Andrew Robinson's Blog

Tag: politics

  • 02/06/2025: Trump Bluffs, Except with China

    Okay, sweet. The proposed 25% tariffs on all Mexican and Canadian goods (with carve-outs for Canadian energy) were postponed by a month. This is undoubtedly good news. To Trump’s credit, he was able to get seeming concessions from our neighbors. He first called Mexican President Claudia Sheinbaum wherein she agreed to send thousands of troops to the border to help curb illegal immigration and the smuggling of fentanyl. In return, the US vowed to help limit the amount of guns funneling into Mexico. Similarly, Trump called Canadian Prime Minister Justin Trudeau striking a deal to delay the tariffs. Trudeau promised to “ensure 24/7 eyes on the border” (to deal with the ‘problem’ of fentanyl from the northern border) and pledged $1.3 billion to that end, as well as agreeing to a US-Canada joint strike force to tackle organized crime. The CBOE volatility index initially jumped slightly as we approached implementation but has since tapered off – so too have long-term interest rates. This reversion reflects the general sentiment of the situation – crisis averted, at least for now.

    Volatility spiked when tariffs seemed likely to be implemented, dipped when deals with Mexico and Canada were reached. Data source: Yahoo Finance
    10-year Treasury yields followed the same pattern. Data source: Yahoo Finance

    The long-term implications of these last-minute deals are unclear. Now that Trump has succeeded in scaring Mexico and Canada into an agreement, will he become more emboldened next time around? As the tariff moratorium comes to a close, will he demand even more from other countries? How much are these countries willing to take? I’m not going to pretend to know what Trump is going to do. However, given that he just implemented 10% tariffs on all Chinese imports, I think the probability of future tariffs is significant. And, even though tariffs on Mexico and Canada were delayed, there was an excellent Bloomberg piece claiming that Mexico in particular is hurt by these threats even if they aren’t executed. The extent of the pain is decidedly mitigated, but the incentive to funnel foreign direct investment and resources into Mexico is diminished with the threat of tariffs and the deterioration of the US-Mexico-Canada (USMCA) agreement. Regardless, let’s talk more about the tariffs on China.

    There is a significant imbalance between the magnitude of the US and China’s tariffs. The US placed 10% tariffs on China across the board. This affects $525 billion of US imports, which accounts for ~14% of Chinese exports and ~3% of their total GDP. Conversely, China assumed a more tepid approach, placing 10-15% levies on roughly 80 US energy products and agricultural tools. These affect $14B of imports, account for 0.72% of US imports and 0.05% of total GDP (import data from Bloomberg, who sourced it from China Customs). China also added export restrictions on tungsten and other metals predominantly used in the electronic, aviation, and defense industries. In sum, the US is taxing China far more than China is taxing the US. As far as China’s response goes, their export restrictions will likely hamper production in the aforementioned industries while their tariffs should increase prices by a small but unknown magnitude. How much? I don’t know but it doesn’t seem like a drastic effect. Nonetheless, if this trade war continues to escalate, these effects will decidedly be felt by the everyday consumer. 

    The tariffs that the US erected are a different, more consequential story. China’s response was measured and relatively light, thus the expected drag on growth should be tame. The lack of tariffs keeps the average price level of US goods and services roughly constant, neither incentivizing nor disincentivizing the purchase of exports. However, our decision to impose tariffs should increase the prices of Chinese exports by a non-negligible amount. As stated, the US is applying 10% tariffs on 14% of our total imports. This is crazy. How much do these price increases matter? As shown below, both headline and core PCE inflation have been hovering somewhat near the Federal Reserve’s 2% target, with core inflation stagnating in recent months and headline increasing. 

    Progress towards the Fed’s 2% inflation target has stalled. Tariffs may force them to keep rates high. Data source: FRED

    Anything that risks increasing inflation – in our case, tariffs on China increasing prices – pressures the Federal Reserve to keep rates higher for longer. Core inflation holding steady implies the underlying, persistent rate of price increases (removing the typically volatile food and energy components) is growing at a steady pace. The Federal Reserve wants to see more progress towards its target but is in a state of limbo. As Federal Reserve President Jerome Powell stated in his Jan 29 press conference, “Inflation has moved much closer to our 2 percent longer-run goal, though it remains somewhat elevated… the Federal Open Market Committee decided to leave our policy interest rate unchanged and to continue to reduce our securities holdings.” That is, they have decided to keep short-term interest rates constant while continuing to engage in quantitative tightening. If tariff-induced inflation becomes a significant problem, Powell and co. will be forced to keep rates high to keep the economy from overheating and inflation from spiraling.

    What I’m getting at is simple: not only will these tariffs increase inflation, but also interest rates by way of expectations of the Federal Reserve. If credit card APR, mortgage rates, auto loans, any other variable loan, or wealth discounting matters to you, then Trump’s tariffs hurt you. The extent of this hurt is controlled for now but might expand in the future. 

