Just when it seemed that auto insurers had caught up with the surge in car prices that followed COVID-19's disruptions, what I'm calling "the uncertainty economy" has tossed a hand grenade into the industry. Even if everything about U.S. tariff policy became crystal clear tomorrow — and it won't — major damage has already been done.
The president's threats of double-digit tariffs on all imports, followed by all the waffling on what he'll do and when, is freezing the world of business. What to invest, where to invest, whom to hire, where to hire, what geographies to sell into: All those decisions depend on the rules of the road, and nobody knows what they are.
Trump could, of course, clear up the situation by disavowing his bold tariff plans entirely. The stock and bond markets are certainly signaling that he should. But backing away from tariffs would be an unfathomable loss of face.
Anything short of a total repudiation of a transition to a tariff-based economy will leave us in this uncertainty economy. Prices for cars and parts will float higher even before underlying costs increase, simply because of the possibility that Trump's tariffs could make prices soar. Prices for lumber and other imported supplies that are major factors in home insurers' replacement costs will climb, too. Insurers will face losses on policies currently in force, and already restless policyholders will be shocked when they see what a new policy or a renewal will cost them.
And those are just the disruptions happening in the near term. If Trump follows through on the extreme form of his tariff plan that he often broadcasts, he will reorder the global economic system that has existed for the past century, in the process disrupting for years the supply chains that insurers rely on.
To sort through all the variables here, I sat down on Friday with Michel Leonard, the chief economist at the Insurance Information Institute.
Michel says the current situation should have some parallels with the COVID-19 pandemic, given the effect it had on supply chains, especially for autos.
"For motor vehicles, we will inevitably see a significant drop in underlying growth, even if tariffs are suspended indefinitely, because the uncertainty is already present," Michel said. "During COVID, replacement costs for motor vehicles — both personal and commercial — rose around 60%, largely due to used auto prices. I could see this happening again, following a similar timeline.
"Ultimately, I believe we'll... end up with a cosmetic renegotiation — remember, the current North American free trade agreement was negotiated by President Trump. The real question is timing — whether it takes one month, three months, or six months. Insurance underwriters and industry professionals should be prepared for increases that could approach those COVID-era numbers for motor vehicles, the longer this situation persists.
"And these double-digit increases in tariffs on lumber, auto parts and other materials don't just mean higher replacement costs – they mean many materials aren't available through the supply chain."
Michel said he remains an optimist about the economy, in general — though, given how fast things have been changing, we noted for this version of our quarterly chats that we were speaking at 1pm EST on Friday, March 7.
"As of this first quarter, I believe we still have enough GDP momentum to weather what we're seeing now, even if these conditions continue for a full quarter," he said. "However, the risk of GDP contraction rather than growth is certainly present.... My current concern is market sentiment."
He sees inflation "hovering between 2.5% and slightly above 3%" but says the Fed won't be able to do much about inflation driven by tariffs. "Higher interest rates can drive down demand," Michel says. "However, when inflation is driven by tariffs or other factors related to consumption issues, raising interest rates doesn't work."
He cautions that other countries seem to be taking Trump's threats much more seriously and reacting much more negatively than they did during Trump's first term, even though much of his language about trading partners is similar.
"I've been shocked by how seriously other countries are taking these developments on protectionism," Michel said.
When I asked if he saw any historical parallels to Trump's attempt to reverse a century of increasingly free trade, Michel said:
"What we're facing is potentially comparable to Margaret Thatcher's first two years as prime minister in the U.K. [which began in 1979]. When Thatcher came in, she cut government spending, privatized industries, and moved extremely rapidly. She was actually on track to lose her position until the Falklands War came about and allowed her to recover politically. During this period, the U.K. experienced one of the deepest recessions since World War II.
"That's the kind of economic pain we could be talking about here, but potentially on an even larger scale because it's the U.S. The agenda we're seeing now is even more transformative."
He says there is the potential for surging unemployment and a major market correction.
"I haven’t given up," Michel says. "I’m still an optimist. But the potential implications go far beyond simple replacement costs, and that's what makes this situation particularly challenging."
I'll add that I believe Trump will have to back off his tariff plan. He just doesn't have the support for it at any level outside of the circle he controls in Washington, DC.
His rich backers during the campaign certainly heard him talking about putting tariffs on every country, but they say they thought he was either blustering or was simply staking out an extreme position to gain an edge in negotiating.
Right-wing economists don't support him. The Wall Street Journal editorial page has run headlines about Trump's "Dumb Tariffs" and "Dumbest Possible Tariffs." Even Stephen Moore, a longtime ally whom Trump once nominated for a seat on the Fed, said recently that the tariffs aren't a good idea for now.
Polls show that the public at large mostly dislikes tariffs... and that's just at the theoretical level. To the extent that tariffs are imposed, they will raise prices and cause supply disruptions and bring the costs home to people. Trump's supporters argue that tariffs will encourage manufacturers to move production to the U.S., and that's surely true, at least to an extent, but it takes an awful lot longer to build a plant and staff it up than it does to raise a price. Besides, the U.S. isn't the only country that can raise tariffs; the U.S. will lose overseas markets as other countries retaliate. In any case, I don't see how Trump can sustain support for tariffs for many months or even quarters while waiting for any benefits to kick in.
He's certainly winning the public relations battle at the moment. He's benefiting from the normal surge of enthusiasm from supporters in the early days of a term. He's also unleashed a barrage of appearances on television, and he's benefited from the stunning pace of activity by Elon Musk and DOGE to cut government programs that Trump supporters dislike. But I think that PR wave is cresting.
DOGE has had to back off on many of its cost-cutting claims. Cabinet members are pushing back on Musk's slash-and-burn tactics when their departments are involved. Judges are ruling in some cases that Musk has overstepped the bounds set by the Constitution. Musk himself has lost some of the Iron Man mystique now that Tesla, the main source of his wealth, has seen its stock price fall 50% since its post-election peak. And, increasingly, we'll all see what the DOGE cuts do to service at federal agencies, to recipients of the aid that is no longer being provided, to the tens of thousands or hundreds of thousands who have been fired (many of them Trump voters) and so on.
If someone doesn't pay their mortgage one month, they may save a few thousand dollars, but that's just the first part of the story. So far, we've just seen claims about the DOGE savings. Some will be welcomed, at least by Trump voters, but some will not. There is another part of the story coming.
And, of course, the stock market has been plummeting. The Dow Jones Industrial Average is down 2,700 points since Feb. 19, or 9.4%, including a nearly 900-point drop on Monday, almost entirely because of the uncertainty about Trump's trade war and the related possibility of a recession. The market is maybe the most important point, because Trump seems to care deeply about how the stock market reacts to him.
But how does this all end? I simply don't know. I'm quite sure the trade war isn't sustainable politically, but I don't see how Trump can back away.
We'll just have to wait and see. In the meantime, we'll have to keep swimming in all the uncertainty.
Cheers,
Paul
