Last weekend, Donald Trump fired the first shots in what could
become a devastating global trade war with the announcement
of tariffs against Canada, Mexico and China.
While the Canada and Mexico tariffs were quickly suspended,
it would be a mistake to assume that this is the last these
countries have seen of his tariff hikes.
The tariffs were implemented under the International
Emergency Economic Powers Act, AUS federal law which allows the
president to regulate international commerce after
declaring a national emergency, which can be done in response to
any unusual and extraordinary threat to the United States.
Had these tariffs been implemented, they would have
covered about 40% of American imports, really driving up
prices for the American consumer.
To delay the 25% tariffs, both Canada and Mexico agreed to
deploy additional troops to their borders to combat the flow
of fentanyl into the United States.
This was the stated motive for Trump's tariffs.
China retaliated with additional tariffs on liquefied natural
gas, coal, farm machinery and other US manufactured products,
which will kick in this week. They also placed restrictions on
the export of critical minerals, which are required for the
production of high tech goods, and announced an antitrust
investigation into Google, which has been blocked in China since
2010 but still sells advertising to Chinese businesses.
Trump, who has said that his favorite word is tariff, is very
likely to come back for more and is also likely to broaden his
targets to include the EU and other Asian economies, in
particular those he views as supply chain stop offs and
offshore production platforms for China.
Just yesterday, Trump said that he would consider imposing
tariffs on Japanese exports and pledge to unveil reciprocal
tariffs on other nations next next week.
Tariffs are, of course, a tax paid at the port of entry on
imported goods. The tax is paid by the person
who imports the goods and the money goes to the US government.
It's not paid for by a foreign business or a foreign
government. While Trump has said that he
will create an external Revenue Service to collect the tariff
income, the tax is charged in the United States and pushes up
the price of goods which is passed on to consumer.
Once taxed, the foreign goods might be more expensive, or
their prices might be in line with the price of domestically
produced goods. If the imported goods are more
expensive than domestically produced goods, this gives
domestic manufacturers room to raise their prices and become
more profitable. Tariffs can be used to protect
domestic industry, to raise revenue for the government, or
used to provide leverage in negotiations with foreign
leaders. What makes Trump's use of
tariffs different is that he's the first modern president to
view them as a preferred form of leverage and to see them as a
source of revenue, which they haven't really been used for
much in the past. Most other presidents have
viewed tariffs as a drag on the economy and as something that
you want to negotiate down as part of a free trade agreement.
A big difference, too, is that Trump is using tariffs as
leverage for goals other than trade, which is quite unusual.
Governments can raise revenue in a variety of ways, through
income taxes, corporate taxes, property taxes, sales taxes,
even fees and fines. Tariffs are a method of raising
revenue, but despite what some people claim, they could not
reasonably be expected to replace income taxes.
The US imported about $3.1 trillion worth of goods last
year and raised about $2 trillion in income taxes.
To try and raise $2 trillion in tariffs on $3.1 trillion worth
of goods would involve massive tariffs which couldn't work as
the tariffs would slash the amount of imports and then fail
to bring in the hoped for revenue.
It's worth remembering that all government taxes and fees are
redistributed by nature, as usually one group pays them and
another group benefits from government spending.
Tariffs would be a tax on households and would benefit the
specific businesses who find themselves dealing with lower
foreign competition. As to whether those businesses
would spend their extra profits by hiring or hiking wages really
depends on the supply demand dynamics for labor.
Businesses could just as easily reinvest their profits in
mechanization if that made Better Business sense.
So once tariffs are applied, how inflation, where should we
expect them to be? Well, tariffs can be expected to
push up the prices of both imported and domestically
manufactured goods. The effect on imported goods is
fairly obvious. A 10% tariff will be charged at
the port of entry and be added to the price of imported goods.
That doesn't mean that the goods will increase in price by
exactly 10%, as once goods arrive in the United States,
they're typically transported across the country to their
point of sale, sometimes being repackaged.
The business selling them will spend money on advertising and
pay to staff their retail outlets too.
They'll also apply a markup so that they can earn a profit and,
if the goods are sold online, charge for delivery.
All of those costs go into the end price to the consumer pays,
but only one of them has a tariff applied to it.
So a 10% tariff will push up the price of goods, but it might
only push up the retail price by around 5%.
Domestically produced goods can also be expected to cost more
once tariffs are applied, as many domestically produced goods
require imported raw materials which will, depending on where
they're sourced, possibly be hit with tariffs.
Even if they entirely avoid tariffs, domestic manufacturers
still get to hike their prices when they see their foreign
competitors raise prices. This price hike allows them to
earn a higher profit margin. Now, while consumers think of
prices going up like this as being inflation, that's not
really how economists think about it.
