The tariffs! My God, what of the tariffs?! (“Think of the children!”)
Most intelligent people (and maybe even some unintelligent people too) understand why it’s not a great idea to slap draconian levies on everything the US imports from abroad.
Imagine a fruit — this is fictional — the papamime, which Americans love, but can’t grow, neither outdoors nor, for whatever reason, in greenhouses. There’s no domestic papamime industry, and no hope whatever of creating one. Why would you tax incoming papamimes? The only thing that’s going to accomplish is making papamime smoothies more expensive for Americans, and exponentially so depending on the tariff rate.
It’s debatable whether “Tariff Man” understands that. On most days, I think he does (because how could he not?), but then again, he often says things that raise questions about his grasp of the self-evident (such questions extend beyond trade, by the way).
Donald Trump, as someone who’s purely transactional, doesn’t differentiate between unrelated issues. Everything’s just one giant racket. That kinda, sorta works if you’re, say, an old school mobster, but it’s no good for a US president. You can’t (or at least you shouldn’t) say to a foreign leader, “Here’s these Javelin antitank missiles you wanted, now do me a favor and accuse my political rival’s son of a crime.” That’s like, “Here’s the address of the Angiulo’s social club, now do me a favor and make sure nobody asks any questions about World Jai Alai.” (Someone will get it.)
It’s not that presidents shouldn’t wield tariffs — or any other tools at their disposal — to change the behavior of other countries deemed to be acting in ways that are injurious to America’s national interests. Rather, it’s that there are established processes for that and those processes typically entail efforts to structure carrots and sticks in such a way that all concerned parties can see the contours of statecraft or at least the shadow of realpolitik. So, for example, “We think you’re building a nuclear weapon under a mountain over there, so we’re going to sanction everyone involved because you can’t be trusted with nuclear weapons.” Or, “We think you’re a communist, so we’re going to support an anti-democratic coup against you.” Maybe it’s fair, maybe it isn’t, but at least there’s a thread to follow.
With Trump, it’s often hard to keep track of the plot. So, “Chinese chemical companies are sending fentanyl precursors to Mexican bandits, so we have to put tariffs on Canadian steel and French cheese, unless Mohammed Bin Salman gives Jared Kushner a real estate contract in Neom, in which case China can expect some tariff relief on plastic toys, assuming, of course, that Xi Jinping promises to buy US soybeans.” That’s stylized, but you get the point. It’s just a string of transactions. Principles are irrelevant.
You could (easily) argue that principles are always irrelevant in US foreign policy (that’s realpolitik after all) once you get behind the rhetoric, but again, Trump’s out-in-the-open Sopranos-esque strategy is problematic to the extent it becomes difficult (if not impossible) to trace a path from the quid pro quos to the public interest. Tariffs are the quintessential example. You slap a US trade partner with punishing levies and demand they take action to remedy, say, the manufacture of fentanyl precursor within their borders. They do (or say they do), then you lift the tariffs, but what were the actual results for everyday people in America? Did you achieve anything measurable? Anything at all?
Again, it’s not always obvious Trump understands this. And no (no, no, no), he’s not “playing 3D chess.” His erratic behavior isn’t “the art of the deal.” Rather, he’s a simpleton who grew up adjacent to mob circles, and as such, he’s violently allergic to subtlety, equates decorum with weakness and thinks “soft power” is a contradiction in terms.
So, what’s the good news? There is some, actually. As Goldman’s Jan Hatzius calmly reminded investors, the impact of Trump’s tariffs “would be a price level increase whose inflation impact should drop out after a year, barring significant second-round effects via wages or inflation expectations.”
Don’t scoff. That’s a good point, simple though it is. Recent survey data — e.g., the University of Michigan release, which showed Americans are inclined to buy durables ahead of tariffs — does indeed suggest households are conceptualizing of Trump’s trade war if not necessarily as a “one-off” price hike on affected goods, then at least as a price shock, which isn’t the same thing as sustained upward pressure on prices for a wide variety of goods and services, year after year.
The chart on the left, above, gives you a sense of how this played out last time and the chart on the right how Goldman expects it might play out during Trump’s second term. Hatzius likened the situation to VAT increases in other economies. Such hikes, he said, “typically leave no lasting mark on inflation or monetary policy.”
Goldman went on to note that in the 2018-2019 trade war, financial conditions actually tightened such that the Fed was ultimately compelled to ease policy. That doesn’t mitigate most (or any) of the concerns raised above, but it does argue against the idea that Trump’s next trade war will be prohibitive vis-à-vis any additional rate cuts the Fed feels compelled to deliver.
