President Trump’s Tariffs: A Return to Mercantilism?

President Donald J. Trump, “Liberation Day,” April 2, 2025

Adam Smith, The Wealth of Nations, Book IV

President John F. Kennedy, signing Trade Expansion Act, October 11, 1962

In his typical boisterous and exaggerated manner as illustrated in the quotation above, President Trump announced on April 2 a broad and sweeping new regime of higher tariffs on most goods imported into the United States. For starters, he imposed a 10% tariff on imports from all countries in addition to a so-called “reciprocal tariff” on the countries with which the U.S. has the largest trade deficits. For example, a tariff of 145% has been imposed on China (which, among other steps, has retaliated with a 125% tariff on U.S. goods). Many investors believe President Trump’s policies will lead to a slowdown in global trade, higher inflation, and a recession in the U.S.

President Trump’s tariff policies reverse decades of policies carried out by both Democratic and Republican administrations dating back to 1934, when FDR lowered tariffs after the disastrous Smoot-Hawley Tariff Act enacted by Congress in 1930. During World War II and shortly thereafter, statesmen from the U.K. and U.S. negotiated the General Agreement on Tariffs and Trade (GATT), which was signed by 23 nations in 1947. Its purpose was to make international trade easier by reducing trade barriers through the removal of tariffs, quotas, and subsidies and the elimination of preferences on a “reciprocal and mutually advantageous basis.” There were eight rounds of GATT trade negotiations between 1947 and 1994.

Most investors had hoped that President Trump’s tariff policies would be transactional in nature. In other words, tariffs would be levied on certain countries in order to achieve specific ends such as curtailing unfair trade practices from countries such as China, stopping the flow of illegal migrants and fentanyl into America, and lowering exorbitant tariffs placed on U.S. goods. But to many observers, the tariffs appear to be transformational in nature — an effort to establish a new global trade paradigm. Former president of the Dallas Federal Reserve, Richard Fisher, observed on April 3, “President Trump’s tariffs are a fundamental reordering of the world trade order.”

The purpose of this investment commentary is first, to review the economic theory of mercantilism and how President Trump’s policies appear to mirror this approach to trade through the imposition of these new tariffs. Secondly, we examine the history of tariff policies that the U.S. has pursued and the world order that was created in the implementation of these policies, which President Trump is seeking to reverse. Finally, it is to estimate the effect of these tariffs on the economy and the capital markets. At the outset, it is also important to note that President Trump is an extremely controversial politician, and this commentary is meant solely to analyze and judge this new tariff program and its likely outcome — not to approve nor disapprove of the president himself.

Mercantilism was an economic theory that was practiced most notably by Louis XIV, King of France, in the 17th and early 18th centuries. The basic idea was that a nation’s wealth, which would ultimately bring about economic, political, and military power, was best achieved by emphasizing a favorable balance of trade (a surplus of exports over imports). This would lead to the accumulation of wealth in the form of gold and silver. Spain, with its Latin American colonies and their valuable gold and silver mines, also followed this approach. Some of the means of achieving mercantilist goals were to impose high tariffs on imports, subsidize certain domestic industries, and give state monopolies to key industries.

The advent of capitalism, accelerated by the Industrial Revolution in the late 18th and 19th centuries as well as colonialism, replaced the practice of mercantilism. A nation’s wealth, economic and political power, was no longer seen as stemming from accumulating large reserves of gold and silver but rather through building industrial might, which would result in both economic and military power. Moreover, Adam Smith’s advocacy of free trade in his seminal work, The Wealth of Nations, and David Ricardo’s theory of comparative advantage, ushered in the free trade that became broadly practiced by great nations in the 19th and 20th centuries. To a large extent, this was aided by the British Navy’s mastery of the seas in the 19th century, and the American Navy taking the place of the British in the 20th century, keeping the sea lanes safe for the practice of free trade.

Tariffs have historically played an important role in the trade policy of the U.S. One of the first bills enacted upon the birth of the American government was the Tariff Act of 1789, signed into law by President George Washington. Alexander Hamilton was the first to use the term “infant industries” and to advocate using tariffs to protect emerging industries from economically powerful European nations. He worried that Britain’s policy would condemn the United States to being only producers of agricultural products and raw materials. Importantly, tariffs were the only source of revenue to the U.S. government until 1913, when a federal income tax was ratified as the 16th Amendment to the Constitution.

In the 19th century, Senator Henry Clay, a Whig, as well as Congressman Abraham Lincoln, advocated continuing Hamilton’s policies of protecting industries and developing infrastructure in explicit opposition to the British free trade system. Basically, American trade policy was very much dependent on tariffs during the 19th century. Toward the end of the century in the 1890s, William McKinley, first as a congressman from Ohio and later as president, was a major proponent of tariffs. Ironically, President Trump points to McKinley’s tariffs as a great success. While they were generally successful economically, the McKinley Tariff of 1890 caused the Republican Party to lose 86 seats in the House that year — the largest loss in number of seats in an election in U.S. history. Perhaps a foreshadowing of what is to come in the 2026 midterm elections?

