This video is sponsored by Novium, creators of the Hoverpen. President-elect Donald Trump has called himself "a Tariff Man," saying that tariffs are "the greatest thing ever invented," and that the word "tariff" is "the most beautiful word in the dictionary."

He announced last week that he would impose new tariffs on goods entering the U.S. from Canada, Mexico, and China on his first day in office. To be clear upfront—this is not a political video—it shouldn't matter if you love or hate Donald Trump; the purpose is just to discuss

the issues that exist in international trade and the impact that tariffs or other government actions might have on trade, employment, and inflation. We will look at how they have worked and failed in the past and how American tariffs today might be different from the

disastrous Smoot-Hawley tariffs of 1930. Trump announced last week, on his version of Twitter (everyone has their own version of Twitter now), that he would sign an executive order for a 25% tariff on all goods coming from Canada and Mexico, and that these

tariffs would stay in place until the flow of drugs and immigrants from these countries into the United States has come to a halt. After the announcement, the Mexican peso fell two percent, and the Canadian dollar traded at its lowest rate to the U.S. dollar in fifteen years.

Trump has already vowed to target China with a 60% tariff and has discussed a 200% tax on some car imports. He says that goods coming from China will be hit with an additional 10% tariff if China doesn’t do something to halt fentanyl smuggling.

Tariffs – which are controversial among economists – are core to Trump's economic vision. He sees them as a way of protecting American jobs, growing the U.S. economy, and raising tax revenue. On the campaign trail, he told voters that his tariffs would not cost Americans anything,

that they are instead a tax on another country, which many economists described as misleading. U.S. trade with China has grown enormously over the last twenty-five years, and while it brought lower prices to U.S. consumers and higher profits to American multinationals, it came

with some downsides too, and both sides of the political aisle have been focused on how to better balance trade and on how to avoid losing access to strategically important goods and industries. While Donald Trump is a divisive politician, with some people loving him and others hating him, his

threats to impose tariffs on foreign imports are drawing support from lawmakers of both parties. Janan Ganesh wrote in the FT a few weeks ago that Trump's biggest success during his first term in office was that he bound the actions of his successors, saying that Trump

moved the consensus on a big issue — foreign trade — such that the next president either couldn't go back, or didn't want to. During Trump’s first term in office, the average U.S. tariff on Chinese imports rose from around 3% to nearly 20%. When Joe

Biden took office four years later, instead of reversing Trump’s trade policies, he added more tariffs – in particular on electric vehicles – and a protectionist industrial policy that included subsidies and a “buy American” mandate. The Cato Institute – a libertarian think tank

described Bidenomics as “Trumpism with a Human Face” – or “Polite Trumpism.” So, let’s try to understand the issues with international trade that have been pushing the United States and other countries in this protectionist direction,

and if tariffs can be expected to improve the situation or make things worse. We’ll discuss whether Trump could impose his tariffs unilaterally on his first day in office and whether the mere threat of tariffs could be used to improve America's bargaining power?

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So, tariffs are quite simply a tax on imported goods, which gets applied at the border when a good is bought from abroad. This is a protectionist trade strategy where the tariffs push up the price of foreign-sourced goods, incentivizing consumers to switch to

domestically manufactured goods, giving domestic manufacturers room to increase their own prices. The benefits that domestic manufacturers receive come at the expense of consumers who, all else equal, pay more for the goods that they buy. For this reason, tariffs are redistributive,

taking income from the household sector and transferring it to protected businesses. Now, there is nothing too surprising about that idea, as all taxes are redistributive, but critics of Trump's plan say that they are not just redistributive, but that they will

be inflationary and harm the US economy. His defenders, on the other hand, point out that this didn't happen during Trump's first term, and that the Biden administration looked into removing Trump's tariffs when inflation was high, but their analysis showed that the

change was unlikely to make a big difference. Because a tariff is charged at the border, it does push up the price of imports—which is inflationary. Some of that impact is offset by changes in exchange rates, where the currency of the tariff-charging country

rises against the currency of the country being subjected to tariffs. Additionally, foreign companies sometimes reduce their prices in order to remain competitive. An analysis by LPL Financial found that the tariffs imposed in 2018 hit producer prices

