As signed into law on Saturday, deep and broad tariffs will begin on Tuesday for goods imported from China, Mexico, and Canada. Retaliatory tariffs have also been announced from Canada and Mexico. Trump’s primary motive is to generate revenue and I doubt they will go away quickly. The basic idea is to monetize the US’s size advantage and healthy consumer. While most of the discussion and writing about this topic centers on rising inflation, there should be an equal, if not greater concern for falling demand. In the simplest economic case, the amount that prices go up, spending comes down.

This is the finding of a Bloomberg article, “Trump’s Tariffs Hit US Growth Before, and Threaten to Again”, from last Tuesday about effects of tariffs in Trump’s first term, writing,

  • “What happened in 2019 matters because it was the first time policymakers dealt with the economic impact of a broad swath of higher import taxes since the 1930s. It was a rare real-world experiment in the effects of protectionism.”
  • “For skeptics of President Donald Trump’s threatened tariffs, the concern raised most often at home is that they will boost inflation and lead to higher interest rates. The biggest lesson from his last trade war, though, may be that it’s the hit to growth that matters more.”
  • [In 2019], the Federal Reserve confronted a slowing economy led by a manufacturing sector shedding rather than gaining jobs, data and new transcripts of policymakers’ discussions at the height of Trump’s first trade war show.
  • On the one hand, policymakers will be wary of tariffs and other upside risks to inflation, which may push them to keep interest rates high. Balancing that will be the potential drag on growth caused by the levies and other policies like a crackdown on immigration, which might suggest rates should go lower — even if above-trend growth over the last few years means it would likely take a material slowdown to prompt a rate cut.”

Bloomberg Economics wrote about the effect of tariffs on Friday,

“In the short term, a key question is how the rise in import costs would pass through to consumer prices and to what extent the upward pressure on prices may be cushioned by the deflationary impact from lower demand, or amplified by second-round effects on wage demands.”

Famed economist David Rosenberg, and founder of Rosenberg Research, wrote about the Fed’s discussions about tariffs in Trump’s first administration on Friday,

“Surprisingly, underlying inflation and inflation expectations not only failed to increase but actually receded — because the hit to demand overwhelmed the cost impact of the tariffs.”

There seems to be no logical or empirical inflationary effect from tariffs that isn’t cancelled out or exceeded by the deflationary impact of less demand. The initial reaction to this news tonight is higher interest rates at the front-end of the yield curve; approximately +4 basis points for the 2-year, but with a fading effect out the yield curve; with the 30-year falling 2 basis points. This is consistent with the idea that the very near-term effect could be inflationary but is economically damaging further out. This level of disturbance to the global economy is what can catalyze a recession and the economy is on the verge of one to begin with. I expect lower demand will soon show up in the economic data with slower real growth nullifying or even exceeding any higher prices.