I Shot the Tariff

But I didn't shoot the deputy

Summary

• All about tariffs, but stick around to the end for an update on passive

Top Comment

Jeoff Wilks asks for clarification and launches us into our discussion of tariffs:

Would you please comment on this assertion from @michaelxpettis that financial controls would work better than tariffs:

"The most likely way the United States might opt out of its outsized role in absorbing global imbalances would be by imposing across-the-board tariffs on U.S. imports or—more effectively—by restraining the unfettered access foreigners have to U.S. financial markets, which it could do by imposing taxes on financial inflows. As these tariffs or financial taxes were gradually raised until the U.S. trade and capital accounts were in balance, the United States would increasingly escape its role of balancing trade and industrial policies implemented abroad.”

"The real U.S. choice is to determine whether those policies are designed in the United States or designed abroad. Either the United States will decide which industrial sectors are strategically important to its future, or its major trading partners will do so, leaving the U.S. economy to specialize in whatever the rest of the world chooses not to."

MWG Response:

There are two separate components of the reply:

1. I cannot overemphasize the agreement with “the real US choice.” If the US refuses to take strategic actions to maximize US citizens' individual and aggregate wealth, others will make those choices for us. This has been the pattern of the US over the last 30 years as we allowed the vision of the “free market” to override commonsense and the objective of a “competitive market.”

   I cannot say it better than Karl Polyani:

“...To allow the market mechanism to be sole director of the fate of human beings and their natural environment, indeed, even of the amount and use of purchasing power, would result in the demolition of society. For the alleged commodity, "labor power" cannot be shoved about, used indiscriminately, or even left unused, without affecting the human individual who happens to be the bearer of this peculiar commodity. In disposing of a man's labor power the system would, incidentally, dispose of the physical, psychological, and moral entity of "man" attached to the tag. Robbed of the protective covering of cultural institutions, human beings would perish from the the effects of social exposure; they would die as the victims of acute social dislocation through vice, perversion, crime, and starvation.”

The US has allowed itself to believe that ALL planning should be decentralized into the private sector and determined by market forces, but this is insanity. As I’ve demonstrated repeatedly, markets have failings and depend on HOW we structure them. What we determine to be our SOCIETAL priorities should determine how we structure them.

2. Tax policy plays a pivotal role in these outcomes and tariffs are simply a choice of WHO to tax. The United States currently taxes employers and employees, largely on incomes. This is a production tax. We have small “use” taxes (gasoline primarily, then car registrations, etc) and virtually no taxes on consumption. We complain that we produce little and consume too much. Now you know why.

Within consumption, we have a choice. We can tax ALL consumption equally (a sales tax), we can tax consumption on value-added (a VAT), we can differentially tax imported consumption (tariffs), or we can tax foreigners for failing to consume US goods and services when they sell imports to us (taxes on foreign inflows of capital). The alternative that Pettis proposes as “superior” is indeed “better” as it theoretically encourages consumption by foreigners of US goods and services (hereafter “goods” for simplicity's sake), subsidizing the production of goods by penalizing investment in US financial assets by foreigners. Foreign producers who do not want to buy US goods will sell their earned dollars to those who DO want to buy them. If they have market power versus US distributors of their product, they can raise prices to offset the increased cost of doing business in the US. If they do not, they will be forced to absorb the cost. All else equal, this is a setting for a weaker US dollar and higher US interest rates.

It also sounds “scary” for a government that believes it relies on foreign savings to finance its deficit or sees the USD under threat. The “Petrodollar” concept is one variant of this logic — “Sure, you can’t buy enough US goods to offset our imported Saudi oil, but can I interest you in a US Treasury bond?” The logic made perfect sense when the dollar was plummeting in the 1970s and interest rates were high versus the rest of the world while the supply of bonds was relatively low and we desperately needed foreign oil. Today, the problem is reversed — the dollar is remarkably strong and we are largely an exporter of global commodities (easily absorbable) and (largely) technology products (including weapons systems). The issue is not that the rest of the world is unwilling to buy US goods but that the quantity of goods demanded by US consumers is too high relative to our productive capacity at market prices. We love our flat panel TVs, but not at $2,000 for a 42” TV. A financial assets tax (or restriction) is simply a method of lowering the relative cost of buying US goods versus buying a financial asset. All else equal, this suggests a financial tax would raise foreign demand for US goods and the marginal required return on US financial assets for foreign investors. Raising the “marginal required return on financial assets” is simply code for “lowering the price of financial assets.”

So the US has choice between the Pettis proposal of a Tobin-like tax (which all else equal will raise global demand for US goods and, by extension, US labor) or tariffs (which all else equal will lower US demand for imported goods). With the world largely suffering from a shortage of demand (e.g. Europe, Japan and China) and a surplus of financial assets, this seems like a no brainer in economic terms. It would also burden financial asset owners (and issuers) rather than consumers. Like most of Pettis’ thoughts, it is remarkably clear and cogent. I wish it was the option available to us. But it’s not.

The Main Event

Given I agree with Pettis and would prefer a financial transactions tax (FTT) or equivalent restriction, I remain supportive of increased US tariffs on imported goods for the very simple reason that it’s the only choice readily available. A broader FTT would fall under Congressional authority and require legislative action. I have low confidence that this can be achieved in today’s political climate. Tariffs, in contrast, can fall under the “Delegated Powers” doctrine which allows the President broad authority to impose tariffs under “unfair practices” (Section 301 of the 1974 Trade Act) or national security (Section 232 of the 1962 Trade Expansion Act). Trump used both of these in his first term. Ultimately, Congress could override his actions, but that would require new legislation to clear BOTH Congress and a presidential veto. Given the closely divided Senate and House under almost any election scenario, this seems to be a very low probability.

What impact would the proposed Trump tariffs have on the US consumer? Well, it would raise the price of imported goods and domestically-produced goods that are substitutes. By how much? That depends on the items. A great place to start analysis is the Observatory of Economic Complexity. Ever wonder why China chose to retaliate on US soybeans after Trump introduced tariffs in 2018? Well, here’s your answer — you hit your opponent where it hurts:

Fortunately, there are very few goods where China is the sole source. But it would be absurd not to consider the magnitude of the challenge here. Mapping out trade with China on an industry basis exposes the issue — there are very few categories of trade where the US is balanced with China and in the vast majority of industries, China dominates. A best fit line for US-China trade by industry shows China sells 10x to the US what it buys from the US on a like for like basis:

The good news is that few of the most egregious industries are central to US economic activity. As I pointed out to Peter Thiel when I first ran this analysis in 2017, the US can survive without cheap toys: