The Days Ahead:

  • Quieter week; home sales and durable goods orders and Fed minutes.

This Week:

  • Several tariffs against China announced this week.
  • Covering batteries, semiconductors and syringes…
  • And electric vehicles (EVs).
  • Even though China doesn’t sell EVs in the U.S.
  • We look at the history of tariffs.
  • This one’s mostly for show.
  • Post Covid-19 savings aren’t gone
  • They’ve just moved around.
  • Households have ample cash.

Programming Note:

  • There will be no Market Digest next week. You can find regular updates from the Cerity Partners Investment Office here.

Tariffs Up Again

There’s more tariff talk these days. The history of tariffs is far older than the study of economics. In his “The Wealth of Nations” Adam Smith claimed that custom duties had “been in use for time immemorial” and that they were an “overcharge on consumers… by merchants who were despised… and envied.”

Customs and import taxes were an established part of the Mesopotamian dynasties in 3500 BCE. By late Roman times, a regional customs service employed 20,000 people and collected duties ranging from 10% on wine to 100% on luxury Indian goods. Punishments for evasion ranged from a fine of eight times the value of the goods to a one-way ticket to the Colosseum.  

The U.S.’s history of tariffs is mixed. The country started with the Tariff Act of 1789 which was designed to encourage home grown industries. It imposed a 50% per ton ad valorem (i.e. value) tax on everything coming into the country and additional levies on individual goods. Tea from China was taxed at around 10%, while Portuguese wine or Jamaican rum was taxed at 15%. The average tariff from 1790 to 1820 was 20% on all imports but climbed to 40% to 50% from 1850 to 1900. Twenty rounds of tariffs were passed in the U.S. during the 19th century ending in the Mongrel Tarriff Act of 1883, so called because it levied multiple tariffs on the same items and was deemed such a mess no one wanted their name attached to it.

The notorious Smoot-Hawley Tariff of 1930 weighed in at over 1,000 pages. It raised tariffs on 20,000 goods and lifted the average tariff to 60%. It led to predictable retaliation and a drop of 70% in imports and 66% in exports. It was ditched in 1934 with the Reciprocal Trade Act which allowed bilateral trade agreements on almost everything. By the early 1950s the average tariff was down to less than 8%.

Today the average U.S. tariff is around 1.5% made up of 2% on half of all industrial goods, and 0% on the remainder. By any measure, the U.S. is not a protectionist country. Yes, it ranks 55 out of 270 countries but 32 of those are at 1.39%, and in the EU or EU customs union and mostly trade with each other. China is at 2.3% which doesn’t sound too much but China uses a legion of nontariff barriers that cover 25% of all U.S. imports into China. What’s a nontariff barrier? Well, anything that makes it hard to import, such as last-minute inspections of perishable goods, permits, volume restrictions, rules of origin or quotas.

When it comes to trade, the U.S. is mostly open, while China is less open. Sometimes special interests succeed in raising tariffs if they feel the need for protection. In 2012, Whirlpool filed a complaint about unfair trade from Korea’s LG and Samsung washing machines. The U.S. International Trade Commission passed a 50% duty. The Korean manufacturers moved production to Mexico and China, then Thailand and Vietnam and finally to the U.S. to avoid paying tariffs. Samsung now builds washing machines in South Carolina and LG builds them in Tennessee.

How did U.S. consumers fare? Here’s the inflation index for laundry equipment.

Figure1 Tariffs on Washing Machines Graff

Prices rose by nearly 100% in 2018 (see green line), at which point manufacturing started to come onshore. In all, consumer costs rose by around $1,500 million while raising $82 million in tariffs. The average cost for each job moving to the U.S. was around $817,000.

In 2018, the U.S. imposed tariffs on China costing around $50 billion on a range of products including steel, solar panels, and over 5,700 Chinese goods. It also passed a 25% tariff on EVs from China even though there were no Chinese EVs coming to America.

EVs are important to China. The government has poured money into the sector. In 2019, subsidies were around $265 billion or nearly 20% of GDP. Some 99% of companies in the sector received tax subsidies or outright cash. The exact amounts are hard to track because they include subsidies to battery producers and component manufacturers as well as buyer incentives….up to $7,500 per vehicle in a market where the average cost of an EV is $32,000. We know that the largest EV manufacturer, BYD receives around $1,800 million a year from the government. The estimated subsidy for each of the 5.5 million EVs sold every year is $1,700 for a total of around $88 billion.

China hasn’t just provided cash subsidies to car companies. It poured money into electric buses and motorcycles of which it builds 7.6 million a year. It changed taxi drivers’ shifts in major cities so EVs would have ample time to recharge. It relocated EV manufacturers closer to critical raw material sources. China accounts for 70% of global production of rare earths, which are neither rare nor earth, but are difficult to extract. Putting Chinese EV companies right at the source gives them considerable logistic advantages. The government encouraged EV companies to partner with Baidu, a dominant company with sophisticated mapping, GPS, and AI services. Finally, it supported companies like Geely to buy foreign companies with drivetrain experience and marquee names like Lotus and Volvo for their overseas plants and brand recognition.

It’s a comprehensive level of support and commitment to build an industry from the ground up, which would be very hard to replicate in the EU or U.S.

