So. Tariff Man is back and apparently more serious than ever. At least for now. Let’s talk about the good, the bad and the ugly. I hope this doesn’t sound political, but that’s probably unavoidable. So if you have hate mail please send it to Jerome Powell at jpow@moneyprinter.net. He had nothing to do with writing this, but he’s a logical scapegoat for all things finance.
First, let’s talk about how tariffs work. When the USA imposes a tariff the importing corporation pays a fee at the border. The foreign country isn’t the one paying the fee. The corporation pays the import fee. And this fee operates like a corporate tax. And corporate taxes aren’t paid by corporations because corporations pass on their costs to actual people. This means increased consumption costs, lower wages or lower share prices (or some combination of all the above). This doesn’t mean foreign countries aren’t sensitive to the threat of tariffs though because the tariff could impact how that US business operates abroad. For example, if the USA imposes a tariff on China then Apple could consider moving their business to Vietnam where they can avoid the import tariff. So China could be sensitive to the tariff and want to bend the knee to a tariff threat. At the same time, China could just impose an equally destructive tariff that offsets the US tariff. In doing so, we all end up doing what Joan Robinson warned about by throwing rocks in our own ports which doesn’t help anyone in aggregate. This is the worst possible outcome as it just ends up being a tax on everyone.
At a more fundamental level though tariffs are anti-capitalist. Capitalism thrives when capital can freely flow to where it’s most efficiently utilized. It’s not called “free” trade because it’s costless. There are always trade-offs in trade. It’s called free trade because traders are free to choose where they will allocate their trade. We let corporations choose where to allocate capital and labor because we know that free markets are better at allocating capital than governments. So it’s especially odd to see the party of free market capitalism promoting a policy agenda that is very much against free market individualism. It’s even weirder to see that party promoting a corporate tax increase that will ultimately end up being a consumer, labor and shareholder tax. I don’t intend to sound political. This is just a basic fundamental truth of free trade and Capitalism. If you think the government is great at fixing things then tariffs are for you. If you’re a true Capitalist then you should despise tariffs.

And speaking of fundamentals – let’s talk about the core reason why tariffs in the USA are fundamentally flawed. The USA is a tech and services economy. Manufacturing is no longer our strength. It was a dominant industry in the USA when we were an emerging market economy in the 1800s and early 1900s. But manufacturing has been in a terminal decline in the USA because the US economy has evolved into the most diverse economy in the world. And much of that is dominated by technology and services industries. Our core competency isn’t manufacturing stuff. It’s designing the intellectual property and technology that improves how all those things are built. This is abundantly clear in the US stock market and its incredible dominance in the last 30 years where US tech firms have utterly decimated the competition.
This doesn’t mean we don’t build stuff or manufacture anything. Manufacturing is still a $2.5T industry in the USA. That’s the entire size of the Canadian economy. So we’re not talking about some tiny industry. It’s just that the rest of the US economy has become much larger with time because we’ve evolved from an emerging market manufacturing economy into a developed technology economy. And there’s no unscrambling that egg. In fact, the egg is only going to get more and more scrambled because the way technology is evolving we will have robots manufacturing virtually everything before long. You just can’t make a developed tech economy magically transform back into an emerging market manufacturing economy.
I am sorry to be the bearer of bad news, but you can tariff everything in the world and nothing is stopping the fact that you won’t turn the largest developed tech economy in the world into an emerging market manufacturing economy. It’s never happening. The jobs aren’t coming back. Ever. So you can tariff this and tariff that and all it will do is add to corporate, consumer, labor and shareholder costs while creating the sort of red tape that we should be stripping down. This is an unstoppable trend and that chart above is never, ever going to spike way up and to the right again.
The Good.
Let’s not be overly pessimistic about this off the bat. I think Trump’s tariffs could be used as a clever negotiating tactic to get other nations to tighten up the border or do his bidding. We’ve seen it in the past and it’s not unreasonable to assume it can be done again. Reagan had some success with very targeted tariffs in the 1980’s and so there are nuanced scenarios where a tariff can make sense. Michael Pettis also makes an interesting argument that consumption based economies could benefit from tariffs. I’m not sure I buy his argument about global trade imbalances as a current problem, but read his argument as it’s compelling and Michael is always sharp on this topic.
