Muzinich Weekly Market Comment: Liberation or aberration?

April 4, 2025

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In our latest roundup of the key developments in financial markets and economies, we examine the longer-term implications of Donald Trump’s ‘Liberation Day’ announcement on tariffs.

Tariffs are not a bad dream: they are here to stay. Since 2008, US governments have consistently increased tariffs, regardless of which party is in power. The Democrats chose not to rejoin the Trans-Pacific Partnership when Joe Biden took office in 2021, and not only upheld the tariffs introduced by President Trump, but also imposed new ones.^[1]

However, for Donald Trump, tariffs represent more than just policy — they are doctrine. The warning signs were evident as early as 1987, when Trump spent nearly US$100,000 on full-page ads in major newspapers, criticizing US allies for exploiting America through trade imbalances and defence agreements.^[2] Now, in his second term, his administration has escalated his belief, using executive orders to raise the effective tariff rate to 22.5%, the highest level since 1909.^[3] 

Tariffs: The pros and cons

Tariffs generate revenue for the country that impose them. If current levels remain in place and we include the effects of retaliatory measures and loss of revenue from slower domestic growth, they are projected to raise US$2.51 trillion over 10 years.^[4] Furthermore, tariffs shield domestic companies from foreign competition, theoretically making them more resilient during economic downturns. They can also help reduce a country’s current account deficit, reducing its reliance on foreign funding and imported goods, a further advantage during periods of geopolitical conflict when supply chains and trade relationships may be disrupted.

However, the downside, as Ricardian economists would argue, is that tariffs disrupt the efficiency and specialization promoted by free trade, ultimately leading to slower economic growth. If current tariff levels and retaliatory measures remain in place, US real GDP growth is projected to be -0.9% lower in 2025 and -0.1% lower in 2026, with output recovering modestly as production and supply chains reoptimize.^[5]

In the long run, the level of real output could remain persistently 0.6% smaller, reflecting lasting inefficiencies caused by the tariffs. Tariffs also drive-up domestic prices, in effect functioning as a regressive tax on US households. If current tariff levels remain in place, consumer prices are expected to rise by 2.3% in the short run, translating to an average household loss of $3,800. As a result, we think the Federal Reserve will bear the responsibility of mitigating the economic impact and offsetting these losses.

Paradoxically, for exporting nations, US tariffs could have a deflationary effect, as excess inventories force producers to lower prices to clear stock and scale back investment, potentially slowing economic growth.

The end of Pax Americana?

Investors must now confront the possibility that Pax Americana (Latin for "American Peace"), an era of relative global stability and order under US influence following WW II, is coming to an end.

Post-1945, US leaders believed global peace and prosperity was best achieved by opening its vast market to countries that shared its values, such as democracy, political and individual freedom and free-market economics, while ensuring these nations had no territorial ambitions. During this period, the US played a dominant role in shaping global politics, trade and security, often acting as the world’s policeman, lender of last resort and financial regulator.

This has led the US economy to run a trade deficit since the 1980s, resulting in a cumulative loss of trade income of US$42 trillion in current GDP terms.^[6] The costs have not been borne uniformly, however, with the burden largely falling on workers in manufacturing, agriculture, mining and other industries directly exposed to competition from globalisation.

In the current administration’s perspective, other countries have exploited this situation through currency manipulation and protectionist policies to shield their domestic markets. Meanwhile, the US’s patience has been tested by rising powers such as China, and regional conflicts across the Middle East and Europe, where territorial ambitions are prioritised over peace.

Tectonic shift

The world order is now shifting, the analogy best represented by the moving of tectonic plates, with the emerging landscape heading toward a system of national or regional capitalism, where sovereigns prioritize self-sufficiency and strategic alliances over globalization.

The concept of state or national capitalism was first discussed by Vladimir Lenin in the early 1920s.^[7] In its simplest form, it involves governments directing national savings towards national objectives.

This idea can be seen in contemporary political discourse. For instance, in a speech at the Sorbonne, President Emmanuel Macron of France remarked that Europe sends €300 billion euros each year to the US, funding both the American government and American corporations.^[8] In this context, Macron highlighted the idea that national savings should be used for the benefit of a country's own priorities.

