American Brexit: Tariffs Are Magic

I have no idea what is happening next and neither do you

Both imports and exports decreased. Exports to the countries that instituted retaliatory tariffs fell the most. Canada was one of the first countries to enact counter-tariffs, followed by Mexico, then France. Unemployment began to rise from single digits, reaching 25 percent in three years.

It was supposed to make the American economy great again. As Ben Stein says in Ferris Bueller’s Day Off, “it did not work, and the United States sank deeper into the Great Depression.”

I am of course referring to the Smoot-Hawley Tariff Act of 1930, but I could very well be describing our near-future under Donald Trump’s new tariff regime. Maybe. Of course, prognostications of recession doom and gloom might turn out to be wrong, just like the Black Monday predictions yesterday, but I doubt it.

Trump does not seem to be operating from a coherent economic theory. Rather, he seems to hold faith in the power of tariffs. They are magic, and furthermore they are a panacea. A cure-all for the American economy, which was not sick in the first place.

Just as Ibram X. Kendi promised to correct all past discrimination by discriminating the opposite way in the present, Trump’s policy seems to consist of righting past wrongs to American workers by making them pay more for things made overseas. His policy is basically DEI for imports and exports. Trump’s defenders will say that other countries are doing it, and that’s true, but irrelevant, because those countries are taxing their own citizens and companies that buy stuff made in the USA.

We are discussing Americans, who will pay a lot more of their money for lots of things made overseas, now. Prices will rise. This is called ‘inflation’ and most Americans find it very distressing, most of the time. Trump’s poll numbers will suffer if there is long-term inflation, suffer worse with a deep recession and unemployment, and then suffer most of all if there is no swift economic recovery. He is taking an enormous gamble.

Over the last two centuries, economies have transitioned from agricultural, to industrial, to post-industrial economies of goods and services. The United States made this painful ‘service economy’ transition in the 1980s and 1990s, most notably with the infamous NAFTA free trade agreement. I am old enough to remember the Bill Clinton administration and the frank acknowledgement in public discourse that families could no longer afford the American dream of a home with two cars in the garage, even on two adult incomes, because of this transition.

China failed to make the transition from agriculture to industry under Mao at the cost of tens of millions of Chinese lives, mainly from starvation, and only became the world’s factory under the liberalizing-ish regime of Deng Xiaoping. Since his death, however, the CCP has resisted the transition to an economy of goods and services, because that would reduce their control over Chinese society.

Like the early United States, China has used protectionist measures like tariffs to protect and nurture native industries. Now Xi Jinping is using tariffs as retaliatory trade war, for example by restricting the export of rare earth metals. Which, we must note, is exactly the sort of industry that Americans used to have, and could have again.

Note that Trump seems very interested in rare earth elements, whether located in Greenland, Russia, or Ukraine. A state focused on control of strategic resources is called an autarky.

Here is the problem. Trump thinks he can reset the American economy back to the previous industrialized form. This will be hard to do when robots and AI are already replacing humans in manufacturing jobs. There are 200,000 Chinese making products by hand in Foxconn’s “iPhone City.” The only way Americans will ever make an affordable iPhone in America is with a factory that uses 20 workers and 20,000 robots instead. So even if the tariff magic works, it will not bring 200,000 iPhone jobs to America.

Trump’s tariff magic is perhaps more style than substance. Michael Shermer writes at Skeptic that it represents a return to the “mercantilist zero-sum protectionism” of the early moderns. Trump shares the populist “folk economic intuitions” that economies are “designed from the top down, and thus it can only succeed with continual tinkering and control from the top.”

Remember, Trump was almost the Reform Party presidential candidate in 2000. He clearly inherited Ross Perot’s famous vow to charge foreign countries “whatever tariff you charge us.”

As Shermer explains, the new autarky, like the old mercantilism, favors producers over consumers. And as Bill Ackman has explained above, the new global economic system favors long-term bond holders (producers) over stock investors (consumers). Producers are rich through ownership, whereas stocks are volatile precisely because the profitability of a company reflects consumer demand for its products. Trump’s new world economic order is biased against American consumers.

Adam Smith had a world-vision of interdependent prosperity through free markets, a utopia that has never really existed, but the pursuit of which has been the single biggest jobs and wealth creator in human history. Disbelief in the ‘invisible hand’ of the market defines populist reactions to globalization on left and right, however, and Donald Trump has become their avatar.

Trump’s new American economic order is biased against the world. It is already making international consumers leery of buying American. Maybe Trump is a genius, and this is all going to work like magic, but I don’t see how. As far as depressions and world wars go, well, I can see how Trump gets us there from here.

As a matter of pure politics and short-term interest, Trump was right not to worry about ‘the markets.’ Americans have lived through black trading days before. ‘The markets’ will be fine after they adjust to the new normal.

Except that Trump doesn’t seem to want to settle here as the new normal. He wants even more tariffs, even more trade wars. That is now the problem. Trump enjoys chaos. Everyone talks about him when he is surrounded by chaos, but chaos will ultimately spook the big investment leaders more than anything else.

Consider Jamie Dimon in February, when Trump issued his first tariffs on Canada and Mexico.

“If it’s a little inflationary, but it’s good for national security — so be it,” Mr. Dimon told CNBC on Wednesday from the World Economic Forum’s annual conference in Davos, Switzerland. “Get over it,” he added.

Mr. Dimon did not specify how he thought tariffs would improve national security.

In his letter to shareholders this week, however, Dimon writes that “whether or not the menu of tariffs causes a recession remains in question, but it will slow down growth.” He is worried “how this will affect America’s long-term economic alliances.” Emphasis added:

There are many uncertainties surrounding the new tariff policy: the potential retaliatory actions, including on services, by other countries, the effect on confidence, the impact on investments and capital flows, the effect on corporate profits and the possible effect on the U.S. dollar. The quicker this issue is resolved, the better because some of the negative effects increase cumulatively over time and would be hard to reverse. In the short run, I see this as one large additional straw on the camel’s back.

In other words, for the tariff-magic to work as advertised, Trump must come to a quick settlement with American trading partners instead of escalating and widening his trade wars. The longer they continue, the more Trump disrupts America’s trading relationships and the supply chains of American companies.

Markets are still sending fresh signals. Trump is so eager to threaten more tariffs against China that the oil markets slid again yesterday in expectation of an economic downturn. Prices were already at a four-year low because of the tariffs Trump imposed last week. In fact, oil prices have dipped enough that marginal wellheads have become unprofitable.

Whereas Trump exempted Russia from his tariffs list because of peace negotiations to end the war in Ukraine, low oil prices are a nightmare for the Russian petroleum industry. The Biden administration almost bankrupted state energy giant Gazprom with a $60/barrel price cap, so the Kremlin was reeling yesterday as Urals crude hit $52/barrel, reaching the limits of profitability for many, if not most, Urals wellheads.

Whereas Russia is in a state of stagflation, China is in a deflationary spiral. According to Gordon G. Chang, the CCP absorbed at least three-fourths of the cost of Trump’s 2018 tariffs. Xi Jinping is doing it again now, but “he does not have the resources to pick up the tab for long.” Both the Russian and Chinese leaders have incentives to come to an agreement with Trump quickly, which would suit his ambitions of forming a three-way new world order with both of them.

Then again, this two-tracked approach might backfire, and the iron law of unintended consequences may kick in.

The American Brexit is here. What shape it will finally take, nobody seems able to say. Maybe this is all grand design. Or maybe all the years of populist harping on trade deficits as a form of robbery have congealed into a form of vengeance. Perhaps this is the inchoate rage of a man who genuinely thinks that Americans got ripped off by having access to cheaper goods from abroad, and who thinks that tariffs are magic.

Maybe this will all be over in a couple of months, with the world rearranged, or maybe this becomes another long, disruptive negotiation process the way Brexit did in the UK. For better or worse — likely worse — we are destined to find out, now.