If the response to tariffs is reciprocal punitive tariffs, the result will be broader stagflation.

Author: Ray Dalio

Translation: Deep Tide TechFlow

Tariffs are a type of tax that serve several functions:

1) They increase revenue for the country imposing the tariffs, with this tax burden shared between foreign producers and domestic consumers (the specific burden depends on the relative elasticity of both parties), making tariffs an attractive form of taxation;

2) They reduce global production efficiency;

3) They have a stagflation effect on the global economy, with a more deflationary effect on the countries being taxed and a more inflationary effect on the importing countries imposing the tariffs;

4) They protect businesses in the importing/tariff-imposing country from foreign competition in the domestic market, providing more protection but also reducing their efficiency; if domestic total demand is maintained through monetary and fiscal policy, these businesses are more likely to survive;

5) During times of international conflict among major powers, tariffs are necessary to ensure domestic production capacity;

6) They reduce imbalances in the current account and capital account, which can be simply stated as reducing dependence on foreign production and foreign capital, especially important during global geopolitical conflicts or wars.

The above are the direct effects of tariffs (first-level effects).

Subsequent effects depend on several factors:

• How the countries/regions being taxed respond to the tariffs;

• Changes in exchange rates;

• How central banks adjust monetary policy and interest rates;

• How governments adjust fiscal policy to respond to these pressures.

These constitute the indirect effects of tariffs (second-level effects).

More specifically, regarding these effects:

1) If the response to tariffs is reciprocal punitive tariffs, the result will be broader stagflation;

2) If monetary policy is loosened, real interest rates fall, and the currency depreciates in the countries under the most deflationary pressure (this is the usual response of central banks); or if monetary policy is tightened, real interest rates rise, and the currency appreciates in the countries under the most inflationary pressure (this is also the usual response of central banks);

3) If fiscal policy is loosened in areas with deflationary weaknesses, or tightened in areas with inflationary strengths, these adjustments can partially offset the effects of deflation or inflation.

Therefore, tariff policy involves many dynamic factors and requires extensive measurement of various aspects to assess the impact of significant tariffs on the market. These impacts go beyond the six first-level effects of tariffs I mentioned earlier and are also significantly influenced by second-level effects.

However, the current context and future trends can be clearly outlined as follows:

1) The imbalances in production, trade, and capital (especially the debt issue) 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) The long-term monetary, political, and geopolitical impacts will primarily depend on the following factors: the level of trust in debt and capital markets as stores of wealth security, the productivity levels of various countries, and whether political systems make countries suitable places to live, work, and invest.

Additionally, there is currently a very active discussion on the following issues:

1) Whether the dollar as the world's primary reserve currency is more beneficial than harmful or vice versa;

2) Whether a strong dollar is a good thing.

Clearly, the dollar as a reserve currency is a good thing (as it increases demand for its debt and other capital; otherwise, without this privilege, the U.S. would not be able to abuse it through excessive borrowing). However, since the market drives this phenomenon, it inevitably leads to the abuse of this privilege, excessive borrowing, and debt issues, which is the predicament we currently face (i.e., the need to address the inevitable reduction of imbalances in goods, services, and capital, take unconventional measures to reduce the debt burden, and decrease foreign dependence on these aspects, especially due to the influence of the geopolitical environment).

More specifically, there are suggestions that the renminbi should appreciate, which may gain consensus when a certain trade and capital agreement is reached between China and the U.S., ideally during a meeting between Trump and Xi Jinping. Such adjustments and other non-market, non-economic adjustments will have unique and challenging impacts on the relevant countries and trigger some of the second-level effects I mentioned earlier to mitigate these impacts.

I will closely monitor future developments and keep you updated on my views regarding the first-level and second-level effects.

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