Trump's Tariffs, Foreign Policy, and Their Possible Consequences
BACKGROUND
Trump, of all people, does not seem to understand that companies, not countries, import and exports goods and services. Trump does not seem to understand that many American companies and industries have outsourced the production of their inputs, products and services to China, Mexico and Canada to lower costs and increase profits. They have already decided what to produce here and what to produce in other countries.
Total American imports are around $3.5 trillion. Total exports are around $2.5 trillion. Both numbers include trade in services in addition to trade in goods. so the total trade deficit is around $1 trillion.
Any higher tariffs the U.S. puts in imports will probably be matched by tariffs on U.S. exports. So while tariffs in imports will hurt foreign exporters, reciprocal tariffs will hurt American exporters. And imports of commodities like oil and copper, steel and aluminum, inputs and sub-assemblies that go into domestic American production are about 40% of total imports.
Retailers source much of their products they sell to other countries, particularly China and Asia. 80% of toys sold in America come from China, as does much of the product sold by America's small businesses. Walmart has 3,000 purchasing agents in China buying over 70% of the products in Walmart stores. A high percent of consumer electronics, clothes and appliances are imported. This is the main reason for America's trade deficit.
Tariffs are basically a tax on imported inputs that go into products produced in America and the wholesale prices of consumer goods imports. The results of a higher tariff are higher prices and lower unit sales in the United States. The more money the government raises (the higher the tariff), the higher the price increases to consumers. It is an
income transfer from households to the government. A large tax increase unless tariff rates are reduced. Regardless, the net effect will be higher prices, less after-tax income and lower real spending. Probably more unemployment, a lot more if higher tariffs cause a recession. Probably less real saving as stock prices fall. A high price to pay for maybe a 10%-20% reduction in the yearly deficit.
In addition to exports, American companies' subsidiaries abroad produce and sell about $2 trillion in other countries.
Most of these sales come from investments in other countries, producing for the local or regional market.These sales are especially important for America’s largest corporations. Of the companies in the S&P 500 Index (500 largest public companies), over 40% of their sales and almost half their profits are earned outside of the United States. As Tesla is learning in Europe, much of this is exposed to retaliation and possibly consumer boycotts.
Many of the consumer goods Americans buy are imported, including clothes, furniture, food, appliances, toys, plastic products (including most Christmas decorations), and
consumer electronics including your smart phone. Many "Made in America" products have foreign inputs and parts, including Teslas assembled in America.
CAUSES OF U.S. TRADE DEFICITS
Why does the United States run large and persistent trade deficitS?
High levels on consumer spending. Americans want low prices. 70% of Walmart's products are Chinese imports. The United States probably has the highest ratio of consumption spending to GDP of any developed country. We have high levels of consumer debt.
American companies account for a low investment to GDP ratio, partly because much of their investing is in other countries. Part of the solution to the trade deficit is higher savings rates and lower government fiscal deficits (more after-tax income for households.
American companies outsourcing all or part of
production chain. For example, Apple's iPhone has over a hundred of input suppliers, most in Asia. Final assembly by a Taiwanese company in China. If final production were moved to the U.S., all of the foreign inputs would become imports.
Overvalued dollar. Partly the result of the special position of the dollar as the international reserve currency. Foreign demand for the dollar balances the trade deficit. Solution - depreciate the dollar. Makes imports more expensive and makes exports less expensive. Low interest rates compared to alternative financial investments in other countries. More radical solution - remove dollar as only reserve currency. But this would have other consequences
In the last month, the dollar has fallen 9%, a huge move by historical standards. Why? Loss of faith of foreign (and domestic) investors in the future of the dollar because of the erratic policies and rhetoric of the Trump administration. The dollars is not seen as safe and stable, making dollar-denominated financial investments seen as unsafe and unstable. Sell-off of dollar and dollar-denominated financial assets, especially U.S. government debt (Treasuries). Rise of interest rates on Treasuries. Whether or not this helps to reduce the trade deficit depends on stable government trade policies.
TARIFFS
The cost of a tariff is split between manufacturers and consumers. The split depends on the price elasticity of demand (mostly determined by the kind of product and the closeness of substitutes). Manufacturers experience lower operating profit margins and lower profits. The company's stock price may fall. Ultimately, American pay most (in some cases, all) of the tariff through higher prices, lower real income, unemployment and the fall in the value of financial savings (401ks, IRAs, pensions, etc.).
