There’s Only One Possible Cause of the Next Recession, And It Isn’t Tariffs

All the malinvestment spawned by the Fed’s years of recent artificial credit expansion has locked in a major and painful correction at some point.

By Connor O’Keeffe, Mises Institute

The stock market experienced a sharp drop last week and earlier this week after President Trump announced he was implementing a number of new tariffs that were higher than most market analysts had been expecting. The dramatic sell-off led many politicians, pundits, and financial firms to declare it more likely than not that a recession will kick off this year.

Some of the president’s supporters countered by pointing out, correctly, that the stock market does not necessarily represent the economy as a whole. But most senior figures in the administration and high-profile defenders of Trump’s agenda concede that their trade policy could indeed cause a period of economic pain. They argue that it is necessary for the president to lead the country through a period of short-term pain if we are ever going to see meaningful structural improvements in our economy.

That is a remarkably and refreshingly honest position for a presidential administration to have. And it’s true. Unfortunately, the president’s team has adopted this position to justify their dramatic raising of import taxes—which is not necessary to meaningfully fix our economy and only stands to bring unending economic pain.

Still, that the team in the White House is willing at all to weather an uncomfortable period of economic transition is progress—especially as the country sinks toward the next recession. Because that mindset and political fortitude will be necessary if we’re ever going to fix what is arguably the biggest, most destructive problem at the heart of our economy: recessions themselves.

But the first step in fixing a problem—after recognizing that it exists—is understanding precisely what is causing it. And the rhetoric we’ve seen from both sides over the past week suggests that there’s a lot of progress to be made on that front.

To clear up one evidently common point of confusion, while it is possible that Trump’s recent round of tariffs will trigger the next recession, they alone cannot cause a recession.

Tariffs create supply decreases that raise the prices of certain goods. That’s very painful for the people who want or need those goods, but it’s also beneficial to the companies competing with the firms hit by the tariff. They’re effectively a wealth transfer from most consumers and businesses to a handful of “protected” companies.

There is only one thing that can cause the kind of all-encompassing economic slowdown experienced across the entire economy that defines a recession: artificial credit expansion.

In short, when new dollars are created and injected into credit markets as loanable funds, they warp the entire structure of production because they are not based on actual savings. This means that the projects these new funds and lower interest rates bring about both cannot be finished with available resources and are out of line with what consumers actually want. Production is boosted, which makes the economy seem strong. But it’s boosted beyond what can possibly be completed and sold, which necessitates an eventual economy-wide correction. That correction is what we call a recession.

These days, this process is carried out on a massive scale thanks to the banking cartels we call central banks. Here in the US, that’s the Federal Reserve.

And don’t think this is some kind of accident. Even though virtually everyone in the economy is hurt to at least some degree by a recession, for the big banks, government officials, and politically-connected businesses who initiate and/or profit from inflation and artificial credit expansion, the process is so lucrative that weathering the recession is still absolutely worth it.

While tariffs are certainly a destructive wealth transfer to certain domestic businesses that, in the long run, leave the entire country worse off, the credit expansion process goes so much further that it’s almost hard to comprehend. In the last few decades alone, it has transferred trillions of dollars from everyday Americans to some of the wealthiest companies in the financial sector and other politically-connected industries, as well as the government officials and politicians carrying it all out.

And, despite what you were probably taught in school, this scheme has been the cause of every recession in American history. The Great Depression was triggered by the crash in 1929 and intensified by Hoover and FDR’s interventionism and the crushing Smoot-Hawley Tariffs, but it was caused by the extensive credit expansion during the “roaring” twenties.

The Great Recession in 2008 was triggered by the collapse of the subprime housing bubble, but it was caused by the credit expansion of the 1990s and early 2000s. And while the next recession may very well be triggered by the market’s reaction to Trump’s tariffs, it will be caused by the aggressive credit expansion that took place in the years after the 2008 recession and, especially, during the covid pandemic.

That distinction between the trigger and cause is important because, as nasty as those market crashes, tariffs, and speculative bubbles were, they would not have brought about an entire recession without all the malinvestment created by artificial credit expansion. It’s like the difference between tossing a lit match on an empty pad of damp concrete versus a windblown field of dry, flammable grass.

All the malinvestment spawned by the Fed’s years of recent artificial credit expansion has locked in a major and painful correction at some point. If we’re ever going to truly escape our recurring nightmare of permanent price inflation and unending recessions, we need an administration and a public that understands the true cause, and that has the resilience and discipline to push through the short-term economic pain that actually fixing this problem for good requires.

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