Speaker 1: Hello, Odd Latch listeners, This is Joe Wisenthal. You are
Speaker 1: listening to an emergency episode of the podcast. It was
Speaker 1: recorded at ten a m. Monday morning, February third. The
Speaker 1: reason I am telling you this is because markets and
Speaker 1: news are moving very fast, and so by the time
Speaker 1: you listen to this, parts of it may already be
Speaker 1: out of date. But the context for the discussion was
Speaker 1: over the weekend, Trump announcing twenty five percent tariffs against
Speaker 1: Canada and Mexico, ten percent tariffs on oil, another ten
Speaker 1: percent tariffs on China. Since we recorded this, about a
Speaker 1: minute after we got out of the studio, Mexican President
Speaker 1: Claudia Schinbaum announcing that the tariffs had been delayed on
Speaker 1: Mexico for a month. We're still waiting to hear if
Speaker 1: something similar happens in Canada. Other than that, take a listen.
Speaker 2: Bloomberg Audio Studios, Podcasts News.
Speaker 3: Hello and welcome to another episode of the Odd Lots podcast.
Speaker 3: I'm Tracy Alloway.
Speaker 1: And I'm Jill Wisenthal.
Speaker 3: Joe, how many of these emergency episodes do you think
Speaker 3: we're going to need to do over the next four years?
Speaker 1: Oh my god?
Speaker 2: You know.
Speaker 1: Well, anyway, I don't know, but this is two weeks
Speaker 1: in a row. A week ago. You know, we had
Speaker 1: to rustle up a deep seek expert last Monday, this
Speaker 1: time a trade expert.
Speaker 3: That's all right, I feel like we might as well
Speaker 3: just preemptively convert the show into a daily because I
Speaker 3: feel like there's going to be a lot of newsflow.
Speaker 3: But anyway, as you mentioned, over the weekend, President Trump
Speaker 3: basically confirmed that the US would be imposing twenty five
Speaker 3: percent tariffs on imports from Canada and Mexico, which are,
Speaker 3: of course, you know, massive US trading partners. He's also
Speaker 3: implementing a ten percent tariff on China. All of this
Speaker 3: is being done via the International Emergency Economic Powers Act,
Speaker 3: and the tariffs are supposed to become effective as of Tuesday,
Speaker 3: February fourth, And of course, you know, a lot of
Speaker 3: stuff can change. The news cycle is very compressed at
Speaker 3: the moment, it feels like, and we're recording this Monday morning,
Speaker 3: so we'll see what happens overnight by the time this
Speaker 3: episode comes out. But in the meantime, there are a
Speaker 3: lot of questions, and who better to ask than Paul Donovan.
Speaker 3: He is, of course chief economist over at Ubs Global
Speaker 3: Wealth Management, someone we've had on the show quite a lot,
Speaker 3: and someone who's been following the ins and outs of
Speaker 3: the tariffs, including some of the technicalities of how they
Speaker 3: actually work, where I think there is quite a bit
Speaker 3: of confusion. So, Paul, thank you so much for coming
Speaker 3: on Odd Blots at short notice too.
Speaker 4: No, thank you for having me on.
Speaker 3: Why don't we just start with I guess there's a
Speaker 3: question that a lot of people have been asking. There's
Speaker 3: a lot of confusion, as I mentioned, about who exactly
Speaker 3: actly is paying these tariffs and when? And the Trump
Speaker 3: administration initially seemed to suggest that foreign countries were going
Speaker 3: to pay, and that they were going to set up
Speaker 3: this external revenue service to collect the income. Now though,
Speaker 3: there seems to be a lot more talk about Americans
Speaker 3: having to accept short term pain for longer term gain.
Speaker 3: A twenty five percent tariff on Mexican or Canadian goods,
Speaker 3: Where is that money actually collected and who is paying
Speaker 3: for it?
Speaker 4: So the US consumer is paying, there is no question
Speaker 4: about this. We have over four thousand years of economic
Speaker 4: history on tariffs. There are literally clay tablets from ancient
Speaker 4: Mesopotamia detailing this. Consumers pay tariff's end of discussion. The
Speaker 4: point at which the tariff is collected, though, is very important.
Speaker 4: The point of entry, when the goods arrive physically in
Speaker 4: the United States, that's when the tariff is paid. And
Speaker 4: that's why a twenty five percent tariff does not fully
Speaker 4: equate into a twenty five percent consumer price increase. Twenty
Speaker 4: five percent tariff would mean about a ten percent consumer
Speaker 4: price increase.
