Post-election optimism around deregulation, tax cuts, and a business-friendly administration has given way to concerns about potential negative economic impacts, especially around how uncertainty may cause consumers and businesses to reduce spending.
The Economic Miracle
The US economy has proven to be surprisingly resilient during its post-COVID recovery. Inflation has come down as employment and real wages have grown, which has enabled the US consumer to maintain high levels of spending. The 2.4% annualized increase in real gross domestic product (GDP) in Q4 2024 (see Figure 1) was primarily driven by increases in consumer spending and government spending that were partly offset by a decrease in investment. Imports, which are a subtraction in the calculation of GDP, decreased.
Figure 1
On an annual basis, the US economy has grown +2.8%, +2.9%, and +2.5% over the last three years. To start this year, economic forecasts called for continued strength with the Federal Reserve estimating in December 2024 that the US economy would grow 2.1% in 2025 and 2.0% in 2026.
Short-term forecasts of GDP are based on assumptions around the expenditure components of the economy and can be summarized with the following formula: GDP = C+I+G+(X-M). The $30 trillion US economy is equal to the sum of personal consumption expenditures, gross private domestic investment, government expenditures, and net exports of goods and services. Consumer spending is by far the most important factor, comprising about 70% of the calculation. Although Commerce Secretary Lutnick has proposed excluding government spending data from the overall calculation of GDP, most economists say such a move would be “nonsensical” and could erode confidence in US economic data.[1]
The US economy has historically been characterized by high levels of dynamism and innovation. As labor and capital are free to flow from the least to the most productive firms, productivity, wages, and overall economic growth increase. Recent US economic exceptionalism is due to: low leveraged balance sheets, high corporate transparency, US dollar reserve status, energy independence, technological innovation, and labor fungibility. Over the long term, the US economy has been the greatest wealth creation engine in history.
Gains from Trade
Adam Smith’s radical insight in his 1776 classic Wealth of Nations was that a free market, driven by individual self-interest, is the most effective way to create national wealth. Smith maintained that everyone “is led by an invisible hand to promote an end which was no part of his intention,” that end being the public interest. “It is not from the benevolence of the butcher, or the baker, that we expect our dinner, but from regard to their own self-interest.”[2] Smith said a nation’s wealth is really the stream of goods and services that it creates (GDP), and the way to maximize it is not to restrict the nation’s productive capacity with counterproductive regulations on commerce, but to set it free. Economic gains from trade refer to the net benefits that economic agents (individuals, businesses, or countries) experience when they engage in voluntary exchange.
Economist David Ricardo, some years after Smith, showed how individuals, companies, and countries benefit from trade by specializing in producing goods or services where they have a relative advantage compared to their trading partners. This specialization and subsequent trade leads to increased overall efficiency and output, benefiting all involved. When countries engage in trade, the imbalance is a trade surplus or deficit. A trade deficit occurs when a country imports more goods and services than it exports—recall (X-M)—from the GDP formula. Bilateral trade balances can provide a useful snapshot of trade relationships between countries, but they are influenced by various factors beyond trade barriers, including the overall level of economic development and relative rates of economic growth, abundance of raw materials, complex supply chain relationships, and rates of technological change.
The United States excels at exporting services, such as banking, insurance, consulting and legal advice. It is also a major exporter of some goods, including aircraft, soybeans, oil, and LNG. Over the years it has increasingly turned to other nations for many of the goods it consumes, including electronics, clothing and agricultural products (i.e. coffee and avocados don’t thrive in America). The US has been running trade deficits since the 1970s, and last year, the US had a trade deficit of about $918 billion (see Figure 2).
Figure 2
After World War II, the Bretton Woods system was established to stabilize global trade, making the US dollar the international reserve currency, backed by gold at $35 per ounce. Countries could exchange dollars for gold, creating a stable postwar monetary framework. In 1971, President Nixon ended dollar convertibility to gold, effectively collapsing the Bretton Woods system. In the aftermath, the US dollar remained dominant, becoming a global fiat currency and store of value. This shift enabled the US to run persistent trade deficits, as it could finance imports by printing money or issuing debt. Another cause for the US trade deficit is the shifting of comparative advantage in goods production, which caused the reallocation of labor-intensive manufacturing from the US to nations with cheaper labor. Manufacturing jobs represent about 9.4% of private sector jobs in America today compared to about 35% in 1950.[3]
From Globalization to Protectionism
While individuals, businesses, and countries benefit from trading, the gains from reordering the global trade system are not shared equally. Free trade and globalization have disproportionately benefited the world’s top 1% and an emerging global middle class, particularly in countries like China, India, and Brazil. However, the lower end of the income spectrum, including the lower-middle class in rich countries, has experienced negative impacts.
