SAM WILKIN: Today we're going to talk about tariffs and the impact of those tariffs on the global economy and on globalized companies, and offer some advice about managing tariff-related risks. So first things first. Imagine I'm a guy who absolutely loves tariffs, and I asked you to brief me about the general economic impacts of tariffs. David, what are the economic impacts of tariffs usually that you would brief me on?
DAVID HOILE: Thanks, Sam. Good morning. Good afternoon, everybody and a great intro. My key point would be that tariffs lead to weaker economic growth and a higher price level. So let's start with GDP growth first. Tariffs impact economic growth across multiple economic sectors.
So they lower income and household spending through higher prices. Higher uncertainty lowers business investment. And that uncertainty channel and fairly sure is something I'll come back to again and again over the course of our discussions.
Tariffs have impacts on net exports, and there are also changes through financial conditions. So changes in interest rates, equity prices, credit spreads. The commonality across all of those is that they are all typically going to exert a drag on economic growth.
There is one other factor that is partially offsetting and positive, and that is that tariff revenue is often recycled through higher government spending or tax cuts. On the price level or inflation side of things what matters is the size of tariff rates and the volume of imports that it's applied to, so the higher of those, the higher the price level impact, how much companies choose to pass on those higher costs to consumers, changes in exchange rates, and knock on spillover effects on demand, on wage growth, production costs, as companies shift the imports to other countries.
What's important is that tariffs exert a shift upwards in the price level. But whether that ends up causing inflation over the longer run is really down to whether it starts to affect inflation, expectations of consumers or businesses, and whether central banks act or not to anchor or push down on any adjustment in inflation expectations. So that's the big picture, sort of, macro context in terms of how tariffs will flow through into economies.
SAM WILKIN: So in addition to the inflation risk it sounds like is the economy growing slower over the long term or am I impacting the business cycle with tariffs?
DAVID HOILE: So we think it's much more a business cycle effect. So the impact on growth is likely to be felt almost immediately and certainly over the next, say, four to six quarters in terms of its impact on companies and its impact on economic activity and growth. After that what do you tend to see is that companies start to adjust to that different global trading operating environment. And so the growth impacts fade and, actually, you can start to see some partial recovery of the initial hit to GDP or growth.
SAM WILKIN: OK. So in terms of the trading side Ian, what's the impact on global trade of tariffs?
IAN WATTS: Yeah I mean absolutely. David, as the economist, has nailed all the points that we would come up with. But the volatility is not good for trade. The uncertainty created by the tariffs globally has dented consumer confidence. Obviously going to increase prices of goods, and it's going to delay investment decisions. But on the other side of that, I mean, if you look at the positive side, if we can find a positive side is that it's going to create new opportunities for partnerships.
So there are some good things that may come out of it, despite the fact that fundamentally it's going to do some damage to global economy. I think that we definitely are drop in consumer demand. I think there's been a deterioration in personal wealth through this crisis. You can see that with anyone who's invested in the stock markets, they've had a very, very substantial decline in their personal wealth. So that's going to damage consumer confidence quite substantially.
So there's a bit of a yin and yang. More yin than yang, but that volatility is going to feed through probably into more corporate bankruptcies in the short term, which in our world is not good for global trade.
SAM WILKIN: OK. So of course, there is a guy who loves tariffs. And he's now President of the United States. And he's imposed trade measures on a scale that really dwarf anything that was in place during the first Trump administration or the Biden administration. Where are we now in the trade wars, if I can call them trade wars. Where are we now, David, in the trade wars?
DAVID HOILE: Yeah I mean, look, I think it's fair to say we are in the middle of a trade war between the US and China, as I'll come to, that the scale of tariffs between those two at the moment effectively amounts to a trade embargo between those two countries, rather than a tariff regime.
So I'll start by re-emphasizing the uncertainty point. So things are changing almost on a daily basis in terms of the exact composition of the U.S. tariff framework. But this is where we sit at the moment. So 25% tariffs on global steel and aluminum imports to the U.S., 25% tariffs on autos and auto parts and 25% on a small number of goods imported from Canada and Mexico that aren't part of their free trade agreement.
Now, critically, there's also been a 10%, it's called a reciprocal tariff that the U.S. has set on all countries apart from Canada and Mexico. Now, there is a reasonably large share of imports that are currently exempted from that. So for example, electronic products are currently exempted, although we think that electronic products, semiconductors, pharmaceuticals will all face sector-specific tariffs in the future.
