Hello, Odd Latch listeners, This is Joe Wisenthal. You are listening to an emergency episode of the podcast. It was recorded at ten a m. Monday morning, February third. The reason I am telling you this is because markets and news are moving very fast, and so by the time you listen to this, parts of it may already be out of date. But the context for the discussion was over the weekend, Trump announcing twenty five percent tariffs against Canada and Mexico, ten percent tariffs on oil, another ten
percent tariffs on China. Since we recorded this, about a minute after we got out of the studio, Mexican President Claudia Schinbaum announcing that the tariffs had been delayed on Mexico for a month. We're still waiting to hear if something similar happens in Canada. Other than that, take a listen.
Bloomberg Audio Studios, Podcasts News.
Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Alloway.
And I'm Jill Wisenthal.
Joe, how many of these emergency episodes do you think we're going to need to do over the next four years?
Oh my god?
You know.
Well, anyway, I don't know, but this is two weeks in a row. A week ago. You know, we had to rustle up a deep seek expert last Monday, this time a trade expert.
That's all right, I feel like we might as well just preemptively convert the show into a daily because I feel like there's going to be a lot of newsflow. But anyway, as you mentioned, over the weekend, President Trump basically confirmed that the US would be imposing twenty five percent tariffs on imports from Canada and Mexico, which are, of course, you know, massive US trading partners. He's also
implementing a ten percent tariff on China. All of this is being done via the International Emergency Economic Powers Act, and the tariffs are supposed to become effective as of Tuesday, February fourth, And of course, you know, a lot of stuff can change. The news cycle is very compressed at the moment, it feels like, and we're recording this Monday morning, so we'll see what happens overnight by the time this
episode comes out. But in the meantime, there are a lot of questions, and who better to ask than Paul Donovan. He is, of course chief economist over at Ubs Global Wealth Management, someone we've had on the show quite a lot, and someone who's been following the ins and outs of the tariffs, including some of the technicalities of how they actually work, where I think there is quite a bit of confusion. So, Paul, thank you so much for coming on Odd Blots at short notice too.
No, thank you for having me on.
Why don't we just start with I guess there's a question that a lot of people have been asking. There's a lot of confusion, as I mentioned, about who exactly actly is paying these tariffs and when? And the Trump administration initially seemed to suggest that foreign countries were going to pay, and that they were going to set up this external revenue service to collect the income. Now though, there seems to be a lot more talk about Americans having to accept short term pain for longer term gain.
A twenty five percent tariff on Mexican or Canadian goods, Where is that money actually collected and who is paying for it?
So the US consumer is paying, there is no question about this. We have over four thousand years of economic history on tariffs. There are literally clay tablets from ancient Mesopotamia detailing this. Consumers pay tariff's end of discussion. The point at which the tariff is collected, though, is very important. The point of entry, when the goods arrive physically in the United States, that's when the tariff is paid. And that's why a twenty five percent tariff does not fully
equate into a twenty five percent consumer price increase. Twenty five percent tariff would mean about a ten percent consumer price increase.
Explain that further.
So essentially, if you think about it, the goods arrive in the United States, your television has arrived from China in the port of Los Angeles. That's the point at which you have to pay the tariff. So you pay it on the value of the television at the point of Los Angeles. But after that point, the consumers still got to pay for transporting that television around the country, for the advertising, for the whole sale of the retail costs. Retailers take a quarter of your money to cover their
costs and profit margins. So of course all of those costs add up to about sixty percent of the consumer price. The import price on average is about forty percent.
Okay, so maybe prices on maple syrup or avocados or whatever don't automatically translate to a twenty five percent price increase because of the dynamics.
That you just laid out.
But I guess the other question that's floating around in terms of the impact on the broader economy is are these types of tariffs, you know, net inflationary or net deflationary, Because on the face of it, it seems like prices will go up that would add to inflation, But there's this sort of contextual impact as well, where you could see, you know, maybe there are fewer jobs and slower economic growth as the US economy has to adjust to a
new trade dynamic, and maybe that exerts downward pressure on prices. Net net, do you see this as inflationary or deflationary?
So in the short term, by which I mean the next year, this is going to add to inflation in the United States because you know, it's it's a sales tax, it's like a VAT tax increase or a consumer tax increase. And if you look at Japan when it's ready to consumer taxes or the UK when it's really value added tax, you see inflation coming through in the in the first instance, and this is just the same it's a sales tax under a pseudonym, so you will see inflation in the
first instance. But then you're right. The question is do we then see jobs being lost, Particularly because these taxes are a lot more focused on complicated supply chains than was the case back in twenty eighteen, that may be a lot more disruptive to the economy and potentially could create unemployment or just fear of unemployment, which would lower demand, and that would then be a disinflation force, but not now, a disinflation force in the future accompanied by significantly lower growth.