Globalization and capitalism have created tremendous prosperity in the US, but this prosperity has not been distributed evenly, with rising top incomes, increased poverty, and a stagnant-to-declining middle class (see Figure 3). Other factors driving the income disparity include inflation, the aging population, immigration, the rise of single-parent households, and a shrinking manufacturing base.[4] Meanwhile, a meaningful portion of the country did not see reskilling in the first wave of globalization.
Figure 3
Trump’s Economic Agenda
During Trump’s first term, US economic growth averaged 2.6% per year driven by individual and corporate tax cuts and deregulation. In his second term, he has promised to rebuild the American middle class by bringing back jobs to the US. He wants to end or sharply reduce trade imbalances, reduce the debt burden, and bring manufacturing onshore. Treasury Secretary Bessent’s proposed 3-3-3 economic plan aims to raise US real GDP growth to 3%, reduce the federal deficit to 3% of GDP, and increase US oil production by 3 million barrels per day. The policies are meant to shift resources, money, and jobs from other countries to the US. The theory goes that higher economic growth rates and lower deficits can pay for extending the 2017 tax cuts and new tax cuts on tips, Social Security, and overtime wages.
Figure 4
As noted in the Winter 2025 QMP, the total US federal debt at $35.5 trillion (118.5% of GDP) remains a critical concern (see Figure 4). With fiscal budget deficits running approximately 6.5-7% of GDP, long-term fiscal sustainability in the US remains a significant challenge. The CBO’s long-term budget outlook suggests that debt levels could reach 214% of GDP by 2054 if tax cuts are made permanent.[5] Furthermore, the CBO predicts that increased federal borrowing is projected to reduce the resources available for private investment. They say this crowding-out effect will contribute to slower economic growth over the next three decades than over the past three decades.[6]
The Trump administration’s plan to reduce federal deficits and debt relies on reducing federal government spending (via the efforts of DOGE, the so-called “Department of Government Efficiency”), increasing revenue from foreign sources (tariffs), and lowering interest rates. They are attempting to lower interest rates by using a new approach: focusing on long-term borrowing costs by influencing the 10-year US Treasury yield, rather than relying on the Fed’s short-term rate policies. In addition to Trump’s direct demands that the Fed cut interest rates, Treasury Secretary Bessent has proposed banking deregulation measures (changes to bank’s supplementary leverage ratios) he says could lower 10-year Treasury rates 0.3-0.7 percent. This strategy marks a significant departure from traditional monetary policy coordination and raises critical questions about its feasibility and market impact.
The Effects of Tariffs
The keys to achieving the Trump administration’s economic policy goals are: lower government spending, deregulation, and a reordered global trade system. Since long before he became president in 2017, Trump had promoted tariffs on imports to retaliate against countries he believes are “ripping off” the United States. The administration expects tariffs to generate revenue and revive US manufacturing. The stated goal is to encourage domestic production, create jobs and rebuild America’s industrial base. In the short term, tariff income could help fund these goals while manufacturing capacity is being rebuilt. Over time, as more goods are made domestically, tariff income may decline but could be offset by job growth and increased US exports.
Trump has insisted that foreign nations pay the tariffs because a tariff is a tax on foreign goods that raises revenue for the imposing government. Importers legally pay US tariffs, but their economic burden (i.e., who really pays) depends: It can be borne by American consumers, businesses, foreigners exporting to the US, or by some combination of these groups. Economists generally find that tariffs benefit some but hurt far more others, thus lowering overall living standards and economic growth. The higher prices that consumers and businesses pay could end up cutting into spending on other goods and services—including ones made in the US.
One case study that demonstrates the short-term costs of tariffs, the possible long-term benefits, and the unintended consequences is the tariffs imposed on washing machines in 2018. According to a study published in the American Economic Review, when Trump imposed tariffs on imported washers, prices rose 11% as manufacturers (both international and
domestic) raised prices. Concurrently, prices for dryers went up as firms raised prices on the complementary good despite no tariff. In response, Samsung and LG Electronics both built new US factories that employ approximately 1,600 people. The study’s authors estimate it could take 25 to 40 years for the economic benefits of the new “Made in America” washing machine factories to offset the $7.3 billion costs consumers paid in higher prices.[7]
From the era of the Founding Fathers through the Civil War, tariffs were the main source of revenue for the federal government. However, after the Civil War and especially after the income tax was introduced in 1913, the revenues generated from US tariffs almost disappeared. The Tariff Act of 1930, known as the Smoot–Hawley Act, significantly raised tariffs in an effort to protect American farms and factories from foreign competition. Ultimately, it invited retaliation, collapsed world trade, and worsened the Great Depression. In the aftermath of Smoot–Hawley, Congress delegated trade negotiation powers and tariff-setting authority to the president, and since 1934, the general policy of Congress and the president has been to gradually liberalize trade, including reducing and eliminating many tariffs. After World War II, the US and almost two dozen other countries signed the General Agreement on Tariffs and Trade in an effort to lower barriers to international trade and rebuild the global economy. Accordingly, the average tariff rate across all imports fell from 19.8% in 1933 to below 2% from 2000 to 2019 (see Figure 5).
Figure 5
Can Economy Withstand New Tariff Shock?
Trump’s economic agenda represents one of the biggest gambles in the modern economic era. President Trump believes tariffs will create revenue for the US government and more jobs for American workers. Lower fiscal deficits and more American production could lead to higher rates of economic growth. If tariffs lead to a global negotiation to bring down tariffs across the board, most countries’ inflation would cool dramatically, and global GDP growth would accelerate materially. On the other hand, tariffs may raise prices, slow growth, disrupt supply chains, and damage alliances. Persistent tariffs and an escalated trade war could lead to a deep recession, perhaps even an economic depression. Concerns that tariffs will hurt corporate earnings are combined with broader concerns about the economy.
Consumer and business survey data have been notably weaker since Trump’s trade policy began to take shape. For example, a survey from Duke University found that optimism among chief financial officers (CFOs) slipped in the first quarter from the fourth quarter. The survey also found that the more the CFOs’ companies were exposed to tariffs, the more worried about the economy they were.[8] Similarly, the Philadelphia Fed’s nonmanufacturing business outlook fell to its lowest level since the early days of Covid-19.[9] If companies get nervous, they can put off expansion plans and freeze hiring, and those actions can snowball through the economy.
Figure 6
American consumers are also feeling less confident about the economy. In March, the Conference Board’s Expectations Index, which measures consumers’ short-term economic outlook, reached its lowest level in 12 years.[10] Similarly, the University of Michigan Consumer Sentiment Index fell 22 percentage points in March to its lowest level in two years (57 v 79.4 y/y; see Figure 6).[11] Sentiment declined for Democrats, Republicans and independents alike. For decades, consumer sentiment and consumer spending moved in sync—when people feel unsure about the economy, they spend less—but recently that relationship broke down. The Consumer Sentiment Index, for example, fell sharply from the middle of 2021 to the middle of 2022 as inflation soared. Yet while Americans felt bad about the economy, they kept spending money. In fact, even when adjusting spending for inflation, in aggregate, consumers are spending more than before the pandemic and are spending more each year.
For now, most of the weakest economic data are in the form of surveys reflecting confidence or expectations, rather than hard evidence. The economy added 228,000 jobs in March, and the March unemployment rate was low at 4.2 percent.[12] The ISM Composite Index points to expansion, and the economically weighted figure is comfortably above the expansion level (50).[13] Most of the investment and production leading indicators are far from a recession signal. Retail sales were better than expected as the control group rose by 4.6% y/y in March,[14] and industrial production soared past expectations due to a surge in manufacturing, particularly autos and durables.[15]
Headlines around President Trump’s tariffs are clearly affecting sentiment but a recession is only likely if that persists and translates into a prolonged pullback in spending. While GDP growth is likely to decline, and recession risk has risen, the US economy still has key sources of strength. If employment holds up, consumers will too, even if it strains their finances somewhat. Ultimately, consumer spending (and the US economy) is dependent on employment, not sentiment. However, if businesses slow investments and hiring due to confusing trade policy and consumers rein in spending due to worries about their jobs, the economy can’t help but deteriorate.
