Why the U.S. economy will grow
Some of Trump’s policies that potentially could be stagflationary, i.e. reducing growth and raising inflation, such effects would ultimately be mitigated by four factors: market discipline, an independent Federal Reserve, the president’s own advisers, and the republicans’ thin majorities in Congress.
The reaction from stock, bond, credit, and currency markets forced Trump not only to back down from his tariffs against most of America’s trading partners, but also to ask China to negotiate. Market traders trumped the tariffs, and bond vigilantes proved more powerful even than the U.S. president.
Then came the outburst against Powell. Markets swooned when Trump suggested that he would fire Powell, and he soon backpedaled, declaring that he has no intention of doing so.
Similarly, like Peter Navarro, Trump’s main trade adviser, initially gained the upper hand, appealing to Trump’s self-image as “Tariff Man”, this did not last. Once markets stumbled, those advocating de-escalate tariff strategy seemed to prevail.
Regardless of tariffs, there are domestic forces in the U.S. that are driving the economy, particularly the technology innovation factor. The U.S. economy’s potential growth will approach 4% by 2030, far above the International Monetary Fund’s recent estimate of 1.8%. America is the world leader in ten of the 12 industries that will define the future, with China leading in only electric vehicles and other green tech. US growth averaged 2.8% in 2023-24, and productivity growth has averaged 1.9% since 2019, despite the pandemic-era dip and mismanagement of the economy under the Biden administration.
Since the launch of ChatGPT in late 2022, Artificial Intelligence (AI) related investments have driven a U.S. capital-expenditures boom. Even tariffs and the resulting uncertainty have not fundamentally changed the guidance from most big tech firms, AI hyper-scalers, and others. Many are even doubling down on AI investments.
If growth goes from 2% to 4% because of technology, that is a 200-basis-point boost to potential growth. Yet even draconian trade protections and migration restrictions would reduce potential growth by only 50 bps at most. That is a four-to-one ratio between positives and negatives; technology would trump the tariffs over the medium term.
The AI-driven investment boom also implies that, with or without high tariffs, the U.S. current-account deficit will remain high and on an upward trajectory. Portfolio inflows will continue despite the trade-policy noise. Although fixed-income investors may pull out of U.S. assets and the dollar, equity investors will remain overweight on U.S. assets, perhaps even doubling down. Any substantial weakening of the dollar will be gradual, and the greenback will not suddenly lose its role as the global reserve currency. There are simply no credible alternatives.
Europe will continue to face the headwinds of demographic aging, energy dependence, immigration mess, an overreliance on Chinese markets, weak domestic innovation, and stagnant growth hovering around 1% at best. The innovation gap between America and Europe will only widen as AI-driven growth moves from logarithmic to exponential.
In this context, populist parties may well take over in most of Europe, as they already have done in some countries as discontent with the old-style establishment will continue to grow stronger. Such a development becomes more likely if Europeans continue to ignore the recommendations by former Italian Prime Ministers Enrico Letta and Mario Draghi. In his report on European competitiveness last year, Draghi pointed out that inter-EU tariffs on goods and services are much higher than the ones Trump has threatened. One silver lining to Trump’s actions is that it could force Europe to wake up.
U.S. trade deals with most countries will limit the tariff rate to an undesirable but manageable 10-15% level, and a de-escalation with China will leave that rate at around 30-35%, on average, driving a limited gradual decoupling of the two economies.
A Fed that remains credibly committed to anchoring inflation expectations will be able to cut rates once growth stalls, and a modest rise in the unemployment rate will weaken inflation. By the middle of 2026, U.S. growth will be experiencing a strong recovery. This is great timing for Trump and the republicans as the midterm elections are in the fall of 2026. After an initial period of pain, the U.S. economy will thrive and Trump will benefit from this development.