La Ze Faire

This just in:  I thought I would explain the impact of Trump’s tariffs in an easily digestible way.

First of all, tariffs cause inflation.  Why?

Let’s suppose you by bagels at your local store for $1 per bagel.  Then, one day, the son of the grocer wants to start making and selling his own bagels.  Since the son is just starting out, he doesn’t have everything streamlined just yet so it costs him more to make a bagel than the original supplier.  He needs to sell his bagels for $2 each.  Now, the dad wants his son to succeed so he tells the original bagel supplier that for now on, he must pay a tax of $1.10 for each bagel sold at the store.  This means his son’s bagels are cheaper than the competition and his business begins to thrive.

Good for the grocer; helping out his son that way.

What does this mean for you?  Well, you used to pay $1 for a bagel and now you pay $2.  This is inflation.

Trump is seeing our steel industry in much the same way as the grocer saw his son’s bagel shop.  Good for Trump.

Except for the inflation part.  We put a tariff on steel so, in the future, everything made from imported steel becomes more expensive.

Yes, this could help our steel industry but that would take decades.  It’s not like a steel mill can be bought and unpackaged like something from Amazon Prime.

So, point #1:  Tariffs cause inflation.

What else happens?

Countries that feel tariffs are unfairly imposed will fight back by putting tariffs on products that they import.  Europe, China, Canada and Mexico are already preparing to do this.

Let’s go back to the Grocer example.

Suppose the grocer has a major customer for its vegetables.  That customer is the brother of the original bagel manufacturer.  The bagel guy tells his brother, “Hey, that grocer is charging me extra to sell my bagels, I think you should tell him that you will stop buying his vegetables unless he gives you a huge discount.  That will teach him a lesson.”

So, the grocer lowers the selling price for his vegetables.  Now, he can’t pay as much for his incoming vegetable supplies so he passes the loss to the farmer.  The farmer can’t make a living at the new prices so he cut back on how many vegetables he grows hoping that the smaller supply will drive up prices.  In the meantime, he has to lay off a bunch of workers.

In the end, bagels cost more; vegetables cost more and jobs disappear.

So, point #2: Unfair tariffs cause retaliation with side effects

What else happens?

The government/Central Bank has basically two ways to impact the economy: Fiscal and Monetary.

Fiscal policy is when the government increases or decreases spending to stimulate (or cool off) the economy.  For example, if they want there to be more money in the economy, they can lower tax rates.  Alternatively, they can increase employment.  People with jobs will spend more money.  This causes economic growth; at least in the short run.  The problem is that putting more money into the economy causes inflation.

This brings us to Monetary Policy.  The Federal Reserve (central bank) can raise and lower interest rates.  When interest rates are low, people spend money instead of saving it.  This causes inflation.  When interest rates are high, people save money (because saved money earns high interest).  This takes money out of the economy and lowers inflation.

The problem with raising the interest rate to control inflation is that is affects everything.  If you want to by a house and have $500K to spend, you can by a bigger house when interest rates are low.  When they are high, you can only buy a smaller house.  If you own a house and interest rates go up, the value of your house goes down because it is now more expensive for someone to borrow money to buy your house.

Higher interest rates also cause companies to save.  Instead of expanding they save.  They won’t spend $10 million on a new production line if the interest on the money borrowed to buy that line eats up all of the potential profit from that line.  No new line = no new jobs.

We recently lowered our taxes.  Today, we just imposed tariffs.

It should come as no surprise that the Federal Reserve just raised interest rates.

So, point #3:  We can control inflation but it comes at a price. 

From my perspective, we are trying to fix an economy that isn’t broken by pulling on both ends of a rope at the same time.  We cut taxes to to incentivize people to spend more which creates jobs.  We impose tariffs that cause inflation.  We raise interest rates to  control inflation which causes us to save instead of spend which results in job loss.

This is the type of economic policy we get when we don’t have knowledgeable economists working in the White House.

Time to save the world.

Up, up and away…

Jim

 

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