How inflationary are tariffs, really?

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0:36American trade. So today on the show, the question everyone's asking, are tariffs really inflationary? This is Unhedged, the finance and markets podcast from the Financial Times and Pushkin. I'm Josh Oliver, the FT's real estate correspondent, filling in for Katie Martin, filling in for Rob Armstrong, and truly scraping the bottom of the substitute host barrel. Luckily, our guest is from the very top of the guest barrel. We have Chris Giles, the FT's economics commentator and author of our excellent Central Banks newsletter. So Chris, let me start with this. Why is it that people think tariffs will be inflationary?

1:10Well, ultimately tariffs are a tax on imports. And it's a tax on price of imports. If it gets pushed through to consumer prices, that raises the price level. And that might be seen as a price level increase. That would certainly raise inflation in the short term. And then if it fed through to wages and prices, it could be inflationary. So that's why people think they're inflationary. The question is how inflationary. I think that's the real question we're trying to get to the bottom of today. Is it sort of just a technical thing where if the tariff means that such and such costs X amount more, then that shows up in the inflation survey and then that gets reported as more inflation?

1:50Or is it more fundamental than that if you have tariffs around an economy that it drives up inflation in other ways? Well, I think if we want to talk about it being genuinely inflationary, then it should be driving up inflation on an ongoing process, not just an increase in the price level of a particular tariff item or good that has a particular tariff applied to it, because that's really a price level shift. But people conflate the two all the time. We're not going to do that, are we? We're not going to do that. We never do that. We're going to talk about this really carefully and try and get to the bottom of whether these things really are inflationary.

2:26And I'll try and tell you when I think it's a price level shift and when I think it might have an inflationary impact. Does the impact depend on what type of economy we're talking about? I mean, you wrote a great piece on this in the FT where you pointed out that the U.S. is a remarkably closed economy. But can you explain what that means and why it matters to the impact of tariffs? It certainly matters. So open economies do a lot of trading when it comes to tariffs. We're talking about trading in goods because tariffs are not applied to services. So they do a lot of trading in open economies, do a lot of trading in goods.

2:59So goods, imports and exports are a big share of the economy. Germany, for example, if you add up all the goods imports and all the goods exports, it comes to about 70 % of the German economy. Clearly, when you get to bigger economies, more of the stuff happens within the borders. So if you look at the EU, it's about 30 percent. It's external trade. China, 33 percent. U.S., 19 percent. So the U.S. is a very closed economy. Much, much of the activity is all happening within the U.S. rather than externally U.S. trading with other countries. And that means that immediately it means the effect of tariffs.

3:42We shouldn't exaggerate them because most of what goes on in the U.S. happens within the U.S., not crossing borders. Chris, what does all this have to do with washing machines? Well, washing machines were a bit of a cause celebrity in the last Trump administration. It was the first thing he put tariffs on very publicly in 2018. and then everyone wanted to look at the price of washing machines. And the obvious thing to do was to look at the price of washing machines in the US compared with the price of other appliances. Because it was washing machines specifically, not dishwashers and fridges and other bits.

4:18Yeah, it was specifically washing machines and specifically US style of washing machines, which are quite different to the rest of the world. But say it was a US thing and the other appliances didn't do it. So you could just go and look in the consumer price index for washing machines and you compare that with the consumer price index for other appliances. And you get a picture that looks like the price of washing machines rose dramatically compared with other appliances immediately after he put the tariff in. Then it gets a little bit complicated. Because it wasn't complicated. Yeah. So in 2019, that price of washing machines compared with other appliances goes back down to basically the difference goes back down to zero for a few quarters.

5:03And then it rises again after the after the covid crisis in 2021. And then when the tariffs expired in 2023, it came back down again. So if you look at the whole period, it does look as if washing machines got more expensive when tariffs were applied. Although there's a difficult period in 2019, which is hard to explain. but this has caused an enormous amount of argument between various economists who all accuse each other of cherry-picking the time frame when they are actually making the comparison. I'm sure it was Donald Trump's intention to give us a sort of control experiment in inflation by choosing one single household good to put tariffs on.

5:41That was very helpful. Speaking of debate, I mean, I gather that there was a big economist showdown on the internet recently on this very subject. Do you want to tell us about that and what did we learn? Well, there was a really vitriolic showdown between Justin Wolfers, who's a professor of economics at Michigan, and Oren Cass, who's the chief economist of American Compass. And they basically had a bit of what we used to call a Twitter war, but now I don't know what it is, an X war, on exactly this, on washing machines, where one person, first of all, Justin Wolfers, would put up the chart showing the prices went up immediately after the tariffs went in.

6:18or on cassettes would say aha but look they came back down again in 2019 justin wolf would say yeah but that was mostly the pandemic and it was went on and on and on and it really got very very heated indeed and the the important thing is washing machines was only one of the tariffs that were put on by the previous trump administration and it's a bit silly just to be looking at washing machines because when academics have really looked at all the tariff lines and done a really careful studies. Wash machines actually is a bit of an exception to the rule. And just to say, where does the academic research come out of all the Trump tariffs?

6:56Well, it says, number one, Trump was wrong in saying that foreigners pay for these tariffs. It was that the US importer paid about 95 % of the tariffs. So a tiny bit was Chinese manufacturers lowering their prices. The vast majority went to the US importer. But what's really interesting, that in the majority of cases, it then didn't appear obviously to get passed on to consumers. So washing machines is here the exception. So, and the way that economists try and work this out is they can see that importers are paying more. So it's a tax on imports. With one exception, sort of commodity intermediate goods.