Similarly, Mario Draghi's report to the European Union Commission last September outlined how new funding should be directed, with three key priorities: accelerating innovation, achieving energy self-sufficiency and, most notably, strengthening defence.^[9] Draghi emphasized: “Europe must respond to a world of increasingly unstable geopolitics, where dependencies are becoming vulnerabilities, and that it can no longer rely on others for its security.”

Meanwhile, in the UK, discussions are taking place on encouraging pension funds to increase investments in domestic assets. Government officials have urged pension fund managers to allocate 10% of their assets to UK equities, both listed and unlisted, reinforcing the concept of using national savings for national purposes.^[10]

Unintended consequences

However, this shift is having an unexpected consequence for the US administration through the depreciation of the US dollar. Since its peak in January, the DXY dollar index has fallen by over 7%.^[11] Conventional wisdom suggests that in a risk-off environment, the world’s reserve currency should appreciate. Similarly, a currency would typically strengthen if a sovereign nation reduced its current account deficit or fiscal deficit.

What the US administration seems to have overlooked, however, is the global capital inflows that have been in motion since the 1980s, when global capital markets fully opened. Over that time, the rest of the world has effectively been returning the US$42 trillion the US has lost in trade income through its financial account. At the end of 2024, the US net international investment position was a deficit of US$26.2 trillion (see Chart of the Week).^[12]

This dynamic has provided the US with access to cheap financing, fuelled its leadership in global innovation, sustained its military superiority, and allowed it to set global standards.

The shifting of tectonic plates is slow, but when movement occurs, it can cause enormous disruption, much like this week’s price action in financial markets. It seems tariffs are here to stay, but we would hope that current levels represent the peak and in the coming weeks, reciprocal relief will be established as countries negotiate fair trade terms.

However, investors should consider that the era of a strong US dollar could be over, and the days of flat or inverted government bonds yield curves are behind us. As Europe ramps up investment and US funding costs normalize, and as capital flows shift from the financial account to the current account, the global landscape is reshaping, and it may be permanent.

Chart of the Week: Rest of the world returns capital to the US

Source: Yale University Budget Lab, US international position at the end of the quarter (not seasonally adjusted), March 26, 2025. For illustrative purposes only.

Past performance is not a reliable indicator of current or future results.

References

[1] Tax Foundation, ‘So-Called Strategic Tariffs Are Still Tariffs—and Still Protectionist,’ May 24, 2024
[2] PBS, ‘Trump's Tariff Strategy Can Be Traced Back to the 1980s,’ May 6, 2019
[3] Yale University, Budget Lab, ‘Where We Stand: The Fiscal, Economic, and Distributional Effects of All U.S. Tariffs Enacted in 2025 Through April 2,’ April 3, 2025
[4] Yale University, Budget Lab, ‘Where We Stand: The Fiscal, Economic, and Distributional Effects of All U.S. Tariffs Enacted in 2025 Through April 2,’ April 3, 2025
[5] Yale University, Budget Lab, ‘Where We Stand: The Fiscal, Economic, and Distributional Effects of All U.S. Tariffs Enacted in 2025 Through April 2,’ April 3, 2025
[6] Nomura, ‘Implications of collapse of Trump-Zelensky talks,’ March 18, 2025
[7] Mater Christi College, ‘State capitalism – alpha history,’ March 6, 2025
[8] Geopolitique, ‘Emmanuel Macron: Europe—It Can Die. A New Paradigm at The Sorbonne,’ April 26, 2024
[9] European Commission, ‘The future of European competitiveness,’ September 2024
[10] UK Department for Work and Pensions, ‘Pension fund investment and the UK economy,’ November 2024
[11] MarketWatch, US dollar index overview,’ as of April 4, 2025
[12] Bureau of Economic Analysis, ‘International Investment Position,’ March 26, 2025

 

This material is not intended to be relied upon as a forecast, research, or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. References to specific companies are for illustrative purposes only and does not reflect the holdings of any specific past or current portfolio or account. The opinions expressed by Muzinich & Co. are as of April 4, 2025, and may change without notice. All data figures are from Bloomberg, as of April 4, 2025, unless otherwise stated.

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