Big Picture -Focus on tariffs: What investors need to know about causes, history and current geopolitics

Together with Christian Gerlach from Tavis Capital, we place current events in the context of financial history. We also look at possible influences on inflation and growth, as well as the US dollar. Finally, we show that there are opportunities even in these volatile times. After just a few weeks in office, the Trump government is turning the decades-old world order upside down. The threatened tariffs are serious, but only a symptom of a long-standing problem. Investors should focus on the deeper causes that justify this new policy of drastic trade barriers in the first place. Especially in uncertain times, it helps to look at the big picture in order to keep a clear head.

 

WHY IS THE USA CONSIDERING TRADE BARRIERS

The US tariffs are an expression of deeper global imbalances. The central problem is that the geopolitical defense alliances of the USA generate considerable costs. Although the US generates 25% of global GDP, it accounts for 40% of global military spending, while allies such as Europe and Japan prioritize social programs under the US umbrella. However, this arrangement, which has grown over decades, is no longer fiscally sustainable for the USA in view of the new strategic partnership between China and Russia to actively weaken the West and the exploding US national debt – regardless of who is in power in the White House.

The overdue realignment of the US military strategy aims to distribute the military burden more fairly and at the same time restore the West‘s credibility and deterrence capability. The problem, however, is that the Trump administration is mixing this necessary strategic adjustment with an undifferentiated tariff policy, with China being the main opponent on both levels. The current US tariffs are therefore not merely isolated protectionist measures, but an expression of the attempt to implement a fundamental economic and security policy reform in an increasingly geopolitically challenging environment. However, Trump wrongly sees tariffs as an instrument for “economic and geopolitical independence” in a zerosum game: He sees trade surpluses as a strength, deficits as a weakness. In fact, it is only thanks to free global trade that private consumption accounts for around 70% of US economic output.

Many products are manufactured in countries with lower costs and imported into the USA, which leads to the American trade deficit. The US imports more than it exports – an imbalance that manifests itself in US debt and dependence on “creditors” such as China. However, the globalized trade model, in which China acts as a global production center and the USA as a consumption centre, is no longer sustainable in view of the growing US national debt and the dramatically changing security situation of the West vis-à-vis China and Russia. However, instead of exerting targeted influence on China in order to force global imbalances and position the West as a closed free trade zone vis-à-vis China, Washington is now pursuing an unrestricted, nationalistic policy of economic isolation through comprehensive tariffs.

Trump‘s dream is to solve all problems simultaneously with these maximum tariffs: to strengthen US industry and military production, secure jobs, significantly reduce import dependency, reduce the high national debt through tariff revenues, persuade the feds to spend more on defense and weaken China economically. However, reality shows that this approach does not do justice to the profound structural and geopolitical challenges. The risk is that Washington‘s short-sighted tariff policy will not solve either the US‘s core fiscal or security policy problems, but on the contrary will exacerbate them. In addition, this policy could weaken the Western alliance architecture in the long term and shift the distribution of burdens in the West to the disadvantage of the USA. Despite these risks, it is already clear today that tariffs are only a small element in a far more comprehensive process of global geopolitical reorganization. The current trade conflicts reflect a fundamental and at the same time dangerous change in the international order, in which economic interests, power shifts and security policy rivalries are increasingly intertwined. Such geopolitical transition phases harbor numerous risks.

 

THE HISTORICAL MEANING OF TARIFFS

History shows impressively how quickly trade wars can escalate: A tariff war can quickly turn into a capital war, which can ultimately lead to a military conflict. Historically, the use of tariffs as an instrument of power politics has been the rule rather than the exception. Peaceful phases in which free trade dominates have remained rare in human history. Trade conflicts therefore always carry the risk of escalating and triggering far-reaching geopolitical consequences.

In fact, Trump‘s current trade policy is bringing us closer to the logic of the 17th century. After 1650, European states systematically pursued the goal of strengthening their national economic power through state intervention for the first time as part of mercantilism: The focus was on more exports than imports, the accumulation of gold, protective tariffs, import bans, subsidies for the domestic economy and an active colonial policy to secure cheap raw materials. Economic power, state control and military strength were closely interlinked – war and economy formed an indissoluble unit. It was not until the 19th century that mercantilism was replaced by the triumph of free trade. With the abolition of customs duties in 1846, Great Britain initiated a “free trade revolution”, which promoted open markets, less state intervention and multilateral trade relations. Today‘s global trading system is a legacy of this period: after 1945, the USA deliberately drew on the British free trade model when shaping the international economic order.

The current return of the USA to protectionist measures makes it clear that the conflict-driven logic of mercantilism can once again gain importance in the 21st century. This inevitably brings the self-damaging effects of such a power-political strategy into focus: tariffs and trade barriers reduce prosperity as they hinder specialization, productivity increases and open markets. The lesson of history is clear: tariffs should only be used against specific geopolitical opponents, as they are ultimately instruments of conflict and not of prosperity. Periods of peace and growth have always been closely associated with openness and free trade – protectionist measures, on the other hand, with loss of prosperity and instability.

 

EFFECTS ON INFLATION AND GROWTH

There is no doubt that the Trump administration‘s move away from free trade harbors considerable risks of recession and stagflation. The forced isolation of the US economy is highly likely to be counterproductive and will trigger negative fiscal and supply-side shocks that could permanently weaken economic growth. At the same time, tariffs increase inflationary pressure. Investors should bear in mind that high inflation combined with weak or stagnating growth – i.e. stagflation – is a toxic mix that is further exacerbated by geopolitical uncertainties. Theoretically, the US Federal Reserve could curb inflation by raising interest rates, but this seems unlikely in view of the increasing polarization of the political system in the US. The public dispute between Trump and Federal Reserve Chairman Jerome Powell further complicates the Fed‘s future decisions. Should Trump succeed in forcing Powell out of office prematurely, the independence of the Federal Reserve would become obsolete and confidence in the US financial system could erode further.

