“Trade War 2.0” will dominate headlines in the week ahead, and not just on financial news portals.
Donald Trump’s weekend tariff declarations may well destabilize markets, but they also risk a diplomatic crisis with Canada and Mexico.
Claudia Sheinbaum’s not a pushover, but Mexico doesn’t exactly come at this from a position of strength, certainly not economically. More than three-quarters of its shipments “abroad” go to the US, and that doesn’t count the drugs. In theory, Trump’s levies, if implemented as announced and sustained for more than a few months, could reduce Mexican exports by more than a quarter, analysts reckon, imperiling some 15% of the country’s overall economic output in the process.
Sheinbaum intends to retaliate, but warned, as I did Saturday evening in the Weekly, that tariffs aren’t going to solve America’s drug problem. “If the US wants to fight the criminal groups that traffic drugs, we should work together in a comprehensive manner,” she modestly suggested.
Unlike Sheinbaum, Justin Trudeau is a pushover, but he’s also a lame duck. The loudest voice in that room’s Chrystia Freeland who, if you believe her overtly aggressive rhetoric, wants a cage match with Trump. The new tariffs, she jeered, not only “harm the world’s most prosperous trading relationship,” they also jeopardize “one of the great historic friendships between nations.” Freeland conjured the fightin’ spirit of “previous generations of Canadians,” who “did not back down.” “We won’t either,” she insisted.
I don’t want to trivialize the “threat,” but Canada’s going to be fine. Sometimes you wake up in a bad mood, you notice your toy firetruck’s gone missing and even though it’s probably in the back yard where you left it yesterday or under the couch, you go beat up your little brother for “stealing” it. You’ll feel really bad about it later, and you’ll apologize, maybe while sobbing. (“I’m sawwwwy Bobby, I wuuuv you!”)
But Trump needs to be careful with Mexico. There’s a lot of desperation down there, the central government’s not especially strong, the rule of law doesn’t really exist in some (most) locales and just on and on. Allow me to elaborate.
Even someone as proudly obdurate as Trump surely understands that the very last thing you want to do if the goal really is to curtail immigration and drug trafficking, is push the local economy into recession and pile a bunch of pressure on the currency.
As the figure shows, the peso’s coming off its worst week in months and already trades near the weakest levels since the onset of the pandemic. Analysts see scope for meaningful additional depreciation if Trump doesn’t relent, where “meaningful” means as much as 20%.
Maybe this actually hasn’t occurred to Trump, but the cartels are always hiring and if necessary, they can pay “salaries” in US dollars. Physical US dollars, which they have on hand, in abundance.
America does need to figure out a way to even things up a little more with Mexican manufacturing. Indeed, that’s part and parcel of this whole dustup, or at least it used to be. Now it’s all about opioids, aliens and coyotes, apparently.
But contrary to popular (populist) narratives, you don’t want to completely undercut Mexico’s competitive advantage. Why not? Why not force them to commit to a whole bunch of onerous labor laws and other measures aimed at leveling the proverbial playing field?
For one thing — and at the risk of trafficking in circular reasoning and tautologies — this playing field simply ain’t level. It’s apples to oranges. Mexico, as an emerging market with a weak central government, doesn’t have the bureaucratic infrastructure (the administrative capacity) to effectively implement and police the kind of complex system of oversight and regulations you find in advanced economies.
Moreover, if you undercut Mexico’s competitive advantages, you risk disincentivizing foreign investment in the country’s official economy, which means fewer jobs and less in the way of economic opportunity… in a narco state. Throw in the fact that counter-tariffs (i.e., if Sheinbaum hits back at Trump) would impart additional upward pressure on consumer prices atop FX pass-through inflation (i.e., inflation attributable to peso weakness), and you’re basically begging Mexicans to turn to the cartels for jobs and dollars.
China’s a horse of a different color. Xi’s not just not a pushover (there are two “not”s in there), he’s a full-on, shoot-you-in-the-face dictator, and although the Chinese economy’s mired in a deflationary quasi-recession, it’s still the Chinese economy. No, it’s not “advanced” in the usual sense of the term — i.e., it’s not Canada. But as a veritable (if currently vulnerable) juggernaut, it’s not really “emerging” either and it damn sure ain’t Mexico.
Further, consumer prices are barely growing at all in China. Beijing doesn’t have to worry about pass-through inflation. The PBoC can neutralize a 10% tariff hike with a couple of weak CNY fixes.
Trump knows all of that, and as I’ve suggested on several occasions since November, I think the US-China bilateral might actually improve under Trump because he’s a fan of Xi’s. Trump the politician idolizes strongmen, and Xi’s the autocrat paragon in 2025.
