I strongly believe it is always important to be aware of-and ideally disclose-our biases. We all have them. It is impossible not to. By ignoring them, either willfully or through ignorance, we allow a blind spot to cloud our thinking. Even with full awareness and disclosure it does not ensure we can be truly clearheaded in analysis, but acknowledgment brings us closer. And hopefully by being open about what those biases are, we can allow others to better interpret our conclusions.
I share this upfront because this month’s Altus Insight bumps right up against a huge bias of mine. Qatari jets, intimidation of judges, dinner with the president for holders of $TRUMP, (not so) random Presidential pardons…it is absolutely disgusting. These strong feelings may well impact my analysis of the tariff situation, though possibly not through being overly critical, but rather in an attempt to not let my anti-President bias create an overly negative interpretation I fear may subconsciously be less critical than I may otherwise be. So, take it all with the appropriate grain of salt.
I know that some readers may be shouting into their screens, “What about the last administration?” A disdain for the action of one, does not excuse the action of another, which is also incredibly disgusting. But those responsible are no longer in power and have no direct role in the current tariff implementations. That said, like the rest of us, they too will be affected by the outcomes of this new world order-well into the future.
*A brief note: This is being written as the courts have deemed-and then un-deemed-many of the tariffs implemented by Executive Order unconstitutional. If the original ruling stands, this entire Insight becomes somewhat academic. But my sense is that these tariffs-especially those targeting China-will end up in place one way or another. There is just too much bipartisan support for a harder line on China. Canada and Mexico could end up being a different matter.
There are no hard statistics I can find indicating how well the U.S. population understands tariffs, but I think it is pretty safe to say more than half of the country can’t accurately describe a tariff. While this is more likely to apply to younger and less educated portions of the population, it is evident from conversations and the reading of articles that many, even in more educated segments of the population, likely also don’t really understand how they work. I am not talking about the outcomes of changes to the tariff regimes-no one can do more than guess outcomes in a global, multiplayer game with this many participants. I’m talking about the direct functionality and impact of the tariffs.
I’m not even convinced the President understands.
ChatGPT doesn’t understand them. I asked it to provide an explanation of tariffs and their impact. Per ChatGPT: Tariffs can be described with a scenario where local orange juice costs $4/gallon while Brazilian orange juice costs $3/gallon. The government wants consumers to drink local orange juice, so it adds a $2/gallon tariff, making the Brazilian orange juice now cost $5/gallon to the consumer.
WRONG! But a common line of thought. Even the President, when referencing how many fewer dolls American children may end up with, echoed this misconception.
Let’s start with defining what a tariff is. Simply, it is a tax on imports. That part is easy. But it is how that tax works and its economic impact which is often misunderstood.
- The impact is likely not as great as everyone fears. According to studies and calculations done by several sources (including the President’s current nemesis Harvard), the new weighted average tariff will be 13%. It was 3% previously, for an increase of 10%. But this does NOT mean that prices will increase by 10% as everyone is claiming. Using a real(ish) life example, the true impact of the 10% increase is much smaller.
Nike shoes are a good product for example:
- It costs Nike roughly $30 for a pair of shoes to be manufactured in Vietnam (Nike’s largest manufacturing base).
- There is another $2 – $4 in shipping and logistics.
- At a 3% tariff rate, Nike pays 90 cents in tariffs.
- Nike would like its gross margins to be around 40%, meaning it would wholesale its shoes to retailers for $58.16.
- The retailer has its own costs and profit margin and sells the shoes for $120 (good luck finding a pair of Nike basketball shoes for $120).
- If tariffs stay elevated at 13%, that adds $3 in extra cost to Nike’s cost of goods sold. Assuming that increase is passed through to the retailer in its entirety (versus Nike compressing its per shoe profitability), and the retailer also passes it entirely to the consumer (versus compressing its profitability), the price of the shoes increases to $123.
- Three dollars on a $120 pair of shoes is 2.5%, just 25% of the headline increase in tariffs.
I don’t want to minimize the impact of a 2.5% increase across all imported goods (again, assuming no margin compression), but it is far smaller than 10%. And that is before businesses adjust their sourcing and shipping methods for tariff efficiency, which is already happening and would/will reduce the 2.5% further.
Further, this increase is not an ongoing impact. The tariffs increase once (big assumption, granted), and the increase in costs passes through, but then it is done. This is very different than a wage-price spiral, though it can’t be assumed it won’t have any part in creating one.
