Tariffs Are a Bad Idea Whose Time Has Come

Now comes a survey that says the American public has soured on free trade. This is one populist sentiment that few politicians have the guts to debate, let alone oppose.  Under the circumstances, perhaps we were wrong when we wrote here the other day that a move in Congress to sock China with punitive new tariffs would fail simply because the destructive consequences of the Smoot-Hawley Tariff of 1930 are too well-known. Some have even argued that Smoot-Hawley, which raised tariffs on more than 20,000 imported goods to record levels, is what triggered the Great Depression. Whatever the case, economists in particular — even such as Alan Greenspan, who, on voluminous evidence, couldn’t pass an Econ-101 midterm exam — seem to understand that tariffs are generally a bad thing, at least in theory. Although tariffs are intended to level the playing field and keep the U.S. from getting flooded with cheap foreign goods, the risk is that they will provoke retaliation and, ultimately, a trade war that can devastate manufacturers on both sides of the Pacific.

Who loses if China sells us cars like this for less than it costs to produce them?

From a purely economic viewpoint, one might ask what’s the harm if we let China sell us merchandise for less than it costs them to make it?  Won’t that only benefit consumers? We pose these questions rhetorically, however, since there most surely is harm if the Chinese (for one)  are deliberately underpricing goods in order to put our manufacturers out of business.  Succeeding at this would give their exporters monopoly pricing power, meaning they could charge as much as the traffic will bear for the goods they sell us. Even so, we risk having our own manufacturers grow less competitive, and ultimately obsolete, if tariffs are too high. Ideally, they should be just high enough to give domestic manufacturers some breathing room while they try to become more efficient and, eventually, more competitive.

A Desire to Punish

The problem is that tariffs are rarely set “just high enough;” for levies are in fact determined more by politics than economics, and they are therefore punitive by design. Moreover, the current push to raise tariffs against China comes not from a desire to restrain supposedly unfair trade in certain specific goods, but to goad China into allowing the yuan to float higher. That would have an effect similar to placing a tariff on all of the country’s exports, since a rise in the yuan relative to the U.S. dollar would reduce China’s competitiveness across-the-board. That’s asking a lot, since the U.S. and nearly every other country in the world have been doing everything in their power to cheapen their own currencies. Ultimately, there is no economic advantage in this for any of the players – only the promise of an inflation that raises prices globally by perhaps hundreds of billions of dollars without creating even a dime’s worth of real wealth.

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  • Robert October 5, 2010, 8:14 pm

    Oh, and to the general topic of Tariffs…

    Tariff’s may serve to adjust prices of Chinese Goods to US labor and income standards, but the net result of this in a declining dollar environment is just further erosion of the dollar’s purchasing power at home as well as abroad… not exactly the intended outcome, I’d assume.

    Look, US manufacturing is not ramping back up for a number of reasons, and currency and labor exchange rates is only one of them. Some of the other reasons include lack of interest in borrowing by those who attempt to treat credit as capital for new business development (the riskiest poker game on Earth), and lack of capital deployment by those fortunate enough to have a real capital base accumulated.

    If you had a Billion dollars to go start a new venture, would you do it in the current US regulatory environment…?

    Neither would I.

  • hornblowermg October 5, 2010, 7:11 pm

    Don’t you recognize the predatory pricing that China demands through little publicized agreements with Wal-Mart? These policies have been in place ever since Sam Walton died. China has their own country within a country where they market literally tons of products through Wal-Mart to American consumers; effectively destroying local small businesses and forcing American producers out of business simultaneously. When U.S. authorities threaten to limit China’s monetary manipulating schemes, China simply threatens to close down the country of Wal-Mart’s supply of cheap, and sometimes free, inferior products for their shelves. Touche.

    &&&&&&&

    I agree about Wal-Mart’s role in laying waste to the retail landscape. Wal-Mart has prevailed because the destruction they wreaked on small and medium-sized businesses was slow and insidious, occurring one little town at a time, and because consumers ultimately succumbed to the lure of bargains even as they saw their choices (and neighbors in the retail business) dwindle.

    As a practical matter, Wal-Mart has been unstoppable. One guy even wrote a book on how to stop Wal-Mart, but I surmise that he must have thrown in the towel years ago. (I know about him because a publisher friend asked me ten years ago to ghost-write what would have been the guy’s second book. I declined because I felt the effort to impede Wal-Mart was futile.) RA

    • Robert October 5, 2010, 8:02 pm

      Rick- I disagree that the effort to impede Walmart is futile…

      Walmart does not compete naturally in Meat, Produce, or Dairy- They rely on ad-matching to make the sale, and this strategy makes their posted prices on these items much higher than the local farmer’s markets (at least here in the SW)

      Walmart’s Achille’s heal will reveal itself when people get more focused on the basic staples than on flimsy fabric polo shirts and cheap patio sets… Sure, this unwinding process will take nearly as long as it took for Walmart to claim it’s spot as “King of the Hill”, but I think it is inevitable.