Speaker 1: Explain that further.
Speaker 4: So essentially, if you think about it, the goods arrive
Speaker 4: in the United States, your television has arrived from China
Speaker 4: in the port of Los Angeles. That's the point at
Speaker 4: which you have to pay the tariff. So you pay
Speaker 4: it on the value of the television at the point
Speaker 4: of Los Angeles. But after that point, the consumers still
Speaker 4: got to pay for transporting that television around the country,
Speaker 4: for the advertising, for the whole sale of the retail costs.
Speaker 4: Retailers take a quarter of your money to cover their
Speaker 4: costs and profit margins. So of course all of those
Speaker 4: costs add up to about sixty percent of the consumer price.
Speaker 4: The import price on average is about forty percent.
Speaker 3: Okay, so maybe prices on maple syrup or avocados or
Speaker 3: whatever don't automatically translate to a twenty five percent price
Speaker 3: increase because of the dynamics.
Speaker 1: That you just laid out.
Speaker 3: But I guess the other question that's floating around in
Speaker 3: terms of the impact on the broader economy is are
Speaker 3: these types of tariffs, you know, net inflationary or net deflationary,
Speaker 3: Because on the face of it, it seems like prices
Speaker 3: will go up that would add to inflation, But there's
Speaker 3: this sort of contextual impact as well, where you could see,
Speaker 3: you know, maybe there are fewer jobs and slower economic
Speaker 3: growth as the US economy has to adjust to a
Speaker 3: new trade dynamic, and maybe that exerts downward pressure on prices.
Speaker 3: Net net, do you see this as inflationary or deflationary?
Speaker 4: So in the short term, by which I mean the
Speaker 4: next year, this is going to add to inflation in
Speaker 4: the United States because you know, it's it's a sales tax,
Speaker 4: it's like a VAT tax increase or a consumer tax increase.
Speaker 4: And if you look at Japan when it's ready to
Speaker 4: consumer taxes or the UK when it's really value added tax,
Speaker 4: you see inflation coming through in the in the first instance,
Speaker 4: and this is just the same it's a sales tax
Speaker 4: under a pseudonym, so you will see inflation in the
Speaker 4: first instance. But then you're right. The question is do
Speaker 4: we then see jobs being lost, Particularly because these taxes
Speaker 4: are a lot more focused on complicated supply chains than
Speaker 4: was the case back in twenty eighteen, that may be
Speaker 4: a lot more disruptive to the economy and potentially could
Speaker 4: create unemployment or just fear of unemployment, which would lower demand,
Speaker 4: and that would then be a disinflation force, but not now,
Speaker 4: a disinflation force in the future accompanied by significantly lower growth.
Speaker 1: One of the arguments made by advocates of terrorists from
Speaker 1: time to time is that the US is still by
Speaker 1: far and away the biggest consumer market in the world,
Speaker 1: and it's sort of a privilege to be able to
Speaker 1: sell to US. So if you want to sell to
Speaker 1: US and there's the tariff, just eat the cost yourself,
Speaker 1: lower your prices by ten percent or twenty five percent
Speaker 1: or whatever so that you could still sell into the
Speaker 1: US market competitively. Does that logic fly?
Speaker 4: Not really one thing. The debatable point is whether the
Speaker 4: US is the largest consumer market in the world. The
Speaker 4: Europe is the largest middle income consumer market in the world,
Speaker 4: so it's not all about the United States. The other thing,
Speaker 4: of course, is that the US is generally a relatively
Speaker 4: competitive market. So in other words, you know, it's not
Speaker 4: that consumers are making super normal beta partment producers are
Speaker 4: making super normal profits when they're selling into the United States,
Speaker 4: and we're just chipping away at those.
Speaker 2: No.
Speaker 4: You know, exporters to the United States are very efficient.
Speaker 4: They're operating on thin margins. They don't have the room
Speaker 4: to do this. And if you look back at what
Speaker 4: happened in twenty eighteen, there was no change in import
Speaker 4: prices trends pre tariff, so import prices are the price
Speaker 4: before the tariff is applied. There was no change in
Speaker 4: those trends when tariffs were applied, you know, because the
Speaker 4: exporters to the United States just basically don't have the
Speaker 4: room to cut the margin.
