Tracy Alloway (2:34)

That's right. I feel like we might as well just preemptively convert the show into a daily because I feel like there's going to be a lot of news flow. But anyway, as you mentioned, over the weekend, President Trump basically confirmed that the US would be imposing 25% tariffs on imports from Canada and Mexico, which are, of course, know, massive US trading partners. He's also implementing a 10% tariff on China. All of this is being done via the International Emergency Economic Powers act, and the tariffs are supposed to become effective as of Tuesday, February 4th. And of course, you know, a lot of stuff can change. The news cycle is very compressed at the moment, it feels like. And we're recording this Monday morning, so we'll see what happens overnight by the time this episode comes out. But in the meantime, there are a lot of questions and who better to ask than Paul Donovan? He is of course, chief economist over at UBS Global Wealth Management, someone we've had on the show quite a lot, and someone who's been following the ins and outs of the tariffs, including some of the technicalities of how they actually work, where I think there is quite a bit of confusion. So, Paul, thank you so much for coming on Odd lots at short notice, too.

Paul Donovan (3:49)

No, thank you for having me on.

Tracy Alloway (3:51)

Why don't we just start with, I guess there's a question that a lot of people have been asking. There's a lot of confusion, as I mentioned, about who exactly is paying these tariffs and when. And the Trump administration initially seemed to suggest that foreign countries were going to pay and that they were going to set up this External Revenue Service to collect the income. Now, though, there seems to be a lot more talk about Americans having to accept short term pain for longer term gain. A 25% tariff on Mexican or Canadian goods. Where is that money actually collected and who is paying for it?

Paul Donovan (4:28)

So the US Consumer is paying, There is no question about this. We have over 4,000 years of economic history on tariffs. There are literally clay tablets from ancient Mesopotamia detailing this. Consumers pay tariffs. End of discussion. The point at which the tariff is collected, though, is very important. The point of entry, when the goods arrive physically in the United States, that's when the tariff is paid. And that's why a 25% tariff does not fully equate into a 25% consumer price increase. 25% tariff would mean about a 10% consumer price increase.

Joe Wiesenthal (5:07)

Explain that further.

Paul Donovan (5:09)

So essentially, if you think about it, the goods arrive in the United States. Your television has arrived from China in the port of Los Angeles. That's the point at which you have to pay the tariffs. You pay it on the value of the television at the point of Los Angeles. But after that point, the consumers still got to pay for transporting that television around the country, for the advertising, for the wholesale, for the retail costs. Retailers take a quarter of your money to cover their costs and profit margins. So of course, all of those costs add up to about 60% of the consumer price, the import price, on average, about 40%.

Tracy Alloway (5:44)

Okay, so maybe prices on maple syrup or avocados or whatever don't automatically translate to a 25% price increase because of the dynamics that you just laid out. But I guess the other question that's floating around in terms of the impact on the broader economy is are these types of tariffs net inflationary or net deflationary? Because on the face of it, it seems like prices will go up. That would add to inflation. But there's this sort of contextual as well where you could see maybe there are fewer jobs and slower economic growth as the US Economy has to adjust to a new trade dynamic and maybe that exerts downward pressure on prices. Net net. Do you see this as inflationary or deflationary?

Paul Donovan (6:34)

So in the short term, by which I mean the next year, this is going to add to inflation in the United States because it's a sales tax, it's like a VAT tax increase or a consumer tax increase. And if you look at Japan, Japan when it's raised consumer taxes, or the UK when it's raised value added tax, you see inflation coming through in the first instance. And this is just the same, it's a sales tax under a pseudonym. So you will see inflation in the first instance. But then you're right, the question is, do we then see jobs being lost? Particularly because these taxes are a lot more focused on complicated supply chains than was the case back in 2018. That may be a lot more disruptive to the economy and potentially could create unemployment or just fear of unemployment, which would lower demand and that would then be a disinflation force, but not now, a disinflation force in the future accompanied by significantly lower growth.

Joe Wiesenthal (7:31)

One of the arguments made by advocates of terrorists from time to time is that the US Is still by far and away the biggest consumer market in the world and it's some sort of a privilege to be able to sell to us. So if you want to sell to us and there's the tariff, just eat, eat the cost yourself. Lower Your prices by 10% or 25% or whatever so that you can still sell into the US market competitively. Does that logic fly?

Paul Donovan (7:58)

Not really. For one thing, the debatable point as to whether the US Is the largest consumer market in the world, Europe is the largest middle income consumer market in the world. So it's not all about the United States. The other thing, of course, is that the US is generally a relatively competitive market. So in other words, it's not that consumers are making super normal, beg your pardon, producers are making super normal profits when they're selling into The United States. And we're just chipping away at those. No, exporters to the United States are very efficient. They're operating on thin margins. They don't have the room to do this. And if you look back at what happened in 2018, there was no change in import prices trends pre tariff. So import prices are the price before the tariff is applied. There was no change in those trends when tariffs were applied because the exporters to the United States just basically don't have the room to cut the margin.

Tracy Alloway (8:52)

Hmm. The other thing that you sometimes hear is that, okay, maybe this means prices go up for American consumers, but some of that price increase could in theory, be offset by a stronger dollar. And we have seen the dollar rallying in recent weeks. And I have a twofold question on this. So, one, how valid is that particular argument, the dollar offset idea? But then secondly, why is it that the dollar actually goes up when the US Announces additional trade measures? I've kind of taken that for granted, and I've never stopped to actually think about why that's happening.

Paul Donovan (9:28)

Well, let's start with the second part first. So essentially, I think what is happening is traders are assuming that because the tariffs will raise consumer prices over a period of time, not all at once, that will then lead to a more cautious approach on the part of the Federal Reserve with regards to policy interest rates. If interest rates don't go down so much or indeed start to go up, that tends to be supportive for the dollar at a time when other countries are still on an easing trajectory. So it's an interest rate differential expectation. Generally speaking, does a stronger dollar help offset the tariffs? I mean, to a very minor extent, a stronger dollar will tend to lower commodity prices that are globally denominated in dollars. But the issue here is that 95% of US imports are priced in US dollar terms. And so what that means is that if the dollar is strengthening, there's no automatic response in terms of the price of those things, because the contract specifies you owe us $100 for this product. Doesn't matter what the exchange rate is. That's what the US has dictated. And again, when we look at what happens Historically, for example, China's 2018 devaluation of the renminbi against the dollar, that didn't change the trend in prices to the United States because effectively, the exporters to the United States were just grateful to get a little bit more profit margin coming out of that process. And the dollar didn't really have a big effect in terms of offsetting.

BetterHelp (11:20)

This show is sponsored by BetterHelp.

Mikayla Shiffrin (11:22)

BetterHelp has been revolutionary in connecting people to mental health services.

BetterHelp (11:27)

Using BetterHelp can be as easy as opening your laptop or your phone and clicking a button and the session begins.

Mikayla Shiffrin (11:34)

Clients are able to choose in what way they would like to communicate with me. Whether video or on the phone or.

Tracy Alloway (11:40)

Chat texting, BetterHelp is there when you need it. And that's what makes all the difference.

BetterHelp (11:46)

Visit betterhelp.com podbusiness to get 10% off your first month. Therapists were compensated.

Stifel (11:54)

I'm alpine skier Mikayla Shiffrin. I've won the most World cup ski races in history. But what does success mean? To me, success means discipline. It's teamwork. It's the drive and passion inside of us that comes before all recognition. And it's why Stifel is one of the fastest growing global wealth management firms in the country. If you're looking for success, surround yourself with the people who will get you there.

Stifel (12:19)

At Stifel, we invest everything into our advisors so they can invest everything into their clients. That means direct access to one of the industry's largest equity range research franchises and a leading middle market investment bank. And it's why Stifel has won the J.D. power Award for Employee Advisor satisfaction two years in a row.

Stifel (12:37)

If you're an advisor or investor, choose Stifel.

Stifel (12:40)

Where success meets success. Stifel, Nicklaus & Co. Incorporated member SIPC and NYSE for J.D. power 2024 award information, visit jdpower.com Awards compensation provided for using not obtaining the.

Joe Wiesenthal (12:53)

Award as of right now. By the way, it's now 10:12am on Monday the third markets falling a little bit more. Nasdaq down 2.3%s and P500 down 1.78%. You know, this is not a gigantic sell off by any stretch. On the other hand, it's significant. So it does seem to be a surprise. One of the things you heard, people love to say it don't take Trump literally, take him seriously. But as far as I'm concerned, it's not clear that anyone is taking him seriously, literally or seriously. When it came to tariff, people were just sort of, I don't think they really think about it at all. Well, you know, when you talk to clients, when they ask you questions, how much surprise is there? How much, how different is this versus, say what, basically what people were expecting?

Paul Donovan (13:40)

I think it very much depends on who you ask. I think that quite a lot of clients in Asia had been expecting quite an aggressive tariff response because of course they bore the brunt of the tariffs in Trump's first term, whereas I don't think that that has been such an expectation in North America and Europe is a bit mixed on this particular point overall, I think as well. I mean, the President prides themselves on their unpredictable management style, which makes my job as somebody who has to predict for a living a lot more difficult. But it also, of course, means that if we look at what happened with Colombia, where Trump retreated within hours from threats of tariff. Colombia didn't really do anything. No. All of a sudden we're backtracking because we can't have the price of coffee going up. That sort of thing, I think, means that there is still this lingering hope that there will be some sort of Colombia style reversal coming out of the administration on the tariffs. We've not seen it yet and the clock's ticking. But I think there's that sort of background belief still in the minds of many investors.

Tracy Alloway (14:49)

This is actually the other thing I wanted to ask you, which is we have seen Trump historically use the threat of tariffs as a negotiating tool. Right. So hopefully he gets at least some of what he wants before the tariffs actually have to come into effect. But I feel like the more he does this, the less impact or the less bang for his buck he's going to be able to get, because at some point people are going to start calling his bluff. I guess. I guess all of this is a way of asking how many times can he do this with the same impact?

Paul Donovan (15:25)

Well, it's more than just sort of crying wolf all the time, which is part of what we're seeing. There are actually some quite serious long term implications from this because, of course, Trump in their first term renegotiated NAFTA and within days of taking office in their second term has torn up nafta. So if you do a trade deal with the US In a year's time, how much confidence have you got that trade deal still going to be operable in two years time or three years time? And so that's going to make doing deals actually more difficult over the longer term. So I think that's a particular challenge that we are facing here. I would also say, though, that the rhetoric from the Trump administration does seem to have shifted. And I think that President Trump believes that tariffs are a good thing, all in capital letters and not just a bargaining tool, that they think that tariffs can be useful for revenue raising, which I personally would disagree with. But it doesn't matter what I think. That's what the President seems to Believe so. I think there has been a break from the very clear bargaining tool position of the first term, that there is sort of a larger role for tariffs in Trump's mind in the second term.

Joe Wiesenthal (16:43)

I just have one last question. Explain to us, you said it earlier, on the disruptive potential of tariffing intermediate goods. One of the things we know, for example, about the auto industry, whether we're talking about the Canadian border or the Mexican border or maybe both, you see parts and you see components crisscross the border several times along the way. Talk to us about how this potentially intersects.

Paul Donovan (17:08)

I think one of the problems that we have is a number of people, including, I would suggest some people in the administration, are sort of stuck in the early 1970s in an imperial model of trade. You import raw materials, everything is manufactured at home, you export the finished product. And that's sort of the state of play when Nixon did universal tariffs back in 1971. But that's not how the world works. Now. A majority of global trade is a company shuffling goods between its subsidiaries. So a majority of global trade takes place inside companies as part of complicated supply chains within a firm. So when you start, start to impose these tariffs, if you've got an auto part in the United States, in a car made in the United States crossing the border with Mexico 12, 14 times, if every single time it comes back into the United States, you're slapping a 25% tax on it, that very, very quickly becomes an economic proposition, and that's the real risk. So that's where the disruption comes through. Supply chains are a lot more complicated than they were 50 years ago. This ain't 1971 anymore.

