Economics Update April 2025 - Impending trade war: Response to Trump tariffs crucial

The tariffs announced by US President Donald Trump go well beyond what was previously expected. Whether this will lead to a global trade war now depends largely on the response of the countries affected. If they demonstrate strength and retaliate in kind, serious negative consequences for the global economy will be inevitable. China's reaction points in this direction. The alternative would be to announce countermeasures, show a willingness to engage in dialogue, and, even if negotiations fail, impose only moderate and targeted sanctions. So far, this seems to be the path the EU intends to follow.

Either way, it should quickly become clear that the damage to the US economy itself is considerable. For more than 40 years, the US has been showing a growing trade and current account deficit. The economic balancing mechanism in the form of a weaker currency, which makes imports more expensive and domestic production relatively more attractive, is not sufficiently effective due to the role of the US dollar as a global reserve currency. In return, US citizens have been able to consume more than their own economic output for decades. Above all, they can borrow at comparatively low rates. If these advantages are lost, this will also have serious consequences for the US itself: the importance of the US dollar in the global economy would decline, and in particular the cost of borrowing would increase.

Significant losses in prosperity loom

A government might be inclined to accept such consequences if, for example, it were a matter of combating mass unemployment in its own country. But that is not the case here: the US economy remains in a situation close to full employment. Even if the intended primary effect of production relocations to the US were to materialize—which would require, among other things, that investors believe in the long-term viability of the tariff regime—companies would have to poach the necessary labor from other sectors of the economy. In the long term, this could theoretically result in a productivity boost. In the short and medium term, however, it would lead to an economically questionable reallocation of resources to less productive areas. Because production in the US is more expensive than at the locations from which the goods have been imported to date, there would be significant losses in prosperity. The fact that these losses could be offset by employment gains in the regions of the United States particularly affected by the shock of globalization required systematic and coordinated regional and structural support—something that has not exactly been a strength of the US economic model to date. The approach taken so far by the Department of Government Efficiency (DOGE) does not seem designed to change this.

Import tariffs are directly fueling inflation, which is already above target. This puts the US Federal Reserve (Fed) in a dilemma between an improving economy and persistent inflation risks. It is not certain that the price effect of tariffs is one-off and temporary, as Fed officials currently want to believe: the effect described above in terms of rising wages could counteract this and ultimately force interest rate hikes, which the Fed does not want to consider at present.

Stagflation scenario gains new momentum

The stagflation scenario for the US economy, which had already been feared recently, is gaining new momentum as a result of Trump's tariff policy. The probability of a recession in the next 6 to 12 months has increased significantly. The negative effects of tariffs on Europe and Germany are weighing on economic recovery after years of stagnation. However, this should not lead to reactions that further exacerbate the damage. It might be wiser to respond moderately and hope that US citizens will vote against this type of economic policy in the midterm elections in fall 2026 due to the noticeable negative effects on themselves.