more than consumer prices in the United States, as wholesalers absorbed some of the price increase. Now, long-term viewers are probably aware that I believe in free markets and limited government intervention in trade. From a free-market perspective,

the correct response to foreign governments subsidizing exports is to do nothing. In fact, an argument can be made that a country should welcome other nations’ export subsidies – which Milton Friedman described as a form of foreign “philanthropy,” saying that if another

government wants American citizens to enjoy its goods and services at artificially low prices, Washington should tell them to bring it on. The problem is that persistent subsidized imports can eventually displace domestic production of often strategically important goods. The

worry is that unfair foreign competition can bankrupt domestic producers, after which prices can be hiked up by a foreign-owned monopoly. The example often given of strategically important production is steel – which I discussed in a recent video about how Britain was planning on

paying huge subsidies to foreign-owned steel mills to keep them open in the UK. Some of the top comments said that if China is willing to ship steel to Britain for less than it costs to produce, the billion-pound subsidy should instead be spent on buying finished steel and

setting it aside as a strategic reserve.
Trump is arguing that tariffs on America's trading partners are necessary to protect U.S. businesses – and the American worker – at a time when U.S. manufacturing jobs have dropped from their peak in the late 1970s.

Trump supporters point out that some of his tariffs did appear to work when he was last in office, giving the example that tariffs on imported washing machines may have created new jobs as they were imposed at the same time as Whirlpool was building

a new factory in the United States – and the tariffs helped the new factory to succeed.
The results of trade policies like this are unfortunately not always clear – as there are a lot of moving parts and it can be a bit like dietary science – where a person

excludes sugary drinks but then eats a bit more food – offsetting most of the benefit.
The Federal Reserve analysis of Trump's first-term tariffs found that a lot of the benefits were offset by the higher costs of imported raw materials that

American manufacturers had to buy, as well as from retaliatory tariffs from other nations.
Overall, they found that there was a small decline in the number of U.S. manufacturing jobs during Trump's first term, but a number of factors – like the start

of the pandemic – could explain that outcome.
Now, it's become a bit of a cliché when talking about Donald Trump to say that you should take him seriously but not literally – and while that might be a cliché – it is still probably true, so while the specifics of what he will do about trade

Once in office are not clear; the thing that is really clear is that foreign trade is the topic he cares most about. You can find old videos online dating back 40 years of Trump on daytime talk shows, being mostly pleasant until the topic of foreign trade comes up. Back then, Japan was

his main target, while today it’s China. Janan Ganesh wrote a few weeks ago that trade is almost all that Trump cares about, with immigration coming in as a distant second. He says that over the last forty years, Trump has had an intense belief that to run a current account

deficit with another nation is to “lose” to it. I think that the exact mechanics of how Trump plans to deal with trade are not clear, but I think it makes sense to take him at his word that this is the issue he cares most about. Exactly how he will put tariffs in place is maybe

the most unclear part of his plan, but I think it’s unlikely that he will do it on inauguration day, as he has said—as that would likely require him to declare a national state of emergency, which is what Richard Nixon had to do to impose 10 percent tariffs on all imported goods when he

suspended the convertibility of the dollar into gold in 1971. Nixon put those tariffs in place to prevent American producers from being disadvantaged in the expected exchange rate volatility around that announcement. Now, if tariffs were applied to Canada and

Mexico and applied to things like oil and gas, it could be quite inflationary, which is the opposite of what Trump promised on the campaign trail, so I don’t think that is awfully likely. The USMCA trade agreement, which replaced NAFTA in 2020, is up for a scheduled review

In 2026—and it seems extremely likely that Trump will use that deal as a bargaining chip to negotiate with Canada and Mexico over things he cares about, like immigration. This is exactly what he did in the past—in 2019, under the threat of tariffs,