Spread out over the whole economy, the originally announced tariffs probably will have a smaller impact on retail price indexes, although some individual products and product groups will see large price increases. Retail prices also cover domestic costs of design, engineering, marketing, distribution and retailing. But as tariffs go higher and are put on more products and countries, tariffs will have a bigger impact. In the extreme, much higher tariffs will cause an American and global recession, higher prices, lower real incomes and unemployment.
Noticeable price increases will probably occur in key consumer product groups like cars, gas, consumer electronics, and clothing. For many groups, there are substitutes produced in America (often with taxed inputs but the retail price will not rise as much as finished product imports from tariffed countries) or countries not yet subject to tariffs. But virtually every product manufactured or assembled in the United States depends on a complicated global supply or input chain. It is impossible that the entire input chain of such products as cars or chips could be produce in America.
Even if the tariffs bring in $200 billion to the government, this will reduce the trade deficit with these three countries by about 20%. The $200 billion would decrease the fiscal deficit of $1.8 trillion by about 12%. This is only half of the increase in the forecasted deficit if Trump's 2017 tax cuts are renewed this year, which is almost certain. And about half of the increase in the interest cost of the national debt if interest rates stay where they are (April, 2025).
President Trump has said the revenue from higher tariffs will "pay for" domestic tax cuts. If higher tariff revenue equals new tax cuts, collectively there is no change in total after-tax income. The only change is that prices will be higher and some households will have more after-tax income to pay them. Why some? Over 40% of American households pay no federal income taxes. So all of the tax cut will go to the upper-income 60% of households. Generally, the higher the income, the greater the tax cut.
Possible extensions of tariffs and intended and unintended consequences are discussed.
EARLY ANALYSIS
This is an early analysis of the tariffs on China, Canada and Mexico announced on March 4.
Some simple math (20-25% tariffs on $1.5 trillion of imports from China, Mexico and Canada) gives a $300 billion tax on Americans, before any adjustments in behavior by consumers and manufacturing companies. This is not going to happen. An analysis by the Tax Foundation, a think tank, indicates that government revenue from these tariffs might be closer to $110 billion. Revenue would be substantially lower if there were "carve-outs" (no tariffs) on imported American cars, oil and naturally gas.
OVERVIEW
The tariffs will affect foreign sales and lead to complicated supply chain changes. It will affect all aspects of corporate strategy. American companies are not going to commit investment funds if they do not know the prices of inputs, production and sales in the future.
Retail prices to consumers will not go up as much as the tariffs. American companies have only outsourced production. Much of the price consumers pay is for design, marketing, advertising, distribution and retailing, all of which is done in America. This is good news for buyers of iPhones and Nikes.
American manufacturers will raise prices as prices of competing imports rise (in addition to the higher costs of imported parts, subassemblies and services). Retaliatory tariffs and restriction from foreign countries will hurt American exports. The U.S.'s export have been rising steadily for decades. Currently (2024), total exports (goods and services) are close to $2.5 trillion.
U.S. farmers are big exporters and are sure to get hurt. China immediately raised tariffs on imports of American farm products.
Canadian and Mexican exports will cost less in global markets than in the U.S. Some exports will be diverted to other countries. For example, some cars assembled in Mexico or Canada for the U.S. market could be sold in other markets.
America imports almost all of its solar panels from China. It is too early to tell how much of proposed American production (subsidized by Biden programs that Trump doesn’t like) will replace imports. The net result will be that the costs and prices of renewable energy will go up. The transition to products that fight global warming will be slower in the United States.
Gas prices will go up in New England because a substantial portion of gas and diesel come from a refinery in Canada. Also home heating fuel. For the same reason, gas prices will go up in the Midwest. Electricity prices will rise in New England and New York.
The price of toys, stuffed animals, Legos and Barbie dolls will go up because most toys (80%) bought in America come from China.
Texas has a lot of cross-border trade with Mexico. Texas trade with Mexico will be hurt, according to Texas Senator Ted Cruz (R), a Trump supporter.
There might be less investment in America. Much of the recent surge in investment has been related to AI, so the overall impact might not be too great for a while.
Mexico, besides cars, is a major source of fresh fruit and vegetables. A major American importer has already raised prices 20%. There goes the movement of trying to get Americans to eat healthier. The cost of Corona and Modelo beer will rise. Even worse is the increased cost of tequila!
