This election cycle, presidential candidates have characterized tariffs as both a miracle cure for all economic injustices as well as a potential tool for mass disruption.

President Trump has described potential tariffs ranging from 20% to 2,000%, sometimes saying they would apply only to certain countries or industries and at other times suggesting they might be applied to all imports. Meanwhile, Vice President Kamala Harris has framed these policies as an unavoidable sales tax paid by American consumers.

This month we want to discuss the history of tariffs, how they are applied, and their economic impacts.

A brief history of Tariffs and how they work

A tariff is a tax imposed on the imports or exports of goods. In modern parlance, it is most often used to refer specifically to a charge on imports.

Tariffs have been a documented part of economic systems as far back as ancient Greece, when Athens levied a two percent charge on goods such as grain that arrived through the docks of Piraeus. Tariffs have been widely used throughout history to raise revenue and compete against economic rivals.

In the United States, the Customs and Border Protection agency collects tariffs and transfers the revenue to the U.S. Treasury. Tariffs are typically levied as a percentage of the price a buyer pays a foreign seller.

Before federal income tax was established in 1913, tariffs were a major source of revenue. Douglas Irwin, a Dartmouth College economist studying the history of trade policy, estimates that from 1790 to 1860, tariffs accounted for 90% of federal revenue.

The most infamous tariff act was the Smoot-Hawley Tariff Act of 1930, which sharply raised tariffs before the Great Depression. Most economists don’t believe the increase in tariffs had a big influence on the Great Depression considering global trade was only 9% of GDP. However, one outcome of this tariff was the Reciprocal Trade Agreements Act of 1934 which gave presidents authority to negotiate and update trade agreements and tariffs without approval from Congress.

After the Great Depression and World War II, tariffs declined as global trade increased and as a result, they are now a meager source of revenue compared to individual income taxes, Social Security taxes, and Medicare taxes (shown in shades of green below). The chart breaks down sources of Federal Revenue for the last decade, with tariffs listed as “Customs Duties”. Note that even during the 2017-2021 period of the Trump presidency which saw new tariffs, they were still not a significant source of Federal revenue.

Are Tariffs a ‘sales tax’? Who pays the cost?
A tariff is not a ‘sales tax’ in the traditional sense. However, importers who pay the tariff typically raise prices to pass on the increased the cost of bringing goods to market to their end customers. Thus, tariffs result in higher costs on imported goods.

If Tariffs raise costs, what’s the benefit?
Tariffs protect domestic producers by making foreign goods less competitive and harder to sell.

For illustration, imagine a U.S. company that produces chocolate bars for $2.50 each competing with a Swiss company that produces similar bars for $2 each. A sweet-toothed President looking to protect jobs in the U.S. chocolate industry might decide that a tariff of 50% would be applied to all imported chocolate, effectively raising the cost of Swiss chocolate bars to consumers by $1 to $3/bar, making them the more expensive choice. This would likely lead to consumers buying American rather than Swiss chocolate bars.

Tariffs have frequently been employed in the past to combat unfair trade practices. For instance, if the Swiss government was subsidizing their chocolatiers to allow them to sell their bars for $0.50 each, a sizable tariff could help even the playing field. Foreign countries’ support of their manufacturing can take many forms: cheap credit, low wages, currency manipulation, and lax environmental laws can provide unfair advantages in trade.

Levying or lifting of tariffs can also be used to form strategic alliances. For instance, NAFTA (1994-2020) and its replacement policy USMCA (2020 – today) reduced barriers to trade across North America and established a process to handle economic disputes between the members. It also further extended U.S. influence beyond our borders.

What are the downsides of Tariffs?
Tariffs frequently lead to trade wars, where one country levies a tariff and in response the targeted country levies a tariff in return. For instance, in response to President Trump’s tariffs on aluminum and steel, the European Union taxed a variety of U.S. products such as bourbon and Harley-Davidson motorcycles. In a similar vein, China responded to Trump’s tariffs by adding their own tariffs to soybeans and pork, which hurt American farmers.

While a targeted tariff can help protect domestic businesses against a foreign rival, in cases where there is little to no domestic production, a tariff is often inflationary and results in higher costs without a meaningful economic benefit. For example, the U.S. continues to have a tariff on certain steel and aluminum products, yet the chart below from the U.S. Bureau of Labor Statistics illustrates how the number of jobs in the steel industry in 2024 is virtually identical to what it was in 2018 and has trended significantly lower over time.

Tariffs are here to stay, but their impact is dependent on their application

The goal with tariffs is to reshape a trade imbalance and reduce unfair trade. Unfortunately, they are not a magic solution capable of halting the advance of foreign competition. For instance, many companies in targeted countries like China avoid tariffs by shipping goods through other countries like Vietnam or Mexico.

Tariffs will continue to be a part of American economic policy for the foreseeable future. However, this is not without risk. Since tariffs result in higher prices, they can slow the pace of progress when battling inflation.

