The US just taxed its own companies to make a point-maybe. Let's break down the logic, or lack thereof.

KEY TAKEAWAYS

• The new tariffs could cost US businesses between $308 billion and $640 billion in profits, depending on the effective rate.
• Vietnam is a major US import partner because of low labor costs and previously low tariffs.
• Even with a 49% tariff, Vietnamese labor remains cost-effective, so reshoring isn't likely.
• The President's strategy may be to pressure foreign nations into lowering their own tariffs on US exports.
• Economic damage is likely, but won't show up right away due to inventory front-loading.

MY HOT TAKES

• The administration's tariff math is political theater rather than sound economic logic.
• Union workers who supported the move may soon feel the pain as their employers face higher costs.
• Comparative advantage can't be undone with tariffs-global labor cost gaps are just too big.
• The "tariff parity" formula is arbitrary and unlikely to change foreign trade policies.
• This is shaping up to be one of the most expensive hypothesis tests in modern US history.
• You can quote me: "This is a costly experiment. The costs are being borne by the US economy, your financial confidence, and your portfolio."
  
  

Politicians gone wild. So, here we are, day 2 of the President's big experiment, and we are still asking ourselves "what is he actually trying to prove?" In other words, most of us are trying to figure out what his hypothesis is.

I have looked up and down the list of new tariffs by country so many times, I simply lost track. I received lots of calls yesterday from folks wondering where the Administration even got those foreign tariff numbers which were the basis for the counter-tariffs the US imposed on its trade partners yesterday. I am not sure we will ever find out, but does it even matter? What we do know is that American businesses that import goods from abroad will now be taxed on their imports. That's right, $3.084 trillion worth of imports are now going to be taxed at a minimum of 10%. That's right, $308.4 billion will be removed from US corporate profits, at a minimum. If we go with the average effective tariff rate of 22.5% as some have calculated it, the decrease is more like $640 billion.

So here is the logic… I think, just based on the way the tariffs were presented the other day in the Rose Garden. Countries have taken advantage of the US. They have enjoyed prosperity because US companies have bought billions and billions of dollars worth of foreign goods. Do we even get a thank you? No. But those countries charge huge tariffs on US exports, some of them even 100%. They do this to protect their local industry. It's simply not fair. So, going forward, we have come up with a formula to make things even. Whatever a trade partner charges the US in tariffs, we will divide it by 2 and round down to the nearest whole percentage point (subject to a random override) and then charge the greater of 10% or that number on all imports from that country. OK, so what then, is the endgame? Looking at the foreign tariffs, some of them huge, it is clear that there is some inequity.

There were lots of eyebrow raises on Wednesday afternoon, even from yours truly. Vietnam, according to the blue, white, and mustard placard, charges US exports 90% tariffs. When I saw this and the counter-tariff of 46%, I jumped to my spreadsheet of imports and noted that the US imports some $114,439,000,000.00-let's call it $114.4 billion worth of goods and services from Vietnam annually. That makes it the US's 7th largest individual country trade partner by imports. Larger than India, and far larger than the UK, for reference.

Bet you didn't know that. The reason is simple. For years, US companies moved offshore suppliers away from China into alternative countries, and Vietnam became the beneficiary of that move. There were other local countries that also benefited as well. One of the reasons for the move was that Vietnamese (Vietnam has MFN status) imports were only tariffed at ~3 - 5% prior to Wednesday, while Chinese imports were taxed at far higher rates. Then there is the mother of all international economics concepts of comparative advantage. Vietnam's average hourly manufacturing wage is about half that of China's, and-why not-10% of the US's. So, to make input costs even lower, companies have shifted manufacturing out of China to Vietnam. Even in a world without tariffs, US companies wishing to reshore manufacturing will have to pay 10 times as much for labor. If you are following me, the rough math shows that even the new tariff of 49% will make Vietnamese labor more costly by 44% (49% - 5%, new versus old tariff). Even with the tariff, therefore, Vietnamese labor is still around $5 / hour at the high end. So, while 49% seems egregious, US importers are still likely to maintain their current supply chains. It's just math, silly.

That brings me back to the original question. What are the ends which will justify these means of taxing US companies, because, as I just laid out, if low-cost labor is the comparative advantage, companies will still be ahead by sticking with offshore in most cases. And remember, as I painstakingly laid out yesterday, shifting manufacturing takes costly time and capital investment (factories aren't free ). Now, going back to the fact that Wednesday's new tariffs are technically counter tariffs, the strategy might just be to get those foreign countries to lower their tariffs on US exports. Ok, I get that. So, if Vietnam lowers its 90% (according to the Administration's placard) tariff on US exports to 3%, there would be parity achieved and US producers wishing to export to Vietnamese buyers will experience a windfall of foreign sales growth. I will leave it at that.

Something else continues to vex me. I am still trying to figure out how exactly all the union workers who were so heavily represented at the Rose Garden event will benefit from all this, especially given that most of their employers will now be struggling to make up for their newly borne taxes. Ok, ok, perhaps we are overthinking all this. Is it possible that the President is hoping to remind the world how important the US is on the world economic stage by forcing everyone-everyone, governments, companies, and even everyday consumers to look closely at it, and then swoop in to negotiate better terms for the US? Indeed, that is highly possible given the President's history, and his commentary since the announcement. If that is the endgame, I would be curious what those better terms might be, and even more curious to know how those better terms will benefit US companies.

Now, I am not calling for a recession just yet, but I can tell you that if these tariffs hold and the markets continue to react the way they have, the probability of an ugly, messy recession will certainly increase. Now, here is a warning to you: don't expect the economic numbers to change right away as many companies and even consumers have front-loaded inventories and purchases to get ahead of the tariffs, so we may even witness a surge in consumption before things rapidly decay.

That brings us back to the President's experiment. Perhaps his hypothesis is: H1: economic and stock market performance will not be materially affected by a massive increase in taxes on companies and consumers. Another way of writing that might be, H1: a boat will not sink if a large hole is punched in its hull. In the academic world we would say that the hypothesis is likely to be rejected.

Folks, this is a costly experiment. The costs are being borne by the US economy, your financial confidence, and your portfolio. I can tell you at this point that it will probably get worse before it gets better as counter-tariffs on US exports will start to appear over the next few days, and whether or not all these massive costs will be justified may never be known.

YESTERDAY'S MARKETS

Stocks were trounced in yesterday's session in response to the President's tariff announcement the day prior. The small cap Russell 2000 entered a bear market yesterday after hitting a post-election surge high back in November. Ten-year Treasury yields continued to decline as fears of economic strife picked up-they are below 4% this morning.

NEXT UP

• Change in Nonfarm Payrolls (March) is expected to be 140k versus last month's 151k gain.
• Unemployment (March) may remain unchanged at 4.1%
• Chairman Powell will speak at 11:25 AM Wall Street Time. Expect comments about the latest tariff drama. Fed put?
• Fed speakers: Waller and Barr
• Next week, earnings season starts, and we will get FOMC minutes, Consumer Price Index / CPI, Producer Price Index / PPI, and University of Michigan preliminary Sentiment. Check back on Monday for earnings and economics calendars.

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