US Tariffs Are Always Taxes on Americans and are Inflationary

Now that the re-ignition of inflation is becoming somewhat more common talk around town, as anticipated here, let’s take a brief look at what Trump’s tariffs are likely to do to inflation down the road.

I will start with an article below that sounds like it is written by a Trump apologist as it lays out the natural counter forces that will help scale back the impact of Trump’s proposed tariffs on the rise on prices. The author is right to note that there are certainly counterforces that are corrective in nature that have to be factored in, but his thinking seems a little incomplete to Trump’s benefit.

Here are the counterforces he lists, after quoting a number of big names that say Trump tariffs will raise inflation higher:

If the price of an imported good increases due to a tariff and the company selling the good commensurately increases the price, consumers respond in three ways.

• Some consumers will decide not to pay the higher price and purchase a substitute good.

• Others decide not to pay the higher price or buy competing goods and save their money.

• Another group of consumers will pay the higher price, leaving them with less money to buy other goods.

Consumers buying a substitute good at a lower price will shift the composition of the inflation basket of goods, minimizing the impact of the tariff. 

Saving, thus not spending, will reduce economic activity, which is deflationary, as we will discuss when we consider how sellers might react to tariffs.  

Some consumers will pay higher prices. While this is inflationary for the tariffed item, the consumers have less money for other items, which is deflationary for those goods.

While the prices of the tariffed item and substitute items may change with demand preferences, the net effect after re-weighting the inflation basket and accounting for any broad economic impact will be minimal.

It is on the first counterforce where his thinking stops short. Yes, consumers will shift to items with lower prices. In fact, that is often the reason tariffs are used—not to raise government revenue but to shift consumers away from foreign products and back to domestically produced items or services by forcing the price of the foreign goods a lot higher.

While the author of the article is correct to say consumers shift to items with lower prices, there are two things to note: 1) The prices they move to are not lower than what those same prices were before the tariff; they are merely not elevated by the tariff, so shifting to them has no counter effect of lowering inflation. In fact, The products they shift to were likely already more expensive than the foreign ones they were buying because the big reason we buy so many Chinese products, for example, is that they are a lot cheaper. That shifts the weighting in the basket to products that were originally more expensive goods, increasing the impact of those goods on CPI. 2) The bigger point that he leaves out is that shifting to particular domestic items will raise the price of those domestic items.

That’s a simple supply & demand equation: Increase the demand while limiting some of the foreign competition, and the prices of the alternative domestic products or services will rise because the producers of those products or services now have more latitude to raise prices and are even pushed to because 1) the products and services of their main competitors for those customers who are now pressured to leave items that originally had lower prices suddenly cost a lot more, giving the domestic producers more headroom to raise their own prices; 2) it may be hard to increase domestic supply of products (and especially services, such as say an answering service, which tend to be more labor-intensive) rapidly to meet the new demand for the domestic alternatives. That will likely raise the producer’s costs to ramp up production or hire more service people. 3) Many of the parts that go into making the domestic products were imported and now are more expensive for the domestic producer because those parts have new tariffs, too.

In other words, when you raise the cost of cheaper foreign goods with tariffs, it not only pushes consumers to products that, in many cases, were actually already more expensive (which they were avoiding by using cheaper foreign products), giving those products and services a bigger share in the basket of goods and services being measure by CPI, but it raises the production costs of those alternative domestic products in order to ramp up supply while it also takes competition away that was helping dampen their prices.

So, it is likely to be significantly inflationary for the very reason he states it will be fairly neutral.

We agree on the effects of the second counterforce he mentions. Saving by just not buying anything is disinflationary, maybe even deflationary. So far, however, we have seen consumers ramp up credit rather than buy less, making this effect negligible at present; but we may be coming to the end of their ability to do that.

On the third counterforce, he’s probably right that continuing to buy the more expensive tariff item will leave those consumers with less money to spend on other things, which could be disinflationary for other things. However, it is the first supposed counterforce where I think we’ll see the most upward pressure on prices.

There is, however one other factor related to that first listed counterforce that he also doesn’t mention. Taking a large number of goods out of the market that are produced oversees when domestic suppliers cannot ramp up production or available service quickly enough, means we will see product shortages again just as we did when the lockdowns of ports took foreign products off shelves. Domestic producers could not keep up. Of course, they had their own Covid lockdowns to deal with that they won’t have this time; but they will still likely not ramp up enough to make up for missing supply. Nothing spells rapid inflation like a shortage creating scarcity.