Ultimately, my guess is the Canada/Mexico tiff will be resolved more quickly than most are inclined to believe. Trump’s not going to be able to sustain 25% tariffs on America’s neighbors (who’re partners in his own USMCA trade agreement) in perpetuity. That’s untenable. All that’s going to do is stoke anti-US sentiment in Canada, chaos in Mexico and inflation in the US.
What is sadly ironic is that these tariffs violate the very agreement that Trump 1.0 negotiated, USMCA which replaced NAFTA in 2020. The US has a long and inglorious history of breaking treaties and agreements. But generally that is done by different administrations. This is a new low.
Trump believes his own BS when he says he has an overwhelming mandate. Its not even clear what he’s asking of Canada and Mexico, so I’m not sure what a resolution looks like (although if it’s anything like Trump’s typical victories, it’ll be slapping a new label on existing deals and declaring total capitulation of our adversaries).
I’m rooting for chaos at this point. I want all those business owners and tech/crypto bros to feel the pain. We need to break this MAGA fever, and short of Trump succumbing to Father Time, economic pain might be the only cure. It might kill the patient in the process (I.e. Trump might just declare martial law and get away with it), but I’d rather see the situation resolved.
Things that wouldn’t surprise me based on what we’ve seen so far:
1. The US economy will go into recession with a healthy dose of stagflation.
2. The government will be hacked in a major way that disrupts payments for major programs like Medicare and social security. All of our personal data will be even more compromised than it already is.
3. The military will participate in a mass casualty event.
4. The FBI will miss signs of a major attack because they are bing gutted.
5. Airports will see shut downs or capacity constraints because they won’t have staffing.
6. Crypto will tank when appetite for risk drops off a cliff.
7. Housing costs will go up dramatically because builders will now have higher costs in the face of a worsening economy and stop building despite supposed deregulation.
8. China will invade Taiwan during his term.
I think the average Joe will be surprised when their lives are impacted directly in a meaningful way by the likes of Elon Musk overseeing government tech and mass government layoffs and Kash Patel leading the FBI (and that’s just the start of the list of the incompetent lackeys in charge now). Trump believes he is the second coming and knows Republicans won’t lift a finger to check all his worst impulses this time around. We are in for a bumpy ride. Cthulhu help us if there is an even worse pandemic or a major war.
The other thing I’d add is even if we come to a new agreement with Canada, I’d be willing to bet Canadians won’t be so quick to forget this treatment. They were booing the national anthem at a hockey game last night. They will be rightfully pissed and may not be so quick to buy American going forward.
Stop spending, hurt economy before midterms. Less pain now than down the road. It’s coming either way. Old college days, we asked what was the best approach to get a win-lose player to cooperate. Tit-for-Tat won; sting defections then cooperate until they change. Problem today, the question is finding the best approach to changing the other person from playing “dictator-lose-lose” (forgot what I’m suppose to say about scare quotes). I have no computer support, but still think Tit-For-Tat best approach. Democrats are scared, soft as tRump would say, to play lose-lose. I say ignore everything he does, just focus all effort on what hurts him, first the economy, hurt it before stopping him is 10X the cost down the road.
Don’t forget the part where a “National Emergency” is declared (invented) and elections are suspended.
Biggest problem Mexico has….” the rule of law doesn’t really exist in some (most) locales “. I don’t think there is anyone down there that our law enforcement could work with. Sad fact. Up here sometimes it seems hopeless, but we are so lucky with what we have !
This is a wake up call for Canada, I’m hopeful that the government/country makes changes to become more productive (lagging for years) and less dependent on the US. Imo the longer this goes on the greater the long term benefit for Canada, short term of course will be difficult.
“All that’s going to do is stoke anti-US sentiment in Canada, chaos in Mexico and inflation in the US.” Does he care, or will be forced to care, about the first two though? And by the time he sees measurable inflation according to lagging measures there’s a fair amount of damage already done.
H-Man, when the kitchen gets hot, he will tell us the tariffs work –fentanyl and illegal immigration down. No more tariffs, problem solved.
He is the fairest reporter of his performance of all time. No sugar coating, only he can perform so well. He is simply amazing …
I got a bridge for you from NY if you want to buy it.
As I catch up on your articles this week, it has been impressive (at least to me) how you link to your prior articles, even some years back, to support or emphasize a point. It helps me go back and read what I may have missed or forgotten. It is in this spirit, while catching up on what you wrote this week on tariffs, I recalled a quote you either posted or article-referenced during the Trump 45 presidency when, I believe, he reneged on an Agreement with the Democrats on tariffs. I may not have the situation exact.
The quote was attributed to Chris Kruger, Strategist at Cowen Washington — “To paraphrase Lenin: there are decades where nothing happens and there are weeks when decades happen…and then there is a single week in the Trump Presidency. What a time to be alive.”
All I know is Trump was correct when he said we’re going to get tired of winning. It’s exhausting after a couple of weeks.