However, if the Trump administration comes to the realization that the tariff policy it has introduced is damaging to the USA and is not sustainable to this extent in the long term, a reduction in these trade barriers could create a scenario in which the above-mentioned effects are less pronounced – the global economy would “muddle through”. However, it is questionable whether the resulting loss of confidence will quickly return.

 

DOLLAR UNDER PRESSURE: THE WORLD LOSES ITS SAFE CURRENCY

The role of the US dollar as the world‘s leading reserve currency and safe haven is already coming under pressure in the face of increasing geopolitical instability. The “exorbitant privileges” that the US has enjoyed since the Second World War – such as stable credit ratings despite rising debt and the perception of the US dollar as a riskfree investment – are increasingly under threat. The US‘s move away from multilateral agreements towards bilateral negotiations and its radical focus on the resilience of US production are undermining the liberal order that has long ensured the dominance of the dollar.

The significant devaluation of the dollar this year has prompted investors to scrutinize US investments more and more critically. Growing doubts about the robustness of the US economy and an unpredictable political environment are accelerating this trend and reinforcing the move away from the dollar. Fears of a “Mar-a- Lago agreement” – an incoherent policy to deliberately weaken the dollar in order to achieve short-term production benefits – are undermining confidence in the US government bond market and increasing general uncertainty. As a result, the risk of US government bonds losing their status as a global safe haven is increasing, leading to a further fall in the value of the dollar and a widening of the interest rate differential between short and long-term maturities – as investors demand higher risk premiums.

Although interest in alternatives such as gold or a pan-European safe asset has increased, there is still a lack of viable and sufficiently liquid alternatives to the US dollar. Even at current highs, gold does not have the liquidity and scale to replace the dollar in the global financial system, while proposals for safe-haven European bonds face significant political and structural hurdles. It is therefore unlikely that the dollar‘s status as a safe haven will be replaced by a realist alternative in the near future.

The core problem is that only assets that are underpinned by deep, liquid financial markets can achieve true supremacy as a “safer investment”. Leadership in global finance depends less on GDP or trade share and more on an enormous, homogenous supply of government- guaranteed bonds that are considered geopolitically safe. Currently, both China and Europe lack the necessary market depth and liquidity to seriously challenge the dominance of the dollar.

What is worrying about the debate on secure investments is not only the lack of alternatives, but above all the structural and political hurdles that prevent credible challengers to the Dollar. These would only disappear with a fundamental geopolitical collapse. History shows that major military conflicts have often triggered shifts in global currency dominance – from the Dutch guilder to the pound sterling and from the pound sterling to the US dollar. After 1945, the USA accumulated the largest stock of safe government bonds, thus consolidating the dollar‘s position of supremacy. Military conflicts are therefore of crucial importance as they reassess the default risk and disrupt existing liquidity pools. War leads to forced debt cuts and only then does a realignment or a possible alternative become conceivable.

 

STAGFLATION, RECESSION OR A RETURN TO NORMALITY –

WHERE CAN INVESTORS FIND ATTRACTIVE INVESTMENTS IN THESE VOLATILE TIMES?

In a scientific study by Baltussen, Swinkels and van Vliet (“Investing in Deflation, Inflation, and Stag-flation Regimes”), the returns of various asset classes were examined over a period from 1875 to 2021 in different inflation phases. The results show that both equities and bonds were unable to generate positive real returns, i.e. returns after deducting inflation, during periods of high inflation (inflation > 4%). Especially in times of stagflation, when high inflation is accompanied by a recession, the real returns of equities were particularly negative at an average of -16.6% and of bonds at -4.4%. A classic multi-asset portfolio consisting of equities and bonds also performed poorly in such phases with an average real return of -11.7%. For investors, this means that classic portfolios are exposed to considerable strain in inflationary or stagflationary phases.

What investment alternatives are there? While passive equity ETFs are fully exposed to volatile economic conditions due to their market capitalization weighting. There are sectors and companies that have clear advantages in times of rising prices and declining growth. Such advantages can be found, for example, in companies from the utilities or materials sectors. Companies that are market leaders in a non-cyclical sector will also be able to pass on the increased production costs to their customers.

The same applies to niche investments such as dividend futures, as these can be bought at a structural discount. This protects the positive real yield from potential dividend cuts. In addition, commodities are seen as a robust hedge against increasing stagflationary pressure, dwindling confidence in traditional safe-haven investments and escalating geopolitical risks. While gold is still highly valued compared to other commodities – many of which have lost value in the disinflationary era before the Trump presidency – strategic resources such as energy appear to be significantly undervalued in the face of growing geopolitical uncertainties and potential conflicts. With the slowdown in globalization and rising trade risks, established supply chains for oil and other key commodities are becoming increasingly vulnerable to disruption. Such disruptions can drive up prices even in the face of weaker global growth. The growing geopolitical turbulence is also likely to lead to more frequent and more pronounced price fluctuations for commodities in the future.

While commodities performed poorly during severe deflationary crises such as the Great Depression, they achieved exceptionally high returns during inflationary phases of deglobalization – for example between 1902 and 1921. This illustrates their particular value as a diversification tool and effective protection mechanism in economically uncertain times such as today.