How Tariffs Impact Your Bottom Line
By Judy Alexander-Wasley, CFP®, MBA
If you’ve been keeping up on economic and market news, you are likely familiar with the Trump administration’s recent assessment of tariffs against major U.S. trade partners.
The new tariffs – taxes on imported goods – have stirred quite a frenzy among investors and economists across the globe and have dominated the financial news headlines throughout the past few months:
Dow drops 250 points on Trump’s tariffs.
Canada tariffs on U.S. goods from ketchup to lawn mowers begin.
Harley-Davidson, stung by tariffs, shifts some production overseas.
The main targets of the U.S. tariffs are (1) China, the world’s second-largest economy and a rapidly developing global power; and (2) three long-standing allies of the United States: Canada, Mexico and the European Union. In both cases, the Trump administration has levied ad valorem tariffs against specific imported products from these countries.
In the case of China, a 25% tariff has been assessed on steel and an additional $34 billion in Chinese goods. The tax, which was announced in April, is being levied on 1,300 products, ranging from medical supplies and machinery to dishwashers and snow plows.
In response, China has announced a plan to retaliate by taxing $34 billion in American agricultural goods, including beef, chicken, pork and soybeans; although these tariffs have not yet been implemented. Additionally, the Trump administration has suggested that any retaliatory measures taken by the Chinese will be met with tariffs on an additional $200 billion of imported goods.
The EU, Canada and Mexico were also hit with a 25% tariff on steel exports and a 10% tariff on aluminum exports. The EU has now imposed tariffs on $3 billion of U.S. goods (e.g. whiskey, peanut butter, Harley-Davidson motorcycles), prompting Trump to threaten a 20% tariff on all European-produced cars sold in America (to be levied on approximately $300 billion in automobiles).
Canada and Mexico have also responded in-kind to the steel and aluminum tariffs. Mexico has imposed a series of taxes on $3 billion in U.S. goods (e.g. pork, apples, potatoes, bourbon), and Canada has assessed tariffs on $12.6 billion of goods (e.g. ketchup, lawn mowers, whiskey).
In light of these recent developments and the looming possibility of further retaliatory actions, let’s examine how tariffs could impact your family and the global economy at large.
Tariffs vs. Reality
Tariffs are often imposed as a well-meaning attempt to protect domestic production of goods and services, as well as to reduce both a nation’s trade deficit with other nations and their overall budget deficit.
However, in a modern global economy, the touted benefits of tariffs rarely materialize. Let’s evaluate three claims that are often made in support of the recent tariffs assessed by the United States federal government.
Claim: Tariffs protect American jobs.
Reality – Mostly false. Tariffs might be effective in protecting domestic jobs in specific industries. For example, those who are employed in steel and aluminum production were ecstatic with the news about tariffs on imported metals. Domestic employment in those two industries should experience short-term preservation and even modest growth.
That being said, increased commodity prices will likely have a negative impact on related U.S. businesses that rely on imports of those goods – leading to net job loss.
The automotive and aerospace industries, for example, are dependent on imported steel to produce vehicles at a competitive price. Steel tariffs will increase their production costs, leading corporations to increase the prices of consumer goods and to take other measures that sustain profitability (scaling back expansion plans, cutting labor costs through downsizing or outsourcing, etc.).
Another prime example of tariff-induced job loss can be observed in the print media industry. The Trump administration levied tariffs against Canadian paper in January and February, leading to a 30% overall increase in the price of newsprint.
The Tampa Bay Times (Florida’s largest independent newspaper) anticipated that the tariffs will result in an additional $3 million in annual costs. Consequentially, the Times cut about 50 jobs to make ends meet.
Other print media companies have expressed similar concerns about the impact of the paper tariffs on their ability to operate in their current capacity. Smaller local newspapers could be forced to cease production altogether, while larger newsrooms will need to cut staff and/or reduce the size and frequency of their print editions.
Claim: The United States’ massive trade deficits with other countries are damaging to our country and need to be corrected.
Reality – Mostly false. Trade deficits can indeed have damaging consequences on national economies, but deficits are not inherently good or bad for an economic powerhouse like the United States.
In theory, running a trade deficit does carry significant risks. Large trade deficits can indicate that a country’s demand for imported goods significantly outpaces demand for their domestic products.
As a result of lackluster demand for domestic goods and services, both employment and currency value within that country would be negatively impacted. These conditions can set the stage for rampant inflation and rising interest rates, which can ultimately put a serious damper on economic growth.
However, the U.S. is largely immune to these negative consequences of trade deficits. Due to the fact that the U.S. dollar serves as the dominant world reserve currency – and given the sheer scope of our economic output – demand for the U.S. dollar remains relatively strong and sustained, regardless of trade deficits or other weak economic indicators.
It is also worth mentioning that trade deficits can lead to positive economic consequences. Countries with whom the U.S. carries a large trade deficit (China, for instance) will often recirculate their nation’s surpluses back into the United States in the form of foreign direct investment.
The best example is the influx of Chinese real estate investors, who have acquired substantial commercial and residential holdings in major U.S. cities since the dawn of permanent normalized trade relations in 2000.
