Q1'25: Smoke & Mirrors

By: Jack Schibli

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TLDR: – "too long; didn’t read." We recognize our posts can be lengthy and challenging to digest, so here’s our executive summary:

The Trump tariff plan has far too many holes in it for long-term implementation to be taken seriously.
The combination of egregious reciprocal tariff calculations, the dismissal of supposed core tenets of the strategy (such as semiconductors, pharmaceuticals, and now electronics), and the sobering reality that, if truly enacted, a global recession would surely follow, leads us to believe the entire charade is Trump’s best poker face.
We suspect the Trump tariff plan is primarily a tool to get allies to the negotiating table where Trump seeks to make a grand “deal”, likely involving guaranteed purchases of U.S. Treasury bonds and perhaps the introduction of century bonds.
In our view, Trump and his trade team went off script by attempting the shock factor and are now walking a tightrope to keep the global recession genie in the bottle.
Trump’s agenda faces immediate threats from rising yields in the U.S. Treasury market, as well as longer-term threats from the judicial system. We suspect he will seek a swift resolution.

Queen’s Gambit or Economic Martyrdom? ♟️

On “Liberation Day,” President Donald Trump announced a sweeping tariff policy that literally swept the world off its feet. Trump had been discussing various tariffs since his inauguration, and the markets spent the first quarter digesting the possible impacts and severity. Markets thought they were well prepared, and during the press conference, equities initially rallied over 1% on the news that Trump was launching a broad 10% tariff (less severe than initially anticipated). It wasn’t until his partner-in-crime, Commerce Secretary Howard Lutnick, approached the stage with the now infamous “reciprocal” tariff chart that the world collectively vomited.

Trump’s broad and reciprocal tariff announcement seeks to take the effective tariff rate to an estimated 29% from the current ~2.5% rate, a level not seen since the start of the 20th century^[1]. The reciprocal tariff calculations are vastly oversimplified and ignore critical nuances of trade dynamics. The official calculations can be seen here, but the Trump administration has calculated an “adjusted” tariff rate each country charges on U.S. goods by simplistically taking the trade deficit as a percentage (ignoring their unnecessarily complex equation where coefficients conveniently balance to multiplication by 1). For example, the U.S. imports $136.5 billion of goods from Vietnam and exports just $13.1 billion to Vietnam, based on the most recent year-end figures. To calculate Trump’s “adjusted” rate, subtract exports from imports and divide by imports [(136.5-13.1)/136.5) = 90%]. The reciprocal rate applied to Vietnam is half the “adjusted” rate (45%) – oh, and don’t forget to add the baseline 10% applied to all nations for a total of 55%. Given that the actual tariff rate Vietnam applies to U.S. imports – per the Trump administration’s own report – is less than 15%, to us this seems entirely nonsensical.

The Trump administration’s justification is that this calculation best captures “currency manipulation” and other “non-tariff trade barriers.” They appear to be targeting bilateral trade deficits of zero, which, in our view, completely disregards basic economic theory and the concept of comparative advantage – a cornerstone of efficient international trade that suggests countries should specialize in producing goods for which they have a lower opportunity cost. Notably, this flawed approach focuses solely on goods while ignoring trade services, in which the U.S. runs a major surplus with most nations thanks to tourism, financial services, media, IP, technology, and more.

For Illustrative Purposes Only

In our view, the indirect benefits are far greater. One of the spoils of the world’s reserve currency is precisely that foreign nations seek to save in U.S. dollars. Surplus trading nations amassed plenty of U.S. dollars, which were then recycled back into the U.S. via foreign purchases of primarily U.S. Treasuries, as well as U.S. equities and U.S. property. This capital flow is responsible for many significant benefits to America and Americans. A constant strong bid for our sovereign debt meant an artificially lower interest rate environment, which created multiple tailwinds. First, low interest rates drove significant gains in asset prices, both equities and housing, which accrued to all asset owners and trickled down (admittedly unevenly) through the wealth effect. [Quick interlude – we have criticized the unsustainable, fiscally supported, and wealth-effect-driven economy in prior posts. We support the move toward a more durable economy focused on bottom-up real wage growth for the lower and middle classes. However, threatening global economic jihad and expecting a decade transition to occur overnight is no way to achieve this goal.] Secondly, the low-interest rate environment funded the U.S. technology industry for over a decade. The era of cheap money enabled persistent loss-making companies to survive long enough to reach the immense scale required for profitability. The likes of Amazon, Uber, et al are indebted to the cheap money era provided by surplus nations. In other words, the United States’ label as the “world’s consumer,” a strength touted by the Trump administration, is an outcropping of the very dynamics they claim to want to reverse.

