When headlines flash about tariffs, trade wars, and trade deficits, it can be difficult to decipher what they mean and how they might impact us. As a financial advisor focused on helping military members, veterans, and their families, I want to break these concepts down so we have a clear eyed understanding of what is going on. In this article, we’ll cover:
- What tariffs are and their historical context
- How tariffs impact personal finances and markets
- The truth about trade deficits
- Why GDP matters more than trade balances
- A simple analogy comparing trade and personal finances
What Are Tariffs?
Tariffs are taxes imposed on imported goods. These taxes are levied at points of import by customs agents who work for the Customs and Border Protection (CPB) which sits under the Department of Homeland Security.
When a government places a tariff on a product, it makes that product more expensive for consumers and businesses that purchase it. It is critically important to understand that these taxes in the form of tariffs are paid for by the individual or organization buying the imported goods or services. Just like a sales tax, tariff taxes are paid for by the one who is purchasing the goods or services.
Tariffs can be used to protect domestic industries, retaliate against other countries’ trade policies, or generate revenue for the government. These are all legitimate reasons to use tariffs but whether or not they are effective depends on the details.
A Brief History of Tariffs
Historically, tariffs have played a significant role in economic policy. In the early days of the United States, tariffs were a major source of government revenue. Before industrialization, economies were largely agrarian and self-sufficient, meaning that tariffs served as a crucial tool to fund government operations and protect emerging domestic industries from foreign competition. Countries relied on high tariffs to nurture their local production and prevent reliance on external markets.
With the onset of the Industrial Revolution and the rise of global trade, economies became more interconnected. The need for raw materials, specialized goods, and technological advancements led to increased trade between nations. Tariffs, once a primary economic strategy, began to shift from revenue generation to tools of economic protectionism with poor real world outcomes.
Tariffs played a significant role in exacerbating the Irish Potato Famine (1845–1852). During the famine, Ireland was heavily dependent on potato crops, which were devastated by a blight. Despite mass starvation, the British government, which controlled Ireland at the time, continued enforcing trade policies that worsened the crisis.
One key policy was the Corn Laws, a set of protectionist tariffs and restrictions on imported grain designed to benefit British landowners by keeping grain prices high. These laws made it difficult to import affordable food into Ireland, even as famine spread. In 1846, British Prime Minister Sir Robert Peel repealed the Corn Laws, which allowed more grain imports, but by then, the famine was already severe. Additionally, even with the repeal, much of the imported grain was priced too high for starving Irish people to afford.
Another tariff fumble, The Smoot-Hawley Tariff Act of 1930, which imposed high tariffs on imported goods, is widely believed to have worsened the Great Depression by reducing international trade.
Thankfully, during the post-World War II era we saw a global movement toward trade liberalization, with agreements like the General Agreement on Tariffs and Trade (GATT) and later the World Trade Organization (WTO) facilitating lower trade barriers and fostering economic interdependence and growth. During the late 20th and early 21st centuries, many countries, including the U.S., shifted toward free trade agreements like NAFTA and the WTO framework that led to great wealth generation at home and abroad.
Despite the success of these trade agreements, in the last decade, tariffs have returned as a political and economic tool, sparking debates on their effectiveness in an economy that now relies heavily on global supply chains and international partnerships. This is a clear reflection of the global drift towards isolationism that was last seen in the lead up to WWII. As we saw then, we now see a general distrust that has been building in our institutions. Then it was due to WWI and the Great Depression and now it seems to be due to the Iraq War and the Great Recession.
My gravest concern is that as trust breaks down globally now, as it did then, we will find ourselves being led into another World War.
How Do Tariffs Affect Personal Finances and Markets?
Tariffs don’t just affect international trade; they have a direct impact on everyday people, businesses, and investors.
- Higher Prices for Consumers: When tariffs are imposed, the cost of imported goods rises. This can make everyday items—from electronics to clothing—more expensive for consumers. Current projections of price increases are above 2% points on average. This is akin to getting nearly a full year of inflation all at once.
