There’s a lot to talk about!
In debating what to write this month’s post about I had the:
- History of tariffs as a political issue for the US, they’ve been there since the beginning
- How and why markets have digested this news so violently.
- How can the president just do this? Especially when the Constitution specifically gives tariff power to Congress
I settled on outlining the state of play and where I think we’re going from here. Next one is probably on tail risks I see coming up! Those are always fun.
Every picture will be in a fun art style because I have ChatGPT pro and need to use it.
Lesotho Must Pay
What’s happening? In a word, tariffs.
In more words? The 9th worst 3 days of trading for the stock market. So far.
There are four tariff regimes announced over the last month or so:
- Liberation Day
- Mexico + Canada + China Fentanyl
- 25% on all cars, and auto parts not covered under the USMCA (NAFTA 2).
- Sanctions-lite tariffs on China
Worth noting that this is just the start. There are more sectoral tariffs on the way. Pharma was already announced in a speech. More are coming.
The Big Board
Liberation Day really kicked everything into high gear.
The rates are quite simple to calculate. It’s just the trade deficit divided by the amount of imports into the US with a base rate of 10%. Countries like Australia with a trade surplus and free trade with the US automatically get 10%.
This calculation is only for physical exports. It misses tiny details like services other countries use from the US, think Google and Facebook, and foreign capital flows, buying our bonds. It’s likely ChatGPT generated.
Trump personally picked this formula and I assume that’s just because you get bigger numbers out of it than others.
Here’s a chart from some major economies that matter from JPMC. These just include additional Liberation Day tariffs, not the already high tariffs from the previous Trump and Biden admins.
Trade deficits are perhaps one of the dumbest ways to calculate tariff rates.
For example, Lesotho, a poor African country has the highest tariff rate. They trade ~250M worth of diamonds and denim to the US and buy almost nothing from us.
If you’re wondering why that is, here’s a street view from their capital to a 3 star hotel recommended by Google.
I doubt they’re going to be importing our 50k to 100k F-150s on the average income of $289 USD.
They’re also in a trade bloc with other African countries. This bloc has free trade between members and a unified tariff rate for imports. Since we’re not calculating the actual tariff rate per country, the others have a different, lesser, tariff rate than poor Lesotho.
Canada, Mexico, and China Have the Good Stuff
Just to recap.
Trump announced a 25% tariff on goods from Canada and Mexico “because of Fentanyl”. Eventually those were paused for 90 days due to symbolic enforcement actions.
Fentanyl as a justification makes absolutely no sense. Its production generally takes place within the United States using legal precursors sent through the US mail. Almost none of it goes across the borders, especially over the Canadian side.
Canada and Mexico’s tariffs are now slated to kick in starting in July. Each country is excluded from the Liberation Day tariffs.
China is paying the 20% rate and not working with the US.
Sanctions-lite
China announced retaliatory tariffs almost immediately after Liberation Day.
Someone drafting the Chinese proposal understood the definition of retaliatory because they’re 34% on Chinese imports from the US, the same as ours, along with other trade restrictions like export controls on rare earths.
Trump responded in typical fashion by adding another 50% tariff on Chinese imports to the US.
This is all additive. The total import tax rate to the US is now 104%. That breaks every single supply chain with a China component. Even Apple doesn’t have enough margin to avoid raising prices.
The Hanoi Hilton, International Golf Destination
Aren’t there carve outs?
Yes!
There are some carve outs from each of the tariff regimes. Some Canadian energy, some steel, some aluminum, whatever. Depending on where it comes from, which regime is applied, and if it somehow annoyed the president in some way that morning.
Many things are not. Even things that make no sense to tariff. Coffee, mangoes and cacao cannot be grown domestically. They were excluded from Nixon’s tariffs in the 70s, but not with this batch from Trump’s team.
This will create a deadweight loss. Industries that use coffee as an input must cut jobs since they can’t substitute and eat the price increases. I’m sorry to the baristas out there, all of the coffee in the country just got more expensive.
The potential deadweight loss also drives out low margin manufacturing businesses that use these products as an input. This is already happening publicly with Mr. Beast chocolate bars, but is indicative of pain to come.
The next step here is corrupt carve outs for favors to Trump.
Russia and Belarus are currently untariffed, supposedly because they’re negotiating on a ceasefire hasn’t progressed, yet Ukraine wasn’t.
The Trump family is not shy about opening up avenues for corruption. If you are a lobbyist in Washington I’m sure a lot of money is up for grabs.
I mean, who wouldn’t want to go golfing in Hanoi?
Who’s on First?
Over the course of the last week the cabinet, MAGA movement, and Trump himself have all said they’re instituting tariffs to serve contradictory purposes.
Tariffs exist in a superposition where they are:
- A negotiation tactic to force other countries to do something. Usually trade related, but not always.
- A way to re-shore manufacturing. We need to take our medicine and become autocratic.
- Some 5D chess thing?
- “We need to crash the economy to save the economy”
- Bring the 5 Year treasury rate down to refinance the national debt!
