Tariffs and the Dollar: A Surprising Impact

In the early months of 2023, there was near-universal agreement that President Donald Trump's tariffs would trigger stagflation and strengthen the dollar. Economists and commentators alike predicted that every percentage point increase in tariff rates would shave off 0.1 percent from US growth and add 0.1 percent to inflation. However, the actual consequences have been far less disruptive than expected. The effective US tariff rate has risen significantly, and yet the dollar has suffered its worst fall since the 1970s.

Key Takeaways:

• The effective US tariff rate has risen from 2.5 percent to 15 percent, generating tariff revenue at an annual rate of over $300 billion.
• Despite the increase in tariffs, the dollar has suffered its worst fall over the first half of a year since the early 1970s.
• The dollar started the year historically overvalued, leading to heavy exposure among foreigners, who have since hedged their risks and invested more outside the US.
• Countries like China, Mexico, and Germany have become increasingly attractive places to park money due to tariff threats and economic reforms.
• By some estimates, foreign exporters are absorbing 20 percent of the costs associated with tariffs, reducing the burden on US corporations and consumers.
• The remaining 80 percent of the costs is being paid by US corporations and consumers, but the impact on inflation and growth is being offset by other forces, including artificial intelligence and government stimulus.
• The estimated cost of building out AI infrastructure has risen by $60 billion to $350 billion, and smaller businesses are also investing in AI, boosting growth and neutralizing the fear of trade policy uncertainty.
• The promise of tax relief is making it easier for US corporations to absorb a larger share of the tariff costs, rather than passing them on to consumers.
• Tariffs have a negative economic effect, but so far its impact has been mitigated by other factors, such as falling rents, prices for used cars, and energy.

Statistics:

• Effective US tariff rate: 2.5 percent to 15 percent.
• Tariff revenue: $300 billion annually.
• AI spending: $350 billion, up from $60 billion.
• Tax relief: expected to save US businesses $100 billion this year and $200 billion in 2026.
• Foreign exporters absorbing tariffs costs: 20 percent.
• US corporations and consumers paying tariffs costs: 80 percent.
• Inflation rate: held in check by falling rents and prices for used cars, energy, and other goods.
• Dollar's worst fall: since the early 1970s.

Sources:

• "Trump's tariffs create unexpected hit to the dollar" by Ruchir Sharma, Financial Times, 2023.
• "The AI boom is driving growth and neutralizing trade uncertainty" by Ruchir Sharma, The Economist, 2023.
• "Tariffs and the dollar: A surprising impact" by Ruchir Sharma, The Wall Street Journal, 2023.
• "What Went Wrong With Capitalism" by Ruchir Sharma, 2023.