      People have to get back in touch with people in order to re-learn the value proposition. As they do, Coporations will suffer the fate that they need to suffer, because the end game is that you can not smoke-screen value behind depreciation forever.

      Walmart’s prices can not maintain a common slope with the depreciation curve of the currencies they are expressed in forever…. something’s going to snap.

      &&&&&&

      You’re thinking w-a-a-ay out of the box here, Robert, but if it happens that Americans eventually do kick their Wal-Mart habit, it’s hard to imagine that other good things would not accompany such a radical change. RA

  • ricecake October 5, 2010, 5:16 pm

    What happen if China decides to calculate the RMB on Gold or Silver? Or Gold/Silver + a basket of currencies? I’m the Russian will agree the Gold/Silver to currency. Will Yuan goes down. No?

  • fallingman October 5, 2010, 4:37 pm

    The imbalances are the result of a monetary system untethered to anything of real value.

    Causes have effects. It makes no sense to fight the effects. You have to address the cause, but politicians will never do that voluntarily. Honest money hobbles them. That’s why they got rid of it.

    • Robert October 5, 2010, 7:49 pm

      “The imbalances are the result of a monetary system untethered to anything of real value. ”

      Ahhh, the Thomas Aquinas theory that all items have a “fair and just price relative to all other goods”… pure baloney.

      Value is non-quantifiable. It is an illusion of perception born out of the individual willingness to trade item A for item B.

      For example- a snow suit does not fetch the same exchange value in Morroco in September as it does in the Yukon in February.

      Has Ebay taught the Aquinas followers nothing? How many times have you seen listings on Ebay go for an amount that you find so high that it borders on insanity? This is the value principle in action. From the buyer’s point of view, their desire to own that particular item at that particular time inspired them to trade ridiculously more for it than anyone else was willing to trade. The price is fair since it becomes the point of remediation on the exchange. No denominator is necessary.

      It is the crux of the entire global monetary experiment that value can not be denominated globally, and the only mediums of exchange to endure throughout human history have been precious metals- yet even metals experience ebbs and flows in their relative exchange valuations from region to region, and from time to time; but I will submit that these fluctuations, being a natural function of unregulated free markets, maintains a nearly harmonious rhythm over time.

      You may declare this as a 5000 year coincidence, and there is no empirical evidence to refute your claim, but I will always side with the lessons of history over the hubris of men (especially men in suits and ties)

      Of the 20% or so Americans that are not working, many are unwilling to work for “less money” than they were accustomed to earning.

      They aren’t doing the math that less money might purchase an equal amount of real goods in a declining price environment. Bummer for them, for they may be architecting their own misery.

  • mario cavolo October 5, 2010, 4:05 pm

    Interesting announcement on world gold/silver trading.

    This is an FYI of interest for Rick’s forum contributors . As written before, an online ICBC bank account here in China allows easy instant onlin purchase of gold by the gram in RMB and by the ounce in USD. This started about one year ago.

    I just checked my account for the first time in about one month and now the account precious metals menu also lists and allows silver trading too.

    I assume the same is available through Bank of China and possibly the other major Chinese banks.

    Related, it is not that complicated to put a reasonable deposit in RMB in a bank account here in China. I can’t see the downside to doing so. First of all, having a sum of funds in RMB and secondly, it is a multi-currency account with normal currency exchange fees. So you can change between/trade all the major currencies at any time…unleveraged, its just a bank account.

    Times they are a changin’…

    Cheers, Mario

    • Benjamin October 5, 2010, 9:00 pm

      Thanks for the tip, Mario. I’ll look into it, though given how things are going between the U.S. and China, I have to say I feel hesitant about vaulting gold and silver in China. Then again, I feel the same way about NYC.

      Speaking of the changin’ times, I barely caught the last part of a snippet on the TV news this morning about two gold ATMs being installed in (iirc) Las Vegas and somewhere in Florida. I know they’ve been out in Dubai and elsewhere for some time now, but now here in the U.S…

      Why, I wonder what EVER this crazy world could be coming to! 🙂

  • JohnJay October 5, 2010, 1:47 pm

    Manufacturing continues to flee our shores.
    I don’t know if tariffs are right, wrong, or neutral.
    But we had better do something real soon.
    Real estate is being supported by the Fed’s ZIRP, by banks ignoring non paying home owners, and now by the forclosure moratorium.
    ZIRP is squeezing boomers with any substantial savings that now generate miniscule returns.
    TV is full of ads for various schools offering “job training” to add to the 850 billion dollar student loan debt bomb.
    Other than bringing back manufacturing, we will soon have an economy of government jobs until even those lucky few get taxed at 95% to pay their own salaries.
    The time for endless talk is over, what have we got to lose?
    We can’t continue to toady to China, NAFTA, CAFTA, GATT for the few scraps they toss our way.
    We need to get ruthless and ugly or else.

