Making Sense of the Tariffs

On April 2nd, Trump announced 10% universal tariffs on all imported goods. Then he announced “reciprocal” tariffs on countries that have high tariffs against the US.

The definition of reciprocal means one country matches tariffs imposed by another country. This approach to countering tariffs imposed on us makes sense, except that’s not what Trump’s new tariffs are. They’re a calculation that weighs the trade imbalance the US might have with another country.

When someone says “reciprocal”, there’s an expectation the action matches the words. The list of countries that Trump held up during the announcement weren’t calculated as reciprocal. Yes, countries have tariffs on US goods, which we think should come down. All the US had to do was match those tariffs. The negative reaction from the market came from the oddball calculation that said Vietnam has 90% tariffs on US goods (they don’t). The tariffs announced were significantly higher than what “reciprocal” suggested. The market was thinking one thing and got slapped in the face with a hot poker.

The market sold off sharply due to this negative surprise. The S&P500 was down 5%, the Nasdaq 100 was down 6%. This was the steepest one day sell-off since Covid. The Nasdaq is currently in bear market territory (20% down) and the S&P500 is 4% away.

Surprised? Trump has been saying this would happen. But did he?

Prior to the announcement, the market was ready for reciprocal tariffs, not the figures on the list above. The tariffs on the list include a trade imbalance between that country and the US. Say Vietnam imports 10% of US goods while exporting 90% of goods to the US. That’s where Trump got his tariff data for his chart. The imbalance is due to Vietnam being not as rich as the US so they simply buy less US goods. They consume less in general.

But Vietnam’s tariff rates on US goods is 9.5%. A reciprocal tariff would be 9.5% on Vietnamese goods. Makes sense. Below is the snippet of the trade agreement.

Vietnam would have to commit to buying a lot more of US made goods, a scenario the Vietnamese consumer cannot afford to do. They’re a poorer country that can’t match how much the US buys and consumes in Vietnamese goods. Their economy relies more on manufacturing and exporting. Of course there’s going to be a trade imbalance.

Those other countries will pay the tariff.

Tariffs are taxes on the importer. If that importer has any pricing power, they’ll raise prices on the end consumer. Ideally, they’ll want the consumer to pay the entire tariff. It is estimated that imported cars would increase in price by as much as $20,000 if tariffs are completely passed onto car buyers.  

A lot of people don’t know what a tariff is because they’ve never had to really deal with it. The US had been less reliant on tariffs since the 1930s as income tax had gradually replaced the tax as a revenue source for the federal government.

Say Walmart imports $100 worth of goods, if there’s a tariff of 10%, Walmart will pay $110 to bring those goods into the country. Walmart can then sell those goods for much more than $110, if they can. If that’s not possible, they’ll eat the increased costs. If the costs persist, there’s a possibility that Walmart will no longer import that good.

The Trade Deficit

The trade deficit means we import more foreign products into the US than we export out. The trade imbalance has been an issue since the 1980s. We don’t make stuff anymore! At the risk of sounding like the crazy uncle at Thanksgiving, “we don’t make stuff anymore”.

US companies have offshored production where labor costs are a fraction of the average US worker. The US consumer has fallen in love with cheaper goods. The stock market rewards businesses that can reduce operating costs, ie, labor and wages. If jobs weren’t being offshored, they were being automated away.

How do we move forward from this?

It does help to look back to 2018 where tariffs were announced, and the US-Mexico-Canada trade agreement soon followed (USMCA aka NAFTA 2.0). The market recovered within weeks and was on the way to recording one of the best years in stock market history.

If long-term investors look at this opportunistically, there could be a repeat of the same market reaction and recovery. Note that history doesn’t always repeat. The wound is self-inflicted and the best way to fix it is to reverse the policies that got us here in the first place.

While we support the idea of reviving American jobs, there’s probably better ways to approach this with the companies and countries providing cheap labor to make our goods. Fully onshoring production will take time and the price of goods will need to be higher to sustain the higher wages.

While we don’t know how it will all shake out, there are benefits to buying assets lower as opposed to higher. Given enough time, markets tend to move up.

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