More smuggling. Unlike Mexican drug exporters, smugglers of many goods will not have to set up new distribution networks. There is already a large distribution network for the related businesses of selling stolen, counterfeit, and black-market goods - eBay and Amazon. Illegally imported food products can be sold at so-called urban “farmers markets.” There has been a big increase in egg smuggling on the Mexican border. ICE agents now search cars and trucks for contraband eggs.
RETALIATION
How retaliation will affect the American economy.
China's probably response. See post on China.
Trump has threatened to impose tariffs on Europe. It would be consistent with Trump's and Vance's harsh criticism of Europe. This would bring in more tax revenue. It is difficult to see how European countries would react. But, given the changing geopolitical relationship between the U.S. and Europe, I think they would impose "reciprocal" tariffs.
In yesterday’s speech, Trump promised more “reciprocal” tariffs. Also, there are tariffs on all imported steel and aluminum continue, again, hurting the auto industry.
Trump's business experience is to negotiate over one deal and then move on to the next. But the reality is that the tariff game is like a poker game with many players and unlimited raises, which are like rounds of retaliatory tariffs and restrictions. The endgame will be a global recession in the short run and unintended negative consequences in the long run. The game never ends. But the consequences will be someone else's problem.
Trump is probably right that American tariffs can hurt Canada and Mexico ("We hold all the cards") more than retaliatory tariffs can hurt the United States. Canadian and Mexican exports to the U.S. as a percent of their GDP are much higher (20% and 30%) than U.S. exports to these two countries. But the U.S. would also lose. Trump is playing a negative sum game. You don't win just because you lose less than the other players.
FINANCIAL AND ECONOMIC CONSEQUENCES
President-elect Trump made his “love” of tariffs well-known during his campaign and right after his election.
President Trump has made it clear that tariffs are at the center of his economic strategy. It overlaps with his geopolitical and foreign affairs policies. Trump seems to believe that the government revenue from tariff will help reduce the yearly deficit substantially, reduce interest rates, and make possible the further tax cuts beyond the extension of his 2017 tax cuts.
Tariffs may not decrease the trade deficit very much because of retaliation. They are almost certain to be reduced to the 10%-20% level for most countries. Also, American and foreign companies will shift production to countries not subject to American tariffs. Already in the business press there are articles on how to minimize or avoid the tariff tax.
If Trump puts a high blanket tariff on all imports, as he is threatening to do, the price of foreign and U.S. products will all go up, leading to higher inflation. Aggregate demand (total consumer and business investment spending) might go down; this is a recession. It will be global.
If the stock market continues to goes down, this will hurt total consumer demand, especially for high-end goods. In economics, this is known as the wealth effect. Also, government revenue from capital-gains taxes could fall.
The stock market has really tanked this week. The long bull market may be coming to an end. The bond market seems to believe higher rates of inflation are coming, leading to higher interest rates. This is bad news for the housing market, which is already weakening.
If tariffs lead to higher inflation rates and higher nominal interest rates, the higher interest rates on the national debt will increase the yearly deficit. A 1% increase from, say, 3% to 4%, increases the yearly deficit by about $300 billion. This will offset the increase in revenue from tariffs. So a large tax increase on American households will not lead to a smaller government fiscal deficit.
Consumer sentiment is falling rapidly, partly due to a fear of inflation and general fear and uncertainty. Consumer spending fell in January, partly due to a large decrease in pending house sales. The Atlanta Fed forecast, based on almost real-time data, dropped a bombshell. From a positive increase in the first quarter of 2025's GDP, they now forecast a decrease of 2.1%. But consumers might rush to buy products, especially cars, before higher prices kick in.
Tariffs on Mexico, Canada and China, with retaliatory actions, would lead to a major unraveling of the global economy. Even worse would be the additions on Europe or blanket tariffs on such imports as steel and aluminum.
Long-standing trade agreements are being smashed.
Rising inflation and foreign distrust will impact the cost of financing America's nation debt. $8 trillion out of a total of $32 trillion is owned by foreigners, about half by foreign central banks and half by private financial institutions and individuals. A 1% increase in the interest rate on the national debt increases government expenses by about $300 billion.
NON-ECONOMIC CONSEQUENCES
The tariffs will further fuel anti-U.S. anger among European, Mexican and Canadian friends and allies. Already, Canadian politicians are reacting by using strident anti-American language. There is anti-Americanism in Mexico, which could explode. No Mexican government can ignore this.
