Pobre México. Tan lejos de Dios, tan cerca de los Estados Unidos. Poor Mexico. So far from God, so close to the United States, has been a lamentation oft repeated by Mexicans to describe their fate of being intertwined with the United States. Decades of observing Mexico, both from the town where I was raised, McAllen, Texas, and from traveling throughout Mexico extensively, tells me that this chorus of lamentation may have to change to “Poor Mexico. Poor United States. So close to each other and so far from God.” And I think that market participants yesterday signaled that they understand that threatening a close ally does not bode well for either nation.
Stock and currency markets reacted negatively to Trump’s threat of imposing 5% tariffs, and possibly more, on Mexican goods imported into the United States. In the last couple of years, when Trump has threatened tariffs on China, Europe, Canada and Mexico, markets have declined and eventually they rebound. Yet, threatening Mexico is a loud signal to China, Europe, India, and any other country which is watching closely that Trump will continue to unilaterally disrespect existing trade agreements and that he will use tariffs as weapons to achieve his political agenda. Market participants cannot afford to be in a stupor of complacency. Investors are underpricing geopolitical risk at their peril and that of unsuspecting investors who rely on them to manage their portfolios.
“I believe this time is different,” argues Dr. Adam Posen, president of the Peterson Institute for International Economics. “Juxtaposed with China’s announcement that it had made up a list of “unreliable” foreign companies potentially to be treated like the United States is treating Huawei, the latest tariff action by the White House tells markets that developments are not entirely under Trump’s control to pull back. Risk of escalation has become real.”
Normally, when market participants do not like the news they hear about country or economic risks, they sell stocks and other assets and buy U.S. treasuries, in what is known as “flight to safety.” Yesterday, in a troubling sign, investors fled to German bonds, bunds, and the Euro. “That even some of the safe-haven flows are going into Bunds and the euro, away from Treasuries/dollars, strongly suggests that concerns about the US economy are rising,” explained Posen. Also, Posen warned that “This is more striking, given that the Trump migration-linked tariffs will particularly harm the auto sector, and similar tariffs could be weaponized against the European Union, too.”
Not only will share prices likely to be pressured downward for a longer period of time due to the hundreds of companies that will have to pay more for Mexican goods, Trump’s tariffs will also affect foreign investment flows in the U.S. “The delay and diminishment of productive cross-border investment—including investments into the United States, which I have been warning about and tracking—will worsen. Companies will increasingly look for alternatives to locate their research and production activities—and erode the US tax base. Additionally, the direct impact on the auto industry is bound to be sharp and fast, given the 5 percent tariff, if implemented, will be multiplied back and forth across the border through the global supply chains in every North American auto produced.”
In addition to the cost of tariffs to American importers, the spillover of the effects of trade tariffs is often missed by those who minimize their effects on American consumers. For example, in an opinion piece by Brett Arends in MarketWatch, he argued that the media ‘is lying to you about Trump’s China tariffs’ and that the amount of tariffs being charged amounts to “is peanuts.” Unfortunately, what Arends calculation did not cover are the spillover effect of imposing 25% tariffs on Chinese imports. According to Dr. Gary Clyde Hufbauer, an expert on international trade, investment, and tax issues, the cost per American household of 3 persons is over $2,200. That may not seem like a lot to those who are fortunate enough to be wealthy. According to the Federal Reserve, 40% of Americans do not have $400 available to them immediately in the case of an emergency. Adding another $2,200 burden is hardly what they need. And those increased costs would make also life harder for millions of other Americans.
Hufbauer shared his analysis with me in order to explain how he calculated the cost to American households.
- He took the U.S. population of 330 and divided by 3 to come up 110 million households.
- The tariff revenue at 25% on $500 billion imports from China = $500 billion*0.25 = $125 billion.
- An increase in prices changed by competing domestic or third country firms that supply similar goods, that is, the spillover effect.
- This would be $500 billion*0.25 = $125 billion. Hufbauer said this is conservative, since sales of competing domestic or third country goods are often much larger than imports from China, as steel and aluminum data show. In a full employment economy, competing firms raise their prices in response to higher landed prices of imports.”
Hence, the total cost to American consumers would be $250 billion, $125 billion (tariff cost) + $125 billion (spillover effect). This translates to a cost per household of 3 persons of $2,273, $250 billion/110 million households.
If Trump goes through with his tariff threats on Mexico, the pain to American consumers will be higher than the $2,200 per household due to tariffs on China. All eyes on both sides of the border should be on Mexican President Andrés Manuel López Obrador. If Mexico decides to retaliate, probably focusing on imposing tariffs on goods from America’s red states, there is no telling how severe the cost to Americans will be.
Banks, pension funds, insurance companies, university endowment funds, and a wide array of asset managers and investors should be monitoring carefully the effect of tariffs on company profits and American consumers’ pocket books. Both companies and individuals will be adversely affected when they have to spend more on Trump’s tariffs. Lower company earnings will hit companies’ share prices and the credit worthiness of their bonds. Higher costs for American consumers translate into less liquidity for them to pay back their $14 trillion in outstanding credit card, student debt, auto loans, mortgages and other debt. As we enter the longest economic expansion period in American history, I fear that Posen is right. Trump is taking all of us from the “Art of the Deal into the Fog of War.”