Stagflation Risk
The president’s moves raise the specter of a stagflationary shock that increases prices while putting more economies, including the US, at risk of recession. Recently Fed Chairman Powell said, “The level of the tariff increases announced so far is likely to result in higher inflation and slower growth.”[16] If GDP is slowing but inflation is rising, the Fed must choose which problem to address. Since tariffs generally lead to one-time price increases, the Fed is likely to downplay the inflation risks, at least initially. But if tariffs lead consumers to think that more price increases are coming, that mindset can become self-perpetuating and result in demand destruction. That may tie the Fed’s hands on interest rate cuts just when the economy needs them.
The Fed accommodated a mountain of federal pandemic spending with easier money which contributed to the worst inflation since the 1970s. Inflation has declined from its 9.1% peak in June 2022 without causing recession, but the Fed hasn’t reached its target inflation rate of 2% (February PCE Price Index +2.5%). It must now walk a tightrope between controlling inflation and supporting economic growth. Despite Trump’s criticism of Fed Chair Powell and his monetary policy decisions, the Fed remains an independent agency.
Long-Term Optimism
The Bretton Woods system, established after World War II, aimed to promote global economic cooperation, stability, and prosperity, based on the belief that a stable global economy was crucial for peace. The institutions it created, like the International Monetary Fund and the World Bank, were designed to encourage trade, manage the international monetary system, and provide financial assistance to countries in need. The Trump administration’s proposed economic policies represent a notable departure from the post-World War II economic framework. These policies signal a broader shift from free trade to one focused on domestic production. This transition could introduce short-term volatility, as tariffs effectively place a tax on consumption to support American industry.
While the policy direction introduces economic uncertainty, our long-term outlook remains optimistic. The US economy continues to demonstrate exceptional resilience and dynamism, with technological innovation expected to drive productivity and fuel sustained growth.
We believe Woodstock clients are well positioned to benefit from the market’s growth over time by remaining disciplined through periods of uncertainty. History shows that equities have generally trended upward, even through unpredictable phases. A well-constructed portfolio can help manage risk and enhance resilience, even amid market swings. Our investment approach is built to continuously monitor and adapt to changes in the economic and geopolitical landscape. We consider short-term developments—such as presidential cycles—within a broader, long-term context. This is a time for measured caution, paired with a readiness to take advantage of opportunities to invest in high-quality companies.
As always, we encourage you to stay in close contact with your portfolio manager to discuss current market developments and how they may impact investment strategy.
James H. Garrett, CFA – Vice President
[1] Megan Leonhardt, “Trump Advisers Want to Strip Public Spending From the GDP Tally. Why It Makes No Sense,” Barron’s, March 3, 2025.
[2] Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations, 1776.
[3] Justin Lahart, “How the U.S. Lost Its Place as the World’s Manufacturing Powerhouse,” Wall Street Journal, April 13, 2025.
[4] “Income Inequality in the United States,” Inequality.org.
[5] “Analysis of CBO’s March 2025 Long-Term Budget Outlook,” Committee for a Responsible Federal Budget, March 27, 2025.
[6] “The Long-Term Budget Outlook: 2025 to 2055,” Congressional Budget Office, March 27, 2025.
[7] Aaron Flaaen, Ali Hortaçsu, and Felix Tintelnot, “The Production Relocation and Price Effects of US Trade Policy: The Case of Washing Machines,” American Economic Review, 2020, 110(7): 2103–2127.
[8] “Optimism Among CFOs Falls Amid Concerns about Tariffs, Uncertainty, “ The CFO Survey, Federal Reserve Bank of Richmond, March 26, 2025.
[9] “March 2025 Manufacturing Business Outlook Survey,” Federal Reserve Bank of Philadelphia, March 2025.
[10] “US Consumer Confidence Plunged Again in April,” The Conference Board, April 29, 2025.
[11]“Final Results for April 2025,” Surveys of Consumers, University of Michigan, April 2025, http://www.sca.isr.umich.edu/.
[12] “Local Area Unemployment Statistics,” Bureau of Labor Statistics, March 2025.
[13] “March 2025 Services ISM Report On Business,” Institute for Supply Management, March 2025.
[14] “Advance Monthly Sales for Retail and Food Services,” US Census Bureau, April 16, 2025.
[15] “Industrial Production and Capacity Utilization – G.17,” Board of Governors, Federal Reserve, April 16, 2025.
[16] “Economic Outlook,” Speech by Fed Chair Jerome H. Powell on April 16, 2025, Board of Governors, Federal Reserve.