Leaving out the 5D chess stuff, because it’s stupid, the two narratives are. Tariffs let us negotiate for more fair trade, and tariffs are part of a permanent shift in the economy.
A lot of the market volatility right now is because of this superposition.
After all he postponed them the last time right?
We’re not going to do it if you don’t make us!
Tariffs are decent leverage!
This is a true fact. The US has the largest economy in the world. We have a lot of people who want to buy things like French wine, Chinese clothes, and Japanese cars. Most Americans have access to every fruit and vegetable on the globe, 24/365 unencumbered by seasonality.
However
If you were building a tariff scheme to give you leverage, you’d want a clear framework which can tick up and down depending on if other countries acquiesce to your goals.
Then you’d pair that with clear messaging that the pain can stop quickly if you come to the table and hammer out a deal. Preferably across multiple countries at once to simplify things and create a trade bloc.
It’s a lot easier to understand the implications of importing/exporting things to and from a bloc than to try and understand 50-100 bilateral trade agreements.
Things end up looking something like this TPP proposal from WEF.
That is the opposite of what has happened over the last week!
Administration officials have been on TV saying that we will never back down, while Trump himself is on TV saying that we’re negotiating. Tariffs must be temporary to be leverage. If they’re not then there’s no point negotiating.
More important than that, the tariff calculation is based on trade deficits. Countries that want to negotiate can’t find something to give the Trump admin.
A deficit isn’t created by a countries policy!
Vietnam cannot afford to buy American products. It’s cheap to produce clothing there. Due to deliberate moves by policy makers to take supply chains away from China, a lot of it is imported into the US.
There is no rational policy that Vietnam’s government could make that would fix that. They even offered the Trump admin a trade deal with zero tariffs, which to be fair is largely a messaging thing, and the admin rejected it! Publicly! Immediately!
Still further, assuming that all the bluster is just a negotiation and the deficit thing is just a starting point, I don’t think the Trump team will win!
On its face they have a strong hand. The US economy has bounced back from COVID extremely well compared to the rest of the world. China and Europe both had deep recessions, we didn’t.
But these decisions are not purely economic though from the Chinese and EU.
The Trump admin is aggressively attempting to bully basically the entire world at once. This has aligned the entire world against the United States. Every country of size now wants the pain! They want to respond to the US and not rollover.
Think about it from the perspective of the other side.
To the EU, this admin has been actively hostile in public and in private.
Publicly, they’ve stopped aid to Ukraine while actively repeating Russian talking points, threatened to pull from NATO entirely, and held press conferences where they talked about annexing Greenland.
I mean come on, it’s Greenland? We already have a military base there, annexing it is pointless. If we did it would go against the will of both the Greenlanders and one of our best critical partners in Europe the Danes. Why?
Through the Signal leak we found out the private thoughts of the Vice President and Co. They used it to reaffirm their hatred for Europe as a concept.
Considering the OpSec posture of admin officials it’s safe to assume that European intelligence, and every other one, is very aware of communications happening in the admin. I doubt they’re much better than what we’ve already seen.
This is the third largest economy in the world, you think they will cave immediately and negotiate? A large majority of the Europeans absolutely hate all of this, even more than left wing Americans.
The Chinese are in the same boat for obvious reasons.
Look at the world from the perspective of an EU prime minister like Macron. You see that decoupling needs to happen for the EU as well in this multi-polar world. You have to find a time to do it, but decoupling is painful.
Your populace loves American blue jeans, whiskey, and cold rolled high quality steel! Now they are pissed and begging to stick it to the Americans. It’s a perfect opportunity to push for it.
Even if that isn’t your perspective, you know at a minimum that Americans are extremely price sensitive. Look at the Biden admin’s issues with inflation and it was peanuts compared to these numbers. Americans already don’t want tariffs, and your population is begging to take the pain.
You shouldn’t fold now. Just wait for a better deal.
There is no world these tariffs have significant leverage. We’ve given away our carrots, and the people we’re hitting want the sticks.
At this rate, we’ll decouple with everyone and tariffs will lose their leverage completely. The only reason why tariffs matter is because your economies are entangled. The US is a rich and attractive place to ship your goods. Even the poorest US citizens have a higher standard of living than most people in developing countries.
Mass affluence is not a Kazakstani problem.
Nothing you try to do will stop us!
The other narrative is that this is permanent.
Tariffs are the medicine to fix the American economy which spent the last few decades bending to the whims of Wall St and the capital class. They shipped well paying jobs to China/India/SEA etc for better profits and to save $50 bucks on a flatscreen.
Now we need to rebuild our manufacturing base in order to rvturn to that. This is usually accompanied by some sad photo of a rust belt town. I grew up in an area like this so I have some opinions.
The messaging is that we need to go from this:
To this:
For a good amount of people on the right the idea collapses down to, “bring back the jobs”. Or more specifically the imaginary lifestyle of a 1950s household, where one man could support a wife, two children, vacations and a set of new cars.