The great recessionary counterforce to inflation

Now, on a later part of his article where he lays out the likelihood that tariffs will slow economic activity and take us into a recession, we agree (though I’d say, of course, “deeper into recession than we already are.”) And a deep recession will typically, at some level of depth, start to become deflationary like the Great Depression. I doubt anyone would like to live through another depression any better. This happens because the other side fights back:

In 1930, Herbert Hoover signed the Smoot-Hawley Tariff Act into law. The timing could not have been worse as the world was entering the Great Depression. Smoot-Hawley was intended to protect American jobs and farmers. The reaction from our trade partners was retaliatory tariffs on exported US goods.

US imports and exports were reduced by more than 50% within four years of the Act’s passage. Many Great Depression scholars blame the tariffs for playing a substantial role in amplifying the scope and duration of the Great Depression. The US paid a steep price for trying to protect its workforce through short-sighted political expedience.

Of course, we learn nothing from history. So, we may leap out of the frying pan of inflation because of a depression but that would put us into the furnaces of hell that burn up livelihoods and even lives.

Take it from those who know where the rubber meets the road

Let’s look to one of the nation’s largest discount-price retailers because Walmart, if any business, should have a clear idea of what will raise prices, since they are all about keeping prices lower than their competitors via large volume, and they do a lot of buying of items that will be hit by tariffs.

Walmart issues dire warning to customers about prices

Walmart is telling customers that prices of some items could rise in their stores if President-elect Donald Trump's plan to hike tariffs takes effect….

'We never want to raise prices,' Walmart CFO John David Rainey said on the earnings call on Tuesday. 'Our model is everyday low prices. But there probably will be cases where prices will go up for consumers….'

He added that about two-thirds of the items the big-box retailer sells are made, grown or assembled in the United States.

That means all of those goods wouldn't be subject to the Trump tariffs, which many economists believe will reignite inflation.

Except that their prices might rise because their competition is effectively eliminated. Competition holds down prices. Plus many of those products incorporate some foreign parts or foreign raw materials, so their prices are likely to rise, too.

'We've been living under a tariff environment for seven years, so we're pretty familiar with that,' he said. 'Tariffs, though, are inflationary for customers, so we want to work with suppliers and with our own private-brand assortment to try to bring down prices.'

In other words, under the current Trump tariffs, which Biden continued, Walmart has gained seven years of experience in what it takes to try to manage prices for minimum tariff impact. With that experience under his belt, he’s telling all his customers that some prices will rise (and he’s not even hinting that some others may fall). He knows from hard experience that tariffs are inflationary and says so quite plainly. And this is from a company that thrives on promising lowest prices. He said this in his report to shareholders, who are not likely to reward that news either.

To top it all off

Trump is proposing a sweeping imposition of tariffs far greater than what he did in his first term as a means of raising revenue in order to cut other taxes (and tariffs are taxes on Americans, no different than a selective sales tax). That will eliminate a LOT broader competition and cause much higher shortages than the original tariffs were seen to cause (well before Covid came to town). We should all be able to remember the major supply-line problems, even for domestic producers, we had because of those tariffs, creating production delays and shortages well before Covid. The shortages due to supply line problems were all over the news more than a year before Covid hit, and that was a far narrower swath of tariffs than Trump is talking now.

I can’t think of any protectionist period where wholesale implementation of tariffs made for a more vibrant US economy.

And, no, China does not pay for them, anymore than Mexico bought us a wall! Import tariffs and export tariffs are paid directly by American businesses. To some extent American businesses may be able to pass some of each import tariff on to someone other than their own domestic consumers by asking their Mexican suppliers to reduce their prices enough to compensate for the added tariffs. However, most Mexican businesses did not lower the cost of the items they were selling into America nearly enough, if at all, to offset the tariffs.

Likewise, American exporters may try to have Mexican buyers pay the tacked-on tariffs, which the American businesses must pay to the US government, whether they collect them or not. However, they didn’t prove very successful in doing that with the original Trump Tariffs. When Trump added export tariffs to American beef producers selling to Mexico and the American beef producers tried to pass that cost on to Mexican buyers as an addition point-of-sale tax, the Mexican buyers said, “No thanks. We’ll just buy all of our beef from Argentina in that case.” And that’s what they did because Argentine beef suddenly became a lot less expensive than buying American.

If you thought loss of business and shortages got a little crazy under Trump Tariffs 1.0, wait until you see what the vastly larger Trump Tariffs 2.0 does throughout the US economy. It could shock the system pretty hard.