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The full version of this newsletter was originally published on lynalden.com, an invaluable source for Bitcoin and macro analysis.
This newsletter issue analyzes the shifting nature of fiscal and monetary policy in the United States.
Fiscal policy is tightening somewhat, and monetary policy is likely to loosen, and that combination has economic and investment implications worth analyzing.
The Fiscal Impact of Tariffs
The United States has implemented the largest tariff increase in modern history. Tariff revenue is currently running at upwards of $30 billion per month, or $360 billion per year.
During President Trump’s first term, annualized tariffs jumped from about $40 billion to about $80 billion, and then were largely kept in place by the Biden Administration. This primarily affected businesses in certain sectors rather than the broad economy. Put simply, a ~$40 billion tax increase is beneath the radar of the aggregate level of consumption.
Tariffs, however, are a much bigger deal here in President Trump’s second term. They’re up to ~$360 billion annualized as of July, and in August a series of new tariffs came into effect that aren’t yet accounted for in that number.
With napkin math, there are about $3.2 trillion in annual US goods imports, so 15-20% average tariff rates equates to $480 billion to $640 billion in total tariff revenue. In reality, such numbers also include exemptions, and will likely affect purchasing decisions which can lead to reduced import volumes, which makes the math murkier and generally lower. So, let’s suppose that 15-20% headline tariffs results in $400-$500 billion in total tariff revenue.
As of July, there has been no reduction in import prices since Liberation Day, which are measured pre-tariff. Thus, foreign exporters in aggregate are not absorbing the tariff costs by reducing prices. This means most or all of the tariffs are being paid by American consumers and American businesses. For context, it takes about a 13% reduction in prices to offset a 15% tariff, or a 16% reduction in prices to offset a 20% tariff.
This shows up in a combination of higher consumer goods prices and/or compressed business margins of goods-heavy businesses, depending on how quickly businesses are able to pass those prices on to consumers (which will vary by industry and company; those with in-demand products can eventually pass on price increases, and those with thin margins have to eventually pass on price increases).
Consumers on the higher end of the income spectrum are less likely to change their consumption behavior and thus will basically just pay the tariffs, giving the government more revenue. Consumers on the lower end of the income spectrum are more likely to have to curtail consumption because their disposable income is scarce.
Relocating a large manufacturing base takes a lot of time and is expensive. The reason so much manufacturing occurs in China, for example, is that they have abundant power and cheap skilled labor. The U.S. will have to build out significant power generation to move manufacturing here, and to the extent that humans are employed rather than robots, those would be at higher wages (including higher benefits, given how expensive our healthcare system is).
From 2014 through 2021, about $80 billion per year was spent on the construction of manufacturing facilities in the United States. During that time, overall US industrial production was flat. Therefore, we can call $80 billion per year to roughly be the maintenance cost of the current industrial base. To actually increase industrial production and relocate manufacturing here would require investment above that level.
During the 2022-2024 timeframe, there was a noticeable uptick in construction spending on manufacturing facilities (hitting a $240 billion annualized rate). This was in large part because the CHIPS and Science Act and the Inflation Reduction Act (both passed in 2022) provided subsidies to semiconductor manufacturers and certain other industries that were targeted as being of strategic importance.
In the first half of 2025, annualized construction spending on manufacturing facilities is decreasing, not increasing, indicating that there is thus far no major investment into relocating supply chains to the United States in response to tariffs. Generally speaking, carrots (subsidies) have a bigger impulse to action than sticks (tariffs) because the former de-risks business decisions, whereas the latter does not. Many businesses don’t know what tariff rates will be one year, three years, or five years from now, and thus don’t want to make investment decisions with decade-long implications based on them.
In terms of magnitude, it would require something like a trillion dollars of manufacturing investment to really make a sustained dent in the US goods trade imbalance, and it would take years for those facilities to come online.
Pushing the Fiscal Brake, Slightly
I have a popular “Nothing Stops This Train” thesis, which refers to the idea that the U.S. is in fiscal dominance, and that U.S. fiscal deficits will remain structurally large for the foreseeable future (i.e., for any investment time horizon of relevance, such as the next decade).
I outlined six reasons for this in my September 2024 newsletter, and they were the following:
- Unbalanced Social Security
- High healthcare costs
- High defense spending
- High interest expense
- Political polarization
- Financialization of tax receipts
However, while nothing stops this train, some things can indeed temporarily slow the train.
If we look at the six reasons above, about four of them are political (Social Security, healthcare, defense, and polarization). It’s very hard to cut any of the major expense areas, and it’s very hard to massively raise income taxes, payroll taxes, or corporate taxes. Those things have to go through a very polarized and pork-filled Congress, and are unpopular among the voter base.
The tariffs actually break through those four items of resistance. This is because 1) the tariffs are enacted by executive order citing national emergency, and thus don’t go through Congress and 2) the tariffs are marketed to the public as being on foreigners even though the data show that they’re on US consumers and businesses thus far.
Courts could eventually shut down this heightened tariff revenue collection method, but I’m not a legal expert and so I defer to others in that area as the cases work their way through the court system. The tariffs are in play for now.
They’re still recent enough that there is plausible deniability and debate about what the impacts will be. Importers front-ran the tariffs, meaning they imported extra goods in Q1 before the tariffs came into effect, which gave them some flexibility to keep prices low in Q2 even though ongoing imports were now tariffed. And some of the later tariffs haven’t kicked in until here in Q3. So, people can theorize about foreigners paying tariffs until a couple more quarters of data come in, even as current data show no decrease in prices by exporters, meaning that American entities are indeed absorbing the cost, as a large domestic tax increase.
