As I write this on Sunday, the DOW is poised to lose another 1,500 pts at the opening on Monday morning, on top of the 4,000 points lost in 30 hours late last week.
If there is anyone out there who still does not understand how tariffs work, or if someone you know still doesn’t understand, I submit this simple explanation.
Mr. Trump and his top Trade Advisor, Peter Navarro have each gone on TV in recent days to “remind” Americans that the tariffs that are being imposed on foreign companies will actually be “eaten” by those companies, and, effectively by those foreign countries.
It always gets under the skin in my lizard brain when people who obviously know better use these statements to attempt to con their supporters, and other less well-informed citizens.
So, once more, this is how tariffs work.
Let’s say you are in Italy (great food and wine) and see a used Ferrari on sale in a dealership in Modena. You agree on a purchase price of $100,000 for the car and the dealer agrees to ship it to Wilmington, DE for you. You wire transfer the $100,000 to the dealer and he transfers title to you and, having received the funds, he ships the car to the US.
Just for the sake of this discussion, and to make the logic simplest, let’s say there were no tariffs in place, and that the VAT collected by the dealer is returned to you after the car is delivered.
You just sent $100,000 of your cash assets to a dealer in Italy for a concrete asset that you value at $100,000.
The US government is not involved
The dealer received $100,000 for an asset that he probably valued at $90,000, so he made a profit of $10,000.
With the new 25% tariff in place, what happens?
When that car arrives at the US port, you get notification from US Customs that the car has arrived and that once you pay the $25,000 tariff to the Customs service, you can arrange to have the car picked up and delivered to you.
YOU pay the US government the $25,000.
Not the dealer.
Not the Italian government.
Your overall cost for the car is $100,000 + $25,000 = $125,000.
You bought the car for $100,000; you paid the US government $25,000; and the dealer got $100,000.
From an asset point of view, you spent $125,000 of your cash assets and received an asset valued at $100,000. You lost $25,000 which was sent to the US government.
The dealer received the same $100,000 as in the first example and he showed a profit of $10,000, just as before.
So, your loss went directly to the US government out of your pocket.
Mr. Trump and Mr. Navarro argue that the dealer in Italy NEEDS you as buyer and in order to retain your business, he needs to keep your out-of-pocket expenses to the same $100,000 as when there were no tariffs in place. In order to keep your business, he then will “eat” the cost of the tariff by reducing your purchase price.
Of course, this assumes that there are no buyers in other countries without tariffs and that if he doesn’t keep your business, that he will be stuck with an unmarketable asset. It assumes that the US market is so important, that the seller (in this case the dealer) will reduce their profits so that they don’t lose the sale.
On the other hand, if there are dealers in the US that may have imported that car in the past, then you should be able to buy it from them. But, with a specific need, like this vintage car, there may be no domestic alternatives, and if there are, they may already be priced at over $150,000, so there is no advantage in buying from them, even without a tariff on the domestic purchase.
Now, if the dealer wants to “eat” the cost of the tariff so that you don’t see any change in your cost, he can reduce the price to $80,000 for the car. He loses $20,000 in profits (if you were such a poor negotiator that he actually has sufficient margin to do that). After receiving the $80,000, he ships the car to you.
Once again, when the car arrives at the port, you are contacted by US Customs, and once you pay them the 25% tariff ($20,000), you are permitted to pick up the car.
Your overall cost for the car is now $80,000 + $20,000 = $100,000.
You bought the car for $80,000; you paid the US government $20,000; and the dealer got $80,000.
You spent $100,000 for an asset that you valued at $80,000 (that was your purchase price).
You lost $20,000 which was sent to the US government.
The dealer received $80,000 but may have incurred a loss of $10,000, since his profit was only $10,000 to begin with.
So, your loss went directly to the US government out of your pocket.
The idea that if the exporter, in this case the dealer, eats the cost of the tariffs; that they are paying the US government is absurd.
Mr. Trump and Mr. Navarro would like you to view this in a different way.
Because the dealer reduced his price by $20,000 and may have made little or no profit, or perhaps lost money on the sale, and that you still paid what you would have paid before, that the net resulting gain of the US government was offset by the loss of the Italian dealer.