Mexico agreed to step up immigration enforcement to prevent migrants from entering Mexico from Guatemala in the south and to stop them from leaving for the U.S. in the north. While it is reasonable to expect Trump to try and extract concessions during

these negotiations—both Mexico and Canada do run persistent trade deficits, much like the United States—so overall, they are on the same side as the United States on this issue. It is worth remembering that during his first term in office, Trump's cabinet mostly moderated his

protectionist instincts, along with the stock market reaction, which he saw as a measure of voter approval. It looks like he might have a less conservative cabinet this time around, but likely still cares about the stock market. So, what are the problems in international

trade that Trump is aiming to fix? Well, the "hyper-globalization" that began in the late 1990s made the world better for most people—it almost eliminated extreme poverty and reduced global inequality. Consumers in wealthy countries benefited

from cheap imported goods, which kept inflation low and standards of living, as measured by per capita income, increased around the world. While the average person was doing much better than before, blue-collar workers in developed countries were struggling

Inequality within the United States had grown.
On top of all of this, Western governments were getting concerned that China—and some other surplus economies—were engaging in unfair competition by subsidizing manufacturing while imposing restrictions on foreign companies in

exchange for access to their markets. This became more of an issue as China developed and could no longer claim to be a poor developing country.
Western economies began to see it as a problem that China had the highest manufacturing share of GDP and the lowest consumption share of GDP in

the world—by agreeing to absorb China's excess production, deficit economies—like the United States—were allowing their most aggressive trade partner to set their trade policies for them.
The economist Michael Pettis argues that surplus countries subsidize their manufacturing industries

and pass on the costs of these subsidies to deficit countries—like the United States. He argues that a free trade country, with open capital markets, when trading with a planned economy is not really engaging in free trade—they are instead accepting the inverse of their

trade partners' trade and industrial policies.
So, how does China subsidize exports? Well, Chinese exporters receive considerable direct subsidies, but the indirect transfers they receive are even larger. Chinese power plants and banks are mostly government-owned, meaning that

policymakers can decide to give cheap energy and low-interest rate loans to favored businesses.
There are a variety of other ways a government can support its manufacturing sector, too, most of which involve transfers from the household sector to the business sector.

Trade surplus countries often have undervalued currencies – this helps exporters at the expense of importers. Manufacturing businesses are usually exporters, and households are net importers. Keeping interest rates artificially low helps borrowers at the expense of savers,

and once again, businesses are net borrowers and households are net savers. Overspending on transportation infrastructure like railways, roads, and ports supports businesses at the expense of households, too. Repressive labor laws, restrictions on worker mobility, and low

penalties for pollution additionally help the manufacturing sector at the expense of the household sector. In China, industrial-zoned land is an order of magnitude cheaper than residential land – another transfer from households to businesses. When all of these policies are combined,

there are huge transfers from households to businesses in China, meaning that while businesses can prosper, households can’t afford to consume the goods that are being manufactured. Now, in a closed economy – this would mean that businesses would be

forced to either raise wages to increase consumption or reduce production due to a lack of demand. In a globalized trading system, the surplus production can be exported. This trade surplus does not necessarily give China an advantage – it is a result of flawed policies

and a means of dealing with a huge disadvantage – which is extremely low domestic demand. This doesn’t just affect China, however; a surge in a country’s exports that are not balanced by a surge in imports means that manufacturers in deficit countries find themselves partially

funding the Chinese subsidies with their lost income. The imbalances in China move the production of goods away from where they might be most efficiently manufactured (under the law of comparative advantage) and cause all sorts of trade distortions.

When exports are high, and imports are low – a country starts accumulating the currency of its biggest trade partners as savings. Chinese savings are not high due to any culture of frugality in China. It is simply a function of keeping

wages low and exporting without importing. You don’t just keep the proceeds of trade in dollar bills in a vault – you usually invest them – in things like bonds, so China’s excess savings are mostly sent back to the United States where there are deep capital

markets. This means that there is more capital in the United States than is needed for investment purposes – which can be seen in the huge cash balances that US companies are sitting on. So, can Trump's tariffs offset Chinese subsidies and help to rebalance global trade? Well,

possibly, but not if Trump just puts tariffs on Chinese imports. The reason this wouldn’t work is that if the United States refused to buy Chinese goods but continued to buy from other countries, this would just push the problem to another trade partner.

