Investors have been living in a real-time economic experiment ever since U.S. President Donald Trump returned to the White House in January.<\/p>\n
Whether it\u2019s tariffs, \u201cAmerica First\u201d isolationism, overt politicization of independent economic institutions, or upended global economic norms, markets are having to deal with challenges few investors have faced before.<\/p>\n
So how are they reacting to the leader of the free world ripping up the economic playbook that has shaped the global financial system for 40 years?<\/p>\n
Wall Street and world stocks are at record highs, U.S. high yield corporate bond spreads are the tightest since before the 2007-08 global financial crisis, and Treasuries are remarkably calm, with the 10-year yield below its average of the last two years.<\/p>\n
It\u2019s not all serene, of course. The U.S. \u201cterm premium\u201d – a measure of the extra compensation investors demand for holding long-dated Treasuries over short-term debt – is the highest in over a decade. Inflation expectations and long-dated yields have shot up too.<\/p>\n
And one needs to acknowledge that the full impact of Trump\u2019s tariffs has yet to be fully felt.<\/p>\n
But, at this point there has been no U.S. recession, even if growth is slowing. And the market plunge on the back of Mr. Trump\u2019s April 2 \u201cLiberation Day\u201d tariff debacle lasted a few weeks.<\/p>\n
The powerful stock market recovery since then suggests investors were less bothered by the actual tariffs than the shock of the initial announcement, the chaotic way it was delivered, and the amateurish way the levies were calculated.<\/p>\n
This outcome is not what economic textbooks would have predicted.<\/p>\n
Tariffs are a tax.<\/p>\n
And the overall U.S. average effective tariff rate looks likely to be around 18 per cent, according to the Budget Lab at Yale. That\u2019s down from an estimated 28 per cent in May but still nearly eight times higher than the level in December.<\/p>\n
Who will ultimately pay this tax is up for debate, but if sustained at that level, the president of the United States will have effectively imposed a tax hike worth around 1.8 per cent of GDP, one of the largest in U.S. history.<\/p>\n
But wait. Aren\u2019t higher taxes bad for business, markets and growth? Don\u2019t higher taxes sap consumers\u2019 spending power, stunt investment and hiring, and crush the private sector\u2019s entrepreneurial spirit?<\/p>\n
Markets\u2019 relatively speedy acceptance raises the question: What happened to the last 40 years of economic orthodoxy, symbolized by the so-called \u201cWashington Consensus\u201d?<\/p>\n
This was the set of principles drawn up in the late 1980s that broadly mirrored the views of the Washington-based International Monetary Fund, World Bank and U.S. Treasury, ostensibly to help direct policy in Latin America but which ultimately served as the economic framework for Western liberal democracies and global markets.<\/p>\n
They included support for privatization, deregulation, the free flow of capital, fiscal discipline, and lower taxes. They also entailed lower barriers to trade, a cornerstone of globalization.<\/p>\n
For years these tenets were regarded by policymakers, business leaders and investors as sacrosanct. Some, like rigid adherence to tight fiscal policy, were put to the test – and shown to be flimsy, at best – during the GFC and pandemic.<\/p>\n
So now that the tariff line has been crossed, what about other economic commandments? Could governments look to raise tax revenue from other sources, such as wealth taxes on the super rich, a \u201cTobin tax\u201d on foreign exchange transactions, or other \u201csoft\u201d capital controls?<\/p>\n
These are obviously anathema to the doctrine of free market capitalism. But then so were tariffs.<\/p>\n
To be fair, we are just entering this new era. And as my colleague Mike Dolan observed earlier this week, even if tariffs don\u2019t send the economy or markets into a tailspin, they may still lead to a \u201cslow burn,\u201d with many years of lost economic potential, elevated volatility and lower investment returns.<\/p>\n
But investors aren\u2019t looking that far ahead. What they see right now is a pretty resilient U.S. economy, solid earnings growth, and red-hot optimism around U.S. tech and AI. And some of the old orthodoxies may be in the rear-view mirror.<\/p>\n