The Smoot-Hawley Tariff Act of 1930, intended to counter the effects of the Great Depression which began in 1929, is perhaps the best example of the damage that tariffs can do to both national and global economies. Many economists attribute the depth and breadth of the Great Depression in the U.S. to two main factors: the contraction of the money supply by the Federal Reserve, and the Smoot-Hawley tariffs. The Smoot-Hawley tariffs not only raised tariffs dramatically to protect American industry, but caused other nations to retaliate by raising their tariffs, causing global trade to decline significantly. It is likely that the passage of the Smoot-Hawley tariffs not only deepened the Depression but prolonged it as well.

On January 1, 1995, the World Trade Organization (WTO) superseded GATT, marking the biggest reform of international trade since the end of the Second World War. While GATT dealt primarily with trade in goods, the WTO also covered trade in services and intellectual property. The WTO also created new procedures for the settlement of disputes. The U.S. trade deficit in 1994 was $167 billion. By 2024, it had grown more than sevenfold to $1.21 trillion. The U.S. imported $3.3 trillion in goods in 2024 but exported only $2.1 trillion. This enormous trade deficit is one of the key issues that President Trump and his advisors are seeking to address with their new tariff policy.

President Trump has advocated tough tariffs for more than 40 years. He views global trade, in which every country has a trade surplus or deficit, as a zero-sum game. He believes that America’s trade deficit is inherently bad, and that America has been taken advantage of by many countries. This is despite the fact that American consumers and companies are purchasing goods at prices that are lower than they would be if these same goods were bought from domestic producers, thereby saving money. Instead, President Trump appears to believe that in incurring these trade deficits, America is being “ripped off.” In his thinking, the fact that U.S. consumers are in aggregate benefiting from these lower prices is not important to him; he sees America as losing in this zero-sum game.

Rather than considering the benefits enjoyed by the entire population of consumers, President Trump has focused primarily on the alleged harm that lower-priced imports have done to specific industries and the damage he believes free trade practices have caused America’s middle class and many small towns. But the data shows a different story. Firstly, manufacturing in the U.S. in 1985 was 13% of GDP, and it was 13.9% in 2023. In dollar terms, manufacturing output increased from $44.6 billion in 1985 to $392 billion in 2023 due to dramatic increases in productivity. However, the chart on the following page does show that the percentage of people employed in manufacturing has declined significantly over the past 84 years:

Like the American workforce who left the farms and moved to industry, it is clear that workers have moved increasingly from factories to service occupations and to technologically-oriented businesses. Adjusted for inflation, wages for production and nonsupervisory employees have increased by 35% since 1985. So, while the argument about the hollowing out of small towns and the middle class in America appears to play well politically, it is not grounded in fact.

Most countries need to pay close attention to their trade deficits. If their overall balance of payments with other nations is negative, it has the effect of draining the foreign exchange reserves of their central bank, which are used to maintain a stable currency. However, not so for the United States. President Trump overlooks the fact that the U.S. dollar is the world’s primary reserve currency. What does that mean? It means that the trade deficits the U.S. incurs with most nations puts dollars into the hands of these countries, which end up as the main foreign exchange reserve currency of their central banks. The central banks of these countries need to hold foreign currency reserves in order to conduct international trade, and the reserve currency that most countries want to hold is the U.S. dollar. That is because they trust the political stability of the U.S., its economic and military power, and the country’s history of abiding by its contractual agreements. The dollars held by foreign central banks are therefore returned to the U.S. when these central banks buy U.S. Treasury obligations, helping to finance the ever-growing U.S. national debt. Currently, over $8.5 trillion — almost 25% of the U.S. federal debt — is held by foreign central banks. In other words, the way the global trade system has worked for many decades is a positive feedback loop for the U.S. Thus, if the U.S. government acts in a fiscally responsible manner, the enormous trade deficit does not, in fact, harm the U.S. This system has been in place since 1971. Consequently, President Trump’s approach turns conventional economic theory and practice upside-down and harkens back to mercantilist theories of the past. As discussed below, President Trump’s tariffs could have very damaging repercussions to the U.S. and the global economy.

The U.S. consumer market accounts for over 30% of global consumer spending. President Trump believes that to have access to America’s market, the U.S. must be treated fairly by friends and foes alike.

And there are, indeed, many examples of countries that have allowed unfair trade practices toward the U.S. An example cited in a White House fact sheet is that counterfeit goods, pirated software, and theft of trade secrets, largely by China, amount to between $225 billion and $600 billion annually. President Trump’s tariff policies are intended to cause other nations to treat the U.S. as we treat them. Investors hope that President Trump’s tariff policies will be largely transactional and that negotiations will quickly result in reciprocal trade agreements rather than retaliatory barriers erected by other countries. This would presumably lead to a beneficial outcome for the U.S. from these tariffs.

