Modern Tariffs

Tariffs are back in the spotlight. What makes them truly powerful today is how easily they integrate with AI and databases, allowing for instant access to current rates.

Remember our steel example? Two steel giants, one with production costs of $1000 and a selling price of $2000, compete if overseas trading is viable. Add $100 for overseas shipping, and the imported steel lands at a competitive $1100, potentially doubling construction output.

Now, imagine a cost difference: $800 versus $1000 to produce a ton of steel. A well-placed $200 tariff can level the playing field.

Without that tariff, the $200 cost advantage becomes free capital for one country until the money supply lasts. This can fuel soaring stock valuations (think 50 P/E ratios) and skew equity-to-bond returns. Sometimes this is a boon, but it can also inflate asset bubbles and the rise of virtual assets like cryptocurrencies. The Bretton Woods system, from 1944 to the 1970s, faced similar challenges. Eventually, imbalances between debtor and surplus nations lead to the bursting of these virtual asset bubbles.

Floating exchange rates emerged as a better solution. These systems link currencies to baskets of assets held by central banks, which can buy or sell to stabilize their currency's price. Over time, the relative strength of asset-building economies aligns exchange rates with differences in inflation and interest rates. Speculators help smooth out the ride until this equilibrium is reached. Ultimately, assets that bet on currency fluctuations without considering real risks, interest rates, and inflation tend to fade away.

In these free markets, a ton of steel might cost £800 (equivalent to $800) in one country and $1000 elsewhere. A shift in the exchange rate from 1.00 to 1.25 creates pressure. Increased demand for steel exports encourages speculators to buy up £, driving its value until it becomes profitable to export steel.

Tariffs, therefore, are tools to address the same imbalances that floating exchange rates and monetary policy tackle in free markets. However, Basel standards limit the elasticity of monetary supply to interest and exchange rates due to depository requirements. With these limitations on free markets, tariffs become a necessary complement.

If interested in the root cause of tariffs, information sharing, education, lending inelasticity to rates, and government barriers may give a hint.

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