By alienating American allies with harsh, derogatory rhetoric, combined with higher tariffs, Trump is stoking anti-American anger throughout the world. The reaction to Tesla may be the beginning of anti-American boycotts in many countries. Much worse, American may become isolationist in an increasingly hostile world.
Tariffs on steel and aluminum have gone in effect. The biggest exporter to the U.S. is Canada. American auto manufacturers, who have begged Trump not to put a tariff on their imported cars and parts, have now asked him to remove the tariff on steel and aluminum.
President Trump is threatening to put higher tariffs on European exports to the United States. This would be a major escalation in the deteriorating relations with Europe. It would be consistent with the recent harsh anti-European rhetoric of the Trump administration. This would all but guarantee a break in U.S.- European political relationships. Many European countries are drawing up contingency plans if America pulls out of NATO or cannot be relied on to help defend Europe. America's attitude towards Ukraine is a wake-up call of that America may stand by if Russia invades a NATO country, such as Poland.
Historically, protectionism and isolationism go together. This would be a losing strategy for the United States in an increasingly hostile and economically interconnected world.
An economic and political breach with Europe would all but guarantee that Chinese car companies will dominate EV sales in Europe and globally.
UPDATES (This is more fun than watching the soaps)
American auto executives spoke with Trump and begged for some relief. Trump has suspended the tariffs on cars imported from Mexico and Canada until April 2.
Trump has suspended tariffs for one month on most Canadian and Mexican exports to the U.S. Either this is another example of Trump's "negotiating" style or someone has pointed out to him that the tariffs will add to inflation and probably increase unemployment. This will contribute to the overall weakening of the American economy.
Trump said Friday that he could impose reciprocal tariffs on Canadian lumber and dairy products as soon as today. Canada is a major source of lumber. Putting a tariff on Canadian lumber (30% of the U.S. supply) will further increase the cost of building houses.
Canada, of all countries, is being treated as Ameria's number one economic enemy.
Canada has imposed tariffs on imports of American booze. No Canada Dry jokes please.
Canada has suspended imports from the biggest U.S. pork processing plant, a facility run by Smithfield Foods in Tar Heel, North Carolina, the company said on Friday. Less competition for Canadian bacon (just kidding).
American corn farmers had a large crop last year in response to high prices. They were planning on planting even more this year. China buys a lot of American corn. China's retaliatory tariff on corn might affect American exports. Also, a major input - nitrogen fertilizer - may be more expensive if imported oil and natural gas go up in price. Since most of this corn is fed to animals, meat prices could go up. Soybean exports, a major export to China, could get hit even harder. China has already signed agreements to buy more soybeans from Brazil.
Canada is launching a C$5 billion program to help Canadian exporters reach new markets as part of measures to support businesses and workers in response to U.S. tariffs, the federal government said in a statement Friday. About 75% of Canadian exports go to the U.S. Canada is a major source of imported oil and natural gas.
President Trump promised "boom" times if he were elected president. That was easy to promise. He inherited an economy with higher-than-average real growth rates, extremely low unemployment and falling inflation. The stock market was enjoying one of its strongest bull markets. Now he is talking about a possible recession or a difficult transition, mostly due to his higher tariffs. A difficult transition from a strong, growing economy?
President Trump said he will be increasing tariffs on Canadian steel and aluminum to 50%, starting March 12, in response to Ontario's 25% surcharge on electricity coming into the United States.
Spot prices for steel, aluminum and copper rose in anticipation of the increased tariffs. The U.S. gets 70% of its imported aluminum from Canada. And again, Canada is the largest exporter of steel to the U.S.
American manufacturers are paying much higher prices for aluminum, steel and copper than rival plants overseas. The spot price for aluminum bound for America is four times higher than the aluminum spot price in Europe (March 11).
Companies around the world are rushing to ship products before tariffs are reinstated on April 2.
Consumers in America are rushing to car dealerships to buy cars before April 2. Maybe this will help America avoid lower real GDP in the first quarter. But then comes the second quarter.
Trump lowered expected tariffs on Canadian car back down to 25%. He raised the rate to 50% when the Prime Minister of Ontario put a tariff on electricity sold to America. This is a little weird since the amount of electricity exported to the U.S is a very small percent of the total amount consumed in America.