Claim: Tariffs increase revenue for the federal government and reduce our bloated budget deficit.
Reality – Partially true. Tariffs do increase revenue to the federal government in the short term, as they collect duties on imported goods.
That being said, tariffs almost always translate into higher prices for consumers because businesses transfer their increased production costs onto you. As tariffs increase the cost of living for American families, people will have less disposable income on average.
By decreasing the purchasing power of wages, more and more Americans might need to utilize social welfare programs to make ends meet – especially SNAP (food stamps), Medicaid and subsidized housing. The increased demand for public assistance will require additional funding for these programs.
If the added revenue derived from tariffs is spent on social welfare programs, then the fiscal benefits of tariffs are neutralized.
It is also important to note that any revenue obtained from collecting duties won’t come close to compensating for the lost revenue from the most recent tax cut, which the Congressional Budget Office estimates will add at least $1 trillion to our 2018 deficit.
Three Additional Consequences
The retaliatory exchange of tariffs between two or more sovereign nations is known as a “trade war” and typically leads to negative consequences for all parties involved. In most instances, no one wins a trade war; it’s a matter of which country loses more.
Tariffs often have a negative short-term impact on U.S. stocks and erode investor confidence.
Whenever new tariffs are levied either by or against the U.S., the New York Stock Exchange and other global markets enter a short-lived freefall.
For example, the Dow fell 495 points on April 2 after China announced retaliatory tariffs against the U.S.; the markets surged back within two days. Similarly, the Dow dropped by 250 points on May 31 when Trump announced tariffs on the EU, Canada and Mexico; stock prices recuperated within 48 trading hours.
Although the dramatic headlines about daily market performance and volatility can be worrisome, the long-term impact of tariffs on investors is even more concerning. Tariffs can result in waning investor confidence about the profitability and growth potential of U.S. industries that are affected by the tariffs (both directly and indirectly).
The uncertainty of looming retaliatory tariffs also contributes to investors’ apprehension, which could further suppress economic growth.
American exporters will struggle to compete in foreign markets.
For American-based companies that sell their goods on the global marketplace, tariffs threaten their ability to sell goods at a competitive price. When a good or service is overpriced relative to the alternatives, demand for the product will drop substantially.
The ensuing loss of sales revenue reduces profitability and could even undermine a company’s ability to continue overseas operations in its current capacity.
Perhaps the most high-profile example of this phenomenon is Harley-Davidson. When the EU announced retaliatory tariffs against the U.S. in April, Harley-Davidson motorcycles were slapped with a 31% tax. The cost of every one of their motorcycles sold in the EU increased by $2,200 on average.
In response to the huge increase in production expenses, Harley-Davidson announced in June that they will be laying off workers at one of their Wisconsin plants and outsourcing motorcycle production for its Europe market.
Likewise, agricultural industry experts and farmers alike have expressed deep concerns about how impending retaliatory tariffs could affect food exports. The state of Iowa, which is the leading producer of pork in the U.S., could be especially hard hit.
Mexico imposed a 20% tariff on American pork in June, which caused pork prices to plummet and will cost Iowa’s producers an estimated $560 million in lost revenue during 2018. In addition, China has floated the idea of a tariff on U.S. soybeans (another staple crop of the Iowa state economy). Iowa’s soybean producers could lose up to $624 million.
The United States’ reputation as a dependable and essential international trade partner will likely deteriorate.
Widespread tariffs have the potential to destabilize the global free trade alliances that have underpinned the U.S. economy for decades. The countries that have been impacted by recent tariffs have expressed a diminished confidence in the U.S. as an integral trade partner.
The full ramifications of this international shift in attitude are yet to be seen. However, some new developments suggest that our current trade partners are more likely to take actions that advance their rational economic self-interest rather than affirming their loyalty to the U.S.
Canadian Prime Minister Trudeau has indicated that he will not engage in NAFTA renegotiation talks until the most recent slew of tariffs has been nullified. Also, amidst economic uncertainty and other outside factors on the Korean peninsula, the South Korean government is now pursuing a trade deal with Russia – a nation that has long sought to chip away at the iron-clad alliance between the U.S. and South Korea.
The current U.S. leadership also seems disillusioned with the established system of global trade, as evidenced by the Trump administration’s introduction of the United States Fair and Reciprocal Tariff Act last week. The bill would grant U.S. presidents far more latitude in levying tariffs on 163 World Trade Organization member countries, a move that would effectively terminate U.S. cooperation with the WTO.
If the economic tensions between the United States and our global trading partners continue to heat up, more foreign nations may begin to seek out alternative trade deals with the European Union, China and other emerging economic powers.
The question is: Will the U.S. will be invited to the table for future negotiations if we upend the chessboard of international free trade?
The Bottom Line: Protecting American jobs and preventing foreign nations from taking advantage of us is an appealing message that has resonated with millions of Americans.
Despite the strong rhetoric of the Trump administration, however, the haphazard implementation of tariffs is an ineffective and inappropriate course of action if our goal is to maintain and expand America’s standing as a global economic superpower.