2. The administration’s justification for the tariff increases is ridiculous. As has been discussed in previous Insights, I can get behind pushing for free-or at least fair-trade. Reciprocal tariffs may be a tool in balancing the trade playing field. But that is not what the administration is shooting for. They aren’t trying to level the playing field, they are trying to level trade itself[1], which they are measuring based on trade deficits. But the US has benefited greatly from the trade deficits, not just in lower prices, but also because the current account balance is a very closely related cousin to trade balances. Here is how:
- Trade balance = Exports minus Imports
- Current Account Balance (CAB) = Trade Balance + Net Primary Income + Net Transfers
- Net Primary Income is income earned outside the U.S. and repatriated into the country. No one in the administration, so far as I can tell, wants this number to decrease. In fact, during Trump’s first administration he offered special tax provisions to increase the repatriation of foreign income.
- That effectively leaves CAB = Trade Balance +Net Transfers
- Trump hates a trade balance deficit, but that deficit, by math has resulted in investment into the US from abroad (Net Transfers). That investment has funded innovation (think Softbank) and more generically has pushed equity and bond valuations much higher than they otherwise would be. It is simple supply and demand math. More dollars chasing the same number of investment opportunities pushes the price of those investment vehicles higher. Retired or soon to be retired baby boomers have massively benefited from this in the size of their 401Ks. The government, companies – and yes even real estate investment – have benefited from lower interest rates (interest rates move inverse to price/demand).
- If the trade deficit “improved” from negative to neutral, it would by necessity reduce the amount of foreign investment into the country, which in turn would impact demand for investment assets, thereby negatively impacting asset prices.
There are obviously many more impacts on the final outcomes than just trade balance, and I am not taking a side in what SHOULD happen, but I fear, with good reason, that the administration is not considering the unintended consequences of their actions.
3. Many of the justifications used by defenders of the administration’s actions don’t hold water when viewed through the lens of real-world outcomes:
Claim #1 – The US has lost a huge amount of manufacturing to other countries: Not true-at least not in recent years. Since the Great Recession the population has grown by a little over 11%. Over those same 15 years, manufacturing jobs have increased by over 12%, an outperformance versus the population. Manufacturing revenue meanwhile, has increased well over 50% over that same 15-year time frame. This is not decline. But is it good enough? That is a different question for which I don’t have an answer. But saying they haven’t grown fast enough is very different than saying we are losing jobs. Have jobs been lost? Absolutely. But Joseph Schumpeter’s concept of creative destruction explains how new industries and roles have emerged. What isn’t considered in this argument is the difficulty in manufacturing in the U.S., which is a completely different topic than the workforce itself. You want to start a heavy manufacturing facility? Hopefully you have a decades long timeline before opening your doors, and plenty of money to spend on consultants before knowing if you even have the possibility of getting your facility approved. Then there is the ongoing compliance to the reems of regulations. Other countries (and even parts of the U.S.) don’t have these same constraints. As with water, manufacturing (and the jobs) flows along the path of least resistance.
Claim #2 – “Free” trade has hurt the lower classes while helping the upper classes: There is no question the wealth and income of the upper classes has exploded over the past couple decades. Many of us reading this Altus Insight are beneficiaries of that acceleration. The wealth gap has widened consistently, which we have discussed in previous Insights. But the rich getting richer faster than the poor or middle class getting richer does not mean the poor or middle classes are also not benefiting. And in many ways, and despite my own frustration with the difficulties, technology has reduced the barriers-at least from a capital perspective-of class mobility. Thirty or forty years ago, many people didn’t have air conditioning. Even growing up in a middle-class household, there is no way we could have afforded laptops or cell phones for my siblings and me. Most kids had to work to be able to afford a car. Near-universal access to the internet, affordable electronics, decreased teen pregnancy and drug use, and increased accessibility of eating out and travel… Many of today’s middle-class (and lower) comforts/“requirements” were out of reach just a generation ago.
I am not saying society is better off for all these things (do kids really need cell phones?), but there is no question that nearly everyone in society has niceties that we couldn’t have previously imagined. The issue isn’t that things are worse, it is that they aren’t as good as what we see others have-BY COMPARISON. A problem defined is a problem half solved, but the converse is also true. If we can’t, or aren’t willing, to clearly define the problem, we will be throwing our efforts in solving it to the wind.
Claim #3 – Many imports are a security threat: Uhhh…okay, there is probably some legitimacy to this one.
Complaining about the tariffs (or not, depending on where you land in the argument) doesn’t get us anywhere as investors. But understanding potential impacts is extremely valuable in making our investment allocation decisions. Those impacts aren’t just technical (like the calculation of price increase versus tariff increase)-but also societal. The growing wealth gaps certainly had a part in the election of Donald Trump, just as it almost certainly did in what Peter Turchin coined as the “over production of elites” that played a part in the “Weekend at Bernie’s” action of the previous administration. Both populism and elitism result in every growing whipsaw of government overreach into the private economy, which in turn impacts-or at least should impact-every investment decision each of us makes.
Happy Investing.
[1] The irony of the administration fighting against “equity” in outcomes domestically while fighting FOR equity in outcomes in trade is not lost on me.
