A Closer Look at Tariffs

“THE TARIFF WAR HAS STARTED!  American consumers are going to go broke paying higher prices and inflation is going back up to Biden Administration levels!”

Ok, maybe this is overstating what’s going on.  It could also be downplaying the benefits that could be generated by the current sporadic trade policy of the Trump Administration.  There is no guarantee of any specific outcome at this time – other than we are in for another wild 4 years.  With this in mind, let’s take a deeper dive into tariffs – what they are, why they are used and potential pro/cons of these strategies.  Brandon and I will be doing a podcast on this same topic next week.

The Oxford Dictionary defines a tariff as “a tax or duty to be paid on a particular class of imports or exports.”  There are two types of tariffs; 1) Specific – a fixed fee based on an item ($500 levy on each car) or 2) Ad Valorem – a levy on the value of the item (a 25% tariff on import value = $4 item means $1 additional tax).  The most basic strategy is to increase the price of goods/services purchased from another country, making these goods/services less attractive to domestic consumers which would theoretically increase the production of these goods/services by domestic companies.

Sounds straight forward, right?  The US imposes tariffs to encourage domestic production and increases manufacturing jobs and wages for US citizens while increasing tax revenues from foreign companies.  In a perfect world where the US can produce all natural resources needed for the creation of the goods/services demanded by US citizens the use of tariffs would work this way.  However, we don’t live in this perfect world.  Thanks to technology, the world economy is more intertwined than it has ever been.  When you go to Amazon and order an item, it might take you (literally) 5 minutes to shop/order/pay – and less than that if it’s a repeat item – without ever leaving your kitchen.  Few consumers research the origin of the item beyond the price and potential quality.  This has created a consumption economy that depends on goods being created throughout the world but available 24/7 for next day delivery.

So how does a tariff work in this imperfect world?  First, understand that the rest of the world has had tariffs on US goods for decades.  China has imposed tariffs on over $110B out of the annual $131B US goods imported into their country.  The EU?  According to TARIC (the EU Taxation and Customs Union) there are over 58 classifications of tariffs on foreign chemicals (pharmaceuticals) and 200+ on animals/animal products alone*.  So, prior to Trump’s imposition of new tariffs, US companies were already limited by the strategy of making US goods less attractive to local consumers.  A few reasons the tariffs haven’t created constant trade wars are that there are usually carve outs for essential industries, some goods/services are better produced near to the resources needed for production, and cost benefits of offshore production can make up for the increased tax burden.

An example of the integration of economic activity is crude oil traded between the US and Canada.  While the US became “energy independent” in 2020, we still import crude from our Northern neighbors.  The oil the US produces is lower density (sweet or low sulfur) grade crude, which is easier to refine and commands a higher price overseas.  American refineries are tooled to process heavier/dirtier grades of crude produced by Canada.  US refiners could reconfigure facilities, but the costs of downtime and capital would be extreme.  It is simply cheaper and more profitable to import the crude from Canada and export the crude produced domestically.  How high would the tariff have to be to make it beneficial to change US refineries, and at what cost to consumers?

How does all this play into the current “trade war?”  Potential benefits to the tariffs imposed by Trump could be more domestic manufacturing, higher tax revenue from foreign parties, and a stronger US dollar.  Potential consequences are higher costs to US consumers, increased inflation, and more geopolitical chaos.  Currently, when GM makes a single car, it may cross the US/Canada/Mexico border multiple times during production without tariffs being imposed.  If the 25% tariff goes into effect, each crossing of the border would increase the price of the car to end buyer.  Will consumers pay more for the exact same car for a theoretical perfect world of complete domestic production?  Does GM have the capacity to build the car completely in the US?  Many companies did bring some production to the US after the tariffs during Trump’s first term but not all.

Financial analysts have no more certainty than the average investor.  Some believe the entire “trade war” is a bargaining tool to improve US trade positioning.  It is true that China puts extreme pressure on other countries by creating cheap exports while increasing costs on imports.  Will new tariffs open that market more than those that have been in place for years?  Are Americans willing to pay more for a happy meal while we find out?

In any case, investing in quality companies that have the financial ability to make it through this uncertainty is more important than trying to be right on all of the potential issues.  We plan on being flexible in our investing to take advantage of opportunities, but we are not willing to increase the risk to clients without corresponding benefits.
 
Written by Sean Budlong, CFP®, AAMS, Chief Executive Officer, Majestic Financial, Financial Consultant, RJFS
 
Disclosures: Any opinions are those of Sean Budlong and not necessarily those of Raymond James. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Every investor's situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Prior to making an investment decision, please consult with your financial advisor about your individual situation. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct.
*Source (AP News, “China counters with tariffs on US products”, 2/4/2025)