Inflation Inevitable?

The Hidden Costs of Trade Wars

I saw someone on the news this week talking about the Trump tariffs and the trade environment. He said that this wasn’t a “global” trade war we’re experiencing right now, it’s an “American” trade war. While it’s global in the sense that China, Canada and Mexico are being targeted with Europe also in the crosshairs, I agree at this point that it’s one country going after the rest of the world.

I think the episode with Colombia reinforces the idea that tariffs, at this point, are a leverage tool for the White House to get what it wants. We heard throughout the campaign trail about how Trump wants to put “America First” and tariffs could serve a longer-term goal of bringing business back to the United States. Given that tariffs on Canada, Mexico and Colombia were all implemented and immediately walked back within a day strongly suggests that any economic goal is purely ancillary for the time being.

But what if it weren’t? What if the goal of tariffs was entirely about reshoring? What if tariffs were to be enacted for the long-term until U.S. companies make sufficient progress to bring manufacturing back to the United States?

The big concern with the long-term application of tariffs (and likely counter-tariffs) is inflation. Tariffs are at their core just an indirect tax on consumers. They raise the price of everything that suddenly has a tariff slapped on it. The inflationary impact might not be immediate, but, just like the slow burn effect of rate changes from the Fed, they show up eventually.

But is inflation inevitable whether tariffs are successful or not? Let me lay out the case in two different scenarios.

Tariffs Are Applied Long-Term; U.S. Companies Don’t Reshore

This would be the current working theory if tariffs were applied with an economic goal in mind.

For the sake of simplicity, let’s say the United States implements a blanket 20% tariff on all foreign imports. In most cases, importing companies would pay the tariff up front and then raise the price of the corresponding goods by 20% so as to not just eat the higher cost themselves (I realize this is an oversimplification, but let’s just roll with it for now). As the higher cost of goods starts to get baked into the economy, inflation rates in the U.S. begin to rise.