- Higher Costs for Businesses: Many businesses rely on imported raw materials and components. When tariffs increase these costs, businesses may pass them on to consumers or cut costs elsewhere, potentially leading to layoffs or reduced investment.
- Market Volatility: Investors watch trade policies closely. Announcements of new tariffs can lead to uncertainty in the stock market, affecting retirement accounts and investment portfolios. The recent market volatility is a direct and obvious consequence of uncertainty with trade policies coming out of the White House.
- Effects on Jobs: While tariffs may protect certain domestic industries, they can also hurt businesses that rely on global supply chains. For example, tariffs on steel and aluminum may benefit domestic producers but increase costs for manufacturers that use these materials, potentially leading to job losses. We saw this during the first round of tariffs from Trump's first term in office. It was estimated then that his tariffs cost the U.S. about 150,000 jobs according to studies by The CATO Institute and the Tax Foundation.
The Truth About Trade Deficits
One of the most misunderstood aspects of trade policy is the trade deficit. A trade deficit occurs when a country imports more goods and services than it exports. This often sparks concern that the country is “losing” money or that it signals economic weakness.
However, trade deficits are not inherently bad. The U.S. has run a trade deficit for decades, yet its economy has continued to grow. Trade deficits can result from factors like strong consumer demand, a robust financial sector, and investment opportunities that attract foreign capital.
The Role of the Dollar in Trade Deficits
A strong U.S. dollar makes imports cheaper and exports more expensive. This contributes to trade deficits but also signals confidence in the U.S. economy. Many countries and investors around the world hold U.S. dollars and Treasury bonds, reinforcing the country’s financial strength despite running a trade deficit.
Why GDP Matters More Than Trade Balances
Instead of focusing on trade deficits, it’s more important to consider Gross Domestic Product (GDP)—the total value of goods and services produced by a country. GDP is the key measure of economic health because it reflects overall economic growth and productivity and it already includes the balance of trade in its calculation.
The equation for GDP is GDP = C + I + G + (X−M).
The terms are as follows:
- C: Consumer spending
- I: Investment
- G: Government spending
- (X-M): Exports minus imports
Two things to note here. First, that last term is called the balance of trade. It is a trade surplus when exports are greater than imports, and a trade deficit when imports are greater than exports. Second, in economic terms, and in real life, one person's spending is another person's income.
As the calculation indicates, even if one you have a trade deficit you can still have positive GDP growth. For example, over the past 30 years, the average breakdown of the United States' GDP by its main components—Consumer Spending, Investment, Government Spending, and Net Exports (Balance of Trade)—has been approximately:
- Consumer Spending: Approximately 68% of GDP
- Investment (Gross Private Domestic Investment): About 17% of GDP
- Government Spending: Roughly 17% of GDP
- Net Exports (Exports minus Imports): Typically a negative figure, averaging around -2% to -3% of GDP, indicating a trade deficit.
Since our typical trade balance is only a tiny fraction of our overall GDP, or wealth creation, it is a poor indicator to focus on. We would be much better served by focusing on those factors that have a larger impact on our GDP.
Economic policies that drive innovation, productivity, and employment contribute to GDP growth. While trade deficits may fluctuate, a growing GDP typically signals a healthy economy even if there is a persistent trade deficit. The last time that the U.S. had GDP growth less than the trade deficit was in the aftermath of the Great Recession.
GDP growth is much more important than trade deficits.
An Analogy: Trade Deficit vs. GDP in Personal Finances
To make this clear, let’s compare a country’s trade balance and GDP to a household’s finances:
- GDP = Your Total Income
- Trade Deficit = Your Expenses
Imagine a person bringing home $100,000 per year but only spending $70,000. You wouldn't say their finances are in danger because they are running a trade deficit with the grocery store, lawn care company or mortgage company. Because their total income (GDP) from the fruits of their labor are more than their expenses (trade deficit) you would say they are making financial progress and they could use their surplus to invest in income producing assets or themselves.