A 2008 paper from the Cleveland Fed points out that inflation is
one of the most misused words in economics, where the term was
originally used to describe a currency and money, not prices.
Strictly speaking, inflation refers only to a drop in the
purchasing power of money that results when a central bank
creates more money than the public wants to hold.
This manifests itself as a rise in all prices and wages, not
just some subset of prices. Milton Friedman famously pointed
out that inflation always results from a monetary
mismatch. It has nothing to do with supply
chain issues or with bird flu pushing up the price of eggs.
Tariffs being imposed would push up the prices of goods in the
same way that a sales tax increase would, but it would be
a one off price hike that the Federal Reserve would likely
ignore except if it caused an economic slowdown that they
decided it requires intervention.
Tariffs can cause an economy to slow down, as if the tariffs
push up the price of essential goods, consumers are left with
less money to spend on other goods and services, and this
could be expected to slow the economy.
There's also the issue of retaliation, where America's
trade partners can be expected to push back by imposing tariffs
of their own, which would then hit American exporters.
This type of retaliation is more of an issue with countries like
Mexico and Canada, who have balanced trade.
It's much harder for China to retaliate with their own
tariffs, as they import very few American goods to begin with.
China instead retaliates by restricting the sports of things
like critical minerals needed to make advanced chips, weapons,
and munitions. Prices of these minerals jumped
as soon as China announced these bans.
China's main form of retaliation will be to put pressure on big
American businesses who rely on manufacturing there, like Apple
and Tesla. the US imports a huge amount of goods from China, and
Trump's 10% tariff could hit more than $450 billion worth of
imports. This is quite different to
Trump's first term in office, as back then the tariffs were more
targeted and applied gradually. This time around, more Americans
will feel the impact. The Tax Foundation estimates
that the new 10% tariff on Chinese goods will add $172 to
the tax burden on every US household.
This time, there's no exemption for Apple, so iPhones and
computers will be hit. During Trump's first term, Tim
Cook managed to convince him to make an exception for Apple, as
while Apple products were manufactured in China, their
biggest competitor, Samsung, were manufacturing in Korea.
So Samsung would have a cost advantage over Apple if iPhones
were hit with a tariff. Starting a trade war with Mexico
and Canada was a surprising decision as the trading
relationship between the US, Mexico and Canada is the most
important relationship for all three countries.
Canada and Mexico are the United States first and second largest
export markets, and the US is the largest export market for
both Canada and Mexico. Trade between these three
countries supports over 17,000,000 jobs, according to
The Economist. The fact that the US exports so
much to Mexico and Canada means that US businesses are much more
vulnerable to retaliation. Supply chains between these
three countries are so intertwined that an all out
trade war would be hugely destructive to all three
economies and no one would win. Mexico provides almost 2/3 of US
fruit and vegetable imports, so food prices would be hit right
away. North American car man
manufacturing is highly integrated between the three
countries, with parts going back and forth across borders as many
as seven times during the production process.
If each time they cross the border they were hit with a 25%
tariff, the US auto industry would really struggle to be
profitable. About 70% of construction lumber
and 70% of drywall come from Canada and Mexico, respectively,
so the tariffs would drive up home construction construction
prices in the United States, where there's already a
construction shortage. In the short term, it would be
extremely difficult to find new sources for these products.
Canada is the largest supplier of energy to the United States,
providing about 60% of its crude oil imports and almost all of
its natural gas and electricity imports.
Given that there are pretty much no tariffs between these three
countries at present, a 25% tariff would cause a significant
economic shock. The impact would be most severe
for Mexico and Canada because a larger percentage of their trade
is with the United States. But the economic hit to the
United States would still be substantial, with some sectors
like auto manufacturing being hit very hard.
Trump's threats against Mexico and Canada are particularly
surprising as they violate the trade deal that he himself
struck during his first term, a deal which was already scheduled
for renegotiation next year. I look at some of the deals
made. I say who the hell made these
deals are so bad? US imports from Canada and
Mexico are in fact higher than US imports from China.
But these two countries also buy a lot from the United States,
and their trade is mostly balanced.
All three countries import more than they export, so it's hard
to argue that Mexico and Canada are taking advantage of the
United States. Trump claims that the tariffs
are unrelated to trade and has tied them to border security and
the opioid epidemic, which may actually be his concern.
But it's hard to know as in order to impose the tariffs,
Trump had to declare a state of emergency, and that was the
reason he gave to declare the state of emergency.
The market reaction to the announcement before the pause
was later announced was quite muted, with the S&P falling
around 1.4% and the dollar rising.