Speaker 3: The other thing that you sometimes hear is that, Okay,
Speaker 3: maybe this means prices go up for American can consumers,
Speaker 3: but some of that price increase could in theory be
Speaker 3: offset by a stronger dollar. And we have seen the
Speaker 3: dollar rallying in recent weeks. And I have a twofold
Speaker 3: question on this, so one, you know, how valid is
Speaker 3: that particular argument the dollar offset idea. But then, secondly,
Speaker 3: why is it that the dollar actually goes up when
Speaker 3: the US announces additional trade measures. I've kind of taken
Speaker 3: that for granted and I've never stopped to actually think
Speaker 3: about why that's happening.
Speaker 4: Well, let's start with the second part first. So essentially,
Speaker 4: I think what is happening is traders are assuming that
Speaker 4: because the tariffs will raise consumer prices over a period
Speaker 4: of time, not all at once, that will then lead
Speaker 4: to a more cautious approach on the part of the
Speaker 4: Federal Reserve with regards to policy interest rates. If interest
Speaker 4: rates don't go down so much, or indeed start to
Speaker 4: go up, that tends to be supportive for the dollar
Speaker 4: at a time when other countries are still on an
Speaker 4: easing trajectory. So it's an interest rate differential expectation. Generally speaking,
Speaker 4: does a stronger dollar help offset the tariffs? I mean,
Speaker 4: to a very minor extent, a stronger dollar will tend
Speaker 4: to lower commodity prices that are globally denominating dollars. But
Speaker 4: the issue here is that ninety five percent of US
Speaker 4: imports are priced in US dollar terms, and so what
Speaker 4: that means is that if the dollar is strengthening, there's
Speaker 4: no automatic response in terms of the price of those things.
Speaker 4: Because the contract specifies UO as one hundred dollars for
Speaker 4: this product, doesn't matter what the exchange rate is. That's
Speaker 4: what the US has dictated. And again, when we look
Speaker 4: at what happens historically, you know, for example, China's twenty
Speaker 4: eighteen devaluation of the rnimbi against the dollar, that didn't
Speaker 4: change the trend in prices to the United States because effectively,
Speaker 4: the exporters to the United States were just grateful to
Speaker 4: get a little bit more proper a margin coming out
Speaker 4: of that process, and the dollar didn't really have a
Speaker 4: big effect in terms of offset.
Speaker 1: As of right now, by the way, it's now ten
Speaker 1: twelve am Monday, the third markets following a little bit more,
Speaker 1: nazdak down two point three percent s and P five
Speaker 1: down one point seven eight percent. You know, this is
Speaker 1: not a gigantic sell off by any stretch. On the
Speaker 1: other hand, it's significant. So it does seem to be
Speaker 1: a surprise. One of the things you heard the people
Speaker 1: love to say it, Oh, take don't take Trump literally,
Speaker 1: take him seriously. But as far as I'm concerned, it's
Speaker 1: not clear that anyone is taking him literally or seriously.
Speaker 1: When it came to tariff, people were just sort of
Speaker 1: I don't think they really think about it at all. Well,
Speaker 1: you know, when you talk to clients, when they ask
Speaker 1: you questions, how much surprise is there, how much do
Speaker 1: you how different is this versus say, what basically would
Speaker 1: people were expecting?
Speaker 4: I think it very much depends on who you ask.
Speaker 4: I think that quite a lot of clients in Asia
Speaker 4: had been expecting quite an aggressive tariff response, because of
Speaker 4: course they bore the brunt of the tariffs in Trump's
Speaker 4: first term, whereas I don't think that that has been
Speaker 4: such an expectation in North America and Europe is a
Speaker 4: bit mixed on this particular point overall, I think as well.
Speaker 4: I mean, the president trides themselves on their unpredictable management style,
Speaker 4: which you know makes my job as somebody who has
Speaker 4: to predict for a living a lot more difficult. But
Speaker 4: it also of course means that if we look at
Speaker 4: what happened with Columbia, where Trump retreated, you know, within
Speaker 4: hours from threats of tariff, but you know, Columbia didn't
Speaker 4: really do anything. No, all of a sudden, we're backtracking
Speaker 4: because we can't have the price of coffee going up.
Speaker 4: That sort of thing, I think means that there is
Speaker 4: still this lingering hope that there will be some sort
Speaker 4: of Columbia style reversal coming out of the administration on
Speaker 4: the tariffs. We've not seen it yet and the clock sticking,
Speaker 4: but I think there's that sort of background belief still
Speaker 4: in the minds of many investors.