One of the arguments made by advocates of terrorists from time to time is that the US is still by far and away the biggest consumer market in the world, and it's sort of a privilege to be able to sell to US. So if you want to sell to US and there's the tariff, just eat the cost yourself, lower your prices by ten percent or twenty five percent or whatever so that you could still sell into the US market competitively. Does that logic fly?
Not really one thing. The debatable point is whether the US is the largest consumer market in the world. The Europe is the largest middle income consumer market in the world, so it's not all about the United States. The other thing, of course, is that the US is generally a relatively
competitive market. So in other words, you know, it's not that consumers are making super normal beta partment producers are making super normal profits when they're selling into the United States, and we're just chipping away at those.
No.
You know, exporters to the United States are very efficient. They're operating on thin margins. They don't have the room to do this. And if you look back at what happened in twenty eighteen, there was no change in import prices trends pre tariff, so import prices are the price before the tariff is applied. There was no change in those trends when tariffs were applied, you know, because the exporters to the United States just basically don't have the room to cut the margin.
The other thing that you sometimes hear is that, Okay, maybe this means prices go up for American can consumers, but some of that price increase could in theory be offset by a stronger dollar. And we have seen the dollar rallying in recent weeks. And I have a twofold question on this, so one, you know, how valid is that particular argument the dollar offset idea. But then, secondly, why is it that the dollar actually goes up when
the US announces additional trade measures. I've kind of taken that for granted and I've never stopped to actually think about why that's happening.
Well, let's start with the second part first. So essentially, I think what is happening is traders are assuming that because the tariffs will raise consumer prices over a period of time, not all at once, that will then lead to a more cautious approach on the part of the Federal Reserve with regards to policy interest rates. If interest rates don't go down so much, or indeed start to go up, that tends to be supportive for the dollar at a time when other countries are still on an
easing trajectory. So it's an interest rate differential expectation. Generally speaking, does a stronger dollar help offset the tariffs? I mean, to a very minor extent, a stronger dollar will tend to lower commodity prices that are globally denominating dollars. But the issue here is that ninety five percent of US imports are priced in US dollar terms, and so what that means is that if the dollar is strengthening, there's no automatic response in terms of the price of those things.
Because the contract specifies UO as one hundred dollars for this product, doesn't matter what the exchange rate is. That's
what the US has dictated. And again, when we look at what happens historically, you know, for example, China's twenty eighteen devaluation of the rnimbi against the dollar, that didn't change the trend in prices to the United States because effectively, the exporters to the United States were just grateful to get a little bit more proper a margin coming out of that process, and the dollar didn't really have a big effect in terms of offset.
As of right now, by the way, it's now ten twelve am Monday, the third markets following a little bit more, nazdak down two point three percent s and P five down one point seven eight percent. You know, this is not a gigantic sell off by any stretch. On the other hand, it's significant. So it does seem to be a surprise. One of the things you heard the people love to say it, Oh, take don't take Trump literally,
take him seriously. But as far as I'm concerned, it's not clear that anyone is taking him literally or seriously. When it came to tariff, people were just sort of I don't think they really think about it at all. Well, you know, when you talk to clients, when they ask you questions, how much surprise is there, how much do you how different is this versus say, what basically would people were expecting?
I think it very much depends on who you ask. I think that quite a lot of clients in Asia had been expecting quite an aggressive tariff response, because of course they bore the brunt of the tariffs in Trump's first term, whereas I don't think that that has been such an expectation in North America and Europe is a bit mixed on this particular point overall, I think as well.
I mean, the president trides themselves on their unpredictable management style, which you know makes my job as somebody who has to predict for a living a lot more difficult. But it also of course means that if we look at what happened with Columbia, where Trump retreated, you know, within hours from threats of tariff, but you know, Columbia didn't really do anything. No, all of a sudden, we're backtracking because we can't have the price of coffee going up.
That sort of thing, I think means that there is still this lingering hope that there will be some sort of Columbia style reversal coming out of the administration on the tariffs. We've not seen it yet and the clock sticking, but I think there's that sort of background belief still in the minds of many investors.
This is actually the other thing I wanted to ask you, which is we have seen Trump historically use the threat of tariffs as a negotiating tool, right, so hopefully he gets at least some of what he wants before the tariffs actually have to come into effect. But I feel like the more he does this, the less impact or the less bang for his buck he's going to be able to get, because at some point people are going
to start calling his bluff. I guess all of this is a way of asking, like, how many times can he do this with the same impact.
Well, it's more than just sort of you know, crying wolf all the time, which is part of what we're seeing. Actually some quite serious long term implications from this, because of course, you know, Trump in their first term renegotiated NAFTA, and you know, within days of taking office in their second term has torn up nafter. So if you do a trade deal with the US in a year's time, how much confidence have you got that trade deal still going to be operable in two years time or three
years time. And so that's going to make doing deals actually more difficult over the longer term. So I think that's a particular challenge that we are facing here. I would also say, though, that the rhetoric from the Trump administration does seem to have shifted, and I think that President Trump believes that tariffs are a good thing all
in capital letters, and not just a bargaining tool. That they think that tariff's can be useful for revenue raising, which I personally would disagree with, but it doesn't matter what I think. That's what the president seems to believe. So I think there has been a break from the very clear bargaining tool position of the first term, that there is sort of a larger role for tariffs in Trump's mind in the second term.