Tracy Alloway (18:13)

We sort of touched on this earlier, but I think it's an important point to hammer home and is the proximate source of the market's confusion at the moment. And also, we would be remiss if we didn't ask Paul to do his impression of a central banker. But how do you expect central bankers to react to all of this? Because as we spoke about earlier, on the one hand, you would expect this to be inflationary in the short term. So maybe they might raise rates to try to offset some of that. But at the same time, you would expect this to slow GDP in one way or another. Eventually, central banks like being ahead of the curve, or at least they say they do. Would they perhaps try to lower rates in order to offset that contraction? Which way are they going to go here?

Paul Donovan (19:01)

So, like most questions in economics, the answer is it depends. So if we just get first Round effects. If all you see is the tax being paid by US consumers pushing up prices, central banks should ignore that. Central banks should not respond to a one off tax increase, which is a one off price increase, because there's nothing they can do about it. However, if we see second round effects, and this is where it starts to get very problematic, if we see for example retailers expanding profit margins, again another profit led inflation episode, if we see U.S. companies saying, well our competitors goods are now being taxed so why don't we raise our own prices as happened with the washing machine tariff where you slap a tax on imported washing machines and domestic manufacturers raise their prices because they can, because there's less competition that the central bank needs to respond to, that then becomes a problem and then there's sort of associated second round effects. Do you see wage pressures coming through in certain sectors? I think that's unlikely. But if you do, the Fed would have to respond. If you see for example higher auto prices that could lead to higher secondhand auto prices which would lead to higher insurance costs for auto. And that sort of chain effect is something the Fed needs to start paying attention to. So the direct effect of the tariff I think the central bank should ignore and indeed the Fed could conceivably continue to cut rates. But if you see those second round effects coming through, that is a five alarm bell warning. That's where the Federal Reserve or any other central bank needs to start paying attention.

Tracy Alloway (20:39)

All right, Paul Donovan from QBS Wealth Management, thank you so much for coming on odd lots for what is probably going to be the first of many impromptu episodes, I imagine. Thank you, Paul.

Mikayla Shiffrin (20:50)

Thank you.

Stifel (21:04)

Jo.

Tracy Alloway (21:04)

I'm really glad we could do that at short notice. It answered a lot of questions for me and also kind of contextualized a lot of the big questions. I will just say on that second order effect point that Paul made at the very end, I already, I'm looking at my inbox right now at a note from bank of America saying they expect US car insurance rates to go up as a result of the tariffs. So, you know, sort of already in motion.

Joe Wiesenthal (21:31)

The two big things for me are a, the sort of real risk of the second order effects, all these other things that could happen the more it persists. And then this idea, I like what he called, you know, the imperial model of trade where one, the old style, you're importing raw goods, you build it all here, you export it, you capture that value you add versus these really complex supply chains where something goes across the border multiple times and Then to your point and to your question, I thought this was key. Even if these get reversed really quickly, the idea of, well, what does that mean for the prospect of any sustained sort of free trade block or free trade zone? That it's also rip up able I think is really key.

Tracy Alloway (22:11)

Yep, lots of questions. Time to start brushing up on our tariff and trade history. So shall we leave it there? Let's leave it there. Welcome back to another episode of the Odd Lots Podcast. I'm Tracy Alloway. You can follow me at Tracy Alloway.

Joe Wiesenthal (22:25)

And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our producers Carmen Rodriguez at Carmen Erman dashiell Bennett at Dashbot Killebrooks Kalebrooks. For more Odd Lots content, go to bloomberg.com oddlots we have transcripts, a blog and a newsletter and you can chat about all of these topics 24. 7 in our discord discord.gg oddlots.

Tracy Alloway (22:46)

And if you enjoy Odd Lots, if you like it when we do these emergency episodes, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad free. All you need to do is find the Bloomberg Channel on Apple Podcasts and follow the instructions there. If you're a subscriber, you'll also get access to our daily Odd Lots newsletter. Joe and I are going to have some thoughts thoughts on the tariffs in there as well. Thanks for listening.

Bloomberg (23:47)

Join Bloomberg in Chicago or via livestream on March 11th for the Future Investor Finding the opportunities this 2025 event series will examine how companies are investing in their businesses to create efficiencies, innovating their products and services, and improving the customer experience. This series is proudly sponsored by Invesco. Q. Q. Q. Register@Bloomberglive.com FutureInvestorChicago that's Bloomberglive.com FutureInvestorChicago.