Tariffs Won’t End Our Trade Deficit

They're a Blessing Given the Real Curse. My Column with my BU Colleague, Tarek Hassan.

President Trump knows he’s brilliant. How? He told himself. Knowing he’s brilliant, he just tripled down on stupid by placing 25 percent tariffs on Canada and Mexico and raising the tariff on China from 10 to 20 percent.

The Wall Street Journal’s editorial board called the tariffs “The dumbest trade war in history.” Who’s next? Surely the EU and, perhaps, the UK. Collectively, today’s and tomorrow’s actual and likely tariff targets account for some two thirds of total U.S. imports.

Canada, Mexico, and China immediately retaliated. Export tariffs are also in the works. This means imports will cost even more, which means even greater pressure on prices. Based on last month’s BLS data, inflation is running at 4.25 percent on a prospective annual basis. According to BBC reporting, the tariffs could kick up inflation over the next year to 5.25 percent. As for consumer goods, we could see 6 percent inflation. This estimate doesn’t include Trump’s impending 25 percent tariff on European imports. Nor does it include the inflationary impact of retaliatory tariffs on U.S. imports.

Altogether, we may be facing 7 to 8 percent inflation over the next year. Then there’s the potential for voluntary boycotts of imports from the U.S. and embargo of exports to the U.S. Buy Canadian is already a thing. Sell anywhere expect the U.S. is not far off.

Theoretically, tariffs produce one-time impacts on prices. But, in practice, inflation gets embedded in everyone’s head, particularly those of our close to 20 million company presidents individually setting prices. Many firms are adverse to taking frequent price increases for fear of undermining customer loyalty. Hence, they will overshoot inflation, potentially by a lot, knowing they can’t take another bite of the apple for, potentially, several years. Add to this the Federal Reserve’s likely raising interest rates to try to limit inflation and we have all the ingredients for stagflation — high inflation and slow growth, if not a recession. We saw this movie in the late 1970s and early 1980s and it wasn’t pretty. This is why the stock market has already given up all its post-Trump election gains and why economists are now warning about a downturn.

Note. No one can predict the stock market. It changes, from second to second based on new news, which, by definition, is unpredictable. But when times get riskier, economics says head to safety. The Vix — the measure of stock market uncertainty — is up 40 percent since the election. One means of lowering your risk is purchasing inflation-indexed bonds, particularly in tax-advantage retirement accounts that limit being taxed on the inflation protection provided by TIPS (Treasury Inflation Protected Securities). The 30-year TIPS yield is currently above 2.2 percent, which is quite high, historically speaking. (This column on building a TIPS ladder using my company’s MaxiFi Planner software may be of interest. )

A Massive, Not-So Hidden Tax

Our Economist in Chief, President Trump, claims tariffs are beautiful because they are paid by foreign exporters. Were that the case, the exchange rate with these three countries would have dramatically depreciated. Had Canadian dollars, Mexican pesos, and Chinese yuan become 20 to 25 percent cheaper to buy with our greenbacks, we’d be able to import from all three countries at the same dollar cost despite the tariffs.

But the three exchange rates have hardly budged since Trump’s election. Hence, in a single pronouncement, with neither advice nor consent from Congress, Trump not only ignited a trade war. He also levied a massive tax on the American public. How large? The Tax Foundation’s estimate is $142 billion or over $1,000 per household. And this doesn’t factor in the damage to American exporters, including the 10 million workers in our export industries.

Unfortunately, the story is worse. Unless our economy saves more, which isn’t unlikely, our trade deficit won’t budge. Here’s why.

My Column with Boston University Economist, Tarek Hassan

The President is obsessed with our large trade deficit. He tried closing it with tariffs in his first term. He failed. He’s trying again – with 25 percent tariffs on all Canadian, and Mexican and 20 percent on all Chinese imports, not to mention 25 percent tariffs on steel and aluminum imports regardless of origin.

The President thinks the world is taking advantage of America – by selling, not buying. Economics tells a far different story.