The Trump administration also set additional tariffs on various countries at different rates. Those have been paused for 90 days. We expect most of those to be negotiated away, but clearly there's significant uncertainty about how or when that might happen.
And the earlier point about trade wars. U.S. 145% headline tariff on imports from China, China 125% Tariffs on imports from the U.S. That just is, as I say, a de facto embargo on trade and is already causing enormous shifts in terms of shipping and transfer of goods at the current time.
So, you're right to say it's on a massive scale. So the U.S. tariff rate on its trading partners has gone from 2%, under the Biden administration, to 18% now. So to put it in context, it's pretty much 100 years since we last saw tariffs at that sort of level.
And almost irrespective of some of the specific negotiations we see in the next few weeks and months, just taking a step back. You know, at the heart of all of this is the rivalry between the U.S. and China. Issues around the products that are considered important for-- or critical for national and economic security, and a refocus on supply chain vulnerabilities that were clearly evident during COVID.
All of those things run much wider and deeper than just putting some tariffs on for revenue-raising purposes or to try and reduce specific areas of the U.S. trade deficit. So, ultimately, you know, one of my key points is that these sorts of big inflections in trade policy, either globally or between countries, are a durable macro driver that are with us for multiple years.
SAM WILKIN: And Ian, what's this doing to global trade or what are your concerns about what it might do to global trade?
IAN WATTS: Yeah. I think, generally, we haven't seen anything specifically yet in the sectors that we operate in. But certainly in automotive there are some elevated concerns about sustainability of doing business, particularly when you've got a 25% uplift in the tariff. So I think we've noticed in the U.K. that there's a bit of support going into the industry.
I don't know if that's been specifically documented yet, but likewise with stuff like the nationalization of British Steel, I mean, that's a statement in itself that's going to play out into global trading. Other sectors that are going to be significantly affected are going to be construction. With the price of steel going up globally, that's going to be a significant one.
Construction was already one which was in a difficult spot and one which credit insurers were particularly concerned about. So any further difficulties that they may face is going to heighten the concerns about solvency of some of the more challenged businesses within that sector. So it's got a bit of time to play out in our world. And we've not seen the credit insurers react in any significant way yet they're watching and waiting and will make judgments about risk assessments moving forward. So at the moment nothing is significant.
SAM WILKIN: Why does it matter how the credit insurers react?
IAN WATTS: I mean, that's, kind of-- they are the invisible stakeholders in the world of doing business. That's-- if you think in terms of global trading, we're looking at $115 trillion of trade globally, credit insurers probably responsible for 10, 15, maybe even 20% of that, depending on how you calculate the numbers.
So if they react, and they have reacted before, during the global financial crisis, they sucked out a whole bunch of liquidity from the marketplace, which immediately impacted the ability of organizations to do business during COVID. They were, kind of, trending along the same lines, where they anticipated a significant increase in the levels of corporate insolvencies.
Luckily, most state governments across Europe backed-- gave them a state-backed guarantee so they maintain their coverage. But even so, I think we're edging towards a situation where they're going to be reviewing and assessing the levels of risk within their portfolios. And at some point, if it deteriorates any further or if the trade wars spike up a little bit further, they may start to take action.
And at that point, what you see is that banks who rely on credit insurers to support lending start to get a bit anxious, which pushes up interest rates a little bit or pushes up the cost of borrowing. Those organizations that already borrow money start to become a bit stressed, so it just feeds into a more difficult trading environment, which is not good for anybody.
SAM WILKIN: So if I can't get the credit insurance, what does that do to me? How does that impact trade? It's a very probably a dumb question, but yeah.
IAN WATTS: I mean, the-- I guess there's two elements to it. You, as an insured party, benefiting from a credit insurer supporting your trading and you as the target of the insurer, so you benefiting from somebody backing your business as a risk. And there are two very distinct things. So the way it works is that in this market, it's been a soft market for several years now so it was quite easy, relatively, to buy credit insurance and to buy coverage on some significant proportion of your portfolio.
Approaching a credit insurer today, I think it's like trying to buy fire insurance when you're already starting to catch light. So it's going to become more expensive. Capacity on certain names is going to be constrained. That means you either have to take the risk yourselves or stop doing business. If you stop doing business, you're creating friction in the global trading environment. So that has an impact generally on global trade.
