Why America's Economic Crisis is Worse than it Looks

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The American economy isn't in great shape at the moment. Trump's tariffs have crippled the stock market, spooked international investors, and pushed the U.S. toward recession. However, the crisis is now spreading beyond the stock market. In this video, we will examine why the markets have responded so negatively to Trump's tariffs and why this crisis is even worse than it appears at first glance.

Never miss an episode and always stay informed by subscribing and ringing the bell. Let's start by explaining why the markets have reacted so negatively to Trump's tariffs. Typically, tariffs do not provoke such severe reactions from markets. While tariffs do have some negative economic consequences, they usually do not have an immediate impact on GDP growth. For instance, if you impose tariffs on foreign cars, it's inconvenient for anyone wanting to import a cheap car from another country because they must buy a more expensive one manufactured domestically. However, the consumer is actually spending more money than they would otherwise, and that money goes to a domestic business, which can reinvest it or spend it on wages. While this situation makes the economy less efficient and may put a drag on growth in the long term, the short-term impact is often minimal.

Trump's tariffs are different for at least two reasons. First is their scope and severity. Usually, when a country imposes tariffs, it is to protect a specific industry. Last year, for instance, the Biden administration implemented massive tariffs on Chinese electric vehicles to protect American EV manufacturers from competitors like BYD and Xiaomi. In contrast, Trump has imposed a 10% tariff on everything, with even higher tariffs on most of America's trading partners and only very limited exemptions. This means America's average tariff rate is now just over 23%, six times what it was last year and the highest in more than a century. This broad approach means tariffs could backfire; while targeted tariffs might shield America from international competition, flat tariffs like those imposed by Trump will make imported components more expensive, potentially reducing overall competitiveness.

Second, there is immense uncertainty involved. No one knows how long Trump's tariffs will last, what recipient countries must do to have them lifted, or whether they will go up or down in the future. The Federal Reserve's so-called trade policy uncertainty index is literally off the charts, at the highest level ever recorded. Uncertainty is detrimental to the economy because it encourages businesses and consumers to hoard their money instead of investing or spending. It also hampers Trump's stated project of re-industrialization, which would require trillions of dollars in sustained investment. This is why markets have reacted so negatively to Trump's tariffs. Goldman Sachs, for instance, believes a recession is now more likely than not if Trump's tariffs take effect, with the odds rising from 20% a month ago to over 60% now. The looming threat of recession has wreaked havoc on the American stock market. The S&P 500, a weighted index of the 500 biggest American companies, is currently down about 20% from its February peak and is experiencing extreme volatility. While it is true that the stock market is not the entire economy, the American economy relies more than ever on demand from the richest 10% of earners, who account for half of all spending. Their spending patterns are disproportionately affected by movements in the stock market.

While the stock market decline and the prospect of recession have attracted significant media attention, a deeper look reveals even scarier trends. First, the media's focus on stocks obscures the worrying movements occurring in American government bonds, otherwise known as treasuries. Typically, during times of crisis, stocks decline while treasuries rally, as investors shift their money from risky stocks to safer bonds. However, that is not happening this time. Instead, people are selling treasuries at the same time as stocks, which is causing the yield on treasuries—essentially the interest that the U.S. has to pay on its debt—to rise. For instance, on Monday, the yield on 10-year treasuries rose from just below 3.9% to just below 4.2%, representing a significant single-day movement for treasuries.

This trend is bad news for Trump for two reasons. First, it suggests that investors no longer view the U.S. as a safe place to park their money. Second, it puts even more strain on America's precarious fiscal position. As detailed in previous videos, the federal government has an enormous debt burden, representing approximately 120% of GDP, and is currently running a massive deficit of around 6% of GDP. Things already look like they would worsen under Trump because he is proposing trillions of dollars in tax cuts without equivalent spending cuts, and tax revenue has failed to make a substantial dent in the budget. If the U.S. slips into recession, it would mean lower tax revenues, and if Treasury yields remain high due to a loss of confidence in treasuries as a safe asset, a full-blown debt crisis could be on the horizon.

A similar situation is occurring with the dollar. Like treasuries, the dollar used to be seen as a safe haven asset, which meant it typically rallied during times of uncertainty, even when American stocks were falling. Most analysts also thought Trump's tariffs would put upward pressure on the dollar because it is viewed as a safe asset. Additionally, because Trump's tariffs would likely have a more negative impact on America's trading partners than on the U.S., they would put downward pressure on those currencies, thereby boosting the dollar. However, that has not been the case. As shown in this chart measuring the dollar's strength against a basket of other currencies, the dollar has actually been falling for the past few months. This is troubling because it suggests waning global confidence in the dollar and threatens to exacerbate inflation. One reason people thought Trump could essentially get away with his tariffs was that, even if they introduced some friction into America's trading relationships—which could theoretically stoke inflation—this could be mostly offset by a subsequent strengthening of the dollar, which would make imports cheaper for the average American. A weak dollar, however, threatens to increase any tariff-induced inflation, which is why analysts are now warning about the possibility of inflation rising back to the 5% range. If this occurs, it would not only be detrimental for American consumers but would also set Trump up for a showdown with the Federal Reserve, with Trump pushing for interest rate cuts to stimulate growth while the Fed may advocate for pauses or even hikes to stem inflation. If Trump were to ignore or steamroll the Fed in some manner—something that feels increasingly likely—we could see a crisis of confidence more severe than anything in modern history.