The U.S. is a haven for investment thanks to our financial and technological dominance. When foreigners invest in our country, their financial investments translate into physical investments -- more factories, equipment, technology, residential real estate, etc. The physical investments lead to increased imports of capital goods and technology.

Imports, of course, mean a larger trade deficit. But that’s a good thing. U.S. workers have more capital with which to work, making them more productive. This spells higher wages. Consider all the physical investments Mercedes Benz has made in Vance, Alabama to build a fleet of cars and SUVs. Much of that capital came from overseas. The rest, “made in America,” is chock full of imported components.

U.S. labor productivity is a major concern. It grew at just 1.5 percent per year, on average, over the last decade. That's better than the 0.8 percent recorded in Europe. But it's far below the 7.4 percent reported by China. It's also below the 2.2 percent rate we averaged over the Post War. Keeping foreigners from investing here, i.e., bringing their physical capital here, will lower our productivity growth even further.

Of course, we import consumption as well as investment goods. Walker’s All-Butter, British shortbread cookies, are an example. They are only good for the eating. Our imports of All-Butters and all manor of other consumption goods reflects just one thing -- our paltry national saving rate. In the 50’s and 60’s, we saved 14 percent of national income. Today we save 3 percent.

Yes, we can impose huge tariffs on consumables, but unless we consume less, in total, and save and invest more, in total, our trade deficit won't budge.

How so?

If we import fewer All Butters, our companies will produce more cookies and other consumption goods to satisfy higher demand for domestic cookies. Consequently, they will make fewer capital goods. This means more capital goods will be imported to keep total investment in the U.S. unchanged – at the level foreign investors set. And if we make more capital goods and fewer consumption goods, more consumption goods will be imported to satisfy our insatiable national appetite. Yes, the composition of imports will change, but not their overall amount.

The only way to lower our trade deficit is for our country to spend less and save more. This is International Trade 101. The only way tariffs will lower our spending is by raising prices and hitting Americans with a hidden tax. Of course, President Trump says this won’t happen. Foreigners, not Americans, will, in his mind, see their living standards fall. He has an active imagination.

Ironically, the only way Trump’s trade war will reduce our deficit is by hurting Americans enough to lower their spending. But even this won’t raise national saving if the trade war triggers a recession. Saving, as every economist, particular the Chief Economist, knows, is income minus consumption. If a recession reduces income by as much as consumption, the trade deficit won’t fall. And if a recession lowers income by more than spending, Trump’s tariffs will raise our trade deficit!

Regardless of the ultimate impact of tariffs on our trade deficit, President Trump's claim that foreigners are taking advantage of us by selling us more than we sell them is groundless. Foreigners are investing in the U.S. like crazy for a simple reason – we are saving next to nothing and leaving foreigners to take advantage of our nation’s terrific investment opportunities.

Why don't Americans save? Simple. Our politicians buy votes by cutting taxes and raising benefits, leaving voters with more disposable income to spend. Thus, our huge trade deficits reflect our massive fiscal deficits, including the growing, off-the-books obligations to cover Social Security, Medicare, and Medicaid benefits.

If the federal government was the big spendthrift, firing federal employees, freezing federal grants, and shuttering federal agencies would make more sense. But government consumption as a share of national income has stayed put at roughly one fifth for 75 years. In contrast, household consumption has risen from 66 percent of national income -- in the Fifties and Sixties, to 77 percent today. Hence, the problem is too much private, not too much public spending.

As explained here, it’s the spending of older generations — the ones who are free to vote on election day — that has risen most rapidly. Indeed, in 1965, 70 year-olds consumed, on average, roughly 10 percent less than 40 year-olds on aveage. Today, they consume roughly 30 percent more. This reflects our ongoing systematic redistribution from the young to the old via take-from-the-young-and-give-to-the-old entitlement programs, tax cuts that leave larger official debt for young and future generations to cover, and a shift in the tax structure that favors asset income, primarily received, relative to wage income, primarily received by the young.

Trade wars and sledgehammering Uncle Sam are destined to do terrible economic damage but do nothing to address our nation's major economic problem -- We spend too much.

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