7:38So things that go into the production of other goods. So steel, their exporters did pay because you can just get steel from pretty much anywhere. And so if you want to stay competitive, you have to lower your price. But that steel is, again, another exception. So the majority of goods the importer paid, but it didn't obviously get transmitted to consumers. Now, people don't know whether that meant that the importers themselves absorbed the additional costs in their margins or passed it on to their own workers in lower pay than they would otherwise get. Or they tried to get ahead of the tariffs, imported all this stuff just before the tariffs came in, so it didn't really affect them too much.

8:17Or they did smart things saying, well, actually, America's not that competitive an economy. We can raise all our prices by a little bit. And so things that haven't got tariffs on will raise those prices as well. So you can't actually easily see it. And so it's sort of confounding the tools that economists use to try and work out whether it had an effect. But basically, the evidence is saying, actually, it's not foreign countries that pay. It is American companies one way or another. So it's America one way or another because American companies are mostly owned by Americans. In some form or other, America pays.

8:51But it's not entirely clear exactly how that is. So the key difference between 2018 and now is the sort of like shock and awe scale. So if Trump falls through with what he said, does the scale of what's proposed blow the existing academic literature out the window? To some extent, it must do. So the things I was talking about, whether an importer can massage the way the companies raise some prices and other prices and make them all a bit level, so push it out in a sort of way to smooth the effect of the economy. If you have across the board 25 % tariffs on your biggest trading partners, so Mexico and Canada, then that is going to have a much bigger effect.

9:36notwithstanding the fact remember all the time that america's quite a closed economy so don't exaggerate that but you it's much harder to disguise it and hide it away if it's big and the partners are big i don't think that means in most cases that the exporter is going to pay so i don't think that you don't really want to be canada or mexico in these circumstances because more likely you'll pay by not exporting at all because America will find or importers will find somewhere else to get the same products from. But those trade flow changes take time. They're not easy to do overnight. And if you think about Canadian oil, for example, which is exported to America, that comes generally because there's a pipeline.

10:23And so that's not going to shift anywhere in the short term. So it does look as if Americans will pay and might pay quite a bit. So we might see more of it in the American price indexes. But again, remember, this is a price level shift at first. And it's only if the response to this is that American workers demand more pay, companies exceed to that payoff, and then because they think, oh, we can raise our prices at all, that it becomes inflationary. So number one, I think this is bad economic policy, no doubt about that. But let's not then compound that mistake by exaggerating the impact. It will be America who pays.

11:06But the scale, even though this Canada and Mexico are America's largest trading partners, is still relatively small to the size of the US economy. Chris, normally, I would ask you to summarize where we go from here and what the evidence means, but you've just done it perfectly. So thank you so much. We'll be back in a second with Long Short.

11:33Welcome back to Unhedged. It's Long Short, the part of the show where we go long something we like and short something we don't. Chris, what's your long short this week? Well, I'm going to go short Scott Besson, Trump's new pick for Treasury Secretary. The markets have treated his nomination with quite a lot of joy. But I think that's more of a relief rally, that a relief that it wasn't just some TV personality. I'm going to go short on him effectively, because I think this morning he worked out that maybe he doesn't have much power as Treasury Secretary. And he's just going to be reacting to whatever Trump dreamed up in the middle of the night, just like he's had to do today with tariffs.

12:13So you're going short on his ability to be a grown up in the room, as everybody keeps saying, on US economic policy. Absolutely. I think it's going to be mad. And I think there's a bit of a cottage industry, partly in our own industry, of trying to rationalize what's going on. And actually, it's just madness. Yeah, I think you could also go short on his tenure, which is the other thing people forget about Trump cabinet picks, is that some of them will stay and some of them will go. And he seems like one who could possibly go. Come on then, how long do you think he's going to last? I'll give him two years.

12:47yeah i think i'm with you on that i am going to go short sadly something that i actually do like which is the smithfield meat market in the city of london you know that in my day job i'm the ft property correspondent and i'm i'm currently waiting on the outcome of a vote in the city of london about closing the market which is depending on how you count 900 years old it's quite sad actually i think i mean i love the history of this place and the problem was they were going to try and move it and it costs too much money. And so there's a vote going on as to whether they should just give up on moving it and close it.

13:19And I think unfortunately, they probably are going to close it. So that's a short, but I think it's a sort of sad note on which I'm going to join you in that. And my favorite retail butcher is really a wholesale place. But my favorite retail butcher is called Smithfield's Butchers, which is just across the road from the market. And it is just fantastic. So I shouldn't really be giving them a plug on the show, but they deserve it. This is unpaid promotion, we promise. Absolutely. Thank you very much, Chris. I'm Josh Oliver. This has been Unhedged. Thank you for joining us. Unhedged is produced by Jake Harper and edited by Brian Erstad.

13:56Our executive producer is Jacob Goldstein. We had additional help from Topher Forges. Cheryl Brumley is the FT's Global Head of Audio. Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Sadler. FT premium subscribers can get the unhedged newsletter for free. A 30-day free trial is available to everyone else. Just go to ft.com slash unhedged offer. I'm Josh Oliver. Thank you for listening.

14:39Thank you.