Trade Wars Begin? Or Not?

President Trump’s 25 percent tariffs on goods from Mexico and Canada might or might not be in effect soon.  As we write this, tariffs are on hold for goods that are covered by the North American trade agreement.  If and when a general tariff kicks in, Canada has promised to retaliate with 25 percent tariffs on $100 billion worth of US imports. Mexico is will likely to do the same.  

Trump also introduced an additional 10 percent tariff on Chinese imports just days ago, bringing the total tax to 20 percent following a similar increase last month. China swiftly retaliated with tariffs on US food and agricultural products and an export ban on some defense firms. 

According to the Peterson Institute for International Economics, calculating the full Trump tariff proposal, “the direct cost of these actions to the typical, or median, US household would be a tax increase of more than $1,200 a year.”

Treasury secretary Scott Bessant minimizes the impact of the tariffs over time, saying that price hikes will be offset by cuts in regulation and cheaper energy.

Warren Buffet disagrees about the impact of tariffs.  “We’ve had a lot of experience with them. They’re an act of war, to some degree,” he says.

We want to be sure our friends and readers make the distinction between inflation, which is the result of increasing the supply of money and credit, and simple price increases which are often called inflation.  If freezing conditions slam citrus growers this winter, the prices of oranges will rise.  But that is not inflation; it is just a rising price. Tariffs are price increases across many goods, but are not the result of money printing.  Even so, you will still want to protect yourself from lost purchasing power.  Many will turn to gold and silver right away, while others will follow.

With that said, and as others argue back and forth about who pays the costs of tariffs, we thought we should offer a couple of simple examples that add clarity to the discussion.  Let us imagine a farmer in Mexico who regularly sells a crate of his products to a family across the border in Arizona.  To make our example easy to understand, we will leave out middlemen like truckers, distributers, and grocers.

BASELINE  – Before Tariffs

In their long-established custom, we imagine the farmer sells a crate of produce to the family for $100.   It is a straightforward and regular transaction.  The government gets nothing.

EXAMPLE 1 – Trump’s 25 Percent Tariff

When the new tariff takes effect, to maintain his same income, the farmer will have to charge the family $125 dollars.  The government takes $25 of that, while the farmer would still get his accustomed $100.  But the family has just seen the cost of these groceries climb by 25 percent.

That is a pretty steep increase.  What will they do?  Will they pay it without complaint? Will they buy less?  Look for substitute foods or a lower cost producer?

EXAMPLE 2 – The Farmer Pays

The farmer doesn’t want to lose his long-time buyer.  Maybe he thinks he can absorb the cost of the tariff himself, at least for a while.  So, the farmer cuts his price for the crate of goods by 20 percent.  Now he charges $80 dollars, to which the government adds on 25 percent.  The final price to the family is the same, $100, leaving the farmer worse off by $20.  The government gets that $20.

EXAMPLE 3 – Splitting the Difference

If the farmer can’t absorb the full loss of income, perhaps he will try to split the difference with the buying family.  He agrees to charge just $90.  The tariff adds 25 percent  or $22.50 to the transaction, so the family now must pay $112.50.  In this case, the farmer is worse off than before the tariffs arrived on the scene.  The family is worse off, too.  But the government is making out on this deal. 

We offer these examples to settle the ongoing argument of who pays for the tariffs, the producers or the buyers?  The only honest answer is no one can say.  In a complex economy of a myriad of producers of competing products and millions of buyers, there are countless individual decisions to be made.  They are never made uniformly, and today’s decisions may change tomorrow.  

What we can tell you is that in two out of our three examples, once the tariffs begin, the family, the consumers, will see prices rising.   Unless sellers can absorb the entire cost of the tariff which is simply not always possible (Example 2), consumers will be worse off.  Their dollars, their earnings and savings will buy less. The Consumer Price Index will rise.  The government will have more money.  People will have less money.

“Over time,” says Warren Buffett, “[tariffs] are a tax on goods. I mean, the tooth fairy doesn’t pay ’em!”  

In such instances, when the consumer’s dollar doesn’t go as far and the CPI rises, they begin to look for proven, reliable alternatives.  Like gold and silver.

We hope that helps.