Let's look at a trickier scenario. Assumes someone making $100,000 per year but spending $110,000 by borrowing or using savings. They have a “deficit,” but does that automatically mean they’re in financial trouble? Not necessarily. If they’re using that spending to invest in education, a business, or assets that will increase their future income, the short-term deficit may be beneficial.
Think about the situation in which a veteran uses their GI Bill. In that case they are running a deficit for years on end. However, they have a high likelihood of their future income being dramatically better than it would have been otherwise. I personally did this when I got out of the Army. I went to a well respected university using a combination of debt and the GI Bill . When I started working full-time I was paid more than double what I was paid beforehand. Nobody was protesting to me at the time that what I was doing was a bad economic move, they understood that investing in myself was wise.
Similarly, a country running a trade deficit might be doing so because its economy is strong and attracting investment for future growth opportunities.
What matters most is that, over a long period of time, income is growing faster than expenses, or GDP is growing faster than the trade deficit. If you get a pay raise of $10,000 but increase your spending by $3,000 nobody would assume you are making a poor economic choice. Why would you assume that with your own country?
What Can You Do To Protect Yourself From Tariffs?
Individuals can take several steps to protect themselves from the effects of tariffs:
- Diversify Purchases: If tariffs make certain imported goods more expensive, consider alternative products from countries not subject to tariffs or buy domestically produced goods when possible. Economists call this the substitution effect. Basically people seek out substitutes to satisfy their needs.
- Consider Adjusting Investments: Tariffs can impact certain industries more than others. For example, companies that rely on imported raw materials may struggle, while domestic producers might benefit. A diversified investment portfolio can help mitigate risks. This is a great real life example of why I insist that my clients pursue an investment strategy that prioritizes asset allocation. In the last few months, while the stock market has been losing money hand over fist, the bond market has done quite well. A diversified portfolio is often a great strategy for avoiding big losses.
- Budget for Price Increases: If tariffs drive up the cost of essentials like food, electronics, or vehicles, adjusting your budget to account for potential price hikes can help manage financial strain. The current projections are for prices to increase by about $3,800 for the average household. If you haven't taken the time to review your budget, now is probably a great time to do so.
- Monitor Trade Policies: Staying informed about tariff policies can help individuals anticipate changes in prices and plan accordingly. I went to Costco the other day as a result of the tariff announcements and stocked up on household essentials. It doesn't hurt to be prepared.
- Consider Inflation-Protected Investments: Tariffs can contribute to inflation, which erodes purchasing power. Investments in inflation-protected securities (like TIPS) or assets that tend to perform well in inflationary environments (such as commodities) can help preserve wealth. I have talked with my clients a lot about the virtues of real estate and TIPS during inflationary times. If we have entered into a stagflation period, as I suspect we have, then these investments tend to perform well.
- Advocate for Policy Changes: Engaging with policymakers, voting, and supporting trade policies that align with personal and economic interests can be a way to influence future tariff decisions. As basic as it seems, civic engagement to promote your self-interest can sometime be the most practical way to advocate for change.
Conclusion
Tariffs, trade deficits, and GDP are complex economic topics, but they have real-world effects on your personal finances, investments, and job opportunities. While tariffs may protect some industries, they often lead to higher costs for consumers and businesses. Trade deficits, despite common misconceptions, do not necessarily indicate economic weakness—GDP growth is a far better measure of economic health.
Understanding the broader picture can help you make informed financial decisions and avoid common misconceptions about trade policy.
As always, if you have questions about how your military pension fits into your financial future, schedule a consultation today or contact us to get started.
Disclaimer: This blog post is intended for educational purposes only, it should not be construed as tax advice or financial planning advice. Consult a professional for tax and financial planning advice before making any changes. All photos are from open source domains.