Trump's Tariffs and Their Consequences

INTRODUCTION AND SUMMARY

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. But 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 cars, oil and naturally gas.

Tariffs are basically a tax on inputs and the wholesale prices of imports. Spread out over the whole economy, the announced tariffs probably will have a small impact on retail price indexes, although some individual products and product groups will see large price increases. 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.

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.

Possible extensions of tariffs and intended and unintended consequences are discussed.

OVERVIEW

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 products and services to China, Mexico and Canada to lower costs and increase profits. Tariffs on "Mexico" will hit American car companies and their suppliers particular hard. Trump has threatened to raise tariffs on Canadian car imports in order to "permanently shut down the automobile manufacturing business in Canada." Most of the imported cars from Canada are made by American car manufactures. 

Foreign sales are important, especially for America’s largest companies. Of the companies in the S&P 500 Index (500 largest public companies), almost 1/2 of their sales are outside of the United States. Much of this is exposed to retaliation. The tariffs will affect foreign sales and lead to complicated supply chain changes. It will affect all aspects of corporate strategy.

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. 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. 

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 and will go up. The transition to products that fight global warming will be slower.

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 bought in America come from China. But the price of coal will not go up. Guess what will be in your children’s Christmas stocking next December?

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.

Americans hate inflation. Some Americans love tariffs. Trump will have to convince them that tariffs do not lead to higher prices.

There might be less investment in America. But the recent surge in investment has been related to AI, so the overall impact might not be too great.

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 a new distribution networks. There is already a large distribution network for the related business of selling stolen, counterfeit, and black-market goods - eBay and Amazon. Illegally imported food products can be sold at so-called urban “farmers markets.” 

 

RETALIATION

China - relatively small, hitting food imports and American farmers the hardest. 

Canada - also relatively small, hitting American booze exports the hardest. But the government announced that if there were no reductions in the tariffs, there would be a four-fold increase (in value) in tariffs on American imports.

Mexico - no new retaliatory tariffs. Yet. The one month reprieve might delay retaliatory tariffs.

Europe might be next; 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 a similar amount of 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 that 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.

Canada has a lot of uranium. 

AMERICAN AUTOMOBILE INDUSTRY

Almost half the cars sold in the United States are imports. About 23% of cars sold in America come from Mexico; another 10% come from Canada. About $100 billion in parts and subassemblies cross the border and will have to pay the tariff, in addition to the tariff on completed cars that are imported. Price of cars in America will go up and possibly car sales will go down. American car manufacturers are in poor financial shape and cannot afford to absorb the cost increases.

One way to avoid paying the tariffs on cars in America is to buy a Honda. Hondas are assembled in America; Hondas also have the highest percentage of American-made parts than any other car. This only applies to gas-powered cars.  

The three American car companies rely heavily on final assembly in Mexico and Canada. Parts and subassemblies for auto assembly often cross the border, as much as 5-6 times, and pay a tariff each time in addition to the tariff when the assembled car is imported.

On example is ZF, a major manufacturer of transmissions. ZF has plants in the U.S., Mexico and Canada. A major part of a transmission is made in Mexico. It is sent to the U.S., where it is included in the finished transmission. The transmission is then shipped back to Mexico to be installed in most of the American cars produced there.

American auto executives must be in shock (or very scared).  The average cost of cars will go up at least $2,700, and more for big pickups and big SUVs (Barclay’s Bank). Barclay’s Bank analysts also estimate that tariffs “could wipe out…all profits” of the three American car companies. Or worse. Profits are a major source of investment capital. If this happens, it implies that the Big Three American car companies will not have the cash flow to invest in EVs. That means eventual extinction.

Taxing big pickups and big SUVs plus higher gas prices strikes at the heart of the American way of life. 

TESLA

EVs are especially vulnerable to the tariffs on China since a high percent of EV car batteries are made in China. Batteries account for about 40% of production costs.

Tesla has huge plants in the U.S., China, and Germany.