A related positive is the argument that tariffs could be a form of consumption tax that incentivizes production and better redistributes wealth in the country. This makes some sense, but this is a very blunt way of doing so. If you want a consumption tax then why not just implement a progressive consumption tax or a tax directly on capital? I suspect that wouldn’t be as popular as a tariff because most people don’t know tariffs are taxes, but it’s certainly a more direct way of achieving that goal.
As it pertains to the negotiating tactics it comes down to how much pain we’re willing to endure in this game of chicken? So far it looks like Canada and China aren’t eager to play nice. So, this is a game of chicken that seems good in theory but could end up looking very silly in the end. Is it worth a shot? It’s probably not how I would advise Trump to manage the economy, but he’s a far better negotiator than I am and if the stock market falls 10% then he rips the band-aid off in a few months and everything probably just reverts right back to where it was. Not a fun ride for a few months, but not the end of the world either.
The Bad.
There are a huge number of bad narratives around this concept. The worst narrative is the idea that we need to impose tariffs because other countries do it. You don’t shoot yourself in the foot just because someone else shoots himself in the foot. And you definitely don’t defeat Communism with creeping levels of Communism. So this is just bad logic from the start. If China wants to manipulate their currency then let them manipulate their currency. We’ll beat them with free trade just as we’ve been doing for decades. It’s become pretty clear that Capitalism is the worst system except for all the rest so if other countries want to try those other systems then so be it.
The second worst narrative is the idea that we will somehow magically reshore millions of lost manufacturing jobs. The evidence there is becoming pretty clear. Since Trump’s initial round of tariffs in 2018 manufacturing jobs have been almost entirely stagnant. The jobs not only didn’t come back (for reasons we’ve already discussed), but if they move they very likely just go to other lower cost manufacturing regions like Vietnam, Malaysia, etc. I know there’s a narrative out there about returning to some magical era like the 1950s or whatever, but those days are gone. We just aren’t that economy anymore and we will never will be again. And that’s a good thing. It’s a sign that we’re now a diverse industrial machine that doesn’t rely solely on building stuff. In fact, everyone else relies on us to build the technologies that allow them to build stuff. This is our core competency now and it’s why the US economy has dominated every global economy in the last 30 years.
And then the last bad narrative is that we need tariffs to protect the domestic borders, especially Canada. This argument is somewhat compelling in the case of Mexico where illegal immigration and drugs are a significant problem. But this argument makes virtually no sense in the case of Canada where the drug imports are miniscule and the illegal immigration is 1% of the southern border. Some people claim we need to get some “leverage” on Canada. Leverage for what? Are you worried some Canadians are going to come across the border and be too nice to you? I kid, but there are much more precise ways to combat these issues. Tariffs are a blunt instrument that cause more domestic damage than foreign, but they’re especially blunt when trying to control a problem that the foreign government has very little incentive to fight in the first place.
The Ugly.
I don’t like to focus too much on short-term market moves, but the stock market is down 2% on this news, the USD is up 1.3%, oil prices are up 2% and gasoline is up 3%. This is surely not the response that any politician wants to see here. And while I would never overreact to such short-term moves it’s not a good sign of potential things to come. The economy is already somewhat soft with just 2.3% RGDP and softening employment trends. It really can’t afford a big trade shock at this moment. So, does this have the potential to get really ugly? That’s not my base case. But this definitely increases the probability that we’re veering towards stagnant growth. Especially when you consider the big drivers of the economy in the last 4 years with huge deficits, government employment gains and immigration. Trump is potentially taking a hatchet to all of those tailwinds and then adding the trade war on top of it makes things dicey. I don’t want to sound overly pessimistic, but it’s impossible to look at all those macro trends and conclude that there is upside risk to GDP growth from all this.
My baseline view on Trump’s economic agenda is still optimistic. I still view this as an economy that is likely to grow in the 2-3% range this year. Not great. And not terrible. But if I were Trump’s economic advisor I’d recommend that he tread carefully and not move too fast with some of these big shifts. He’s trying to reverse a lot of big trends all at once and some of it appears, at least in my view, to be based on some rather unsound economics.
So, in short, stay optimistic, but add some extra skepticism in there and as always, stay disciplined.