Bridgewater founder Dalio: Understanding the impact and operation of tariffs

Original Title: "The Effects of Tariffs: How the Machine Works"

Author: ++Ray Dalio++

Compiled by: Shen Chao TechFlow

Tariffs are a type of tax, and their functions include:

1) Increasing revenue for the country imposing the tariffs, which is shared between foreign producers and domestic consumers (the specific burden depends on the relative elasticity of both sides), making tariffs an attractive form of taxation;

2) Reducing global production efficiency;

3) Having a stagflation effect on the global economy, with a deflationary effect on the producing countries subject to tariffs, while having an inflationary effect on the importing countries that impose tariffs;

4) Protecting domestic companies in the importing/tariff-imposing country from foreign competition, thus providing more protection, but also reducing their efficiency; if domestic total demand is maintained through monetary and fiscal policies, these companies are more likely to survive;

5) Being necessary for ensuring domestic production capacity during conflicts among major international powers;

6) Reducing imbalances in the current account and capital account, which in simple terms means decreasing reliance on foreign production and foreign capital, especially important during global geopolitical conflicts or wars.

The above are the direct effects of tariffs (first-order effects).

Subsequent effects depend on several factors:

• How the country/region subject to tariffs responds;

• Changes in exchange rates;

• How central banks adjust monetary policy and interest rates;

• How governments adjust fiscal policy to respond to these pressures.

These constitute the indirect effects of tariffs (second-order effects).

More specifically, regarding these effects:

1) If the response to tariffs is reciprocal retaliatory tariffs, the result will be broader stagflation;

2) If monetary policy is loosened, real interest rates fall, and currency depreciates in countries under the greatest deflationary pressure (this is the usual response of central banks); or if monetary policy is tightened, real interest rates rise, and currency appreciates in countries under the greatest inflationary pressure (this is also the usual response of central banks);

3) If fiscal policy is loosened in areas with deflationary weaknesses, or tightened in areas with inflationary strengths, these adjustments can partially offset the effects of deflation or inflation.

Therefore, tariff policy involves many dynamic factors and requires extensive measurement of various aspects to assess the impact of significant tariffs on the market. These impacts go beyond the six first-order effects of tariffs I previously mentioned and are also significantly influenced by second-order effects.

However, the current context and future trends can be clearly stated as follows:

1) Imbalances in production, trade, and capital (especially debt issues) must be resolved in some way, as these imbalances have become dangerous and unsustainable from monetary, economic, and geopolitical perspectives (thus the current monetary, economic, and geopolitical order must change);

2) These changes may be accompanied by sudden and unconventional adjustments (similar to what I described in my new book "How Countries Go Broke: The Big Cycle");

3) The long-term monetary, political, and geopolitical impacts will primarily depend on the following factors: the level of trust in debt and capital markets as stores of wealth security, the productivity levels of various countries, and whether political systems make countries suitable places to live, work, and invest.

Additionally, there is currently a lively discussion regarding the following issues:

1) Whether the dollar as the world's primary reserve currency is more beneficial than harmful;

2) Whether a strong dollar is a good thing.

Clearly, the dollar as a reserve currency is a good thing (as it increases demand for its debt and other capital; otherwise, without this privilege, the U.S. would not be able to abuse it through excessive borrowing). However, since the market drives this phenomenon, it inevitably leads to the abuse of this privilege, excessive borrowing, and debt issues, which is the predicament we currently face (i.e., the need to address the inevitable reduction of imbalances in goods, services, and capital, take unconventional measures to reduce debt burdens, and decrease foreign reliance in these areas, especially due to geopolitical influences).

More specifically, some have suggested that the renminbi should appreciate, which may gain consensus when a certain trade and capital agreement is reached between China and the U.S., ideally during a meeting between Trump and Xi Jinping. Such adjustments, along with other non-market and non-economic adjustments, will have unique and challenging impacts on the relevant countries and trigger some of the second-order effects I previously mentioned to mitigate these impacts.

I will closely monitor future developments and keep you updated on my views regarding first-order and second-order effects.