Tariffs: Russian Roulette With A Bullet In Every Chamber

It's the ultimate lose-lose.

China tech companies shares information about US and China trade war

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And so, it begins.

Over the weekend, US President Donald Trump announced 25% tariffs on imports from Mexico and Canada (but only 10% on imported Canadian energy) and an additional 10% tariff on products arriving in the US from China.

Unsurprisingly, Canadian Prime Minister Justin Trudeau has retaliated, putting a 25% tariff on imports from the US.

In his announcement Trudeau was blunt, telling Americans:

"Tariffs against Canada will put your jobs at risk, potentially shutting down American auto assembly plants and other manufacturing facilities."

"They will raise costs for you, including food at the grocery store and gas at the pump."

Discussing Canada's retaliation, Trudeau said:

"We didn't ask for this but we will not back down".

Canada's department of finance estimates that cross-border trade (in both directions) currently adds up to nearly $1 trillion per year.

Mexico is reserving its options, with plans to announce its own response in the near future.

This is, unfortunately but not surprisingly, the first of a likely long series of 'threat, action and counteraction' scenarios we could see play out over the next four years.

And it's hard to separate the politics from the economics because, frankly, the economic justification is as weak as the foreign policy one.

Donald Trump claims this decision was made primarily in response to imports of the drug fentanyl from Canada to the United States.

Notwithstanding that border controls are universally about policing imports, not exports, as recently as 2020 the United States Drug Enforcement Agency found that:

"China remains the primary source of fentanyl and fentanyl-related substances trafficked through international mail and express consignment operations environment, as well as the main source for all fentanyl-related substances trafficked into the United States."

And

"Some fentanyl products are smuggled from Canada into the United States for sale, on a smaller scale"

Perhaps things have changed meaningfully since, and Canadian fentanyl is the new overwhelming scourge.

Perhaps.

But that data makes the above-mentioned tariffs seem just a little disproportionate.

Indeed, if the 25% tariffs are necessary, why only 10% on energy? One might suppose that the price of petrol is more important than the self-declared war on fentanyl. Then again, given more of it comes from both China (10% higher tariffs) and India (no tariffs, yet at least) – and that there's been no concurrent action on drugs inside US borders – one might question whether the war on drugs is really the motivation it's claimed to be.

But back to the economic impact.

Former US Treasury Secretary Larry Summers has, overnight, suggested that tariffs could increase US inflation by 1% over the next nine months. And, as we know well from the experience with inflation over the past five years, when prices go up, they tend to result in a permanent reduction in living standards.

Indeed Trump has acknowledged the potential impact (though characteristically hedging his bets), posting on social media:

"WILL THERE BE SOME PAIN? YES, MAYBE (AND MAYBE NOT!)"

(His capitalisation, obviously.)

Which is the stupidity of tariffs. While the political spin is 'tariffs on Canada' (Mexico, China…), the tariffs aren't paid by those countries, but by US consumers.

And then, predictably, those countries retaliate, putting tariffs on imports from the US, pushing prices up for, in this case, Canadians.

It is a textbook lose-lose scenario.

But what about 'making things again'? Isn't that a justification?

Well, American unemployment is 4.1%.

Perhaps a small minority of those people have skills that could be directly and immediately applied to new US manufacturing…

… after new plants were built, machinery bought (from overseas?) and operations commence. Which could take years.

And that assumes those businesses were prepared to make capital investments given the risk that such investments may not be economically feasible if a future administration was to roll back tariffs.

Regardless, most of those unemployed Americans wouldn't have the right skills or be in the right places, anyway.

So then 100% of Americans would be paying more, but for almost no meaningful employment gain.

That's the problem (and we hear echoes here in Australia) with 'we should build things here'.

We absolutely should, if it makes sense; if the workers would earn more than they do now, if consumers of those products will pay less than they do now, if the quality of the products would be better than they are now, and if we don't have to tip more government spending into the endeavour.

Also, I'd like a unicorn.

See, that's the benefit of free(r) trade: we sell them things we do better and/or cheaper, and we buy things they do better and/or cheaper. It's not perfect, but it's a very good way to improve living standards in both countries.

Tariffs reverse all of those things. Either we pay more for imports, or we pay more for locally produced alternatives. Think that's a good thing? Because it supports 'local' jobs and products? It seems like it at first. But if you're paying more for Product A, you can't buy as much of Product B (or buy Product B at all).

Your living standards fall, and the business making Product B goes broke and those workers lose their jobs.

Something that started sounding good at first blush, suddenly seems more complex and maybe a bad idea after all.

If it's easier to conceptualise, consider if there were trade tariffs across Australian state and territory borders.

Queensland bananas would cost more in NSW. NSW-made steel would cost more in Queensland.

NSW workers wouldn't be any better off, but the bananas would cost more. Queenslanders would pay more for steel, and get no benefit from the higher price of the produce they send south.

Back to international tariffs. For now, at least, there's little direct impact on Australia.

Higher tariffs on Chinese imports into the USA will almost certainly reduce demand for those products. And I don't need to remind you that China is our largest trading partner. According to DFAT, China bought $219 billion worth of Australian exports in 2023, fully one-third of everything we sent offshore.

So it's probable that any Chinese economic impact will have echoes in that country's demand for Australian exports.

Beyond that, it's anyone's guess. Will Trump pick a fight with Australia? We would have assumed not, but he picked a fight with Canada, the US' long-time ally, with which it shares an 8,891km land border.

And how would the Australian government, before and/or after the next election, respond?

At the moment, Trump appears to be two parts schoolyard bully (tariffs and bluster), one part 17th century king (executive orders aplenty) and one part Roman emperor (with designs on Greenland, the Panama Canal and, yes, Canada).

Perhaps the rest of the world comes to an explicit or implicit agreement to build and maintain multilateral trading partnerships to reduce the potential and actual impact of a volatile and demanding United States.

Or individual countries might try to curry favour with the US administration by deciding to play Trump's game, for the short-term financial benefits that could accrue.

Individual companies would be well-advised to meaningfully and quickly diversify their international customer bases, much as many had to do when China put tariffs on Australian products in 2020.

There's one last one, too: economic types have long said that when the US sneezes, Australia (and other countries) catch a cold. While inflation is the immediate threat, any significant disruption to trade could risk global economic growth, too.

With my investor's hat on, the immediate impact will be on the profitability of businesses with significant cross-border trade between those jurisdictions. There aren't many ASX-listed businesses selling much from US factories into Canada or Chinese plants to the US, thankfully.

We should prepare for more global market volatility, though, as investors try to work the announced and potential changes into their assessment of value. The ASX fell 2% out of the gate this morning. I don't do predictions, but I think we can assume we should expect the unexpected, from here.

Oh, and a reminder that Trump has only been in office for 2 weeks. It's going to be a helluva ride.

Fool on!

Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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