Europe has retaliated to the tariffs on steel and aluminum by putting tariffs on imported bourbon, jeans and Harley Davidsons. Well, there goes Europeans' opportunity to imitate the American way of life. Maybe President Trump will buy a Harley Davidson.
New tariffs on imported steel and aluminum go into effect. Quote from the New York Times, March 13:
Canada, a major supplier of metal in the United States, said that it would impose new retaliatory tariffs on $20 billion worth of American imports, including metals, computers and sporting goods. And the European Union swiftly announced tariffs on up to $28 billion worth of American goods, including bourbon, boats and motorcycles.
These tariffs are important because they are global, that is, affecting all countries exporting to the United States. And another source of higher car prices.
In response to Europe's retaliatory tariff on bourbon, Trump threatens a 200% tariff on "wines, champagnes, and alcoholic products" if the EU does not remove this tariff.
President Trump said he would impose a 25% tariff on countries that buy oil or gas from Venezuela. The tariffs are scheduled to take effect next month. China and India are two of the top importers of Venezuelan
crude.
Updated March 25.
A LITTLE INTERNATIONAL ECONOMICS
Tariffs raise prices, making American consumers poorer. Americans buy fewer foreign goods. Foreigners earn fewer dollars to swap for their domestic currency (to meet domestic costs). Fewer dollars are offered (supplied) in foreign exchange markets. The value of the dollar rises against other currencies, making American exports more expensive. The foreign demand for American goods go down. Among other consequences, employment in exporting companies and industries go down.
So tariffs are a tax on American exports as well as American imports. If foreign countries retaliate against American exports, there is even less demand for exports, further harming American manufacturing.
Data
The 20 product types that were exempted on Friday account for nearly a quarter of U.S. imports from China. Other countries in Asia would be even bigger winners, he said. Should the tariffs on those countries kick in again, the exemption would cover 64 percent of U.S. imports from Taiwan, 44 percent of imports from Malaysia and nearly a third of imports from both Vietnam and Thailand.
America’s share of world chip manufacturing has fallen to just 12 percent today from 37 percent in 1990, according to industry figures. America buys the most advanced chips, needed for AI development, from Taiwan Semi (TSMC), which manufacturers the chips with machines bought from ASML, a Dutch firm with 5,000 suppliers. TSMC announced a huge new chip-making couplex in the U.S. well before Trump's election. One motivation was that Taiwan might be taken over by China in the future. Trump's rhetoric, plus his abandonment of Ukraine, seems to increase the probability that American will not defend Taiwan if China attacks.
Discuss importance of foreign investments of large American corporations.
For the absurdity that chips are made in one country, see New York Times, "The Global Effort to Make an American Microchip," March 20, 2024.
HISTORIC ANALOGIES
At the beginning of the Great Depression, Congress passed the Smoot-Hawley tariff bill of 1930 to protect farmers. Of course, everyone in Congress added their favorite worthy special interest group that wanted protection. Tariffs went up to 60%. 1,000 economists, a rather conservative bunch in 1930, opposed the bill and warned of its negative consequences.
The main target was Canada, America's largest trading partner at that time. The more anti-American party won the next election.
Anti-American boycotts of American products started in Europe. American exports to Europe and Japan fell.
England walled off its Dominion countries and colonies from American imports; France and Holland did the same with their colonies. Since imports and exports were a small percent of the American economy, the Smoot-Hawley tariff bill was probably not a major cause of the Great Depression. But, on the margin, it contributed to the length and depth of the Great Depression.
Imports and exports are a much higher percent of the American economy now, about 5% in 1930 vs. about 20% now of a much larger economy.
Protectionism had a higher cost than in the 1930s.
Tariffs and other barriers to trade reenforced America's isolationism. To keep America out of the looming European war (on the side of England and France), a strong America First movement arose. Some of its members, including Charles Lindbergh and a future president of Yale, were pro-Hitler. The organization effectively disbanded in December, 1941.
Another possible analogy is political. In 1938, Neville Chamberlain, the Prime Minister of England, caved in to Hitler's threatened annexation of part of Czechoslovakia. He said he believed that Hitler, as promised, would not try to take over any more of Czechoslovakia or Europe. Chamberlain, on returning to England, announced there would be "peace in out time." A year later England went to war when Hitler invaded Poland. Chamberlain remained Prime Minister until Dunkirk.
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