    Long-term interest rates, including 30-year fixed mortgage rates, are near a two-decade high. Trump’s tariffs reduce the probability of these rates ‘normalizing’ soon. Data source: FRED

  • 02/02/2025: Trump’s Impending Tariffs

    The biggest story of the day appears to be the incipient stages of a trade war between the US, Mexico, and Canada (I don’t believe any tariffs are being planned between Canada and Mexico, though). Trump is allegedly imposing these tariffs in response to excess drug/opiate smuggling and illegal immigration. Assuming this is justified, I don’t particularly see why Canada finds itself at Trump’s mercy. From what I understand, many of the intermediate inputs of dangerous drugs like opioids are legally imported from East Asia to Mexico, assembled there, and then illegally smuggled across the border. This is a problem. I ought to do more research into how this issue could be solved. What can US Customs & Border Patrol do? What about Mexican authorities? Chinese authorities (assuming East Asia = China)? Regardless, it doesn’t seem to be Canada’s fault. 

    If actually imposed (slated for Tuesday, the 4th), these tariffs will have a couple of domestic economic effects. First, US imports from both countries will become more expensive. A first-order effect would imply that 25% tariffs across the board should raise prices by around 25%. I don’t know if this will actually hold true. Consider this example:

    Suppose exporting firms in Canada and Mexico have some degree of price-setting power. That is, they are currently charging above their marginal cost and can lower their price, or they can lower their price below marginal cost because they expect future rewards with increased market share. Then, these firms may lower the sticker prices of their goods and services to sell more. That is, if prices are 100% sticker with 0% tax ex-ante, ex-post prices may be 90% sticker with 25% tax for a total of 115%. A 15% increase (which, conspicuously, is lower than 25%). This depends on how much market power these firms have and the perceived importance of market share (which goes hand-in-hand with the perceived duration of tariffs. If a firm believes tariffs are short-lived, they may want to lower prices for more market share to benefit when tariffs evaporate and would be willing to operate at a loss). 

    Another domestic effect (and the seeming economic rationale) is protectionism. By taxing firms that are exporting to the US and increasing their prices, domestic firms in competition with foreign firms benefit. Suppose we go from a 0% tax on Canadian cars to a 25% tax. We likely see a price increase for the reasons listed above. Purchases of domestic cars, on the other hand, are not ~25% more expensive. Thus, domestic cars seem much more attractive, people buy more, and these firms are better off. These firms pay their employees income, so domestic income increases. As incomes increase, spending increases. And, since one person’s spending is another’s income, incomes across the board increase (this income effect may be relatively small, but overall good for Americans). 

    However, this assumes that we are only taxing final goods. I don’t know the exact details of these tariffs – maybe it is the case that 25% across the board refers to final goods (probably not, though). Let’s strip away this assumption. 25% means 25%. We aren’t just taxing Canadian cars at 25%. We’re taxing their steel, aluminum, electronics, microchips, and all the other intermediate goods that we use to construct a car. In this scenario, the price of domestic cars rises as well! The price probably won’t rise as much as foreign cars (because I’m assuming every factor of production in car assembly isn’t imported and taxed. If every part was imported and taxed, labor costs aside, prices should rise in tandem). Nonetheless, Domestic prices still probably rise. Then, the effects on domestic firms are ambiguous. On the one hand, they capture more demand from foreign firms because foreign firms now have higher prices. On the other hand, production is now more costly as intermediate inputs are taxed and more expensive, raising the price, and reducing demand for these domestic firms. This probably nets positive for the domestic firms, but perhaps that’s just me spitballing. 

    Everything I just mentioned is a first-order effect. We tax Mexico and Canada, they don’t tax us. In reality, it only seems logical that Canada and Mexico would respond with tariffs in turn. And, it seems that these countries are already planning retaliatory targeted tariffs. So, suppose Mexico and Canada levy 25% tariffs on American goods and services. Then, flip all the effects I previously laid out and add them. American goods become more expensive for foreign consumers. We lose their business. Domestic firms lose money, pay less income to employees, they spend less, resulting in less spending/income in the US. This doesn’t seem great for the US. It is this retaliatory effect that appears to have so many economists concerned about a destabilizing trade war. 

    I’m glossing over much of the nuance involved in these tariffs. I failed to account for three main forces: game theory, foreign exchange effects, and budget deficit effects. Game theory applies because it could be the case that tariffs are being used to ‘bully’ other nations into submission. And, if successful, America could accomplish other economic and non-economic goals with the threat of tariffs alone. These goals include limiting immigration and drugs, the purchase of Greenland, renaming the Gulf of Mexico, etc. Also, if Trump can implement relatively smaller tariffs and prevent retaliation (which seems unlikely), these tariffs could truly help the American people. I have also ignored the foreign exchange rate in this analysis. In short, USD should appreciate as relative demand for peso and Canadian Dollar fall. Demand for these currencies fall because exports to US account for more of MEX and CAN economy than exports from US to MEX and CAN matter for the American economy. Thus, a greater proportion of MEX and CAN’s output is slapped with tariffs and see reduced demand for their currency. This is corroborated by Bloomberg’s report that USD and oil jumped. Further, I have ignored the effect on the budget deficit (increased tax revenue should decrease the deficit). 

    Although I could enrich my prior analysis with these omitted variables, I think the general effect remains the same: unless Trump forces heavy concessions and prevents retaliation, these tariffs will hurt the American people. At this moment, it seems unlikely Trump can accomplish that. Maybe that changes, and if so I’ll write about it. It also seems very likely that America’s trading partners will suffer from these tariffs.