This past week, I told people on several occasions the administration’s tariffs are not necessarily inflationary. They aren’t. As such, the Federal Reserve shouldn’t be horsing around waiting to see what tariffs will do to consumer prices.
To be sure, that might seem counterintuitive. After all, someone has to pay for the thing, and that means it will take more money to buy the same product. Voila. That is inflation, by definition.
Come on, Norris. Where are we going?
Let me ask you a question. Are sales taxes inflationary? After all, they require the consumer to pay more for something. So, if your municipality increases the local sales tax, is that inflationary? While your “out of pocket” expense may be higher, what has actually gone up? The price of the product itself? Or the government’s pound of flesh?
You might think I am being too clever by half, and I could be. However, the concept of taxes being inflationary is almost as baffling to me as my arguing that they aren’t might be to you.
Of course, there is the possibility that domestic producers, if there are any, could simply raise their prices to “match” the higher cost of imports due to the tax. Arguably, that would be inflation since the underlying product has gone up in price. However, using the old test for liability, BUT FOR the tax on imports, the price of domestic manufactures would NOT have increased.
As such, it is the tax which caused the increase in price, not supply and demand, which sort of takes us back to square one. If not all the way back, then mostly so.
Interestingly enough, longer-term, tariffs could have the potential to be either disinflationary or even deflationary.
Imagine you $25 and you have your eye on a widget which costs $20. Assuming no hidden fees or taxes, how many can you purchase? No, this isn’t a trick question. The answer is obviously 1. However, how many can you purchase IF the government slaps a 30% tax on it?
Well, 30% of $20 is $6, meaning you would need $26 for one. Since you only have $25, you can’t purchase any with the product priced at $20. It is just math.
However, how many could you buy if the store owner were to drop the price to, say, $19? Since the whole transaction would set you back $24.70, you could purchase one.
You see, absent a commensurate increase in the supply of money chasing goods and services, tariffs will ultimately lead to a decrease in consumer demand. This isn’t rocket science. As famed economist Milton Friedman was famed for saying:
More simply stated, the more money the government takes, the less money you have to spend. The less money you have to spend, the less you purchase. As such, demand goes down. If that happens, what happens to prices? That’s right, they should go down until supply equals demand.
Laughingly, in Washington, I wouldn’t be surprised if prices went up. Has anyone ridden AmTrak recently? However, everywhere else, a demand curve shift to the left will bring about lower prices for the consumer until supply equals demand.
Therefore, the Federal Reserve should be more focused on the impact monetary policy has on consumer prices instead of the impact tax policy has on them, and tariffs are a tax. That last phrase isn’t even open for debate.
This is important.
It is unclear how effective the Bureau of Labor Statistics’ (BLS) methodology is in capturing the impact tariffs have on prices. At first blush, it doesn’t look very promising to me. As a result, tariffs could very easily show up in the official data as inflation. Essentially, higher taxes will be masquerading as higher prices.
That is IF businesses pass them along to the end consumer. That is most definitely not a given. Think about it.
What would happen if firms could blithely pass along increases in their costs to their clients? That’s right, if they could, they would be able to maintain their profit margins. If so, how many companies would go out of business? The answer is undoubtedly none, at least not because they are losing money.
Which means corporate America will eventually have to start cutting what is known as their SG&A (sales, general and administrative expenses) costs in order to compensate for the arguably arbitrary (there, I have said it) increase in their COGS (costs of goods sold) due to tariffs.
Hmm. If so, what could that mean for employment moving forward? Do you think it goes up or down when companies are staring at some combination of reduced demand and/or reduced profitability square in the face? Intuitively, well, it doesn’t look so good.
Psst. You want to know something? Consumer driven economies absolutely hate weak labor markets. After all, more jobs mean more paychecks. More paychecks mean more consumers. More consumers mean more demand. More demand means more revenue. More revenue could mean more profit.
If that is true, the inverse must be as well.
Therefore, does it make any sense why the administration has been hectoring the Federal Reserve to start cutting the overnight rate? The implication is that the White House is not going to stop it with the tariffs. As such, understanding the potential ramifications, the President wants the monetary authorities to increase the supply of money in the economy to ensure demand doesn’t fall as rapidly as it would otherwise. Now, is THIS inflationary? Very well could be.
In the end, as long as the White House is messing around with tariffs, consumer will likely feel a pinch. Interestingly, one way could be inflationary and the other not. However, that is the nature of the work for those of us in my line of business.
Always making things more complicated than they need to be.
Thank you for your continued support. As always, I hope this newsletter finds you and your family well. May your blessings outweigh your sorrows on this and every day. Also, please be sure to tune into our podcast, Trading Perspectives, which is available on every platform.
Chief Investment Officer
Please note, nothing in this newsletter should be considered or otherwise construed as an offer to buy or sell investment services or securities of any type. Any individual action you might take from reading this newsletter is at your own risk. My opinion, as well as those of our Investment Committee, is subject to change without notice. Finally, the opinions expressed herein are not necessarily those of the rest of the associates and/or shareholders of Oakworth Capital Bank or the official position of the company itself.