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

The tariffs announced by US President Donald Trump go well beyond what was previously expected. Whether this results in a global trade war now depends crucially on the reaction of the countries affected. If they demonstrate their strength and repay like with like, serious negative consequences for the global economy are unavoidable. China's reaction points in this direction. The alternative would be to announce countermeasures, show a willingness to talk and, even if negotiations fail, only impose moderate and targeted sanctions. So far, this seems to be the path the EU wants to follow.

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

Significant loss of prosperity looms

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

The import tariffs are directly fueling inflation, which is already above the target value. This puts the US Federal Reserve (Fed) in a dilemma between a growing economy and persistent inflation risks. It is not certain that the price effect of tariffs is of a one-off and temporary nature, as Fed officials would currently like to believe: the described effect in the direction of rising wages in particular could counteract this and ultimately force interest rate hikes, which the Fed does not want to think about at the moment.

Stagflation scenario receives new impetus

The recently feared stagflation scenario for the US economy has been given fresh impetus by Trump's tariff policy. The probability of a recession over the next 6 to 12 months has increased significantly. The negative effects of the tariffs on Europe and Germany represent a burden for the economic recovery after years of stagnation. However, this should not lead to reactions that exacerbate the damage. It could be wiser to react in a measured manner and to count on US citizens voting out this type of economic policy in the mid-term elections in fall 2026 due to the noticeable negative effects on them.