Capital Markets

Equity markets were lower in October, breaking the pattern of five months of back-to-back gains. The All-Country World Index (ACWI) declined -2.2%, the S&P 500 declined -0.9%, while the EAFE retreated -5.4%. U.S. Small caps declined -1.4%. Emerging market equities fell -4.3%. U.S. Bond prices fell -2.5% for the month.

This document contains forward-looking statements, predictions and forecasts (“forward-looking statements”) concerning our beliefs and opinions in respect of the future. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements.

Equity markets finished September higher, after a rough start with the S&P 500 down over 4% during the first week, the biggest weekly pullback of the year. Investors initially fretted over softer than expected August employment that featured negative revisions to prior months and a disappointing ISM manufacturing report. These data points exacerbated existing worries about U.S. election uncertainty, potential further escalation in Middle East conflicts, U.S. labor disputes (port workers and Boeing) and ongoing economic woes in the Chinese economy.

However, several developments reversed this pessimism. The Fed announced a 0.5% rate cut at their September meeting while telegraphing another likely 0.5% in cuts before year-end. The September cut was supported by positive data showing continued disinflation, a stable (albeit slowing) labor market, still-healthy consumer spending, and continued earnings growth projected for U.S. corporations. The soft-landing narrative was further buttressed by initial unemployment claims falling to the lowest level since May.

A 0.5% drop in policy rates is significant paired with the Fed’s updated Statement of Economic Projections (aka their “Dot Plot”) penciling in another 1% in cuts during 2025 and 0.5% in 2026. Car loans, credit cards, some adjustable-rate mortgages and some other forms of borrowing are based on the Prime Rate, which typically runs approximately 3% above the Fed Funds rate. Thus, a full 1% drop in the Fed Funds rate by year-end would represent a meaningful reduction in borrowing costs for many U.S. consumers.

When Will Fed Rate Cuts Help Homebuyers and Refinancers?

The short answer is “Eventually.” Unlike the Fed Fund rate, which is decided by the Fed, mortgage rates tend to be closely related to 5-year Treasury yields, which are driven primarily by supply and demand factors. These yields tend to rise when the economic outlook is strong and fall when the economic outlook is weak. Over time, Treasury rates tend to follow the direction of changes in the Fed Fund rate.

• The caveat is that mortgage rates don’t always adjust at the same pace:
  When the 5-year yield is rising, borrowing rates tend to go up quickly as lenders are eager to offer loans at higher and higher rates while the economic outlook appears strong. From their perspective, this is a win-win: they’re charging higher rates to borrowers in an environment where defaults are less likely.
• Not surprisingly, when 5-year Treasury yields are falling, lending rates don’t fall quite as fast as they rose. In other words, when the economic future looks more uncertain, lenders prefer to keep rates higher for longer to hedge against future risk.
• This phenomenon is observable in the chart below: the gap between 5-Year Treasurys (yellow line) and 30-year average Fixed Mortgage Rates (white line) is minimal when rates are rising (as in 2022) but tends to widen when rates are flat or declining.

The takeaway: Homebuyers and refinancers should be optimistic that lower rates on mortgages are coming, however they should also expect that these lower borrowing costs for consumers may lag the decline in Fed rate cuts.

Chinese Equity Markets: Avaricious Stimulus

During the last week of September, Chinese equities rose nearly 20% in response to the Chinese government’s announcement of a tidal wave of stimulus measures intended to jump start their economy. The stimulus included cuts to mortgage rates, a decline in down payment requirements for second homes, relaxed capital reserve requirements for banks, and a large stimulus program that explicitly incents brokers, insurance companies and other entities to buy Chinese stocks.

While this caused Chinese stocks to move into positive territory for the year, it does little to address fundamental issues plaguing their economy. China still faces weak retail sales, falling real estate prices, and a crippling dependence on government investment, rather than consumption, to maintain growth. Perhaps worst of all is that the heavy hand of communist rule has undermined shareholder rights, especially those of foreigners. In June this year, foreign direct investment in China turned negative for only the second time since 2005.

Despite the recent rise in Chinese equity prices, we continue to believe investors should be wary of rallies driven by government spending and policies intended to entice speculative investments.

Capital Markets

Equity and fixed income markets rose in September. The All-Country World Index (ACWI) rose +2.17%, the S&P 500 rose +2.02%, while the EAFE rose +0.62%. Emerging markets surged with a gain of +6.68%, driven primarily by the aforementioned move in Chinese equities. U.S. Bond prices rose +1.34% for the month.

This document contains forward-looking statements, predictions and forecasts (“forward-looking statements”) concerning our beliefs and opinions in respect of the future. Forward-looking statements necessarily involve risks and uncertainties, and undue reliance should not be placed on them. There can be no assurance that forward-looking statements will prove to be accurate, and actual results and future events could differ materially from those anticipated in such statements.