Tariffs – A Complex Path Forward
Trade Deficits and Tariffs: A Billionaire’s Perspective
Two of America’s most successful investors – Ray Dalio and Warren Buffett – have warned about the dangers of persistent trade deficits and offered their perspectives on tariffs as a potential remedy. Despite their different investment approaches, both billionaires share concerns about America’s growing trade imbalance and its long-term consequences for national wealth.
The Trade Deficit Problem
For decades, the United States has consumed more than it produces, resulting in a persistent and growing trade deficit. As Warren Buffett explained in his 2003 article, this wasn’t always the case. After World War II until the early 1970s, America operated in what he called a “Thriftville style,” selling more abroad than it purchased and investing the surplus internationally. The U.S. was a net creditor to the world.
However, the trade situation reversed in the late 1970s. Initially, deficits ran about 1% of GDP, but by 2003, when Buffett wrote his piece, the deficit exceeded 4% of GDP. Today, the situation has worsened significantly, with the foreign ownership of U.S. assets growing at approximately $500 billion per year at current trade deficit levels.
As Buffett memorably put it: “In effect, our country has been behaving like an extraordinarily rich family that possesses an immense farm. In order to consume 4% more than we produce—that’s the trade deficit—we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own.”
The Consequences of Persistent Deficits
Ray Dalio outlines several consequences of these persistent trade imbalances:
- Transfer of National Wealth: Both Dalio and Buffett emphasize that trade deficits represent a transfer of a nation’s wealth to foreign countries. Buffett notes that foreign entities owned approximately 5% of U.S. national wealth when he wrote his article, and this percentage has grown substantially since then.
- Negative Compounding: As Buffett explains, “We have entered the world of negative compounding—goodbye pleasure, hello pain.” The U.S. has shifted from earning investment income on foreign assets to paying ever-increasing dividends and interest to foreign owners.
- Growing Foreign Dependency: Dalio points out that trade and capital imbalances increase dependencies on foreign production and capital, which becomes especially problematic during global geopolitical conflicts.
- Stagflationary Effects: According to Dalio, large trade imbalances can create stagflationary conditions—combining economic stagnation with inflation.
The Case for Tariffs
Both investors view tariffs as a potential, albeit imperfect, solution to address trade imbalances.
Dalio outlines several first-order consequences of tariffs:
- They raise revenue for the imposing country, paid by both foreign producers and domestic consumers.
- They reduce global production efficiencies.
- They protect domestic companies from foreign competition.
- They can reduce both current account and capital account imbalances.
- They may be necessary during international power conflicts to ensure domestic production capabilities.
Buffett proposed a specific mechanism, Import Certificates (ICs)—that would function as a type of tariff. Under his plan, U.S. exporters would receive certificates equal to the dollar value of their exports, which importers would need to purchase to bring goods into the country. This would naturally balance trade over time.
The Recent Trump Tariffs
The document includes reporting describing how President Trump has implemented significant tariffs on Chinese goods—a 34% reciprocal levy bringing total tariffs on China to 54%. These tariffs were imposed to address what many in Washington view as China’s market-distorting practices, including intellectual property theft, massive state subsidies, currency manipulation, wage suppression, and labor rights violations.
China quickly retaliated with its own 34% tariffs on U.S. goods, along with tightening export controls on rare earth elements and adding U.S. companies to its “unreliable entities list.”
The Global Context
Both investors place trade policies within a broader global context. Dalio emphasizes that responses to tariffs—including reciprocal tariffs, currency adjustments, and changes to monetary and fiscal policies—create second-order consequences that are complex and far-reaching.
Buffett frames the issue in terms of global balances, using his allegorical tale of “Squanderville” and “Thriftville” to illustrate how one nation’s consumption can lead to another owning its assets. He warns that continuing down this path will eventually force painful adjustments, whether through currency devaluation or other means. Buffett concludes with a warning: “From what I now see, action to halt the rapid outflow of our national wealth is called for… Just keep remembering that this is not a small problem: For example, at the rate at which the rest of the world is now making net investments in the U.S., it could annually buy and sock away nearly 4% of our publicly traded stocks.”
Growth Rate of Foreign Ownership (1995-2024)
Overall Growth
- Percentage Ownership CAGR: 5.23% annually
- Total Value CAGR: 13.70% annually
This means that while foreign investors have increased their percentage ownership of US stocks by about 5.2% per year on average, the total dollar value of their holdings has grown much faster at 13.7% annually due to both increased ownership percentage and the overall growth of the US stock market.
Growth by Period
- Pre-Financial Crisis (1995-2007)
- Percentage Ownership CAGR: 8.59%
- Total Value CAGR: 15.50%
- Financial Crisis (2007-2009)
- Percentage Ownership CAGR: 0.72%
- Total Value CAGR: -0.15%
- Post-Crisis Recovery (2010-2019)
- Percentage Ownership CAGR: 3.60%
- Total Value CAGR: 14.92%
- Recent Period (2020-2024)
- Percentage Ownership CAGR: 2.19%
- Total Value CAGR: 11.03%
Key Highlights
- Foreign ownership grew from approximately 7.7% in 1995 to 33.8% in 2024
- The dollar value increased from around $0.6 trillion to $24.8 trillion
- The fastest growth in percentage ownership occurred before the 2008 financial crisis
- While the growth rate of percentage ownership has slowed in recent years, the total value has continued to grow substantially
This trend reflects the increasing globalization of financial markets, the attractiveness of US equities as investment vehicles, and the growth of the US stock market itself over this period. The US pre- April 2024 represented 70% of global stock market capitalization an unsustainable path.
The Path Forward
Despite their concerns, both investors remain fundamentally optimistic about America’s economic resilience. As Buffett notes: “Our country has consistently made fools of those who were skeptical about either our economic potential or our resiliency.”
However, both see the need for decisive action. Dalio observes that “the production, trade, and capital imbalances (most importantly the debts) must come down one way or another, because they are dangerously unsustainable.”
The concerns of these legendary investors highlight the complex challenge America faces in addressing its trade imbalances while maintaining its economic dynamism in an increasingly interconnected global economy.
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