Tariffs are taxes on imports that aim to limit the supply of foreign goods into a country. Their impact on prices and trade volume is no different from what a supply shock like the pandemic or the war in Ukraine had on inflation and growth.
And that’s just what the United States is heading toward—another supply shock, which will spur the worst kind of inflation.
If three years were not enough for the Federal Reserve to claim victory over inflation—which is still running above the target rate even with highly restrictive interest rates—we don’t think tariff-induced inflation will be “transitory” either.
Our RSM US Supply Chain Index has already flagged weaknesses since November, staying below the neutral threshold for supply efficiency.
In addition, there are other reasons to believe that inflation will not be a one-time event, as some proponents of tariffs have suggested.
First, one of the most important goals of taxing imports on such a large scale is to generate enough revenue to pass a tax bill as early as the first half of next year.
Read more of RSM’s insights on the economy and the middle market.
Since tax cuts are inflationary, they would only put more pressure on inflation. The combination of a supply-driven shock followed by a demand-driven shock on inflation is exactly what happened during the pandemic.
Second, the labor market is already at full employment. With tariffs and tax cuts later on, the pressure on hiring would only ramp up to fulfill domestic demand.
While there will be more available workers on the market because of layoffs from the federal government, they account for only a small portion of the total labor market. That should keep wage growth elevated.
Finally, as the dollar continues to weaken—both intentionally and unintentionally—Americans’ purchasing power when it comes to foreign goods will only decline further.
It is no secret that the new administration wants to weaken the dollar to increase U.S. export competitiveness while lessening the burden of interest rate payments on government debt.
Reducing the trade deficit also means reducing foreign capital inflow into the U.S., which would depreciate the dollar even further.
The takeaway
For decades, the U.S. has benefited from a financial account surplus—positive capital inflow—that has financed its growth and its trade deficit. The recent sharp turn in trade policy will have a major impact on the flow of capital toward other regions, putting U.S. growth at higher risk.
After the pandemic, the U.S. was able to come out ahead of almost every nation because of how swiftly it addressed the inflation problem and kept growth at a robust pace while other countries struggled with inflation and growth.
But this time around, inflation will likely be a U.S. problem only, as it places tariffs of 10% or more on virtually every country.