If you are the risk, which is being supported by a credit insurer, there are some very simple things you can do. Just create more transparency. Just engage with that invisible stakeholder that has an impact on your business by sharing information, by sharing data, by making sure you pay people on time. Very simple things you can do that conserve your credit rating per se.
So if you're looking to take out cover on your buyers because you're worried about defaults, do it early. Don't wait till it's too late. If you are benefiting from a credit insurer writing cover on you, just make sure you keep that transparency. Make sure you keep that dialogue going.
Find a friend within the credit insurer that you can speak to and say, hey, this is what's going on in my business. I'm not worried. I'm not affected by tariffs. I'm doing this to protect myself. So there's lots of things you can do, which are very simple steps you can take.
SAM WILKIN: OK, so one thing that's really struck me about the second Trump administration's trade conflicts is the amount of retaliation. David already alluded to this on China, which was a big change from the first Trump administration, when China's retaliation was much milder.
In the first Trump administration, of course, Canada and EU were very enthusiastic and effective retaliators against the metals tariffs, steel tariffs. But, this time around, there's been a big change in that retaliation has really been-- the first time around, the retaliation tended to be legal, for instance, through the WTW's.
Now it's really ad hoc. I think I counted 20 ad hoc announcements of trade retaliation measures against only five legal measures since the new administration took office. Another big change is that China has become a major retaliator, not just in terms of tariffs, but in terms of indirect measures and apparent retaliation or retaliation measures involving various U.S. exports, individual companies.
And that trend has is really challenging, I think, for companies to manage because it doesn't impact most companies, but then it impacts a few companies quite a bit. So on the topic of where the risks are David, where are you seeing the biggest changes in the economic outlook so far as a result of the tariffs?
DAVID HOILE: Yeah, at a country level, starting with price levels, inflation, it's really the U.S. that is going to see the most impact. And that's because it's imposed high tariffs on a very large proportion of its imports. And so we're forecasting U.S. core and annual U.S. core inflation to be running at around about 3 and 1/2 to 4 by the time we get to the fourth quarter.
And that's really quite a concentrated price level impact. Most other countries, as you rightly mentioned, Sam, haven't set major retaliatory tariffs against the U.S. And so the prices and prices in those countries are much less affected. I think it's important to say that we expect that price level inflation shift in the U.S. to gradually fade as we go through 2026. So we are expecting it to come back to a more normalized rate of 2 and 1/2 ish by the end of 2026.
So we don't see it as a permanent reset of inflation or a multi-year reset of inflation higher, but it's certainly an issue that companies will need to deal with over the next 12 months or so. From a growth perspective, China is the most impacted in terms of a hit to its GDP.
We know, and it's announced that it will enact very large rounds of government spending, which won't-- I don't think will fully offset it, but will certainly go a long way to partially offset it. But the risks of recession in the U.S., Europe and other advanced economies this year has materially risen. And so we certainly expect U.S. growth to be weak over the next few quarters and just about to avoid recession.
But I think there are a couple of points around that. The first is that the ongoing high level of policy uncertainty, in particular, increases the risk of a larger slowdown in business investment that then flows through to lower employment, lower incomes, and you start to get these self-reinforcing effects in terms of lower consumer spending. And so that's a very clear risk that could tip us into recession.
The second point I think is really important is if we do see a recession in the U.S. or Europe, we expect it to be shallow and short lasting. And so whether it's the U.S. Federal Reserve or other major central banks, all of them have the ability to cut their policy rates by 2% or more in the event of a shallow recession, to stimulate their economies quickly.
The Federal Reserve is because of that inflationary problem. That tension between growth and inflation is, we think, is a little bit less likely to be pre-emptive in terms of trying to, you know, to prevent that downturn from occurring. And is a bit more likely to be reactive in cutting interest rates in response to relatively clear evidence of growth starting to slow.
SAM WILKIN: OK. That seems to explain one thing that's really surprised me, which is that the U.S. many countries are much more dependent on trade than the U.S., but the financial market movements in the U.S. have been some of the largest in the world. And I guess that your explanation there, with the U.S. having this inflation problem to deal with, unlike most countries, makes a lot of sense then, and how these markets have responded.