We believe the idea that we, as a country, have been taken advantage of is entirely far-fetched. The other fantasy the Trump administration promotes is the dream of an American manufacturing renaissance. Do Americans know the working conditions of a Chinese factory? Commerce Secretary Lutnick said the quiet part out loud – any chance of a competitive U.S. manufacturing industry relies purely on robotics. Yes, you will need workers to build and operate the systems, but the purported job boom would likely fall short of White House rhetoric. Secondly, our skilled labor force has declined due to a generation of offshoring. Apple CEO Tim Cook once said, “In the U.S., you could have a meeting of advanced tooling engineers, and I’m not sure you could fill the room. In China, you could fill multiple football fields.” We agree that relying on a foreign adversary for critical products, such as semiconductors, pharmaceuticals, and medical devices, is not a sensible long-term national security policy. Yet, the Trump administration’s tariffs have excluded these critical goods, and most recently, Trump exempted computers, phones, and electronics. Thus, it is currently more expensive to import raw materials to manufacture electronics here in the U.S. than to import the finished goods – some motivation to Make in America.

These points, along with the absurdity of the calculations and entirely unintelligent economic narrative, lead us to believe this is Trump playing “Art of the Deal” on the grand stage. The threats are so preposterous that it is hard to take them seriously, but Trump plays the madman character well enough to make every world leader question his sanity. Hence, it is no surprise that nearly every country except China has agreed to come to the negotiating table. Strengthening the “smoke and mirrors” argument is that if followed through, Trump’s tariff plan would undoubtedly, in our view, cause a major U.S. (and global) recession. For a nation that ran a 6% deficit last year in a “strong” economic (and peacetime) environment, a recession would bring deficits into the double digits as tax receipts decline and even more government spending attempts to fill the void. Trump and Treasury Secretary Scott Bessent know this would be the nail in the coffin, as our already elevated debt-to-GDP would explode. Not to mention, a struggling economy (from a self-inflicted wound) would surely shatter Trump’s GOP midterm hopes.

Let’s assume our predictions are correct, and this entire charade is one large gambit. Tariffs are the sacrificial pawn, but what is the Queen that Trump is after? We think there are perhaps multiple objectives. Trump appears to be seeking a major global reordering, in which China – the primary target of tariffs – is left isolated and the West strengthened. We think there is a high likelihood this stunt was the calling card for a “Mar-a-Lago” accord. Stephen Miran, now Trump’s Chairman of the Council of Economic Advisors and possibly the key architect of Trump’s vision, wrote “A User’s Guide to Restructuring the Global Trading System” in November 2024, which we believe spells out the playbook.

Miran argues that the dollar’s reserve status gives it an artificial premium far in excess of what would balance international trade, eroding the competitiveness of America’s export sector, particularly during global slowdowns when dollar demand rises. This is true, though, as Miran points out, there are benefits, including lower domestic borrowing costs and the ability to implement capital controls. We think he ignores many others, but Miran is convinced the U.S. dollar reserve status is now more of a burden than a benefit. He goes on to discuss the role of tariffs in rightsizing trade imbalances and documents how the 2018/2019 US-China trade war resulted in a 17.9% increase to tariff rates, offset by a 13.7% decline in the Chinese Renminbi, making the real increase to import prices just 4.1%.

For Illustrative Purposes Only

In this case, most of the burden of tariffs fell on China – the exporting nation – in the form of decreased purchasing power. Miran notes that if no currency offset occurs, then U.S. consumers suffer higher prices and bear the full burden of the tariff. Miran concluded that a currency offset was “more likely than not to occur” in the next iteration of tariffs – unfortunately, this could not be further than reality. The U.S. dollar index (DXY) has declined nearly 8% in 2025 and over 4% since “Liberation Day,” which serves to aggravate (not offset) the impact of tariffs on U.S. consumers. Trump must have conveniently forgotten to read Miran’s pages on tariff implementations, where he argued for very gradual implementation to reduce market volatility and global disruption. In our view, Howard Lutnick and Peter Navarro, producers of the egregious reciprocal tariff calculation, persuaded Trump to pursue the shock factor strategy instead – and they very well may be the scapegoats if it backfires.

What might a “Mar-A-Lago Accord” entail? Miran quotes Zoltan Poszar’s idea of hypothetical terms:

“Security zones are a public good, and countries on the inside must fund it by buying Treasurys
Security zones are a capital good; they are best funded by century bonds, not short-term bills
Security zones have barbed wires: unless you swap your bills for bonds, tariffs will keep you out”. (Poszar, 2024).

Make no mistake, this would be a major retooling of the global monetary system and the first major multilateral currency agreement since Bretton Woods. Such a deal would shift a portion of the defense umbrella financing burden to our trading partners and alleviate longer-term U.S. debt default concerns. It would also disincentivize dollar reserve holdings in favor of longer duration Treasuries (and possibly gold – a neutral reserve asset), thereby weakening the U.S. dollar relative to those currencies and subsequently increasing the competitiveness of U.S. exports.

To sum up, we believe Trump’s tariffs are his best bluff intended to get our trading partners to take very seriously the merits of a currency agreement with provisions for U.S. Treasury purchases and “burden sharing,” as the Trump team calls it. However, we fear the trio of Trump, Lutnick, and Navarro went entirely off script with respect to the ferocity of reciprocal tariffs – much to the dismay of Bessent and Miran – and have risked pushing our allies irreversibly farther away. We are also concerned that the longer this period of uncertainty drags on, the higher the probability of an unavoidable recession. Current uncertainty has frozen hiring and capital investment decisions, which alone can cause economic slowdown, not to mention the stagflationary impact of actual tariffs. Equities, bonds, and currencies have spoken loudly – particularly the U.S. Treasury market, which has seen the 10Y yield rise to 4.4% amidst the chaos. Bonds selling off is extremely atypical behavior in the face of an economic slowdown, and we believe this will force a swift resolution.

The Golden Ticket 🎫

What are the investment consequences of a hypothetical “Mar-A-Lago Accord” or post- “Liberation Day” fallout? In our last blog, we highlighted the high concentration of foreign investment in U.S. markets due to the dollar reserve system and the recycling of dollars into U.S. assets.

For Illustrative Purposes Only

We suspect that foreigners have been significant net sellers of U.S. assets in 2025, most acutely in the wake of “Liberation Day”. Trump’s actions to date signal an America turning inward, reversing the many decades of globalization, and even include comments about a withdrawal of the global security umbrella. A deal amongst trading partners would alleviate many of these concerns, as we believe Trump does not intend for these threats to become reality, but he is playing a very dangerous game of poker. We believe without a swift (and fair) resolution, Trump risks foreigners continuing to reshore capital out of U.S. markets and into their domestic markets, leaving a formidable headwind for U.S. assets. However, our base case is that Trump, forced by Treasury markets and a looming, deficit-increasing recession, will quickly clean up his spilt milk.

It is also worth mentioning the ongoing legal battles Trump faces, as nearly every executive order has been challenged in court – you can follow along here. Concerning tariffs, Trump is invoking the International Emergency Economic Powers Act (IEEPA), which, provided a justified emergency exists, allows the President to “regulate” various international economic transactions, including imports, but does not explicitly grant the power to impose tariffs. The landmark case will be Emily Ley Paper v. Trump, where the Florida-based paper company is taking issue with Trump’s “emergency” declaration and challenging whether IEEPA even grants Trump the ability to enact tariffs, particularly given that tariffs are taxation, and taxation is explicitly regulated by Congress. There is a scenario where virtually all of Trump’s significant actions since inauguration are shut down eventually by the courts, and we revert to the Biden-era economic policies already in place, barring any new legislation passed by Congress. We believe Trump is aware of the losing legal battle he is fighting, and to eventually be shut down by the courts would be far more embarrassing to him than to walk back tariffs on his own accord – the clock is ticking. We suspect markets would respond very positively to this scenario.

We have been a broken record on the merits of gold ever since Biden’s sanctions on Russia’s U.S. dollar reserves in the wake of its Ukrainian invasion. Gold has risen 68% since the invasion and over 21% in 2025, despite immense financial market volatility. We have suspected for some time that a new monetary regime may be underway, and we cannot rule out gold’s possible explicit role in a new system. If not, we see indirect tailwinds as well. The declining use of U.S. dollars as a reserve asset (which still stands around 60%) has and will continue to benefit gold – the only time-tested neutral reserve asset. Since 2008, global central banks – particularly emerging market nations – have been accumulating gold, and we suspect recent developments have only accelerated this trend.

For Illustrative Purposes Only

Gold imports to the U.S. surged in the first quarter – so much so that the Atlanta Fed had to adjust its GDPNow model to exclude gold imports because it was so distortive to the trade deficit. Gold is typically excluded from the national accounts because it reflects the transfer of existing financial assets rather than current economic activity. We cannot be sure who is importing all this gold, or why, but we can be sure it is a significant signpost. Based on the Atlanta Fed’s estimates, gold imports accounted for a ~2% differential in US GDP growth – that is a lot of gold!

For Illustrative Purpose Only

Earlier this year, there was chatter about a possible revaluation of the Gold held by the U.S. Treasury. Scott Bessent’s comment on “monetizing the asset side of the U.S. balance sheet” was music to the ears of gold bugs. However, he later clarified revaluing the gold was not part of their plan “now.” The fine print of the Financial Accounting Manual for Federal Reserve Banks (Section 2.10) allows the Treasury to “monetize” the 261 million ounces of U.S. government gold by crediting the Treasury General Account with an offsetting debit at the Federal Reserve. Given that the gold is marked at $42 an ounce, marking it to the present ~$3,100 price would mean a TGA credit of nearly $800 billion.

Perhaps this niche rule will never be exercised, but its existence certainly implies a U.S. deficit benefit to a rising gold price. Considering that one of the main objectives of the Trump administration appears to be devaluing the U.S. dollar, we believe gold—and its digital brethren, Bitcoin—remain attractive in the face of continued currency debasement.

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Sources

^[1] Evercore ISI Reserach