China makes around 30 million vehicles a year and sells around 24 million domestically, with exports making up the difference. It makes around 9.5 million EVs and hybrids and sells around 5.5 million in China. The rest are for export. The global stock of EVs is around 41 million of which 53% were built in China.

The U.S. makes around 11 million vehicles and sells 15.7 million. The difference comes from imports. Nine million of those built are SUVs or trucks. Only around 440,000 are EVs.

The large number of SUVs and trucks is because of the 1964 Chicken Tax or Proclamation 3564, which imposed and never rescinded, a 25% tariff on all imported trucks. Most SUVs are defined as trucks and so almost any SUV you see on the road, be it Mercedes, BMW or Toyota, are U.S. made. There are an insane number of work arounds including companies building SUVs overseas, disassembling them to import into the U.S., which qualifies the end product as U.S. made.

Anyway, back to EVs. In 2023, some 1.2 million EVs were sold in the U.S. and the U.S. has produced 9% of all EVs in the world.

The result is that China has a large exportable surplus of EVs, which it sells in Asia, Latin America and Africa. The U.S. has insufficient domestically made EVs to reach its federal or state net zero targets. It must either build more or import more.

The Chinese government has a lot riding on the success of the EV industry. This week’s decision by the U.S. to increase the 25% tariffs on Chinese EVs to 100% makes it almost certain that no Chinese cars will ever find their way into the U.S.

Do the tariffs matter? Not in the sense that U.S. consumers will suddenly see a big increase in EVs costs. China’s auto industry has no presence in the U.S. Only 67,000 cars come into the country today and very few are electric.

But China can retaliate. In 2018, China stopped buying U.S. soybeans and took monthly trade from $4,000 million to $211 million in six months. That, in turn, led to more soybean production in Brazil, which led to more clear cutting and forest fires. In a global economy, a lot of chaos can come from tariff actions.

In 2019, China agreed to increase purchases of U.S. exports by $200 billion a year at a time when it was buying around $156 billion a year. But that didn’t happen. It’s unchanged. Meanwhile, China now accounts for 7% of all U.S. exports down from 10% in 2018. Retaliations are real, even if they take time.

Figure2 China US Trade Graph

The chart shows trade between the U.S. and China over the last few years. Since 2017, both imports and exports are flat. In real terms, imports from China are at the same level as September 2006 and down 36% from their 2018 peak.

The 100% tariff on the zero number of Chinese EVs coming into the U.S. means that EVs sold in the U.S. will be more expensive than global prices and there will be less adoption of reasonably priced models. People will continue to see EVs as exclusive and pricey and they will be correct. EV adoption in the U.S. is around 6% of sales and 1.3% of all cars on the road. If the U.S. wants to meet net zero targets it must buy or import 9 million EVs a year in the next 10 years…up from the 1.6 million sold today.

By contrast, EV adoption in the EU is 18% of sales and 2.4% of all cars on the road. In China it’s 20% and 5%.

What’s next? China has four options. Drive down prices and absorb the tariffs. Partner with more companies like Volvo that already have U.S. operations. Move production overseas, perhaps to the U.S. or Mexico. Or sell elsewhere and come back another day. Given the current state of the U.S. relationship with China we’d say the last is most likely.

Either way, it seems the EV arms race just entered a new phase and lower prices aren’t on the short-term horizon.

About Those Savings

A few weeks ago, we wrote about the run down in excess savings accumulated during Covid-19. Our thought was that total savings were down but the number of people working at higher wages would support spending and growth.

Last week the San Francisco Fed updated the data.

Figure3 Excess Savings Data Graph

It’s not as bad as it looks. The authors cite the difficulty of measuring savings and that households’ other assets, such as equity and real estate have grown significantly. Americans thus have the means to borrow and could sustain spending.

That seems fine but we thought we’d look at a few other places for the excess savings. If they were run down, then other cash assets would have fallen, right? We looked in three places: the household wealth survey of assets held in cash (blue line below), retail money market funds (black line) and bank deposits (green line).

Here’s what we found:

Figure4 Bank Deposits Graph

Bank deposits, at $16,248 billion are down around 3% from mid-2022, but many of those deposits are corporate and institutional accounts. Household assets held in checking cash are down around 9% or $450 billion. But savings deposits (not shown) were up $106 billion. Finally retail money market funds were up 20% or $404 billion.

Numbers have fallen from recent peaks but they’re also all well above pre-Covid-19 trends. The three together accounts for around 66% of GDP, in line with pre-Covid-19 levels. There is certainly some spending down of savings, but households still have cash, savings and jobs. The best indicator of spending is having a job and the confidence that you can keep it. There’s ample cash around. The run down in savings is not as the Fed’s graph shows.

The Bottom Line

The market liked the two big inflation reports this week. The CPI came in at 0.3% after a string of disappointing prints at 0.4%. Core inflation is now at 3.6%, not where the Fed wants it, but the best number since February 2021.

Some headlines inflation line items remain high, especially auto insurance which is running at 22%. But insurance is linked to car prices which rose 21% between 2021 and 2023. Price increases have recently subsided and we’d expect the auto insurance to follow later this year.

Markets took the inflation news well with the 10-year Treasury yield falling to 4.3%. It was 4.7% less than a month ago. That was enough to push the S&P 500 and Nasdaq to all-time highs. They’re both up around 11.5% year to date.

Art of the Week: Andre Derain (1880-1954)

Please read important disclosures here.