Oddly enough, crypto prices reacted more than the stock
market did, with Bitcoin falling by almost 10% and Ethereum
falling around 25%. This is obviously very
concerning as it appears that the meme coin industry is one of
the real drivers of growth in 2025.
A guy who has the unlikely sounding job title of Global
Head of Digital Assets Research at Standard Chartered Bank gave
some sort of an explanation to the FT about that.
The fact that the stock market mostly shrugged off the tariff
announcement implies that market participants don't believe that
they were likely to be sustained and possibly felt that this was
a negotiation tactic like Trump's quickly cancelled
tariffs against Colombia a week earlier.
The problem with this lack of reaction is that it possibly
gives Trump the green light for more extreme announcements in
the future. Well, it might be reasonable to
believe that the tariffs against Canada and Mexico were just
being used as negotiating tools with no real intention of ever
implementing them. The tariffs against China should
probably be taken more seriously, as while a lot of
negotiation went on between China and the United States in
Trump's first term, not much came of those discussions other
than an agreement to buy more soybeans and eventually tariffs
were applied. The balance of trade between the
United States and China is extremely distorted and there
may be no real desire to negotiate.
The tariffs are just being applied as a tax, which could be
cranked up over time. If businesses believe the
tariffs are just temporary, there are a few things that they
can do, like drawing down their in country inventories while
waiting for a deal to be struck. Since the pandemic, businesses
have been holding larger parts inventories to avoid the supply
chain issues they had to deal with a few years ago.
We also saw a surge in Chinese exports in the lead up to Trump
taking office, likely driven by businesses building up
inventories in preparation for tariffs.
While this works, if there are short disruptions, these
inventories will only last so long and eventually the tariffs
just have to be paid. If Trump's goal is to onshore a
lot of manufacturing, a more gradual roll out of tariffs
would probably make sense, as that would give businesses time
to adjust their supply chains. Trump closed a loophole known as
the de minimis exemption, which allowed packages mailed into the
United States containing less than $800 in goods to avoid
duties, based on the idea that the government shouldn't spend a
dollar to collect $0.50 in taxes.
I believe that this rule was originally put in place so that
individuals could bring back small value goods from overseas
trips without having to pay customs duties or taxes.
Chinese e-commerce firms like Xi'an and Timu, along with a lot
of Amazon marketplace sellers, have gotten very good at
exploiting this loophole, and this is part of the reason that
they can sell goods so cheaply in the United States.
Most countries do have a version of this rule, but with different
thresholds. It's $800 in the United States,
$155 in Europe, $170 in Britain, and only $20 in Canada.
I've occasionally bought something online in the UK and
had to go down to the post office to pay the tax to get my
parcel released, which can be quite inconvenient. the US
Postal Service initially stopped accepting packages from China on
Monday when the announcement occurred, but resumed service
the next day. According to The Economist,
America's customs agency lacks the manpower to examine even a
fraction of the incoming parcels from China, and the cost of
building that infrastructure might cost more than the taxes
raised. It's not crazy to narrow this
loophole, but it would have made sense to put the systems in
place to collect the taxes before implementing the rule.
Now, about 5 minutes before I recorded this video, news broke
that Trump is pausing his suspension of the de minimis
exemption until adequate systems can be put in place to collect
the revenue. You'd normally expect something
like this to be worked out before a rule is passed, but
things are a bit more chaotic now.
So is Trump right about U.S. trade being out of balance?
Well, he kind of is. In 2023, China ran the largest
annual trade surplus for any country in world history, where
they sold $823 billion more goods than they bought.
Then last year they surpassed that when their trade surplus
through by a whopping 20% to $992 billion, which is just
under a trillion dollars. China imports next to nothing
from its trade partners other than commodities and computer
chips. Chinese imports of manufactured
goods as a share of GDP have in fact been falling since 2005,
according to Brad Setzer. If you strip out components that
are bought in for RE export, import of manufactured goods for
domestic use come to less than 4% of Chinese GDP.
The economist Michael Pettis argues that surplus countries
like China suppress domestic consumption, subsidized their
manufacturing industries, and then pass on the costs of these
subsidies to deficit countries like the United States.
He argues that a free trade country would open capital
markets when trading with a planned economy is not really
engaging in free trade. They're instead accepting the
inverse of their trade partners, trade and industrial policies.
Trump's former trade representative, Robert
Lighthizer, recently wrote in the New York Times that nations
are supposed to export in order to import.
This exchange is intended to raise the standard of living for
citizens of both the exporting and importing countries, and
countries should export what they make best and maintain
balanced trade by importing goods that are made relatively
cheaper by their trade. Partners.
That is the theory, he says. But this has mostly not happened
in practice. Instead, many countries have
adopted lopsided industrial policies that allow them to
export much more than they import.
