Dalio, founder of Bridgewater Fund: Understand the impact and operating principles of tariffs

Original title: " The Effects of Tariffs: How the Machine Works "

Author: Ray Dalio

Compiled by: Deep Tide TechFlow

Tariffs are taxes whose functions include:

1. To increase income in countries that impose tariffs, this part of the tax is shared by foreign producers and domestic consumers (the specific proportion of burden depends on the relative flexibility of both parties), which makes tariffs an attractive tax;

2. Reduce global production efficiency;

3. It has a stagflation effect on the global as a whole, and has a more deflation effect on the producers that are subject to tariffs, and has a more inflation effect on the importing countries that are subject to tariffs;

4. Enable enterprises from importing/country levied tariffs to protect themselves from foreign competition in the domestic market, thus gaining more protection, but also reducing their efficiency; if total domestic demand is maintained through monetary and fiscal policies, these enterprises are more likely to survive;

5. During conflicts between major international powers, tariffs are necessary to ensure domestic production capacity;

6. Reducing the imbalance between current accounts and capital accounts, in layman's terms, is to reduce dependence on foreign production and foreign capital, which is particularly important in times of global geopolitical conflicts or wars.

The above is the direct impact of tariffs (first-level impact).

The subsequent impact depends on the following factors:

• How the country/region that is subject to tariffs respond to tariffs;

• Changes in exchange rates;

• How central banks in various countries adjust monetary policies and interest rates;

• How governments adjust fiscal policies to cope with these pressures.

These constitute the indirect effect of tariffs (second level of impact).

More specifically, regarding these impacts:

1. If the tariff response is a reciprocal retaliatory tariff, the result will be broader stagflation;

2. If monetary policy is relaxed and real interest rates fall, the currency will depreciate in countries with the greatest deflationary pressure (this is the conventional reaction of the central bank); or if monetary policy is tightened and real interest rates rise, the currency will appreciate in countries with the greatest inflationary pressure (this is also the conventional reaction of the central bank);

3. If fiscal policy relaxes in areas with weak deflation, or tightens in areas with strong inflation, these adjustments can partially neutralize the impact of deflation or inflation.

Therefore, tariff policies involve many dynamic factors and require extensive measurement of all aspects to evaluate the impact of major tariffs on the market. These effects go beyond the six first-level effects of tariffs I mentioned earlier, but are also significantly affected by the second-level effects.

However, the current context and future trends can be clearly defined as follows:

1. Production, trade and capital imbalances (especially debt issues) must be resolved in some way because from a monetary, economic and geopolitical perspective, these imbalances have become dangerous and unsustainable (and therefore the current monetary, economic and geopolitical order must change);

2. These changes may be accompanied by sudden and unconventional adjustments (similar to what I described in my new book How Countries Go Broke: The Big Cycle);

3. Long-term monetary, political and geopolitical impacts will mainly depend on the following factors: the level of trust in debt and capital markets as safe storage places for wealth, the level of productivity of each country, and whether the political system makes the country a place for habitable living, working and investing.

In addition, the discussion on the following issues is also very lively:

1. Is the US dollar more beneficial than disadvantages or disadvantages more beneficial as the world's major reserve currency?

2. Is the strong US dollar a good thing?

Obviously, the US dollar is a good thing as a reserve currency (because it increases the demand for its debt and other capital, otherwise it cannot be abused by over-borrowing if the United States does not have such privileges). However, as markets drive this phenomenon, this inevitably leads to abuse of this privilege, excessive lending and debt problems, which is exactly the dilemma we are facing now (i.e., the need to deal with the inevitable reduction of imbalances in goods, services and capital, take unconventional measures to reduce debt burdens, and reduce foreign dependence on these aspects, especially due to the impact of the geopolitical environment).

More specifically, some people have proposed that the yuan should appreciate, which may be agreed upon when some kind of trade and capital agreement between China and the United States, ideally when Trump and Xi Jinping meet. This adjustment, along with other non-market, non-economic adjustments, will have unique and challenging effects on the countries involved and trigger some of the second-level effects I mentioned earlier to mitigate these effects.

I will keep an eye on future developments and will update you at any time on my view of the first and second level effects.