Tariff Impacts: Economic and Consumer Perspectives

Tariffs have been a popular topic as of late. There are debates on if they are positive or negative for the economy, and how they can impact the everyday consumer. In this episode we explore details associated with tariffs and their effects on investment strategies. Jose Torres, Interactive Brokers’ Senior Economist joins Cassidy Clement to discuss.

Summary – Cents of Security Podcasts Ep. 84

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement:

Welcome back to the Cents of Security Podcast. I’m Cassidy Clement, Senior Manager of SEO and Content here at Interactive Brokers. And today I’m your host for the podcast. Our guest is Jose Torres, Interactive Brokers Senior Economist. Tariffs have been a very popular topic as of late, and there are debates on if they are actually positive or negative for the economy and how they can impact the everyday consumer. In this episode, we’re going to explore the details associated with tariffs, and the way that they can call for some adaptation in your financial investment strategies. Welcome back to the program, Jose.

Jose Torres:

Hi Cassidy, great to be here. Excited to talk about a theme that’s been around all the headlines and the news lately.

Cassidy Clement:

Yeah, so just to jump right into this, I mean, everyone, everywhere, any news site, any newspaper, I mean, this is the jackpot of the word for the week. This is the keyword, right? So, tariffs have been a big talk of the town, and some people have a good view of them, some people have a bad view of them, but we’re more so interested in the core of this conversation. So, when it comes to a tariff, what exactly is it, and who would cover the actual cost of this once it’s integrated into the economy and thus into products? Or I guess a better way to put it is, who pays for it?

Jose Torres:

Sure, so a tariff means that a nation is putting a tax on imports from other nations. So in the US’ case, for example, there, were additional tariffs placed on Chinese imports. So who pays for that? That could either be the producer, the manufacturer, or that can get passed on to the consumer. That’s essentially what a tariff is. Why are tariffs implemented? Sometimes they’re used as negotiating tactics. Other times they’re used to protect domestic industries, because what happens is if you tax products coming from other nations, you may be stimulating domestic production. So here in the US, you know, there’s been a more of a domestic manufacturing push. So there’s a thought process that tariffs can disincentivize American consumers from purchasing international goods and buying goods that are domestically manufactured.

Cassidy Clement:

You had mentioned that a lot of this is utilized in a way of kind of a protection economically, whether it’s for production, goods and services, or manufacturing, which of course all comes down to that overarching view of importing and exporting goods. So, how exactly would someone see these tariffs impacting the economy? And, you know, examples are welcome if you have any examples from the past.

Jose Torres:

Sure, so, if tariffs were placed on Canada and Mexico, then all of a sudden, a lot of the automobiles that are manufactured in Mexico were going to become more expensive. So, in cases where manufacturers have narrow profit margins, then there’s a bias that that cost is going to get passed on to the consumer because the manufacturer doesn’t have much capacity. in its financials to assume the cost themselves. Now, if the profit margins are heavy, then in that case, the manufacturer and the consumer can perhaps share some of the cost burden or the manufacturer can just assume all of the cost burden and keep their selling prices to consumers unchanged.

So that’s really the dynamic there but automobile manufacturers don’t tend to have heavy margins. So if those tariffs that were postponed for 30 days against Mexico, if those tariffs came into fruition, we would see higher prices for used and new automobiles. Shifting north, an important import from Canada happens to be lumber, which is a critical commodity for construction. So to the extent that tariffs were placed on lumber and that would drive their costs higher, then that would also push up the cost of housing because new construction would cost more and that would support the prices for existing homes as well.

Cassidy Clement:

So, when we have conversations about tariffs, whether it’s by the water cooler, or if it’s more nuanced for something like maybe a college classroom, or even, you know, some type of economic forum, people always go back and forth on the age old question: Well, is it a good thing or is it a bad thing? Does it matter what side you’re on? Etc. I know for myself, having these conversations with friends and family when economic policy becomes whatever, the topic of dinner. You know, I go back and think about this scene that a lot of people are referencing now with the current news, which is, if you’ve ever watched Ferris Bueller’s Day Off, one of the opening scenes is they show a high school classroom where all the people are very bored and they’re in like an economics 101 class, and the topic on the board is tariffs. And the teacher is going through the Hawley-Smoot Tariff Act and saying, does anyone know what happened and why they did this? And essentially the idea was, in the 30s, around the Great Depression, the government tried to put in a tariff act to help stimulate some federal government money or economically stimulate, and it ended up not working, unfortunately, and it caused more of a problem. So, this is where we kind of go to someone like yourself, the economist, and we say, okay, taking the current state of affairs out of it, are tariffs usually considered a good thing, a bad thing, or is it more nuanced than that?

Jose Torres:

Definitely nuance like most things in economics. Here in the US we’ve been more of a free trade nation in the last four to five decades or so, right? We’ve embraced the idea that we should be able to trade goods around the world for free without tariffs, but along the way other nations began treating the US unfairly when it comes to trade. So what does that mean? That could mean manipulating currencies, making the US pay duties where we’re letting other nations not pay any duties or tariffs, right? Some countries are more tariff oriented, they’re more restrictive and then other countries like the US have been more free trade.

So the pendulum seems to be swinging the other way. Since the peak of manufacturing employment back in the 1970s, we had roughly 20 million manufacturing jobs. Today, we only have roughly 13 million, despite our population increasing significantly throughout that time. We have roughly 6 to 7 million less manufacturing jobs.

Now part of that is due to automation. Manufacturing has been an automation heavy industry where robots and machines have been able to replace a lot of the tasks that humans used to do previously. But also, a lot of the factories, especially in the Rust Belt of the United States and places that really depended on factories to drive economic prosperity, you know, home ownership, child births, better life expectancy, et cetera, a lot of those communities were negatively affected by manufacturing being shipped to overseas, to lower cost destinations.

So, folks, that have that kind of background they tend to nowadays be more supportive of US embracing tariff measures against other nations, whereas folks that are more cost sensitive and less affected by the manufacturing shift that occurred in the last 40 to 50 years, they tend to be more of the mindset that, oh wow, tariffs just means that I’m going to have to pay higher prices. More money is going to come out of my pocket. So some people think about it as goods are going to get more expensive. Other people think about it like a lot of the jobs that used to support these communities are no longer here. And a lot of those cities, a lot of those neighborhoods they’ve seen declines in population. A lot of folks, they move to the gateway cities because they don’t have much opportunity in those areas. There’s more vacant homes, the vacancy rates in apartment buildings and single family homes are higher, etc.

Cassidy Clement:

So, within your answer there, you know, we talked about it being on a per country basis. Obviously, the economies of Various countries are not exactly the same. There’s different manufacturing trends of goods and services, and then of course, you know, the way that people are employed or the places that people are employed, is it more centralized to cities or is it widespread?

Or if the country’s on a smaller side, is it, you know, evenly dispersed? But all of these things will come together to essentially influence someone’s portfolio. As you know, there kind of is the financial version of the butterfly effect. It’s like if the butterfly flaps its wings, who knows if you’re going to see a percentage up or a percentage down. It’s not like everyone is, not affected by anything else but when it comes to putting these tariffs into place, are there certain things that investors should keep in mind when they’re looking to make a portfolio or strategy adjustment? Because this is going to essentially impact some type of a cash flow or maybe a broader trend in what they were anticipating if it was set to more of a predictable trading environment.

Jose Torres:

Sure. So specifically the companies that have exposure to other regions that may have an adversarial trade relationship with the US and perhaps that relationship is becoming more tenuous with time. That’s a significant risk. Also, what the inputs are for the firms that are in the portfolio, right? If the inputs are coming from places where the US is placing tariffs on those nations, then all of a sudden that could increase their cost structure and an investor’s job at that point is to determine if the company is able to pass along those higher costs to the consumers or not, right? Are there alternatives for those products? If there aren’t any alternatives, then perhaps firms can pass on those higher cost to consumers. So those are some important considerations.

