Trump’s Tariff Playbook: Bold Strategy or Inflation Trap

Tariffs are a trade tool, but they're not cost-free. Understand why companies and consumers ultimately bear the burden.

Alternate facts return. Well, my friends, today is the last trading day before Donald J. Trump gets sworn in as the 45^th President of the United States. Traders have been exhausting quite a few calories trying to factor in what number 45 will actually do and what the implications might be for the economy, the markets, and… um… the world. The Wall Street Journal reported WHILE YOU SLEPT that Trump has allegedly prepared 100 executive orders for his first day in the Oval Office. Additionally, it is reported that Trump has warned his Congressional party members that he will act without them, putting them on notice. Now, I think it is fair to assume that no matter how many orders get signed, that some will get signed, indeed, and that there will surely be some adjusting by the markets in the days that follow the inauguration.

While markets have most likely factored in the worst-case scenario at this point, most traders are probably building in a bluster-factor based on Trump's dealmaking style. What does that mean? It means that the market has assumed the "worst", but it could get worse yet if Trump changes his strategy, which is likely, if not probable. That is just a round-about way of me saying, buckle up.

At the center of all the debate is the question on tariffs. Though the debate died down for a few weeks, it has raged back in the past few days as Canada sort of leaked a list of counter-tariffs on the US, should Trump slap his northern neighbor with fresh tariffs, as promised. Regardless, as I have been saying for months now, all we can do is wait and see what happens on January 21^st, which, last year, sounded like a long way off, but here we are, and it's… um, Tuesday.

Earlier this week, I penned a note on inflation at a lemonade stand. The conflict, or plot driver to my story was a tariff, which caused the lemonade maker to have to raise prices to cover the increased cost. I thought that it would be my last comment on tariffs before Trump 45 took Sharpie Marker to order on Tuesday, but alas Scott Bessent changed my plans.

You may remember back when Bessent was first nominated by Trump to be his Treasury Secretary, the markets had a very positive reaction to the choice. Bessent is viewed by Wall Street as someone who may provide counsel on moderation when it comes to tariffs. Well, yesterday, Mr. Bessent, who is expected to get confirmed, was, unsurprisingly, questioned on tariffs. He said something to the effect that tariffs used to be normal in the olden days, like before World War II. Back then, the US used the tariffs as a source of revenue. I am chuckling. Why? The revenue could not have been much back then, because the US was far less reliant on foreign goods than it is today. Therefore, the impact on the US economy would have been less invasive than it would today.

Now, the debate about tariffs has two very clear sides. Those that believe tariffs are inflationary, and those that are trying to convince the other side that they won't. I feel like now is a good time to, very simply, set the record straight on tariffs. Pay attention.

Tariffs are paid by the importing company not the foreign exporter or foreign government. If you import lemons from Mexico, you will pay YOUR government the tariff. Read that again, then let's move on. That is why the domestic business will have to raise its prices to consumers to cover the increased cost. Now, I realize that companies can choose to eat the cost, but I think it is fair to assume that they won't… if they are rational. Now take a breath and listen carefully. If tariffs are being used to exact pressure on foreign governments, THEY ONLY WORK IF PRICES GO UP AND CONSUMERS BUY LESS IMPORTED GOODS, otherwise they will have ABSOLUTELY NO IMPACT ON THE ADVERSARY.

If I am wrong about most companies being rational and they, all of them, opt to eat the increased cost, then the only effects of the tariffs will be lower profitability for US companies. That would not be desirable, would it. It is certainly not what the incoming administration is hoping for. Are you following me so far? Consumers are going to ultimately pay for some or all of the tariff costs. But wait, Scott Bessent is a smart guy, he reads economics papers like us, and he flexed some of his economics prowess yesterday in front of lawmakers.

He told senators that tariffs would not cause prices to increase, because currency strength would offset the out-of-pocket expenses. Oh, ok, so we are good then, right? Nope. First of all, this effect is well known to economists, but let's have a look at this assumption. If the US Dollar strengthens against its trade partners, indeed the cost of imported goods becomes cheaper. HOWEVER, Scott, that only happens as a result of lower demand for the foreign currency used to purchase the foreign goods. That diminished demand only happens if consumers buy less goods domestically as a result of increased prices induced by tariffs. At the end of the day, someone has to pay the tariff. Whether it is the company or consumer. The only relief from currency strength will come if consumers decide to forego purchasing foreign goods.

Going back to the top and the US consumer's reliance on imports. It is not just sneakers made in China or Mexico. Many products that go into the products from domestic companies are made from components that are imported. I will give you just one random example. General Motors, the iconic Detroit Michigan automaker, gets 72% of its supplies from non-US domiciled companies. Would you believe that 21.2% of GM's suppliers are in China, Mexico, and Canada? They will all be subject to tariffs. That means that GM itself will get the tax bill from the US Government. Will GM eat the tax, or pass it along to you when you go to buy your next car? I will let you decide.

Finally, I want to make it clear that I am not strictly opposed to tariffs. They are a very credible tool to be used to extract concessions in trade negotiations. However, I would be more comfortable it everyone would stop trying to 'splain that they do not come without a cost, and that the cost will not end up on yours and my tab. Finally, there is one scenario where the pain can be avoided. If companies and consumers substitute all foreign-made products and components with domestically produced ones. That would be fantastic and an all-around win for the US. That could certainly happen, but it will take a long, long time to get there… you know back to where we were pre-World War II. There you go. Record set straight.

YESTERDAY'S MARKETS

Stocks struggled to stay afloat yesterday with indexes ultimately closing in the red. Though young, earnings season has so far been on or better than estimates, though market reactions have been muted. Retail Sales for December underwhelmed with less spent in food service and building materials.

NEXT UP

• Housing Starts (December) ­may have increased by 3.0% after sliding by -1.8% in November.
• Building Permits (December) are likely to have declined by 2.2% after jumping by 5.2% in the month prior.
• Industrial Production (December) is expected to have climbed by 0.3% after a 0.1% slip in the prior period.
• Next week: Donald Trump will be inaugurated Monday while markets are closed for Martin Luther King Jr. Day. Though markets will get a day of rest, you can be rest assured, that there will be no rest for Wall Street as all eyes will be on the day's events. From Tuesday on we will get a barrage of earnings along flash PMIs, Existing Home Sales, University of Michigan Sentiment, and regional Fed reports. Check back in on Tuesday to download your weekly calendars and get the latest insights.

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