Blame spread like wildfire over the United States’ first-quarter GDP numbers.
President Donald Trump pinned Q1’s contraction on the prior Biden administration, while analysts from across the aisle claimed that the GDP shrinkage was exclusively Trump’s fault for initiating a multifront trade war.
With so many fingers pointed at so many targets, the Q1 GDP data must have been an absolute disaster, right?
Well, no. Despite the headlines assigning fault over a technical contraction in the U.S. economy, the Bureau of Economic Analysis’ advance estimate of Q1 GDP was quite positive overall.
First, the headline: GDP fell at an annual rate of 0.3%, or 30 basis points (bps), from Q4 2024 to Q1. This decline was undeniably caused by the quarter’s tidal wave of pre-tariff goods imports, which skyrocketed 50.9% in Q1.
Imports are counted as negative for production — the “P” in GDP — but are rarely a bad sign for the broader economy. After all, businesses that spend money to import goods assume that consumers will have some stateside demand for them.
Consumer demand, meanwhile, is shaped by financial and job security, which are both reliable metrics for the health of an economy. They are, in fact, the two aims of the Federal Reserve’s dual mandate, which is to ensure price stability and maximum employment.
Another line item that is counted as a negative for GDP but is, in a vacuum, usually desirable among voters is decreased government spending. Federal expenditures fell 5.1% in Q1, a loss that made for a 33-bp headwind for the headline figure.
It should be noted that, although voters generally like the idea of a reduced federal deficit, the methods used to achieve it can be quite controversial (as they are now).
What, then, does reflect economic health in the GDP data?
Consumer spending, for one. Q1 saw consumer spending rise 1.8% on top of Q4’s 4% quarterly growth, which was the highest such growth since Q1 2023.
Business investment is another useful metric, since businesses often (though not always!) require more promises of long-term economic security than consumers when making financial decisions. Private domestic investment was up 21.9% in Q1, a reversal of Q4’s 5.6% loss and one that was driven by a 22.5% rise in equipment investments.
The flip side of seeing Q1’s GDP data as good is that subsequent quarters’ growth should not be taken as a positive sign, if that growth was achieved by a dramatic reduction in imports instead of rising consumer spending or private investment. This point is worth hammering home: GDP can be positive while the U.S. economy is in turmoil, and it can be negative while the economy thrives (or at least does all right, as now).
The bad news is that Q1’s surprising strength was likely achieved by robbing Peter to pay Paul.
Consumers probably made some of their discretionary purchases earlier than usual to preempt the potential impact of tariffs. Now that a wide-ranging set of tariffs is newly in effect, there is the possibility of inflation rearing its ugly head in the coming months.
Rising prices on foreign goods (or domestic goods with foreign inputs) could deter U.S. consumers from purchasing such goods, although it might instead weaken consumer health if purchases continue to be made from shrinking budgets.
If there is a major party concerned about this tenuous outlook, however, it is not the Fed. At its meeting on Wednesday, the Fed elected to maintain its target range for federal interest rates between 4.25% and 4.5%.
No doubt this extension of the Fed’s “wait-and-see” stance was granted by April’s shockingly robust print on the labor market. The U.S. economy added 177,000 nonfarm jobs in the month, blowing past consensus for a gain of 138,000 and topping even Wall Street’s highest estimate of 171,000.
Before this report, it was not uncommon to find expectations for a rate cut in May: Citibank, for one, initially called for a 25-bp cut, though it since pushed its forecast back to the Fed’s June meeting. Other investors like Goldman Sachs and Barclays kicked their rate-cut forecasts even further, from June to July.
The lesson here is that stock markets trade on nanoseconds’ worth of data, sparking knee-jerk reactions and countless confusing headlines. Fears of a surefire recession in 2025 — defined informally as at least two consecutive quarters of negative GDP growth — have since given way to cautious optimism for future economic health.
In a prior column, I hinted at two different ways of looking at trade wars with respect to actual wars: the modern conception of the “all-or-nothing” total war and the more classical idea of a limited engagement with discrete goals.
The U.S. trade war with China, I argued, was likely to be of the former class, given the ideological differences between the two nations as well as the textbook tension that arises between an established superpower and a rising one. [To be sure, I believe that China has some structural and possibly irreversible demographic challenges that are often downplayed by analysts who are bullish on China’s long-term prospects.]
Yet the conflicts with Canada and Mexico appeared to have more in common with the old-school style of war, in which the loser is whoever is the first to cry uncle.
There are good reasons to continue believing that our trade wars with Canada and Mexico are not meant for the long run. Canada, for instance, is a mineral-rich nation that could alleviate our reliance on China’s output of rare-earth metals — a class of inputs vital to technological manufacturing.
But Canada is hardly a threat to the U.S. Since Canada implicitly relies on the U.S. for its national security, defense spending accounts for less than 2% of its GDP. The U.S., whose GDP is more than 10 times larger than Canada’s, spends around 3.4% of its GDP on defense.
And while our trade deficit with Canada totaled $63.3 billion last year, this imbalance makes Canada — not the U.S. — more vulnerable to tariffs.
More than three-quarters of Canada’s exports go to the U.S.; about one-eighth of our imports are sourced from Canada. Energy products, especially crude oil, comprise the bulk of our imports from Canada; the U.S. is the top producer of crude oil in the world, and it isn’t even close.
True, there are complexities to be found in the types of oil we produce versus those we import. I am not suggesting that the U.S. could halt all trade with Canada and feel no pain whatsoever.
What I am suggesting, however, is that Canada would feel pain orders of magnitude greater.
Trump is acutely aware of this imbalance, which is why he has taken to bullying our gentle neighbors to the north: In a Sunday interview with NBC, Trump remarked that “we do very little business with Canada. They do all of their business practically with us. They need us. We don’t need them.”
Though it is an embellishment — in typical Trumpian fashion — to say that the U.S. does “very little business with Canada,” the underlying sentiment holds true.
Mark Carney, Canada’s newly elected prime minister, is also aware of this imbalance, which is why he flew to Washington earlier this week to repair his nation’s fractured trade relationship with the U.S. Although the two leaders bantered before the press about Trump’s desire to annex Canada, both parties had nothing but positive things to say about each other.
“Regardless of anything,” Trump concluded, “we’re going to be friends with Canada.”
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