The Effects of Tariffs:
How the Machine Works - Ray Dalio on the Tariffs

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Author: Ray Dalio - Founder, CIO Mentor, and Member of the Bridgewater Board - April 2, 2025 | Source: Linkedin/Pulse


Tariffs are taxes that:

1) raise revenue for the country imposing them that both the foreign producers and the domestic consumers pay (how much paid by each depends on their relative elasticities), which makes them an attractive tax

2) reduce the global efficiencies of production

3) are stagflationary for the world as a whole, more deflationary for the tariffed producer, and more inflationary for the importer that imposes the tariffs

4) make companies in the importing/tariffing countries more protected from foreign competition in the domestic market, which make them less efficient but more capable of surviving if aggregate domestic demand is maintained through monetary and fiscal policy

5) are necessary in times of an international great power conflict to assure domestic capabilities for production

6) can reduce both current account and capital account imbalances, which in plain English means reducing the dependencies on foreign production and foreign capital which is especially valued in times of global geopolitical conflicts/wars.

Those are the first order consequences.

A lot of what happens from there depends on how:

  • 1. tariffs are responded to by the tariffed country/countries

  • 2. currency rates are changed

  • 3. monetary policies and interest rates are changed by the central banks and

  • 4. fiscal policies are changed by the central governments in response to these pressures.

Those are the second order consequences.

More specifically regarding these:

  • 1) if tariffs are responded to with reciprocal tariffs, the effects will be more broad-based stagflation,

  • 2) if the monetary policies are eased, real interest rates decline, and the currency is weakened in countries where the deflationary forces are greatest (which is a normal central bank response) and/or the monetary policy is tightened, real rates are raised, and the currency is strengthened where the inflationary forces are greatest (which is a normal central bank response) and/or

  • 3) the fiscal policy is eased where there is disinflationary weakness and/or fiscal policy is tightened where there is inflationary strength, with such changes neutralizing some of the deflationary or inflationary effects.
    So there are a lot of moving parts and there is a lot to measure in order to judge the market impacts of big tariffs. These impacts go beyond the first six first points I made about the first order effects of tariffs, which are influenced by the second order effects I referred to.

However, what is clear as the background and the future is that:

  • 1) the production, trade, and capital imbalances (most importantly the debts) must come down one way or another, because they are dangerously unsustainable for monetary, economic, and geopolitical reasons (so the current monetary, economic, and geopolitical orders must change)

  • 2) they will likely come with abrupt, unconventional changes (like those I describe in my new book How Countries Go Broke: The Big Cycle) and

  • 3) the longer term monetary, political, and geopolitical effects will depend mostly on the trust in the quality of the debt and capital markets as a safe store-hold of wealth, countries' productivity levels, and the political systems that make countries attractive places to live, work, and invest.

    Additionally, there is a lot of talk now about whether it is a helpful or harmful thing that 1) the the U.S. dollar is the world’s primary reserve currency and 2) the dollar is strong. It is clearly a good thing that the dollar is a reserve currency (because it creates a greater demand for its debt and other capital than would otherwise exist if the U.S. doesn’t have that privilege to abuse via over-borrowing). Though since the markets drive such things, it inevitably contributes to abusing this privilege and over-borrowing and debt problems which has gotten us to where we now are (i.e., needing to deal with the inevitable reducing of goods, services, and capital imbalances, needing to take extraordinary measures to reduce the debt burdens, and reducing foreign dependencies on these things because of geopolitical circumstances.) More specifically, it has been said that China’s RMB should be appreciated which probably could be agreed to between the Americans and Chinese as part of some trade and capital deal, ideally made when Trump and Xi meet. That and/or other non-market, non-economic adjustments would have unique and challenging impacts on the countries they apply to, which would lead to some of the second order consequences I mentioned earlier happening to cushion the effects.

I will watch what is to come and will keep you posted on what I think will be the first and second order consequences.
Ray Dalio

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