Because your transaction was equivalent in both cases, and because you experienced neither profit nor gain, that the tariff collected really came from the Italian dealer. You were just the intermediary.
You paid the US government in both cases.
No funds came into this country as a result of your purchase. In reality, the Italian dealer lost money, and you moved some of the assets that would have gone to him, to the US government. And that is a tax on you as a consumer.
The only thing that changed was that your costs in the second case were comparable to when there were no tariffs. But in both cases you paid the US government. You cannot become rich by simply shifting your money around from one pocket to the other, without adding to the money in total from some outside source.
The money did not come in from overseas, it came out from the US consumer (you). The revenue collected by the US government came from the US citizen (you). That is an additional tax on the consumer in the same way that a sales tax on that item would have been.
The misleading statements by Mr. Trump and Mr. Navarro are fluffed up with terms that are hard to understand simply to make their nonsense seem too hard to grasp. But take away those ribbons and lace, and it is as simple as the sales tax you pay when you buy a car here.
Why do they do this? Are there no advisors who understand the truth? Do they ignore that advice? Or are they misdirecting the public on purpose?
As I pointed out in my last essay, when Mr. Trump held up that fancy poster with the Presidential seal, to show that other countries were charging us ungodly high tariffs, he tried to confuse you that the % trade deficit compared to our imports of goods only, with no accounting for services, from a country was, in fact, due only to their tariffs and that by imposing “reciprocal” tariffs upon them, that we would be doing only what was right. As a matter of fact, since we were only trying to reduce that trade deficit in goods by half, we were being magnanimous.
As the Secretary of the Treasury said to Bret Bair on Wednesday: “My advice to every country right now is: Do not retaliate. Sit back, take it in, let’s see how it goes. Because if you retaliate, there will be escalation. If you don’t retaliate, this is the high-water mark.”
And if no country did change anything, and if all of the countries and their exporters absorbed all of the new fees that were going to be imposed upon US importers at their ports of call, the deficit would drop and US consumers would see no change in their costs while the US government would collect hundreds of millions of dollars in tariffs from those American importers.
You can make your own conclusions on the likelihood of that happening. Because if other countries do retaliate, or if those exporters do not absorb the new costs out of their own profits, then all of the administration’s calculations crumble.
Is there anything in Mr. Trump’s history that would lead you to conclude that if these measures resulted in a drop in the trade deficit percentage for goods in countries by half, that he would not add on more tariffs in the future to negate the other half? I have seen nothing in his actions throughout his life or political career that demonstrates magnaminity.
Finally, with respect to inflation, it seems that the supporters of these new tariff policies also calculate that the imposition of tariffs will result in a one-time only step-up in the price of goods, and that those increases will immediately plateau. Prices may rise 10%, but that would be a single one-time inflationary event that will immediately level off. They view this as a “blip”, one that is necessary to absorb as a country because the new plateau would result in a reshaping of the global economy, and the Stock Market and the economy will immediately begin to recover any “perceived” losses.
Once again, that theory requires other countries to take the punch from the US, accept it as the new normal and do nothing in return. If they do not just “take it”, the theory collapses.
I do not see Mr. Trump, having raised tariffs on China, following his Secretary’s advice: “Do not retaliate. Sit back, take it in, let’s see how it goes”. China, having now retaliated with their own economic weapons, particularly ones that will hurt American farmers in the swing states that provide the margin for his reelection, what new measures will Mr. Trump add on and how will other countries understand that move? Perhaps a good secondary response to China’s new moves will teach the EU a lesson, that if you retaliate against Mr. Trump, he will come after you even more harshly. Perhaps that will temper their responses. But what if they don’t read it that way? How much strain on the relationships with our “allies”, those “friends” that have supported us in our wars over the past 80 years, whose sons have died on our battlefields, whose people have invested in our economy, how much strain will they accept before they impose cultural, political and social barriers between us and them?
How much losses in your own IRA’s are acceptable to you? At what point do you start to rethink the arguments made by this Administration on the value of tariffs and a trade war?