Speaker 3: This is actually the other thing I wanted to ask you,
Speaker 3: which is we have seen Trump historically use the threat
Speaker 3: of tariffs as a negotiating tool, right, so hopefully he
Speaker 3: gets at least some of what he wants before the
Speaker 3: tariffs actually have to come into effect. But I feel
Speaker 3: like the more he does this, the less impact or
Speaker 3: the less bang for his buck he's going to be
Speaker 3: able to get, because at some point people are going
Speaker 3: to start calling his bluff. I guess all of this
Speaker 3: is a way of asking, like, how many times can
Speaker 3: he do this with the same impact.
Speaker 4: Well, it's more than just sort of you know, crying
Speaker 4: wolf all the time, which is part of what we're seeing.
Speaker 4: Actually some quite serious long term implications from this, because
Speaker 4: of course, you know, Trump in their first term renegotiated NAFTA,
Speaker 4: and you know, within days of taking office in their
Speaker 4: second term has torn up nafter. So if you do
Speaker 4: a trade deal with the US in a year's time,
Speaker 4: how much confidence have you got that trade deal still
Speaker 4: going to be operable in two years time or three
Speaker 4: years time. And so that's going to make doing deals
Speaker 4: actually more difficult over the longer term. So I think
Speaker 4: that's a particular challenge that we are facing here. I
Speaker 4: would also say, though, that the rhetoric from the Trump
Speaker 4: administration does seem to have shifted, and I think that
Speaker 4: President Trump believes that tariffs are a good thing all
Speaker 4: in capital letters, and not just a bargaining tool. That
Speaker 4: they think that tariff's can be useful for revenue raising,
Speaker 4: which I personally would disagree with, but it doesn't matter
Speaker 4: what I think. That's what the president seems to believe.
Speaker 4: So I think there has been a break from the
Speaker 4: very clear bargaining tool position of the first term, that
Speaker 4: there is sort of a larger role for tariffs in
Speaker 4: Trump's mind in the second term.
Speaker 1: I just have one last question. Explain to us you
Speaker 1: said it earlier, on the disruptive potential of tariffing intermediate goods.
Speaker 1: One of the things we know, for example, about the
Speaker 1: auto industry, whether we're talking about the Canadian border or
Speaker 1: the Mexican border, or maybe both. You see parts and
Speaker 1: you see component crisscross the border several times along the way.
Speaker 1: Talk to us about how this potential intersects.
Speaker 4: I think one of the problems that we have is
Speaker 4: a number of people, including I would suggest some people
Speaker 4: in the administration, are sort of stuck in the early
Speaker 4: nineteen seventies in an imperial model of trade. You import
Speaker 4: raw materials, everything is manufactured at home, you export the
Speaker 4: finished product. And that's sort of the state of play
Speaker 4: when Nixon did universal tariffs back in nineteen seventy one.
Speaker 4: But that's not how the world works now. A majority
Speaker 4: of globe mobal trade is a company shuffling goods between
Speaker 4: its subsidiaries. So a majority of global trade takes place
Speaker 4: inside companies as part of complicated supply chains within a firm.
Speaker 4: So when you start to impose these tariffs, if you've
Speaker 4: got an auto part in the United States, in a
Speaker 4: car made in the United States crossing the border with
Speaker 4: Mexico twelve fourteen times, if every single time it comes
Speaker 4: back into the United States, you're slapping a twenty five
Speaker 4: percent tax on it that very very quickly becomes on
Speaker 4: an uneconomic proposition, and that's the real risk. So that's
Speaker 4: where the disruption comes through. Supply chains were a lot
Speaker 4: more complicated than they were fifty years ago. This ain't
Speaker 4: nineteen seventy one anymore.
Speaker 3: We sort of touched on this earlier, but I think
Speaker 3: it's an important point to hammer home and is the
Speaker 3: proximate source of the market's confusion at the moment. And
Speaker 3: also we would be remiss if we didn't ask Paul
Speaker 3: to do his impression of a central banker. But how
Speaker 3: do you expect central bankers to react to all of this? Because,
Speaker 3: as we spoke about earlier, on the one hand, you
Speaker 3: would expect this to be inflationary in the short term,
Speaker 3: so maybe they might raise rates to try to offset.
Speaker 4: Some of that.
Speaker 3: But at the same time, you would expect this to
Speaker 3: slow GDP in one way or another. Eventually, central banks
Speaker 3: like being ahead of the curve, or at least they
Speaker 3: say they do. Would they perhaps try to lower rates
Speaker 3: in order to offset that contraction? Which way are they
Speaker 3: going to go here?
Speaker 4: So, like most questions and economics, the answer is it depends.
Speaker 4: So if we just get first round effects. If all
Speaker 4: you see is the tax being paid by US consumers
Speaker 4: pushing up prices, central banks should ignore that. Central banks
Speaker 4: should not respond to a one off tax increase, which
Speaker 4: is a one off price increase, because there's nothing they
Speaker 4: can do about it. However, if we see second round effects,
Speaker 4: and this is where it starts to get very problematic.
Speaker 4: If we see, for example, retailers expanding profit margins, again
Speaker 4: another profit led inflation episode. If we see US companies saying, well,
Speaker 4: you know, our competitors' goods are now being TechEd, so
Speaker 4: why don't we raise our own prices? Has happened with
Speaker 4: the washing machine tariff? Why you slap attacks on imported
Speaker 4: washing machines? And domestic manufacturers raise their prices because they
Speaker 4: can because there's less competition that the central bank needs
Speaker 4: to respond to. That then becomes a problem, and then
Speaker 4: there's sort of associated second round effects. Do you see
Speaker 4: wage pressures coming through in certain sectors? I think that's unlikely,
Speaker 4: but if you do, the FED would have to respond.
Speaker 4: If you see, for example, higher auto prices, that could
Speaker 4: lead to higher second hand auto prices, which would lead
Speaker 4: to higher insurance costs for auto and that sort of
Speaker 4: chain effect is something the FED needs to start paying
Speaker 4: attention to. So the direct effect of the tariff I
Speaker 4: think the central banks should ignore, and indeed the FED
Speaker 4: could conceivably continue to cut rates. But if you see
Speaker 4: those second round effects coming through, that is a five
Speaker 4: lom bell warning. That's where the Federal Reserve or any
Speaker 4: other central bank needs to stop paying attention.
Speaker 3: All right, Paul Donovan from UBS Wealth Management, thank you
Speaker 3: so much for coming on odd lots for what is
Speaker 3: probably going to be the first of many impromptu episodes
Speaker 3: I mentioned. Thank you, Paul, Thank you.
Speaker 2: Joe.
Speaker 3: I'm really glad we could do that at short notice.
Speaker 3: It answered a lot of questions for me and also
Speaker 3: kind of contextualized a lot of the big questions. I
Speaker 3: will just say on that second order effect point that
Speaker 3: Paul made at the very end, already I'm looking at
Speaker 3: my inbox right now at a note from Bank of
Speaker 3: America saying they expect US car insurance rates to go
Speaker 3: up as a result of the tariffs, so you know,
Speaker 3: sort of already in motion.
Speaker 1: The two big things for me are the sort of
Speaker 1: real risk of the second order effects, all these other
Speaker 1: things that could happen the more persistent. And then this
Speaker 1: idea I like what he called, you know, the imperial
Speaker 1: model of trade, where one the old style, you're importing
Speaker 1: raw goods, you build it all here, you export it,
Speaker 1: you capture that value ad versus these really complex supply
Speaker 1: chains where something goes across the border multiple times. And
Speaker 1: then to your point, to your question, I thought this
Speaker 1: was key, Like, even if these get reversed really quickly,
Speaker 1: the idea of like, well, what does that mean for
Speaker 1: the prospect of any sustained sort of free trade block
Speaker 1: or free trade zone that it's also rip up able,
Speaker 1: I think is really key.
Speaker 3: Yeah, lots of questions. Time to start brushing up on
Speaker 3: our tiff and trade history. So shall we leave it there?
Speaker 1: Let's leave it there.
Speaker 3: This has been another episode of the ad Thoughts podcast.
Speaker 3: I'm Tracy Alloway. You can follow me at Tracy Alloway.
Speaker 1: And I'm Jill Wisenthal. You can follow me at The Stalwart.
Speaker 1: Follow our producer Carman Rodriguez at Carman Ermann, Dashel Bennett
Speaker 1: at kill Brooks Killbrooks. From all odd lotscontent, go to
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Speaker 3: access to our daily Odd Lots newsletter. Joe and I
Speaker 3: are going to have some thoughts on the tariffs in
Speaker 3: there as well. Thanks for listening