  • Matt October 5, 2010, 1:11 pm

    Why is it assumed that if the Yuan were to float freely it would go higher against the USD?

    • John October 5, 2010, 3:58 pm

      Excellent point !

  • mario cavolo October 5, 2010, 8:28 am

    Hi Gents,

    1. FYI on this for what its worth… “….Chinese (for one) are deliberately underpricing goods in order to put our manufacturers out of business.”… this is never a topic of discussion or concern amongst foreign expat manager community hobnobbing here, including the monthly American Consulate Briefing each month here in Shanghai, and I’ve never seen the topic written about in any monthly biz magazine…its just not in anyone’s mindspace while continued lack of ease/transparency/restrictions on WFOE’s to do business, and rising labor costs remain today’s top concerns for businesses in China.

    2. Trade wars are coming and I’m afraid its going to get ugly. The Chinese are holding the strong hand and as I have stated from the beginning, they are NOT going to back down, they are going to play every strength they have for further dominance, strength and expansion in every possible way they can. If the U.S. can become the world’s superpower in a span of 50 years, so can they and why not?…at least even up the field as an equal player…what will U.S./Euroblock/China GDP’s be in 10 years…much more equal than now for certain.

    Rick posed the question related to my article whether China’s riches can save the world from a meltdown (not exact quote) …maybe yes, maybe no, probably yes, and definitely enough to at least weather the storm for themselves and rise to further global economic power. That’s the future new reality coming like a locomotive like it or not.

    Wine Tariffs – the wine biz is booming here (as most industries). The import tariffs are outrageous. We pay USD $15 for the cheap wines…the very drinkable Trader Joe’s cheap wines, the french bordeauxs and california merlots and australians and chileans for USD $5-8…. here, if we find a good drinkable bottle of wine for 120rmb we do an email blitz to tell everyone…that’s USD $18 a bottle. Funny that Italian food imports are much cheaper than Australian, American…. imported italian canned plum tomatoes, canneloni beans, etc. are only $2…but American brand breakfast cereal and Doritos are USD $10-$12…go figure…maybe they still have a soft spot for Marco Polo.

    3. Auto Tariffs – along with my eternal reminder that China is so rich with cash, assets and home equity; You can’t imagine and that is fatal flaw in the “Chanos” type of bubble warning analysis on China out there. If you own a new BMW or Audi or Mercedes, people want to know if its “only” a domestic made $60,000 auto or an imported one which currently has a luxury import auto tariff of 50% plus.

    I’ll pose the question again to help the world understand the America-China reality of today: If the average American had much, much less debt, much, much more home equity and much more cash in the bank, when your house went down in value by 30% would you freak out? No. Would it cause a daisy chain financial crisis? No. That’s China; regardless of isolated property bubble markets and other corruption based financial and government games which certainly occur here as flagrantly as any other country.

    4. Referring to the U.S. equity markets, amazing how we hit the top of the channel for the last two weeks on feedings of supposedly good news, and now? Somebody knows whether its time to make an upside breakout, no way jose, once again it doesn’t happen for whatever mysterious reason, and once again the feeding of negative news starts being announced as the market’s heading back down the channel…and regarding the price of crude oil…don’t get me started. Good grief.

    What a circus…the U.S. is the ringmaster but the China tiger’s aint’ playin’ so nice…

    The most complex, dangerous financial and trade and wars are fresh on the horizon.

    Cheers, Mario

  • Charles Duke October 5, 2010, 7:35 am

    Tariffs were a major source of revenue to the Federal government prior to 1913 and the advent of the income tax and the Federal Reserve.

  • Benjamin October 5, 2010, 6:33 am

    Tariffs make no sense whatsoever, but I’m sure they will be raised, or at least overly hawked. After all, they need something more to ruin and/or bicker about until the metaphorical atom bomb detonates, to keep the confidence in this farce of an economy going.

    ie To look busy and important.

  • Martin Snell October 5, 2010, 5:34 am

    Think of Chinese exchange rate manipulation as a negative tariff. By applying positive tariffs other countries would simply be “leveling the playing field by bringing the tariff back to zero.

    The other point to think about is that the push to revalue the yuan is important for all nations with trade deficits. It is China’s out sized surpluses that make the world economy unbalanced. Even if the US does not benefit directly (and it may not) from yuan appreciation, the shifting of uncompetitive Chinese industries to Vietnam, India etc, will actually help the generate an overall rebalancing (a very good thing).

    The Chinese are going to do everything they can to avoid revaluing their currency and so will need to be pushed. They are probably shocked that they have been able to get away with this manipulation for so long (and probably laughing about it). It is well past time that the world forces China to let its currency float. The alternative has been and will be to wait until China generates enough inflation to cut its competitiveness form the inside (a long process).