David R. Kotok, Cumberland Advisors Co-Founder and Chief Investment Officer, September 25, 2024

(The following was first published on Cumberland Advisors’ and The Kotok Report websites, and via LISTSERV. For details, visit https://www.cumber.com/ or https://kotokreport.com/.)

Recently I received a well-thought-out communication from a reader offering the following:

“Tariffs on foreign goods are said to be inflationary because they increase prices for materials and goods that are then passed on to the consumer. Tariffs are said to be good for small and large US businesses because labor is so cheap in other countries that manufacturing stuff here can’t compete with China or Bangladesh. These two statements are probably both true, at times, depending on the tariff’s being specifically valued to create a price point that will allow US manufacturers to make a profit and not cause a significant burst of inflation, which would quite possibly lower the purchases of items not specifically necessary for people to live decently. The tariff on Chinese electric vehicles would be a good example of a number that seems screwy: 100%. Which way would that work, increasing US manufacturing and raising the price of all US cars? How is that price point arrived at? Who advises the executive branch regarding the size of a tariff? What examples do we have to show that the tariffs are imposed rationally, and what example do we have (besides Smoot-Hawley) that arbitrary tariffs are detrimental to both consumers and manufacturers? And since both Harris and Trump are “supporting tariffs,” do we know yet the specific policies of Harris? I think we know that Trump’s idea is to put a huge tax on Chinese goods in order to strangle them. What are the consequences of attempting to strangle an economic and political foe? I’m not asking for an answer at this time to either question, but I wonder if these are worth posing at some of the various conferences you go to.”

Kotok response: The issue of tariffs is a big one for economists and for the landscape of market and economic agents. Some financial market agents are trying to figure this out now.  Example: look at the strength in the Utility Sector (setting new highs) is it just because of lower interest rates or is it also the fact that domestic utilities don’t have much financial exposure to tariffs? 

The issue is highly complex. The citizens, IMO, don’t pay a lot of attention to the details of tariff policy, but they must confront the outcomes every day. There is the disconnect between policy and outcome. Therein lies the danger.

A politician says “I’m gonna show China what things are all about.” And they impose a tariff and claim they are hurting the Chinese business or industry sector or government. But the actual tariff is collected by an American firm and paid to the US Treasury as a tax. It is simply a form of sales tax. The Chinese don’t pay it; Americans pay it.

Now that we have that established that, the harder question is, are tariffs good or bad? For decades they were considered bad. Those were the multidecade years of reducing tariffs and decreasing protectionism The General Agreement on Tariffs and Trade (GATT) was a monumental accomplishment for its time. See https://en.wikipedia.org/wiki/General_Agreement_on_Tariffs_and_Trade

The structure of the World Trade Organization (WTO) was negotiated for the purpose of reducing protectionism (aka tariffs and quotas). See https://en.wikipedia.org/wiki/World_Trade_Organization

Like it or not, that time of free trade has passed. Free trade is now on the ropes, IMO. So what happens next?

We don’t know, because the outcome of the election will determine the pathway. We do know that both Harris and Trump are in favor of using tariffs. We do know that tariffs are no longer seen as a “shock” by market agents, who are adjusting to the new regime.

I opposed Trump’s introduction of tariffs when he first launched them. My view then was that this would eventually become a vicious and downward spiral and would only lead to more and more tariffs and greater and greater protectionism. Well, look around now, after Trump’s tariff wars were followed by Biden’s continuation of tariffs.

History is not kind here. Tariffs protect inefficiencies and raise prices. They defeat free expansion and open exchanges, and they increase pressures for countries to misbehave by countering with more tariffs while also circumventing existing ones. I expect more of that to come. I fear the intensity will lead to a higher risk of war.  History shows that tariff wars have sometimes been followed by shooting wars.

Here’s a NY Times discussion of the differences between Harris and Trump when it comes to tariffs. This is the author’s opinion and not mine. “Harris and Trump Embrace Tariffs, Though Their Approaches Differ,” https://www.nytimes.com/2024/08/27/us/politics/trump-harris-tariffs.html. I’m in the camp of “I don’t know where the tariff wars will end or what the trajectory will be.” What I do expect is that they are likely to continue and intensify. History suggests that does not bode well for our economic future and it poses a risk to financial markets.