The Trade War Begins

Thoughts on Tariffs, Economic Certainty, & More

Well, the first skirmishes of the new trade war are done. To recap:

On Friday, the Trump administration announced they’d be slapping 25% tariffs on Canadian and Mexican goods, a 10% tariff on Canadian energy products, and additional 10% tariffs on Chinese goods.

Those tariffs were set to go into effect today, but eleventh hour meetings between Trump and his Mexican and Canadian counterparts got the tariffs on our North American neighbors delayed for 30 days (the Chinese tariffs are now in effect).

What we gained:

• Mexico is sending 10,000 National Guard troops to the border.

• Canada will appoint a Fentanyl Czar, list cartels as terrorists, and do a few other things in that vein. They also said they’re implementing a $1.3 billion border plan, but that was actually announced in December.

What we lost:

• China retaliated with 15% tariffs on U.S. coal and natural gas and 10% tariffs on crude oil, agricultural equipment, and certain vehicles (going into effect February 10^th).

• Business certainty took a hit. It’s difficult to commit to large capital investments when you don’t know what trade policy will look like in 30 days.

• The S&P 500 is down about 1.5% since the announcement on Friday. That’s not insignificant, but it’s also not as bad as many feared.

• Anyone who had to make sense of these tariffs (like manufacturing managers or, you know, newsletter writers) had to work over the weekend.

The Big Question

But why, though?

We’ve gotten lots of justifications, from drugs to immigration to trade imbalances to wanting to make Canada the 51 state, none of which are particularly compelling.

These tariffs, or tariffs threats, or whatever you want to call them, just don’t make much sense. The typically pro-Trump Wall Street Journal editorial board called it The Dumbest Trade War in History, and not only because it violates the USMCA trade agreement that Trump himself negotiated. As economist Tyler Cowen explains, “there is not any good argument for doing this.”

But No Need to Overreact

Yes, these trade wars are economically harmful. But they’re not cataclysmic. Predictions of economic ruin, aside from being inaccurate, don’t help the situation.

Still, “not cataclysmic” doesn’t mean “good,” and even the ongoing threat of tariffs will weigh on economic growth.

The Basics

U.S. tariffs are a tax on Americans. It works like a sales tax, except instead of the store collecting the tax, the importer has to calculate and pay it when the good crosses U.S. customs. Currency effects will mitigate some small portion of the tariffs, but only a small portion. If there’s a 25% tax on buying Mexican avocados, the price of avocados is going up.

Consumer Impacts

The Tax Foundation estimated that these tariffs—had they been implemented and stayed in effect until the end of 2025—would cost the average U.S. household $830. The Budget Lab estimates these tariffs would result in a $1,000 decrease in purchasing power per household as a result of higher prices. That’s tough, especially for lower income households.

Energy Impacts

It’s nice that the White House was going to put a lower tax on Canadian energy imports (a tacit acknowledgement that tariffs do, in fact, raise prices), because U.S. and Canadian energy infrastructure are inextricably intertwined. “Companies have invested billions integrating the two countries’ oil infrastructure. A network of pipelines and storage tanks bring millions of barrels of oil from Canada down to the U.S. Gulf Coast every day. The countries — and especially their fossil fuel industries — are interdependent.” Notably, even U.S. oil producers oppose tariffs on Canadian oil.

So these 10% tariffs on Canadian energy products would raise fuel prices—diesel, gas, propane, etc.—in the Midwest, Great Lakes, and northeast. The best estimate I can find puts the short term increase somewhere between $0.05 and $0.20 per gallon. Again, not catastrophic, but also not necessary.

Manufacturing Impacts

One pro-tariff argument is that it will help U.S. manufacturing. And for certain manufacturers, like this steel plant in Baltimore, that’s probably true!

Outside of a few favored industries, however, tariffs hurt U.S. manufacturers because about half of all U.S. imports are inputs to manufacturing. Further complicating matters, the U.S. makes a lot of parts that are shipped to Canada or Mexico, turned into a finished good, and then shipped back to the U.S.

“On average 50% of the content of the vehicles built in Canada originates in the United States, and on average about 35% of the content of all vehicles assembled in Mexico originates in the United States.” That’s from a comment submitted by American Automakers regarding Trump’s USMCA.

Construction Impacts

To the extent these tariffs help specific U.S. manufacturers, like that steel plant in Baltimore, they’ll hurt downstream industries like construction (or automaking). The 2018 steel tariffs, for instance, reduced production in downstream industries by about $3.4 billion each year (construction accounts for about 47% of all steel consumption). Another estimate finds that downstream industries paid about $650,000 extra in steel costs per each job created in the steel industry as a result of the tariffs.

Note that annual construction spending is about $2.2 trillion. So $3.4 billion isn’t a particularly large reduction—and that’s in all downstream industries, not just construction—though the 2018 steel tariffs were small and concentrated compared to this current salvo.

For the residential side of the industry, higher lumber costs will suppress construction activity. In an open letter to the president, the National Association of Home Builders wrote: “While home building is inherently domestic, builders rely on components produced abroad, with Canada and Mexico representing nearly 25% of building materials imports. Imposing additional tariffs on these imports will lead to higher material costs, which will ultimately be passed on to home buyers in the form of increased housing prices.”

Because we already had 14% tariffs on Canadian lumber, this would bring the total rate to 39%. About a quarter of all lumber used in the U.S. comes from Canada.

Final Thoughts (at least until 30 days from now)

It’s good that the tariffs on Mexico and Canada were delayed. It would be better if they were never threatened in the first place. The business community supported Trump because of his business friendly policy stances, but businesses need policy certainty to thrive.

Just ask JPMorgan, who is now wondering: “Is this a business friendly administration?” The U.S. Chamber of Commerce echoes that question.

While the trade skirmishes with China continue, we have 30 days to get things sorted with Canada and Mexico. A long-term truce would go a long way toward improving economic certainty.

What’s Next

This week is jam packed with economic data releases, including on construction spending, jobs, and a bunch of other topics. We’ll cover all that and more, and update the tariff situation if necessary, in our next every-Friday Week in Review post. That’s only for paying subscribers. If that’s not you and you want it to be, just click the button below: