.1
Now, the “reason” behind tariffs may seem academic, but it’s actually important – because it sets the conditions required for reducing tariffs in favor of free trade. For example, it’s conceivable that if the US, Canada, and Mexico were to set new agreements on border security, tariffs will be lowered, and the trade war would end. The early signs for this are good. On February 3, the Mexican government agreed to move ten thousand troops to the border to guard against the flow of illegal drugs in exchange for a one-month suspension of new tariffs.3 Canada, meanwhile, agreed to also deploy new security measures along the border.3 So, it may be the main argument in favor of tariffs is for their use as a negotiating tool.
Okay, but what if tariffs are here to stay? What’s the argument against tariffs?
Many economists see tariffs as applying a blunt instrument to a delicate problem, because they can create unintended consequences.
First, tariffs have the potential to be inflationary. If companies must pay more for the goods they need, they will often pass those costs onto consumers. That’s especially important during a time of higher-than-normal inflation. While consumer prices have come down over the past two years, they actually ticked up in recent months.5 But even if the effect is modest, any rise in price can be difficult to handle. In this case, Canada and Mexico are two of the U.S.’s largest trading partners. Mexico is a large supplier of fruit and vegetables, and a major provider of automobiles and car parts.6 Up north, Canada exports grain, meat, poultry, lumber, and oil, among many other goods.6 Meanwhile, China supplies electronics, appliances, clothes, and other manufactured products.6 In short, that is a lot of items that could potentially rise in price.
Now, businesses could turn to U.S.-based suppliers for many of these items, but there are issues. Domestic industries can’t just replicate the volume of foreign trade overnight. Furthermore, cutting down on the number of suppliers can snarl supply chains — the very problem that led to higher inflation in the first place. Now, it’s worth noting that inflation did not rise dramatically during President Trump’s first term…but we should also note that these tariffs are much more extensive than last time.
Another problem with tariffs is that they often result in a trade war. This is when two countries continuously escalate tariffs on each other. While tariffs can benefit certain domestic industries, a trade war can end up hurting as many industries as it helps. For example, Canada’s new tariffs — assuming they are implemented — apply to American orange juice, coffee, liquor, footwear, cosmetics, paper, steel and aluminum, recreational vehicles, and more.2 If Canadians stop buying these products, the companies that provide them will suffer.
The final argument against tariffs is that they don’t always work as intended. For example, while the trade deficit between the U.S. and China narrowed during President Trump’s first term, the overall trade deficit actually widened by a significant margin.7 More notably, when the U.S. raised tariffs on a large scale in 1930, the trade war that resulted ended up worsening the Great Depression — one reason the U.S. moved away from tariffs after World War II.
How do tariffs affect the markets?
As investors, this is the most important question. Typically, tariffs don’t impact the stock market directly. However, they can potentially cause various indirect effects. Again, the single most important thing to keep an eye on is probably inflation. As you know, the Federal Reserve raised interest rates to 40-year highs to bring down consumer prices. After inflation fell below 3% last fall, the Federal Reserve began cutting rates in response. However, the Fed has signaled they only plan to cut rates twice in 2025.8 Any significant uptick in inflation will only slow the pace of future cuts — or even cause rates to rise again.
Why does this matter? Because the expectation of lower rates was a main driver of the market’s performance in 2024. So, if investors feel rates will remain high, or even rise again, it could put a damper on investor enthusiasm. Another thing to keep an eye on: While tariffs alone aren’t likely to cause a slowdown in the economy, the combination of tariffs and higher inflation and high interest rates could conceivably do just that. To be clear, we are a long way from this, but it is something we need to watch.
The good news is that the markets are driven by many factors, and tariffs are just one. During President Trump’s first term, the trade war between the U.S. and China had a very small effect on the markets, occasionally injecting short-term volatility but having little sustained effect on performance. And there are still many good reasons to feel confident in the stock market. The economy is coming off a strong year. Interest rates are lower. Some sectors, especially in tech, are experiencing tremendous momentum. For these reasons, we don’t intend to make major investment decisions based on tariffs alone.
So, what happens now? What’s the plan for us moving forward?
There are still so many things we don’t know. For instance, we don’t know exactly which tariffs will go into effect and how long they will last. Should tariffs continue to bring countries to the negotiating table, it’s possible this trade war could end quickly. That would certainly be a positive result for everyone!
We do know the possibilities, both positive and negative. So, while we cannot predict what will happen, we can certainly plan for what may happen. Fortunately, our team has been doing just that ever since the election. For the moment, we don’t believe we need to deviate from our long-term strategy. While the markets dipped in response to President Trump’s announcement, it’s far too early to make any major changes to your portfolio.
However, this is why our team keeps such a close eye on what’s going on in the world. Part of our job is to keep you informed of any ripples in the water so that you always stay afloat. It’s impossible for us to say what’s going to happen next, but we'll tell you this: We’ll always be here keeping our hands on the tiller. And we will notify you the moment we feel something needs to change. In the meantime, please contact us if you have questions, or if there’s anything we can do for you!