Pim Poppe: How crazy can it get?
This column was originally written in Dutch. This is an English translation.
By Pim Poppe, Managing Partner at Probability & Partners
On Wednesday 2 April 2025, during his Liberation Day address, President Donald Trump announced trade tariffs ranging from 10% for the UK to 49% for Cambodia. The EU will be subject to a tariff of 20%, with exceptions for pharmaceutical products and chips.
The tariffs are high and material, and they differ substantially per country. On Friday evening, China immediately introduced tariffs comparable to the American tariff increase: an eye for an eye, a tooth for a tooth. On 7 April, Trump threatened new increases in response to China's increases. The stock markets reacted with shock to the escalating trade war. In the Far East, share prices generally fell by around 10%; in Europe, after a poor opening, the fall was ultimately not too bad, with drops of 3% to 5%.
Why are import tariffs so bad?
Trade between countries becomes less attractive due to import tariffs. Countries will produce more for their own country and less for foreign countries. Countries will no longer only produce what they do best, but also what they need, because importing will become too expensive. In short, a loss of prosperity will occur because we will produce less efficiently on a global scale. The result is that production decreases and prices rise. Because less is being produced, less will be consumed. So we will all be poorer. Households will be able to buy fewer goods and services and companies will make less profit. Everyone loses.
DNB focuses on geopolitical risks
In November 2024, the Dutch Central Bank (DNB) published the document Resilient in a bleak world: Geopolitical risks and financial institutions. This document outlined geopolitical risk domains. DNB called on the financial sector to assess the geopolitical ‘risks’, create scenarios and take measures. In that document, DNB, as is always the case with regulators, refers to ‘extreme and plausible scenarios with serious economic headwinds’.
If you reread the document now, you will be shocked at how quickly things are moving. What still seemed extreme in November quickly became conceivable, then probable, and has now materialised. Take trade tariffs, for example: the disruption of supranational institutions seemed extreme, but is now a fact. This raises the question of what is now – five months after November 2024 – an extreme scenario. How crazy can it get?
What do we learn from the 1930s?
In the 1930s, we learned that trade tariffs can seriously harm world trade and economic growth, resulting in high unemployment, loss of prosperity and, above all, human suffering. The Great Depression and even the Second World War can be partially attributed to the war on import tariffs. These lessons are either unknown to the Trump administration or are being neglected. We do not know. Under the leadership of the Trump administration, the world is now falling into the same trap. It is conceivable that if the trade war escalates, there will be massive unemployment, as well as conflicts within and between countries, with or without violence.
What can we learn from the 1970s and 1980s?
The 1970s were characterised by oil crises. There was high inflation, declining investments and high savings. The higher oil prices trickled through the economy, wages rose and everything became more expensive. The labour markets, which were inflexible at the time, could not properly absorb these shocks. High unemployment was the result. Shares did reasonably well with a return of around 5 to 7 percent per year and offered some protection against inflation.
In the eighties, the focus was on fighting inflation. Interest rates were raised sharply worldwide under the leadership of the then Fed chairman Paul Volcker. The economy was stabilised, but at a high price.
Naturally, the current situation could degenerate into a scenario with characteristics of both the 1930s (trade war) and the 1970s (a wage-price spiral followed by a tough monetary policy with interest rate increases).
Looking a step further, there are several practical questions to ask about investments:
What do we do about strategic asset allocation?
Until Trump 2, we generally assumed that a global asset allocation for shares and bonds offered the best diversification for the investment portfolio. A global benchmark for shares is therefore desirable and commonplace. Over the past decades, we have considered the fact that the liabilities of pension funds are denominated in euros and are therefore driven by European or Dutch growth dynamics and not those of the world to be less important.
The future may be different. There may/could/will probably (the choice is yours) be several separate trading blocs with their own inflation, interest rate and growth dynamics. In this world, we would want to keep the assets closer to the liabilities in terms of region and currency. A kind of home bias is once again emerging in asset allocation: diversification in the assets is now possibly less important than matching the liabilities. This is certainly something for pension funds and insurers to think about.
Is a high risk premium for US equities appropriate?
We are all familiar with the risk premium for emerging markets. High risks in terms of government policy, currency convertibility, democracy, property rights and capital restrictions mean a higher risk premium and therefore a higher discount rate for emerging markets. The result is lower valuations and higher expected returns and risks. That is how it should be, of course.
We now know that the US is fickle. It seems that the trias politica is being gnawed at and that agreements made by previous governments are simply not being honoured. We do not yet know if the central bank will remain independent and we also do not know to what extent the judiciary can continue to operate autonomously. There are cracks in the free press, as witnessed by the turmoil at the Washington Post after Amazon boss Jeff Bezos interfered with the paper's editorial policy.
In short, the question is: is the country risk migrating from the US to that of an emerging market? If so, this will also include an emerging market valuation. I am curious to see what the ALCOs of the insurers and the investment committees of the pension funds will think of this in the coming weeks. Will it happen? How quickly will it happen? And will we arm ourselves against it? This question too – I am not saying it will – will require some thought.
How do I assess my custodian bank, fiduciary and asset managers in turbulent geopolitical times?
Over the past decades, Dutch asset owners have increasingly exchanged their Dutch custodian bank, fiduciary manager and asset manager for an American one. This has often been done based on the argued quality of the service. What we in the Netherlands are not sure about at the moment, but should consider, is whether these American parties are able and willing to properly represent the interests of Dutch pension funds and insurers in conceivable scenarios. It also seems important that pension funds and insurers create scenarios for this, so that risks can be assessed and measures taken to ensure that services continue to be guaranteed in conceivable geopolitical scenarios.
Nothing seems inconceivable anymore. It is possible that your assets will soon be used by the asset manager for political ends. Consider, for example, sanctions that the US imposes on countries or companies and that these institutions have to implement. Consider the introduction of import tariffs on the services of these service providers or intervention by these service providers in your ESG policy. Determine criteria to monitor these parties on these points and consider triggers when you are going to terminate the collaboration.
This risk analysis can be included in the mandatory risk analyses such as the Own Risk Assessment (ERB) for pension funds or the Own Risk and Solvency Assessment (ORSA) for insurers. Given the urgency, it is also conceivable to carry out this risk analysis separately and at an accelerated pace. It seems wise to discuss the conclusion of this question with the Supervisory Board. The DNB document from November 2024 is not such a bad idea.
Other questions
There are more questions. What kind of inflation regime are we entering, what kind of asset allocation goes with that? What do we do about the influx? Do American investments still meet our ESG criteria? Will this all blow over once Trump is gone, or will a new Trump emerge with a mandate from the American voters? What damage could be done to democracy? Is there any hope of a silver lining and will American public opinion correct Trump's course? For pension funds, a relevant question is whether the funding ratio should be protected in these harsh times, or whether the costs have already risen too high.
In summary
The world is at a tipping point along several axes. It's a toss and turn. Or a little more than a toss and turn. We could end up in an escalating trade war. It could blow over. We could end up in a spiral of wage and price increases. A new world order could arise very quickly. This could be rough or controlled. Market parties will earn an awful lot of money, while other parties will lose a painful amount.
Assuming a zero-sum game is too optimistic. We will all lose out in this world. Using the period after the Second World War as a guideline for strategic investment choices for the future is easy, but not good enough. It is advisable to do scenario planning, reconsider basic principles and possibly make big decisions, and if you do not do so, to properly substantiate why.