For obvious reasons, there’s been a lot of talk about tariffs over the past several weeks, since President Trump rolled out his tariff plan on April 2. (It seems a lot longer ago than that, doesn’t it?) I’ll weigh in with my thoughts on the plan; the good and the bad; what I believe the end game is, including possible other scenarios and why I believe they’re not likely; and what I believe are the key risks regardless of how it plays out.
But first, a couple of posts are in order to lay the foundation for further discussion. It’s a complex topic, and rather than inundate readers with one of my trademark “War and Peace” length posts, I thought I’d be kind and break this into more manageable chunks (assuming you consider nearly 2,000 words “manageable”). So let’s start with some basic definitions, because from some of the comments I hear, a lot of people don’t really understand what tariffs are, what they’re used for, and who actually pays them.
And because President Trump is obsessed with trade deficits, I also want to address that topic on a fundamental level, since it appears to be equally misunderstood. In the next installment, I’m going to delve into trade deficits in more detail, and that post may be the most important one in truly understanding what all of this is about.
In general, as a free-market monetarist, I’m not a fan of tariffs. When I’ve remarked that I don’t like this tariff plan, I’ve had friends ask me, “What’s wrong with us slapping tariffs on countries that have been charging tariffs on the U.S.?” That question may indicate a misunderstanding of what a tariff is. (I say “may,” because it could be that the person who asks it is just playing fast and loose with the wording of the question.)
The textbook definition of a tariff is that it’s a tax on the importer of a good (or service) from a foreign country. It is not a tax on another country itself. The U.S. doesn’t have the authority to impose a tax on another sovereign country. So when the headlines say that the U.S. is charging China a 145% tariff, they’re misrepresenting the facts.
What’s actually happening is that the U.S. is charging a tariff, or import tax, on any company that imports goods into the U.S. from China. That could be a Chinese company, like AliExpress, which is kind of the Chinese version of Amazon Marketplace. AliExpress aggregates a bunch of smaller Chinese sellers who sell goods through its platform to U.S. consumers. So the tariff would be charged to AliExpress. Then it’s up to them to either absorb part or all of the tariff, or pass it along to its sellers, who also have to decide whether to absorb part or all of it, or pass it along to their U.S. consumers.
I can guarantee you that given the magnitude of a 145% tariff, AliExpress and its sellers are going to pass that tariff along to the U.S. consumers, in the form of higher prices. So that $15 shirt you buy from AliExpress is going to cost more than double that amount.
(Note that this example is overly simplified for illustrative purposes.)
Another possibility is that the tariff is applied to a U.S. company. Apple builds their iPhones in China and ships them to the U.S. to sell them here. So they’re importing the phones from China. Thus they, too, would be charged a 145% tariff, even though they’re an American company. (And they, too, are going to pass a tariff that large on to their customers, who are now going to pay a whole lot more than $1,600 for an iPhone – except that President Trump granted an exemption for electronics coming in from China, and is now only subjecting them to the 20% “fentanyl tariff.” Are you confused yet?)
Actually, there’s a third form of tariff. Have you ever traveled abroad, or gone on a cruise and visited a foreign port, and bought souvenirs? You bring them home, and when you clear Customs, you have to declare what you bought and how much you spent. If it’s more than the duty-free exclusion (currently $800 per person with some conditions), you have to pay a duty on the amount you spent above the exclusion.
That duty is a tariff. So if you ever declared more than the exemption and paid a Customs duty, you paid a tariff for importing goods into the U.S. Congratulations.
Now that we’ve cleared up what tariffs are and who pays them, let’s turn our attention to trade deficits. A trade deficit occurs when one country (or entity) imports more from another country (or entity) than it sells to that country. For example, the U.S. imported about $439 billion worth of goods from China last year. (I know I’m picking on China – but hey, so is President Trump.) We exported $144 billion worth of goods to them. So our trade deficit with China was about $295 billion.
If we export more to a country than we import from them, we run a trade surplus with that country. (China runs a trade surplus with us; for every country “A” that runs a deficit with a country "B,” country “B” runs a surplus with country “A.”) Our largest trade surplus in 2024 was with the Netherlands; we exported $124 billion to them, and imported just $51 billion from them, resulting in a surplus of more than $70 billion. Love that gouda cheese.