Overall the S&P 500’s revenues, almost a third come from foreign sources. So knowing what the revenue structure and the cost structure is of each company is particularly important when navigating these kinds of tariff threats. You know, overall, folks have been favoring more of the small caps because they’re more domestically oriented, but at the same time, they also have a lot of inputs that are from foreign lands and the large, you know, global conglomerates. They have more exposure to countries in Europe, countries in Asia that could be hit with tariffs, and then that could negatively affect them, not just from the cost side, but also from the revenue side.

You know, for example, Apple has had some trouble selling iPhones in China, you know, because the trade at the adversarial trade relationship between and Beijing has really weighed on consumer demand from that country.

Cassidy Clement:

So just to kind of round this out, I know that this conversation does have a little bit of a skew towards the domestic values of the United States because that’s the hot topic right now. But if we are to look at this from the view of, we’ll say, the United States economics, you’re the right person to ask. So when it comes to inflation and economic growth being either increased or decreased in this conversation, can you shed some light on how tariffs can impact those, thus impacting the Federal Reserve and interest rates?

Jose Torres:

Well, turning to current events, goods, physical products, drove the entire disinflation train from 2022 to today. Those numbers that we had, the inflation numbers up in the nine handles that are now at the two handles, that was all driven mainly by goods disinflation. Goods deflation rather, so disinflation is slower price increases and deflation is outright price decreases.

So, for example, new and used automobiles, their prices went down significantly from 2022 to 2024. In a worst-case scenario of tariff implementation, inflation will rise from roughly the 3 percent annual clip that it’s running at now to around 4%. Economic growth will also decline by about 1%. And the reason why goods are so sensitive and why they’re going to push up the entire inflation picture if tariff implementation is widespread is because the other aspects of inflation haven’t been reliable contributors.

Labor intensive services, wage pressures have been too strong. That’s also a predominant risk now that we have immigration policy becoming increasingly harsh. So there could be pressure on behalf of corporates to pay more because the labor pool could shrink against the backdrop of mass deportations. And then shelter services, there’s labor intensive services and then there’s shelter. Shelter also has been rising significantly, shelter costs, and that hasn’t cooperated on the inflation front.

Commodities have been on and off. They haven’t been a reliable contributor. Some months they come in hot, some months they come in cold. Even so, commodities aren’t enough of the pie to move the needle one way or another. So really, if the tariff implementation begins to heighten, that one reliable contributor of deflation from 2022 to now reverses, and then we’re in a realm of 4 percent inflation. 3 percent inflation, the Federal Reserve is fine tolerating.

They’ve been tolerating inflation above their target for the last four years or so. but when you get to 4 percent inflation, right, that’s double their target. Now it’s not 50 percent of other target. It’s double their target. At that point, then the Fed becomes apprehensive towards the equity market interest rates have to go up and then you’re in a little more of a complicated situation. You know, mortgages are at roughly at 7 percent now, they have to go up to 7. 5, the tenure has to go to 5%, 5.5%, and then all of a sudden, you know, uh, economic growth begins to slow because the cost of capital is too elevated.

Cassidy Clement:

Love it, meaning great example, because I wanted to be able to have a conversation to kind of show the way of kind of the dominoes falling, that kind of element, because it’s not just limited to, you know, something getting imported and, you know, your pairs of shoes are more expensive now. There’s incredible impacts to how this policy can roll out. So as always, thanks for joining us, Jose.

Jose Torres:

My pleasure, Cassidy, looking forward to next time.

Cassidy Clement:

Yeah. Awesome. So as always, listeners can learn more about an array of financial topics for free interactivebrokers.com/campus. Follow us on your favorite podcast network and feel free to leave us a rating or review. Thanks for listening, everyone.