The final reason for the “nothing stops this train” thesis, the financialization of tax receipts, is still in play. To the extent that tariffs temporarily boost government revenues but come out of US consumer and/or US business pockets, they’re likely to slow down consumer spending and/or slow down the growth rate of the U.S. stock market. With a lagged effect, this is generally negative for tax receipts in the other areas (income tax, payroll tax, and corporate tax). Thus, $500 billion in new tariff revenue could eventually be offset by something like $300 billion in weak tax revenue, making the net fiscal impact only $200 billion and thus not reducing the deficit as much as the headline numbers suggest.
As of the most recent data, the U.S. government is spending about $7.3 trillion per year and taking in about $5.3 trillion per year, giving us a ~$2 trillion fiscal deficit:
Since federal spending continues to increase, and tariffs could add upwards of $400-$500 billion in headline revenue for a bit of time, it could reduce the deficit to something like $1.5-$1.6 trillion. In other words, the U.S. currently has around 6-7% of GDP deficits, and there are some scenarios that could temporarily reduce them to 5-6%, which is still above the historical baseline.
Back in April of this year when the first round of hardline tariff negotiations were occurring (Liberation Day), the stock market, bond market, and currency market all sold off. Then there were myriad delays on the tariffs, giving the market more breathing room and allowing for a recovery. Here in August, those April-level tariffs are generally back on the table (less extreme on China, but heightened elsewhere in the world), and yet the market is sanguine about it, trying to look through it.
For example, credit spreads are back down, showing no concern, and stocks are back up to all-time highs:
However, without market or economic turmoil, we should expect tariffs to largely stay in effect. Only with market or economic turmoil (or court intervention) are they likely to materially come back down. Thus, there are some good reasons to be cautious in the intermediate term.
Major Uncertainty Variables
A number of uncertainties apply:
- Will foreign exporters pay any share of the tariffs? I.e. could we see maybe a 3-5% reduction in import prices in the quarters ahead? If so, this could lower the potential $400-$500 billion tariff bill on Americans to maybe $300-$400 billion.
- President Trump could back down from the tariffs, but this seems unlikely without economic or market turmoil that results in more urgent calls to do so. Alternatively, courts could substantially impact the magnitude of tariffs.
- President Trump has talked about the possibility of rebate checks, i.e., sending out stimulus checks to the public from the tariff revenue received. If enacted, this would undo some or all of the new tax burden and re-accelerate the fiscal deficits as a new stimulus.
- All of the focus in this newsletter has been on imports. To the extent that foreign countries enact retaliatory tariffs and sustain them, it could also affect foreign demand for U.S. goods, and thus slow down the volumes of U.S. exports. The foreign sector could also go after our tech sector to some degree, by imposing taxes on the usage of certain American software services and so forth.
Monetary Policy Expectations
The short-term interest rate market is currently pricing in an expectation of Federal Reserve interest rate cuts starting in September and continuing through 2026. The latest economic data do show some degree of deceleration, although it’s too early to be definitive.
If the Fed reduces interest rates, it’s likely to keep the dollar from strengthening too much relative to other currencies, and gives emerging market central banks more room to cut their rates, too. All else being equal, this is good for emerging market economies and globally priced assets such as gold and bitcoin.
Just because the Fed cuts interest rates, however, doesn’t mean long-end rates (such as mortgages, corporate bond yields, or small business loan rates) will decrease. They might or they might not. Even if they do go down, I don’t think we’ll get a lower-low in mortgage rates, which will mean we won’t get a major US residential refinancing cycle which we normally get in response to Fed cuts. In other words, without a lower-low in rates, the positive consumer impact from them is likely to be rather lackluster.
Summary of Investment Implications
- Most U.S. spending on Social Security, Medicare, and Defense is unaffected by recent policy. All of this spending is sideways-to-up for the foreseeable future, which trickles into the consumer economy, the healthcare sector, and the defense sector.
- The two-speed economy is likely to remain in effect. High interest rates (even after some cuts), Medicaid cuts, and other things continue to put downward pressure on lower-income and younger consumers on average. Meanwhile, fiscal spending continues to be aimed at older Americans on average, and wealthy Americans and institutions have generally locked in the bulk of their liabilities at low long-term rates.
- Tariffs are likely to at least moderately slow down the US economy unless they are reduced or offset by rebate checks. This is still in the context of 5-7% deficits as a share of GDP, which is net stimulatory compared to the historical baseline. In other words, it’s still a “run it hot” environment, but not necessarily as hot as 2023 and 2024. There’s more risk of mild-to-moderate stagflation here in 2025 and 2026 depending on what happens with the ongoing tariff policy.
- Federal Reserve rate cuts can ease domestic financial conditions to some extent, but are unlikely to result in lower lows in interest rates, and thus the overall stimulatory effect will likely be somewhat capped domestically. In contrast, any reduction in rates should be pretty beneficial to emerging markets and global hard assets.
- China’s credit impulse is on the upswing, which all else equal is positive for global assets.
I am not making any taxable changes to portfolios based on expected market conditions. The structural trends I focus on all remain in place, while some of them have cyclical pressures. Around the margins, I am remaining liquid and unlevered and becoming slightly more cautious on US equities, with heightened uncertainty for the next six months unless or until I see something that would offset current tariff policy.
More money is lost by people trying to prepare for recessions than in recessions. However, there are times to lean in with conviction and other times to remain flexible, and I view this as a time to remain flexible.
Best regards,