Their objective is not to raise the standard of living of their
citizens, but to accumulate power and wealth by buying
assets abroad. Lighthizer argues the tariffs
are necessary to bring global trade back into balance.
He goes on to argue that countries with democratic
governments and mostly free economies should come together
and create a new trade regime where they work together
imposing tariffs on countries that suppress wages and
consumption in order to export more than they import, forcing
the inverse of their industrial policies on their trade
partners. This argument of trade
cooperation between countries who run persistent trade
deficits is very similar to Michael Pettis's arguments.
This is not what seems to be happening, however, as both
Canada and Mexico are deficit economies like the United States
and should be on the same team. It would appear that Trump takes
a more transactional approach to diplomacy than we've seen with
other presidents in the past, where he doesn't worry about
building long term relationships and cooperation, instead
focusing on striking deals where he wins.
The problem with that approach is that once countries are no
longer expecting long term relationships, they have to make
backup plans that might not be advantageous to the United
States. Canada, for example, exports 97%
of its oil to the United States. And while there have been
discussions for decades about shipping ripping oil to other
countries, Canada's good relationship with the United
States and environmental protesters have meant that
pipelines to the coast were never built.
Canada's natural resources minister said this week that the
country should weigh building a new WE oil pipeline after
Trump's threatened tariffs exposed a vulnerability in
energy infrastructure. It does make good sense for
Canada to have a back up plan like this, but this may not be
good for the United States in the long run.
With so many countries running persistent trade surpluses
following the post World War 2 Japanese and German model.
There's no shortage of supply in the world, and without a handful
of countries like the United States, there would be a
shortage of demand. Well, there has been a lot of
talk about how countries should stop relying on trade with the
United States and trade with Europe or China instead.
We have to remember that these are both trade surplus economies
with no plans to run a trade deficit.
To quote Michael Pettis once more, the idea that trade with
the world's largest deficit economy could be replaced by
trade with the world's largest surplus economy implies a world
in which sellers don't need buyers.
For most countries, trade with China could in no way replace
trade with the United States. If the next four years are
likely to be anything like the last few weeks where tariffs are
threatened, ordered, and then quickly cancelled, it creates an
awful lot of uncertainty for businesses as if a company can't
decide where to build factories or who to sell to or buy from,
they start to take a wait and see approach to business
planning. This may be a wise business
decision, but it would be very bad for the overall economy if
every business were to halt expansion plans because of trade
uncertainty. According to the Financial
Times, tariffs have been discussed on over 200 corporate
earnings calls this year. In a sign of how Trump's
policies are rippling through corporate America, analysts are
grilling corporate executives as to what their contingency plans
are for possible trade disruptions.
One of the benefits of long term trade deals like the USMCA,
which Trump struck five years ago to replace NAFTA between the
United States, Mexico and Canada, is that they lock trade
relationships in place, sidelining government and
allowing businesses to get on with producing and selling goods
in a stable business environment.
As of this week, Canada and Mexico have one month to arrange
a deal with the United States. Even if they work something out,
they'll possibly be left wondering if the United States
will stick to their word or if it'll be broken on a whim like
the current trade deal was. It would probably be wise for
them to come up with contingency plans in case another national
emergency is declared to break whatever deal they strike.
Who the hell made these deals are so bad?
Brad Setzer of the Council for Foreign Relations pointed out in
a recent podcast that there are many reasons for the US trade
deficit, one of which are U.S. tax policies that penalize U.S.
companies who export from the United States, instead
incentivizing them to hold their intellectual property offshore
and manufacture offshore too. Better tax policies would
possibly do a lot to bring manufacturing back to the United
States. In the same podcast, sets are
raised the question of whether Trump's overall goal is to
recouple or decouple from China. Does Trump want to stop trading
with them all together or strike a deal with balanced trade?
Right now, we just don't know. While the US will be able to
reduce its imports from China, which will mean having less
access to cheap goods, China won't be able to find a
substitute for the United States in trade simply because no other
economy or group of economies would be able to absorb the
trillion dollars of excess production China is exporting
every year. If the United States pushes
hard, China would be forced to balance its economy and raise
workers wages so that they can consume more of the goods being
produced in the country. This would be a very difficult
adjustment for both the United States and China.
If the US is to balance global trade by moving in the direction
of a system where countries export goods in order to fund
their imports rather than running persistent trade
surpluses, it would likely require cooperation with other
deficit economies like the UK, India, France, Turkey, Canada,
and Mexico, who would need to work together to strike a long
term, mutually beneficial trade deal.
Thanks for tuning into this week's podcast, with special
thanks to those of you who support the channel on Patreon.
If you'd like to join that group, I'll put a link in the
show notes. Have a great week and talk to
you again soon. Bye.