Note that I said that countries or entities can have trade deficits and surpluses. Although the data isn’t readily available, individual states have deficits and surpluses with each other (and you don’t see them threatening each other with tariffs). And why don’t they?
Because there are certain benefits to be derived from running a trade deficit. Let’s start with a very simple, “entity-level” example. I don’t mow my own lawn. I haven’t since 2013. It’s not that I’m not physically able, nor do I not have the time now that I don’t travel for work much. There are just other ways I’d rather spend my time.
So we pay a guy to mow our lawn. He provides that service to us, and we pay him for it. There is no quid pro quo. I don’t do anything for him that he pays me for. Therefore –
I run a chronic trade deficit with him.
He gets my money, I get my lawn mowed. That’s my benefit. I guess you could say that he “pays” me in time, or quality of life. If I wanted to balance that deficit, I could do it in one of two ways: I could demand that he pay me an equal amount to do something for him (like what – manage his investments?), or I could “onshore his production” by mowing my own lawn, which would save me some money (after I invested in a lawnmower, gas, oil, and a weed eater), but it would cost me my time. Plus my allergies would suffer in the Spring, and I’d get hot and dusty in the Summer.
I also run persistent trade deficits with the person who cuts my hair, the person who grooms our dogs, my doctor, my dentist, our veterinarian … And I run occasional, but large trade deficits with airlines and cruise lines, but I get significant benefits from the experiences I enjoy when we travel (I’d much rather pay for experiences than things).
Wow, how do I pay for all these trade deficits? Well, my clients run chronic trade deficits with me (technically my employer does – they “import” my services on behalf of my clients, who “consume” them).
Are you getting the picture? Unless an entity is entirely self-sufficient, it is going to run trade deficits. For an individual to avoid running trade deficits, one would have to basically live off the land. And for a country to do so, it would have to either be entirely isolationist, and not trade with any other country, producing everything its citizens consume (and nothing more, unless it ran surpluses, but let’s not get into that scenario); or, it would have to balance trade with every country by requiring each trading partner to import from it the exact amount of goods that it exports to that country.
Before we wrap this up, let’s look at an extreme example of why that’s impractical. We’ll use the African nation of Lesotho, and I’ll be revisiting this example in subsequent posts, because it helps define what the likely end game of the tariff strategy is.
Lesotho is a small landlocked country in the middle of South Africa. Its area is about the size of Maryland, and its population is less than that of Kansas. Its poverty level is roughly similar to that of Malawi, a country I’ve visited four times, and I can tell you that it’s poverty the likes of which most Americans will never see.
Our trade deficit with Lesotho was $234 billion last year, resulting from imports of $237 billion less exports of $3 billion.
There are two ways to balance that deficit. One is to require that they import an additional $234 billion from us, or about 80 times what they already buy from us. Lesotho’s GDP is about $2 billion. Do you think that’s going to happen?
The second way is for the U.S. to onshore the production of what we import from Lesotho. And what do we primarily import from them? Textiles, for one – like jeans. Sure, we could start making Levi’s in the U.S. Between paying union wages, complying with the alphabet soup of U.S. labor laws, and wading through the myriad of other regulatory hoops that the U.S. imposes on businesses, your Levi’s would cost upwards of $100 a pair.
What else do we import from Lesotho? Diamonds. Guess how many diamond mines are operating in the U.S.? Zero. Okay, technically, there’s one: Crater of Diamonds State Park in Arkansas, where you can dig for diamonds and keep what you find, which is most likely going to be nothing but dirt. But there are no active commercial diamond mines in the U.S. So we’d have to import the diamonds we buy from Lesotho from some other country, which would reduce our deficit with Lesotho, but increase our deficit with that nation.
But wait – the U.S. also happens to be the second-largest exporter of diamonds. How can that be? We import primarily rough diamonds, polish them, and export the finished product. And guess what? We make money doing so – about a 26% margin. Given Lesotho’s $56 million worth of diamond exports to the U.S. in 2023, that means we might have earned a margin of nearly $15 million selling the finished product. So we do gain a benefit from importing a product that it’s impossible for us to produce domestically due to a lack of mines.
Okay, this post is long enough for an introduction. In the next post, I’ll address the biggest benefit the U.S. gains from running trade deficits. In fact, it’s the very reason we run trade deficits, and the reason that we would never want to return to being an export-led manufacturing economy (yes, you read that right).
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