What a Fast-Changing World Means for Your Money

There are three big questions investors need to grapple with, and none have simple answers. The most important is the remaking of global alliances and the long-term implications. The most immediate is the Federal Reserve’s reaction to tariffs. In between are deglobalization, loss of trust between countries and the potential for financial barriers.

Start with the short term. The tariffs on Canada and Mexico, together with an extra 10% on China, threaten instant price increases and disruption to production across the U.S. as companies try to unwind the integration of their North American supply chains.

Goldman Sachs, which expected the tariffs to be delayed again, predicts the Canada/Mexico tariffs will add 0.6 percentage point to core inflation, excluding food and energy, with a little extra from the China tariff. With consumer inflation expectations rising, the Fed is in a difficult position.

Traditionally central banks try to ignore supply shocks such as tariffs, as the price increases that result are a one-off. That would allow them to cut rates to try to support the economy, which would also reduce the damage to stocks.

But if consumers and businesses think price increases will be repeated, the Fed will worry that those expectations alone could lead to more inflation and be less willing to cut rates.

For now traders are betting the Fed will be more focused on the economy, and cut. The probability priced into futures of at least four cuts this year has soared to 38% from 4% since President Trump took office on Jan. 20, according to CME FedWatch.

But will the Fed really be willing to cut even as tariffs push inflation up?

In the long run, new global alliances threaten the post-Soviet order. Trump’s decision to side with Russia and North Korea against Ukraine at the United Nations was a powerful symbol, driven home by the treatment of the Ukrainian president in the Oval Office. Europe got the message, with politicians lining up to warn that the continent needs to be a military power in its own right and can no longer rely on the North Atlantic Treaty Organization. New borrowing under discussion by the European Commission and Germany could raise hundreds of billions of euros for military spending.

Since the Berlin wall fell, we’ve lived through almost half a century of preferring butter to guns. With the rise of China, and with the U.S. no longer seen as a reliable ally, guns will again take priority. Restructuring the economy, trade and tax systems to replace consumption with defense spending will be politically contentious and expensive. European military contractors are clear winners. Who are the losers?

Coming when global alliances are fluid, this shift could also move us toward a multipolar world for the first time since the World War II.

Some friends of America are trying to convince themselves that Trump’s term is only for four years, and the next president will be more willing to stick to promises the country has made. But even some committed Atlanticists, such as incoming German Chancellor Friedrich Merz, recognize that once broken such trust can’t be quickly rebuilt. And this week that trust broke. America’s allies need to be able to stand on their own, even if the U.S.—under Trump or his successor—were to turn friendly again.

Just how much damage will rearmament and the potential for a new multifront cold war do to the global economy? What new alliances will form?

Trump made this mix even more volatile by throwing in tariffs. Investors who thought the president was bluffing were disabused by his willingness to hurt the U.S. economy and relations with its nearest neighbors by imposing hefty import taxes. Global productivity and growth will be lower with more trade barriers, and retaliation—China’s and Canada’s came straight away—means those barriers might keep escalating.

Tariffs imposed at the whim of the White House increase the power of the government over business. Companies have to lobby for exemptions for their essential parts and can no longer rely on trade pacts when deciding on factory locations or suppliers—even when the trade deal was struck by the very same president, as with the 2018 U.S.-Mexico-Canada agreement. The uncertainty on its own is bad for business, even without the actual tariffs.

Some are already starting to worry about how bad an economic slowdown could be, and while I think it’s too early to talk about a U.S. recession, the R-word is being bandied about. The yield curve has again inverted, with the 10-year Treasury yield dropping below the three-month yield—although this classic recession warning was flashing red for two years until December without a recession.

In the long run there are bigger problems. Europe’s governments are already heavily indebted before they start piling on military spending. The U.S. is on what’s politely called an “unsustainable fiscal trajectory”—debt rising forever with no prospect of reining it in. Higher taxes are politically challenging everywhere, while lower spending is rarely popular and also hurts growth. Less efficient global trade makes debt even harder to deal with.

When developed-country governments borrow too much, investors flee their bonds and yields rise, as Europe found in the 2010-2012 eurozone crisis and Britain rediscovered in 2022 under here-today-gone-tomorrow Prime Minister Liz Truss. The solution for many countries after the Second World War was financial repression, keeping interest rates artificially low and using capital controls to prevent investors from taking their money out of the country while using inflation to whittle away the value of the debt.

We’re a long way from Western capital controls. But things are moving fast. How bad could it get? How to protect against these risks? And where did I put my piece of the Berlin Wall? It would be great to rediscover the hope its fall brought.

Write to James Mackintosh at james.mackintosh@wsj.com