This is a fantasy. Life in the 50s was incomprehensively worse than it is today. One third of homes in the United States lacked indoor plumbing, and car crashes killed people twice as often, ok? It was closer to Fallout than it is to the marketing material. What you think is normal was a middle upper class lifestyle back then.
On the more extreme parts of the right this blends with the stronger idea of “destroy the fake email and office jobs that women have so they are forced to become my wife”. No more HR jobs where you make tiktoks when you have to do this in the new economy! Gotcha!
This is absolute loser politics, and I’m not engaging with it. There’s record low unemployment in the US at this point. If you think it’s bad for you now imagine what it’ll be like if it goes up.
That said, manufacturing capacity is really just the ability to make stuff. That’s neutral. Making more stuff that isn’t good or bad for labor.
National manufacturing capacity does not equal a better standard of living for you, your children, or your loved ones. The goal is to make us more independent from other countries. That’s it. Usually at great economic cost compared to allowing countries that are better at making a given thing do it.
Factories are terrible places to work. Ask anyone with a manual labor job if they’d rather be a programmer and they’d take that job every time. Every blue collar person I’ve ever met, has said to stay in school so that way you don’t end up breaking your back picking shit up for a living. The Chinese are making fun of us for wanting our toaster assembling and sewing jobs back.
Humanity has a solution to doing the things we don’t want to do. Automation.
And we’re doing this already! US manufacturing capacity has been up and to the right for the past 30 years, even through manufacturing as a percentage of GDP has gone down.
Encouraging automation is good for production, but it’s not really good for labor. The point of automation is not to create jobs, it’s to create stuff. There is displacement to other parts of the economy by design.
Even if it’s not good for labor, we do still need a strong industrial base to deal with national crises.
As we learned during COVID, supply shocks for critical things like masks, ventilators, and medical supplies can cost lives. So there is a case to be made for having smart industrial policy to get there, tariffs alone don’t get us there.
We should nurture domestic industries to become globally competitive. A lot of 21st century success stories like ship building in Korea, and semiconductor manufacturing in Taiwan boil down to that. Those countries chose to build those advantages using a combination of public sector funding, protectionism, and global competition. The US has our own specialties in Aerospace, precision manufacturing, and software. We should keep that!
There is some legitimate need to make things that are further down the value chain than software and airplanes. Cloth masks and bullets come in handy when you need them, and the only way to ensure we’ll have them is to make them here. All good!
But only using tariffs to do this is incomplete policy. I am more sympathetic than the average person to the goal here, but even I can see that this is economic malpractice.
If I want to bring my manufacturing stateside I need:
- Parts that likely aren’t built in the US, which are now more expensive
- Money, either credit or equity, that has now disappeared due to the financial market collapse
- A labor pool willing to make it, which is historically small in the US and due to demographic reasons is only going to get smaller.
- A market to sell to, which now is more difficult because of other countries tariffs on American goods.
We’ve relied on other countries that are better at these things. Mexico has fantastic demography, Canada has a ton of raw materials, Europe has world leading precision.
Now we’re all fighting for no reason! It makes the goal harder to reach. We should use the global supply chain to build up our industrial capacity, not cut ourselves off and try to make do without. It’s out there already!
In a way this is a huge leap of faith by Trump. He’s assuming that if he destroys global markets that private capital will simply fill in the gaps for him.
Most frustrating of all, you know who had effective industrial policy? Joe fucking Biden, or the 25 year olds puppeting his corpse doesn’t matter to me. We can cover that another time.
Will They Stop?
No, I don’t think they will.
Trump 2.0 has bred out any “adults in the room” that existed in first term. There were people in that admin who snatched letters away from his desk to get things done.
Trump himself is much older, more stuck in his ways, and surrounded by sycophantic cranks. At this rate the pain is going to be immense. We’re going to create an unprecedented stagflationary shock in the economy.
Normally during a crisis the government is trying to stop the crisis. Here the government is creating the crisis and pushing for it to worsen.
This will continue until Trump decides for it to stop, or something forces him to stop. I don’t have confidence the latter will happen. If that’s the case a recession or potentially even depression is inevitable.
This is the universal known end to this policy decision. Everyone from Milton Friedman to Karl Marx agrees that tariffs are bad.
As I mentioned last time markets are quick to price in new information. Market participants were systemically blind to the danger Trump posed to the global economy back then and still were as early this morning. The optionality of a rollback will decrease every day, along with the market price of everything.
The multiple on the S&P is 18x, if it compresses we’re in for a bad time even before the earnings hit comes.
JPMC, Goldman, etc. have to be more cautious about estimates than I do. I believe we’re likely already in a recession due to decreased confidence.
In the physical economy who is hiring right now? Only people who will soon stop.
Basically every business person in the economy is already cowering in fear of these tariffs and we should expect it to worsen as they continue.
When things break they break in accelerating ways. There’s still time to pull out for Trump. The market is currently begging for good news, and will rocket up on anything even fake tweets.
The stock market is forward looking, if they pull back the real economy is still fine right now.
After that? All the king’s horses and all the king’s men, couldn’t put humpty dumpty back together again
-Chris