So I think we get to our last question here, and that is on where is this going and advice to companies that you may have. And I know you've answered this to some degree already. For me you know, I'd be really interested to see how the first deals come out, because it's unclear, in my mind, how far the Trump administration is intending to go in its objectives.
At a maximalist level there's the famous, now infamous paper from Stephen Moran, which lays out a number of the measures the administration has now adopted and advises using these tariffs to achieve various geopolitical ends. A geopolitical lock in. Essentially locking countries into the Western sphere of influence, a bit of a return to a Cold War style approach but instead of locking countries in the Bretton Woods treaty, locking countries into the dollar, you're going to lock in countries using the threat of tariff barriers if you don't go along with the Western sphere of influence.
That, of course, creates a lot of risks, certainly for China, as we've discussed already, but also for other countries that have a lot of trade with the United States, but a ambiguous geopolitical alignment. Think, for, for instance, of Cambodia, which appeared pretty high on the tariff chart, maybe even Vietnam. Where do you think this is going? Or what are your concerns?
I mean, I know it's very hard to predict, but what do you think this is going? Let's start with David and then Ian where do you think this is going? What would be your advice to companies as you think about how this might evolve?
DAVID HOILE: Yeah. So I'd make two points. The first you very much alluded to it, Sam, which is that you could see very significant ongoing economic and financial volatility over this business cycle, both to the upside and the downside. And that kind of goes hand in hand with the potential for big shifts in financial asset pricing, whether it's the cost of debt or equity for companies or, for example, the value of the dollar versus other major currencies. And I think real world scenario stress testing frameworks are a useful mechanism for understanding and managing these uncertainties and risks.
The other thing that because it's the operating environment over a multi-year period that matters for companies, while the discussion today has quite rightly been focused on tariffs, which are top of mind, it's worth thinking about some of the other policy priorities of the Trump administration. So, for example, trying to reduce government spending in favor of supporting higher private sector investment. The likelihood of U.S. tax cuts this year, potential for big deregulatory shifts across major U.S. industries.
A number of those are actually much more-- if executed well are much more positive for U.S. growth than the corporate operating environment. Not so much from the next few weeks or the next few months, but certainly they could start to become more impactful later this year, and in the next few years, especially. So, I think taking a more holistic view, rather than just tariffs is also beneficial at this time.
SAM WILKIN: And Ian.
IAN WATTS: From my side, I think it's time to really evaluate where your risks are on a detail by detail basis. So really drill down into your client portfolio, identify those that may be vulnerable to some of these seismic shifts in global trading. So are there any exposed to a shift in interest rates, any who may be sort of heavily exposed to your drop in consumer demand.
So look at that in terms of your own portfolio of clients. And if you perceive there to be a really heightened level of risk, explore the ways in which you can manage that risk. And there are many ways you can do that. I mean, the simplest way of managing risk of a corporate default is to stop doing business on open account trading, which would be foolish because at that point you lose most of your client base.
But in some senses to manage your risk, that may be where you might be driven to with some counterparties. But the alternatives would be to evaluate using external reference agencies to identify risks in a slightly different way, or using credit insurance or factoring or invoice discounting. These are things, things that you can do to manage the risk of a corporate default within your portfolio.
So that's one aspect of it really drilling down into the detail, identifying where the vulnerabilities of your portfolio are, and then taking specific actions to mitigate that risk. As on the other side of that, again, it's just about providing transparency to those stakeholders that have an influence over your business and affect the credit liquidity of your business by providing suppliers with effectively free liquidity on open account credit. So two different aspects of that.
There's a whole bunch of things colliding. We don't know how they're going to play out completely yet, but it is a heightened level of risk. At that point taking proactive action to measure, evaluate, and assess that risk is critical.
SAM WILKIN: OK that's interesting. I mean, it's been very interesting in this conversation to see some of the things you're talking about, Ian, how the macro movements that you're talking about, David, would arise from some of the micro decisions of companies and insurance carriers like you were talking about, Ian.
So this is really interesting to see both sides, the macro and micro together. So thanks David and Ian for joining me today and thank you all for listening to Geopolcast. To get the episodes as soon as they're released, make sure to subscribe to Geopolcast. You can find us via your usual podcast players. And please recommend us to your friends and colleagues. So thank you very much for listening and goodbye.
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