Burning Thoughts

President Trump has recently implemented tariffs against Canada, Mexico, and China. The stock market has already shown its negative reaction to this tariff war, with the S&P 500 index dropping 1.5% today, following a 1.75% decline yesterday

Consider what FED Chairman. Jerome Powell, said in mid-2022 about the effect of oil prices on the US economy. Every $10 per barrel increase in the price of crude oil raises inflation by 0.2% and sets back economic growth 0.1%. That’s a classic stagflation condition: inflation with declining GDP.

Size of Inflation Caused by Cost Increases

Inflation of 0.2% might seem small; however, at that time, oil prices were nearly $120 per barrel, translating into an 8% increase according to Powell. Those of us who lived through the mid-1970s will recall the formation of OPEC and the subsequent quadrupling of oil prices, which ushered in a period of stagflation that defined the rest of the decade.

This morning, reports indicated that the effective US tariff rate on all imports has jumped from 3% to 9%. A reasonable estimate suggests that this could result in a 6% increase in inflation once current warehouse stocks are depleted and need to be replenished with imports. As we will discuss in the next section regarding new car prices, certain goods are expected to experience more significant inflationary pressures.

Tariffs Exogeneous Shock Like OPEC

Tariffs have a similar impact to oil price increases, as both raise the prices of imported consumer goods and industrial inputs needed to produce those goods. Tariffs and oil price hikes due to OPEC actions are external shocks to the economic system, triggering responses from the law of supply and demand.

Tariffs increase prices because they inflate the cost of imports. For example, the price of new automobiles is estimated to rise by $12,000 due to tariffs, as reported by Transport Topics. Even if prices increase by only half that ($6,000) sticker shock will lower the demand for new car.

The reduction in demand occurs as US consumers allocate a larger portion of their income to essentials, such as groceries from Mexico and Canada, and household items imported from China. This shift in spending ultimately decreases the US GDP.

Retaliatory Tariffs

As expected, Canada, Mexico, and China have announced tariffs on good coming into their countries from the US. This will decrease US exports to those countries, causing their exported-oriented corporations to lay off employees and dampen their economic activity (GDP).

Tariff wars generally result in a poorer economic outcome for all involved parties.

The Bigger Picture

This ill-considered tariff war hastens the day when US government debt becomes an overwhelming economic problem for the federal budget, as other countries may begin to shun US dollar reserves.

This tariff war is just one prong of a deeper disorder, to be explored further in “Global Trading Blocs and the Diminished US World Role.”

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Additional Information
Car Prices With Tariffs
Trump 2.0 Reasoning

Citation: Image of two traders adding tariff to their deal created by Copilot from my prompt