Perhaps the most compelling argument for imposing tariffs against some nations is to restore U.S. manufacturing production for our national defense to strengthen national security. This is referred to as onshoring businesses and industries back to the U.S. There are a lot of bad actors in this increasingly dangerous world, as Russia and China are demonstrating so clearly in Ukraine and Taiwan, respectively. China’s Navy is now larger than America’s. Can America afford to lose its mastery of the seas? Iran is causing great turmoil in the Middle East, supporting Hezbollah, Hamas, and the Houthis. North Korea, with its nuclear weapons and missiles, is a constant threat. To build ships and other military assets, the U.S. needs to produce iron, steel, aluminum, titanium, and other special metals. The U.S. cannot rely on supply chains based in foreign countries for defense. During the COVID pandemic, we learned that much-needed medical supplies were only available in China, as companies had outsourced manufacturing abroad. Curtailing the flow of illegal criminal migrants and fentanyl across our borders is also necessary to protect the U.S. homeland. Fundamentally, President Trump needs to emphasize transactional tariffs for national security purposes, but not seek to transform the global trade order.

Tariffs are taxes. Someone has to pay the additional costs occasioned by importing goods into the country. Analysts at various investment banks and public policy research organizations estimate that the Trump tariff proposal will translate into tax revenues of approximately $600 billion annually. It is likely that three parties will shoulder the cost of this tax: U.S. consumers through higher prices; U.S. companies through cutting profit margins, thereby lowering earnings; and exporters abroad lowering their prices somewhat to maintain market share in the U.S. In any event, the tariff tax must be paid, and it is expected that U.S. companies and consumers will bear much of the cost.

It is likely that U.S. corporate operating margins will be squeezed by the tariffs, lowering corporate earnings growth. The 2025 S&P 500 earnings had been previously projected by various investment banks to increase about 11%, but analysts are now forecasting that these earnings will be diminished by between 4% and 10% if the tariffs remain in place. If the impact is large enough, it could well tip the U.S. economy into a recession. The U.S. stock market dropped 11% after “Liberation Day” on April 2, but then bounced back around 5% when Trump postponed his tariff plan for 90 days. If investors sell in the face of the uncertainty of how these tariffs will work out, we may well experience a 20% bear market. If the E.U., China, and other major U.S. trade partners put retaliatory tariffs in place, global trade will clearly suffer, possibly triggering a global economic slowdown. As the great economist Thomas Sowell notes, uncertainty causes people to hang onto their money, and a lack of spending — by both companies and individuals — would have very negative outcomes for the U.S. economy. Before the Trump tariffs were announced on April 2, the S&P 500 was trading at a P/E ratio of 21.5 (compared with an historical average of 18.5 with inflation at this level). With a modest drop in estimated 2025 S&P 500 operating earnings of $260, the S&P 500 with a P/E ratio of 18.5 would trade at around 4,810. The S&P 500 peaked intraday at 6,144 on February 19, so if the market fell to 4,810, investors would experience a bear market of 21.9%. However, markets often overshoot on both the upside and downside, so the stock market could possibly fall further into bear market territory.

There are some mitigating factors to consider. In a recent TV interview, former Treasury Secretary Steve Mnuchin emphasized some of the major steps that the Trump administration is undertaking to seek to accelerate economic growth. He spoke about the likelihood that the Trump administration will succeed in extending the 2017 tax cuts (and include lower or no taxes on tips and Social Security). As in President Trump’s first term, the administration is emphasizing deregulation, which many economists believe will also help to accelerate the growth of the economy. And President Trump has repeatedly stressed his goal of increasing the production of oil and gas, which should mean lower prices at the pump. Lower gasoline prices could conceivably counter the threat of higher inflation that the tariffs might pose. The attempts to cut waste, fraud, and abuse by the DOGE initiative might also lower the projected 2025 fiscal deficit of $1.9 trillion, which could lead to lower interest rates, as the government would need to borrow less. And if the tariffs do result in billions of dollars in revenue, the Trump administration could use that revenue to reduce the deficit even more.

In our view, the above steps are quite positive and could well counter some of the negative effects of the tariffs. But the sweeping Trump tariffs, which seem intended to create a new world trade order, have the potential to create very negative unintended consequences. At Bradley, Foster & Sargent, our hope is that cooler heads will prevail, and that President Trump will be persuaded to dial back the tariffs to a more transactional approach, thus sparing us a recession which would bring an even steeper decline in the stock market. The situation is very fluid, and we at BFS are paying very close attention to the developments in the tariff proposals in order to take whatever steps are necessary, first to protect our clients’ capital and then continue its growth.