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Economics in 2025
A Declaration of Economic Warfare
As one would expect, the primary economic discussion of 2025 at the moment is tariffs. This is an important discussion. Tariffs have the potential to disrupt economics and result in a range of outcomes (many of which can be unintended).
A tariff is nothing more than a tax on imported goods, which could be raw materials, luxury finished goods, or anything in between. It is a declaration of economic war on another country. The most frequent intent of tariffs is to provide for protectionism, and the result is a disruption of an orderly flow of goods.
The last large occurrence of tariffs occurred with the Smoot-Hawley Act(3) in 1930 as a method of protectionism during the Great Depression. It is important to remember that at the time this was a failed tool.
Are There Any Tariff Winners?
There are no winners with tariffs. Initially, government tax revenues increase from tariffs, but ultimately government tax coffers become emptier because consumer spending budgets deplete more quickly - consumers have less discretionary income to spend as higher prices stress their cash flow. Businesses have lower revenues/profits from slowing consumer demand. And, of course, all tax revenue flows from businesses and consumers - a result of economic activity. Hence, tariffs result in less tax revenue long-term.
Why is International Trade Important?
Businesses are generally savvy in terms of where they source their products. They look for the cheapest cost, the best quality, the most efficient manufacturing methods. Very often this results in international implementation of company resources. Consumers benefit from this by getting higher quality products at lower prices. Businesses can operate more productively and profitably. A win/win.
Who Ultimately Pays Tariffs?
Perhaps the biggest misconception is who pays a tariff tax. Contrary to what many believe, the foreign country does not pay the tax. It is the importer who pays the tax, which means American corporations bear the burden of the tariffs, at least initially.(5) Ultimately, consumers pay this cost. Items cost more and are often then produced by less efficient, more costly providers in the home country. Items are imported for a reason - better price, better quality, better use of resources.
It is important to remember that ultimately tariffs reduce consumer cash flow and net worth.
As currently configured, it's clear that proposed and implemented tariffs in 2025 may be the biggest consumer tax increase in history. Not directly paid on a 1040, but rather through household cash flow.
Aren't Tariffs a Noble Effort to Domesticate the Economy?
Companies implement their operations where they can best benefit discriminating consumers. They know that consumers are selective and have other competing alternatives. Tariffs that force companies to more costly, less efficient geography are not a win for consumers or businesses.
In the U.S., unemployment in 2025 is very low by historical standards at 4.1%(6). Much of this is attributable to 10,000 baby boomers retiring every day(4) resulting in fewer workers counted in the workforce. Finding replacement labor has been a large challenge for many businesses in recent years. Because of this, significant and often huge labor shortages are expected in many industries in the coming decade. The available labor pool is small relative to the large number of workers migrating into retirement.
Prior to existing tariffs, labor shortages have been an ongoing business challenge. New tariffs will simply exaggerate the labor shortage. Forcing industry to relocate production to the U.S. will result in futile economic outcomes without adequate workers. Businesses cannot exist and services cannot be provided without labor.
Unintended Consequences
Countries targeted for tariffs will reach out to other non-tariff countries to promote their products. This will create a cohesive affiliation among these countries. As a result, assuming tariffs remain in place for any length of time, the U.S. will suffer economic isolation as a number of countries band together for economic benefit. In addition, these countries can restrict needed resources for the U.S. - resources can include overseas labor and even natural resources (such as minerals) found only in specific geographies.
Economic ties could then foster cultural and military goals among these nations.
The current interplay of tariffs and tariff retaliations is ongoing. The longer tariffs continue to be an economic force, the more exaggerated the economic impact. Since tariff policy has been erratic on a day-to-day basis, there are no solid answers for what the final impact will be. Business decision-makers will be monitoring policy, but most decisions are in a holding pattern until there is more clarity.
Impact on Markets
By definition, no one knows unknown factors that will cause market declines. In early 2025, the factor just happens to be a confirmation of tariff implementation.
Nonetheless, markets were due for a correction. Markets went two years without one. We suggested this in late 2024 - a period when animal spirits were high, speculative investments were in favor and political fervor was in full force. Just a few high-flyers were driving equity markets at the time - seven out of 500 stocks in the S&P 500.(1) But also several casino-like asset classes.
As typical, the high-flyers and the riskiest sectors have shown the greatest damage in recent declines. We count eight out of seventeen asset categories(2) in correction territory. For example, small cap stocks (a volatile sector) are down 23% from their highs.(1) In the first three months of the year, markets have done a 180 relative to 2024: the magnificent seven stocks showing magnificent declines in 2025. Large growth and domestic stocks are underperforming (after stellar returns in 2024), and have been replaced by international and large value stocks outperforming by a wide margin.(1) It has paid to allocate for this transition in 2025, a phenomenon we anticipated.
Quality securities, as they most often do, are showing extraordinary resilience. This is historically typical and a cause for celebration for those committed to quality securities: systematically building a cushion during speculative, expensive markets, and then using the cash cushion as gunpowder for buying securities when valuations are attractive.
The catalysts for declines are nearly always different and unexpected. This time around, we know that declines are occurring due to tariff talk and economic policy.
We will take advantage of moments like this to help clients allocate for their best long-term outcomes.
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