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Written by: Tim Pierotti
There is a lot of debate happening right now, largely along partisan lines, about whether tariffs are inflationary. Market participants in support of the President-elect are loudly making the case that the example of the tariffs of 2018 prove that tariffs are not actually inflationary. The Fed Staff and the economics team at Goldman Sachs have empirically demonstrated those claims to be misleading at best. The chart below from Goldman illustrates the reality of what happened last time around. The chart shows that while broad measures of inflation showed little impact, the industries impacted by the tariffs saw meaningful inflation.
Goldman’s analysis showed that the vast majority of the imposed tariffs were passed along to US producers and to US consumers. If you don’t trust Goldman’s analysis, you might consider reading what the staff at The Federal Reserve concluded regarding the last round of tariffs. In a 2019 working paper titled, Disentangling the Effects of the 2018-2019 Tariffs on a Globally Connected U.S. Manufacturing Sector ∗ Aaron Flaaen Federal Reserve Board Justin Pierce Federal Reserve Board. The authors wrote,
We find that tariff increases enacted in 2018 are associated with relative reductions in manufacturing employment and relative increases in producer prices. In terms of manufacturing employment, rising input costs and retaliatory tariffs each contribute to the negative relationship, and the contribution from these channels more than offsets a small positive effect from import protection. For producer prices, the relative increases associated with tariffs are due solely to the rising input cost channel.
Beyond the fact that so many commentators are misrepresenting the 2018 example, the limited and targeted tariffs of that time bear no resemblance to what we should expect from universal tariffs directed at not just China, but at all of our major trading partners. Some of the 2018 tariffs were avoided as many Chinese made goods were rerouted and repackaged though other countries where there was no import tariff. Avoidance isn’t an option in a universal tariff regime being proposed.
Another argument being made is that tariffs won’t be inflationary because foreign currencies like the Yuan, the Euro and the Peso will adjust lower, pushing the dollar higher, and thereby allowing the foreign producer to accept a lower price from the American importer. This argument absolutely has merit. I have little doubt that the US dollar will continue to make new highs vs. a basket of our trading counterparts but is the Yuan going to depreciate by 60%? Is the Canadian dollar going to depreciate by 25%? If they do, what does that mean for US exports? It means that our exporters will have to raise prices to offset the currency losses rendering them uncompetitive.
All the economists and strategists who analyze the global economy need to approach the looming tariff war with a large dose of humility. As Helmuth Von Moltke famously said, “The best-laid plans never survive contact with the enemy.” There is a reason why people use the term “Trade Wars”. There are actions and there are reactions. There will be retaliation. How exactly will the US produce batteries and other electronics without commodities that are almost exclusively refined in China? Will this tariff regime have the impact that Smoot-Hawley did and crush global trade by two-thirds as occurred in the 1930’s? I doubt it. But we are on the precipice of a massive global economic experiment and the fact is, neither I nor anyone else knows how it will ultimately play out. That said, benign is amid the least likely.