Don’t get it confused: Goldman does expect tariffs to lift inflation — by as much as 0.4ppt next year, in fact. But the bank’s point is simply that the impact will be temporary, and that, as far as the Fed’s concerned, “the 2018-2019 experience shows that the monetary policy risks from tariffs are at a minimum two-sided.”
No long run sustained inflation. Just foolish policy, and lower real incomes worldwide.
“It’s a papamine, Michael. How much could it cost? $10?”
I am surprised that the markets assume Trump’s policies will be de facto inflationary. As you point out, tariffs are a one-time price shock and may be offset by their recessionary effect.
I’m also guessing any tax cuts will be more limited than people expect given the slim margins in the house and will largely benefit the people who are already rich. You might have some wealth effect, but it seems equities have already priced those effects in. Add in the impact of deportations and likely government layoffs and you’ve got a recessionary stew going.
My bet is Trump will extend his existing tax cuts with some slight modifications that further tilt the benefits to the wealthy, cut some of Biden’s IRA funding, and declare victory.
excellent point re.: deportations. If those should ever be enacted on a larger scale, the inflationary effects will be much worse than any tariffs could ever be. The only hope is that after back-to-back media coverage of some initial raids Trump will declare a “win” and lose interest. Cf. “wall” from his last administration.
Mr. Hatzius is normally pretty balanced and measured. But I wonder what inspired this piece?
One quibble is that Tariff hikes will not be a quick one off and done. They will be a time lag between when they are announced and actually start being collected, something I doubt he is unaware of since he cites the experience from the last round of hikes. But there can be no doubt that patriotic American companies in the affected industries and users of those products will immediately start raising prices using the tariffs as cover. (A $20 Cracker Barrel gift card to anyone who can convince me that Pepsico will not immediately raise prices 15% per quarter once again.) It would be safer to say that there will be a two year lag before the full impact on price levels starts to become fully evident.
And then there is the follow-on impact IF US companies use some of the pricing windall to actually expand production rather than funneling most of it into stepped up share buy backs. They’d have to pay for more equipment that will likely be more scarce and costly to acquire.
But there is always a Polyanna narrative out there that we investors can cling to.
No doubt his prediction is based on a model that has not been updated to account for how concentrated many sectors have become and do not account how extreme the impact of share-based compensation has come to drive corporate behavior. Update your models, Hatzie!
The Roger Wheeler Killing?
Your “stylized” Trump quote, unfortunately, is not far from his usual blather. Contrast that with this quote from David McCullough’s bio on John Adams, (p-106). Adams responding to James Warren:
“We may please ourselves with the prospect of free and popular governments. But there is great danger that those governments will not make us happy. God grant they may. But I fear that in every assembly, members will obtain an influence by noise not sense. By meanness, not greatness. By ignorance, not learning. By contracted hearts, not large souls…
There is one thing, my dear sir, that must be attempted and most sacredly observed or we are all undone. There must be decency and respect, and veneration introduced for persons of authority of every rank, or we are undone. In a popular government, this is our only way. ”
Decency and respect, that’s Donald to a T.
As we’re often reminded, inflation is not the same as prices, in that high inflation followed by low inflation leaves prices high. Voters get madder about inflation when prices are already high, especially when their incomes do not similarly inflate.
Even if tariffs are only a “one-off” price increase in goods prices, they will then trigger a rise in services prices or, if wages fail to rise, a decline in real income. As this will come when prices are already high, voters will get mad more quickly.
There will be no distracting global pandemic, less fiscal headroom, and a less accommodative Fed.
JL – well put, as always.
But I’m slightly surprised by yorr statement that “There will be no distracting global pandemic” since you have have been one of the few market people to call attention to the rising number of bird flu cases in the US.
Not that being early is always rewarded – especially in our “forward thinking” stock markets where news to actually start to hit shre prices in a way which will wake up the algos. .
You’re right, I should have said “base case” is no pandemic. If avian influenza picks up one remaining mutation and turns into a human pandemic, then all bets are off but we can start a pool on how long RFK lasts.
I may have said this before, but in 2025 watch for Republicans using tariff revenues as increased tax revenues to fund tax cuts. That will change tariffs from transactional bargaining chips to semi-permanent barriers to trade, which can’t be dismantled without blowing up the deficit and/or large tax increases/spending cuts.
Trump’s tariffs are so damned regressive and that’s the part that bugs me the most. It will be fascinating, however, to observe how he blames the resulting inflation on his predecessor.