Unable to sell EVs in the United States, China would ship them to Europe, undercutting European EVs. European manufacturers, unable to compete in their own markets, would ship European EVs to the United States, and the overall problem would be the same.

If China continued to keep consumption low while exporting, Chinese savings would continue to be exported to the United States. The Chinese trade surplus would remain as large as before – even if it fell against the United States – and the US trade deficit would continue to grow too.

So, tariffs applied on a country-by-country basis are unlikely to have any notable effect; they would really need to be applied equally to all trade partners in order to work. But this would be very politically contentious, as it would involve upsetting America's allies who are not really

to blame for the imbalances in global trade.
If China is already an aggressive trade partner, and the US joined them, every other country would be forced to follow suit, as otherwise they would be paying the cost. This is the biggest problem with government trade intervention.

A number of journalists have expressed concern that Trump's trade plans are worryingly similar to the Smoot-Hawley Act passed under Herbert Hoover, which contributed to the problems of the Great Depression. I made a video a few weeks ago about the

Great Depression, and a notable difference between the late 1920s and today is that in the twenties, America was the world's biggest exporter and had much more to lose than it does today. In a trade war, countries who need to export are in a much weaker position

than countries that are absorbing excess supply. While the Smoot-Hawley Act was a terrible idea, I don’t believe that it was to blame for the Great Depression, and I don’t believe that new tariffs would lead to that scale of economic catastrophe.
Trump has said in interviews that he would love to

entirely replace income taxes with import tariffs. I think this is mostly bluster and shouldn't be taken too seriously. The Peterson Institute—a mostly centrist think tank—wrote a report on this recently, pointing out that last year the United States imported $3.1 trillion worth of

goods but raised around $2 trillion in income taxes. Tariff rates would have to be over 65% to replace the income tax—and that is assuming no fall in imports—which would be extremely unlikely in such a situation. Replacing income taxes with tariffs just couldn't work.

A number of big US companies have been stockpiling goods in preparation for Trump's tariffs. The Economist reports that Microsoft, Dell, and Hewlett-Packard are among the American tech

companies that are rushing to import as many electronic components as possible before the new administration takes office in January. While this might help them in the short term, I doubt that they could import enough components to get them through years of potential tariffs.

It is difficult to predict how Trump's trade policies will work. The US could act unilaterally, as they do run the largest trade deficit in the world. There is plenty of supply in the world, and the thing that is scarce is demand—which is what the US brings to the table. A better

option might be for the United States to work with other large deficit economies like Canada, Australia, and the UK—where combined they make up about 70% of global deficits. If they struck a deal where they, as a group, placed tariffs on countries that run large persistent surpluses, that could help to rebalance global trade. If

Would either have to take steps to boost domestic demand or cut production. Other countries wouldn't have to really agree, as most of the rest of the world are trying to export rather than agreeing to import. If they wanted to sell to these countries, they would have to agree to the terms.

A rebalancing of trade like this would be extremely painful for surplus countries like China, Germany, Japan, Russia, and Saudi Arabia, but it could be expected to boost American manufacturing and allow American businesses to compete internationally without slashing wages.

This rebalancing would also mean repatriating the capital which has been flowing into the United States for decades. Foreigners own around 20 percent of all US securities outstanding, and as trade rebalanced, these savings would be repatriated, which would

have to occur in an orderly manner. It is very difficult to predict what Trump might do in his second term in office, other than to say that he will amp up trade negotiations, while likely keeping an eye on the stock market as a measure of his success.

As always, I'll be interested to hear what you have to say in the comments section. If you found this video interesting, you should watch my video on whether Elon Musk can cut two trillion dollars from the US budget next. Don't forget to check out our sponsor Novium

using the link in the description below. Have a great day and see you in the next video. Bye.

Can Trump's Tariffs Work?

Patrick Boyle is a hedge fund manager, a university professor and a former investment banker. 

This channel is all about quantitative finance. By subscribing you will see videos explaining what is happening in markets right now, you will learn about financial derivatives, corporate finance and how traders use quantitative tools like statistics. You will see interviews with some of the most interesting people in the financial industry.  In addition, you will see some longer form documentaries on the history of financial markets.

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Can Trump's Tariffs Work?

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