Surprisingly, the company that could be hurt the most is Tesla. Data from the China Passenger Car Association showed that Tesla’s February sales, which includes exports and domestic sales from the Chinese plant, dropped 49% year-over-year. Shipments from Tesla's Chinese plant are the lowest since 2022. I doubt if any patriotic Chinese will now buy a Tesla. 

Already, Tesla sales in Europe are going down. In January, Tesla's sales in Europe fell 45% - 76% in Germany while overall EV sales were up. Another big drop in February. The European press has reported a great deal of anger at Trump and Musk and organized protests and business boycotts aimed at Tesla.

Sales in the U.S are going from spectacular growth to no growth. In 2024, EV sales in the U.S were up 7% but sales of Teslas were down 1%. Sales would have been even lower if not for a surge in sales after Trump’s election, and reduced prices. Profits are down over 50%. Things might get worse because the political backlash aimed at Musk might reduce American sales and profits more; someone in marketing must know that a large part of Tesla’s target market are liberal, higher-income, and environmentally aware. And I doubt if there will be many new Teslas in federal government parking lots or family farms or in the driveways of veterans.

Globally, Tesla sales in 2024 were flat, compared to a 40% increase in 2022 and a 38% increase in 2023. Teslas are becoming less competitive models offered, wizzy electronics and features, and price. Tesla doe not need a global political backlash on top of its weakening global market sales and market share.

Tesla’s stock price rose after Trump’s election and is now getting clobbered. As of March 10, Tesla is the worst performing stock in the S&P 500 this year. But the P/E ratio is still very high, about 130 times 2024 earnings per share (EPS). Any fall in earnings per share will lead to another large decline in Tesla's stock price. In the worse case scenario, Tesla's investment in the huge plants in China and Germany could be close to worthless.

Elon Musk is proud that all Teslas sold in America are assembled in America. But 40% of its car batteries are from China. The company also buys parts from Mexico and Canada. Tesla's growing battery business is in storage batteries.

There could be retaliation against American companies in China and elsewhere. In the extreme, China could seriously weaken Tesla sales in China and exports to other countries. 

Currently, the Chinese government considers Musk a "friend" and a possible pro-Chinese voice in the administration. But as tariffs climb and rounds of "reciprocal" tariffs kick in, the China government might reconsider.

Tesla exports cars produced in China to Canada.

Although sales are falling in the U.S, what will keep Tesla afloat is that the U.S. government effectively bans imported Chinese EVs. And tariffs on American EVs produced in Mexico should also help, although they are much less of a competitive threat than Chinese EVs would be.

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. Promises of reducing the yearly deficit substantially, reducing interest rates, and instituting further tax cuts beyond the extension of his 2017 tax cuts have almost disappeared as economic policy goals.  

Tariffs may not decrease the trade deficit very much because of retaliation. 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 blanket tariff on all imports, as he has threaten 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 called 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. 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 $250 billion.

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 2.4%.

Tariffs on Mexico, Canada and China, with retaliatory actions, would lead to a major unraveling of the global economy. Long-standing trade agreements are being smashed.

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.

President Trump has threatened to put 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 breeds isolationism. 

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 for one month.

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 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.

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. 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 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. The U.S. gets 70% of its imported aluminum from Canada. 

Spot prices for steel, aluminum and copper rose in anticipation of the increased tariffs. 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.

Updated March 11.

HISTORIC ANALOGY

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 other groups that wanted protection. Tariffs went up to 60%. 1,000 economists, a rather conservative bunch in 1930, warned of the negative consequences of the bill.

The main target was Canada, America's largest trading partner. 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. Protectionism has 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 England's and France's side), 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. 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 Europe. Chamberlain, on returning to England, announced there would be "peace in out time." A year later England went to war because Hitler invaded Poland. Chamberlain remained Prime Minister until Dunkirk.

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 goes down. Indirectly, tariffs are also a tax on American exports.

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.