I just have one last question. Explain to us you said it earlier, on the disruptive potential of tariffing intermediate goods. One of the things we know, for example, about the auto industry, whether we're talking about the Canadian border or the Mexican border, or maybe both. You see parts and you see component crisscross the border several times along the way. Talk to us about how this potential intersects.
I think one of the problems that we have is a number of people, including I would suggest some people in the administration, are sort of stuck in the early nineteen seventies in an imperial model of trade. You import raw materials, everything is manufactured at home, you export the finished product. And that's sort of the state of play when Nixon did universal tariffs back in nineteen seventy one.
But that's not how the world works now. A majority of globe mobal trade is a company shuffling goods between its subsidiaries. So a majority of global trade takes place inside companies as part of complicated supply chains within a firm.
So when you start to impose these tariffs, if you've got an auto part in the United States, in a car made in the United States crossing the border with Mexico twelve fourteen times, if every single time it comes back into the United States, you're slapping a twenty five percent tax on it that very very quickly becomes on an uneconomic proposition, and that's the real risk. So that's where the disruption comes through. Supply chains were a lot
more complicated than they were fifty years ago. This ain't nineteen seventy one anymore.
We sort of touched on this earlier, but I think it's an important point to hammer home and is the proximate source of the market's confusion at the moment. And also we would be remiss if we didn't ask Paul to do his impression of a central banker. But how do you expect central bankers to react to all of this? Because, as we spoke about earlier, on the one hand, you would expect this to be inflationary in the short term, so maybe they might raise rates to try to offset.
Some of that.
But at the same time, you would expect this to slow GDP in one way or another. Eventually, central banks like being ahead of the curve, or at least they say they do. Would they perhaps try to lower rates in order to offset that contraction? Which way are they going to go here?
So, like most questions and economics, the answer is it depends. So if we just get first round effects. If all you see is the tax being paid by US consumers pushing up prices, central banks should ignore that. Central banks should not respond to a one off tax increase, which is a one off price increase, because there's nothing they can do about it. However, if we see second round effects, and this is where it starts to get very problematic.
If we see, for example, retailers expanding profit margins, again another profit led inflation episode. If we see US companies saying, well, you know, our competitors' goods are now being TechEd, so why don't we raise our own prices? Has happened with the washing machine tariff? Why you slap attacks on imported washing machines? And domestic manufacturers raise their prices because they can because there's less competition that the central bank needs
to respond to. That then becomes a problem, and then there's sort of associated second round effects. Do you see wage pressures coming through in certain sectors? I think that's unlikely, but if you do, the FED would have to respond. If you see, for example, higher auto prices, that could lead to higher second hand auto prices, which would lead to higher insurance costs for auto and that sort of chain effect is something the FED needs to start paying
attention to. So the direct effect of the tariff I think the central banks should ignore, and indeed the FED could conceivably continue to cut rates. But if you see those second round effects coming through, that is a five lom bell warning. That's where the Federal Reserve or any other central bank needs to stop paying attention.
All right, Paul Donovan from UBS Wealth Management, thank you so much for coming on odd lots for what is probably going to be the first of many impromptu episodes I mentioned. Thank you, Paul, Thank you.
Joe.
I'm really glad we could do that at short notice. It answered a lot of questions for me and also kind of contextualized a lot of the big questions. I will just say on that second order effect point that Paul made at the very end, already I'm looking at my inbox right now at a note from Bank of America saying they expect US car insurance rates to go up as a result of the tariffs, so you know, sort of already in motion.
The two big things for me are the sort of real risk of the second order effects, all these other things that could happen the more persistent. And then this idea I like what he called, you know, the imperial model of trade, where one the old style, you're importing raw goods, you build it all here, you export it, you capture that value ad versus these really complex supply
chains where something goes across the border multiple times. And then to your point, to your question, I thought this was key, Like, even if these get reversed really quickly, the idea of like, well, what does that mean for the prospect of any sustained sort of free trade block or free trade zone that it's also rip up able, I think is really key.
Yeah, lots of questions. Time to start brushing up on our tiff and trade history. So shall we leave it there?
Let's leave it there.
This has been another episode of the ad Thoughts podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.
And I'm Jill Wisenthal. You can follow me at The Stalwart. Follow our producer Carman Rodriguez at Carman Ermann, Dashel Bennett at kill Brooks Killbrooks. From all odd lotscontent, go to Bloomberg dot com slash odd lots. We have transcripts the blog in a newsletter, and you can chat about all of these topics twenty four to seven in our discord Discord dot gg slash od Lots and if.
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