The next few months will offer a clear test of who is right about Donald Trump’s trade policies in the wake of his announcement of higher tariffs for Mexico, Canada and China that will become effective on Tuesday.
CNN reports that in order to put the tariffs in place, Trump invoked the International Emergency Economic Powers Act, which authorizes a president to manage imports during a national emergency. The emergency that Trump cited in his social platform was “the major threat of illegal aliens and deadly drugs killing our Citizens, including fentanyl.”
Investors have been supportive of Trump’s policies of tax cuts and deregulation thus far, and many are hopeful they will usher in “a golden age of America.” But sentiment could shift decidedly if Trump’s tariffs spread to other countries.
Economists Phil Gramm and Larry Summers warn that a trade conflict could disrupt the global economy in a Wall Street Journal commentary. They flat out reject the claim that the implementation of broad-based tariffs will reverse the hollowing out of American manufacturing and reduce the U.S. trade deficit. They conclude: “We are united in our belief that broad-based tariffs will impede economic growth, risk triggering a trade war, and inflicting long-term harm on the economy.”
Prior to last week, many investors clung to the view that Trump’s threats to raise tariffs were part of a bargaining strategy to extract concessions from America’s trading partners.
This past weekend, however, Trump followed through with his pledge to boost tariffs on Mexico and Canada by 25% and on China by 10% with few limits. A Financial Times article quoted Trump as saying, “It’s not a negotiating tool. It’s pure economic. We have big deficits, as you know, with all three of them.”
This reflects Trump’s view that international trade is a zero-sum game. The “winners” are countries with trade surpluses, while the “losers” run trade deficits. He sees tariffs as a way to level the playing field and reduce the size of U.S. trade imbalances.
As shown in the table below, the U.S. merchandise trade deficit has increased from nearly $800 billion when Trump became president in 2017 to a record $1.2 trillion last year. While the bilateral trade deficit with China narrowed by about $100 billion over that period due to tariffs imposed in Trump’s first term, it has been more than offset by increased deficits with Mexico, Canada, the European Union (EU) and other countries such as Vietnam.
Note: bilateral trade imbalances are as of November 2024.
This is what Trump is trying to stop. Bloomberg reports that Trump also said he would impose tariffs on a wide range of imports in coming months, and he indicated the U.S. would “be doing something very substantial” with tariffs targeting the European Union. Imports from Mexico, Canada, China and the EU represent about 60% of total U.S. imports.
The Economist states that the tariffs announced on Saturday should erase any doubts about Trump’s resolve to take a hard line on trade, while ignoring warnings from businesses, diplomats and economists about the potential fallout. They are more sweeping than Trump’s tariffs on China in his first term that applied to about $370 billion of imports and are estimated to cover roughly $900 billion of imports from Mexico and Canada.
Trump sees both Canada and Mexico in weak bargaining positions because the vast majority of their exports are to the United States. One concession he was willing to make was to announce a lower tariff on Canadian crude oil and electricity of 10% instead of 25%. The primary reason is that the Midwest and several other regions import a large amount of their energy from Canada.
Trump acknowledged Americans could temporarily feel “some pain” from the tariffs. The Tax Foundation, a nonpartisan think tank, estimates the tariffs announced on Saturday would result in an average tax increase of $830 per U.S. household in 2025. The items that will be impacted the most include autos, agricultural products, energy and lumber.
Goldman Sachs economists estimate that if sustained, the tariffs on Canada and Mexico would increase U.S. core prices by 0.7% while GDP would be hit by 0.4%. Goldman’s equity researchers estimate that every 5 percentage point increase in the U.S. tariff rate would reduce S&P 500 EPS by roughly 1%-2%. The actions announced on Saturday are estimated to increase the effective U.S. tariff rate by 7 percentage points, and it is likely to climb further as tariffs are announced on other countries.
The backlash over Trump’s tariff pronouncements is just beginning. The Wall Street Journal’s Editorial Board did not mince words, labeling the actions against U.S. allies “The Dumbest Trade War in History.”
The WSJ editorial depicts how interdependent trade has become in North America, and especially in auto production, since NAFTA was launched in 1994 and then supplanted by the US-Mexico-Canada Agreement in mid-2020. The Journal points out that the U.S. willingness to ignore its treaty obligations, even with friends, won’t make other countries eager to do future deals.
Meanwhile, Canada, Mexico and China are prepared to retaliate even though Trump’s orders include clauses that will increase U.S. tariffs if they respond in kind. Canadian Prime Minister Justin Trudeau immediately announced reciprocal tariffs of 25% on U.S. goods totaling more than $100 billion, while Mexico’s president, Claudia Sheinbaum, promised new levies without giving any details. Both China and the EU will be watching what happens very closely as they map out their own strategies.
So, what should investors do when faced with these prospects?
In a previous commentary, I noted that financial market volatility increased when Trump launched a trade war with China in his first term. The announcements this weekend suggest he is prepared go much further and is willing to risk a global trade war. The main thing that could stop him would be a stock market selloff, which could cause investors to hedge some of their equity exposure.