Are steel users hurt by tariffs on imports? Probably not.

[Jan van Eck + 7,558]

Parallel to our discussion on the steel industry profiting from the Trump tariffs on imported (and dumped) steel, is the question of who, if anybody, is getting hammered by the increased domestic costs of steel.  Any manufacturer who consumes a large component of steel in their product line is going to be placed at a disadvantage as respects say a Japanese or Korean manufacturer, who is buying their raw steel at world-market (i.e. dumped-product) pricing.  So, let’s take a look. 
Perhaps the largest manufacturer and exporter of heavy machinery based on steel would be Caterpillar.  When you look at their product line, it includes big bulldozers with large cast-steel parts,  and big machine frames and bodies, such as in those gigantic dump trucks (called haul trucks in the mining industry).  Caterpillar, Euclid, and Oshkosh are all fabricators of such heavy vehicles and machines, together with the heavy steel castings used as components. 
    You have to assume that the duty on steel has effectively boosted the domestic price of steel by 25%.  This is great for steelworkers and steel company shareholders; the duty wall protects a certain profit level.  But does it hurt Caterpillar in their international sales, which does make up a significant portion of their profits?  And here the answer is not so clear.  The major reason it is not directly evident, I would argue, is the variables in the currency exchange rates.  If you have a ten million dollar machine, and your steel cost is 25% of that, and your steel is now 25% more expensive, then your steel fraction costs have increased from $2,500,000  to $3,100,000, and you now have to sell that machine for  $10,600,000.  But, if at the same time the US Dollar has devalued by six pennies, then Caterpillar comes out exactly the same. 
    In recent years the Dollar has bounced around from 85 cents to the Euro, to $1.45.  Thus the volatility in exchange rates is far greater than the changes in raw materials costs.  And if you look at the relative costs of casting an engine block, where the material is iron, even if the iron is 25% more expensive, it has a much smaller impact on the sales price (assuming Cat does not eat any of the additional costs, which of course it can easily do). 
    If you take Komatsu as the direct world-wide competitor to Caterpillar, then the relative exchange rates of the dollar and the yen to the Euro are going to have a much greater impact on their price competition than some raw material increases.  Sure, Cat is going to scream and holler, but in the larger picture, I would predict that Cat will not lay off one single worker because of the steel tariffs.  Much more important to Cat would be a tariff on the Komatsu finished product, excluding Asian excavators from the giant US market.  That would have a gigantic stimulus effect of Cat earnings  (and product demand, and thus employment numbers).  Where tariffs force the substitution of foreign good by domestic product, the domestic producers and citizens prosper, to the expense of the foreigners.  This raw truth is not lost on Mr. Trump. And that truth does not change just because some ideologue economist does not favor that approach. It is what it is. 
 

[Dan Warnick + 6,100]

I learn something every day, and that ain't bad.  Signing off from the Land of Smiles.  I look forward to the new dawn.

[Epic + 390]

2 hours ago, Jan van Eck said:

If you have a ten million dollar machine, and your steel cost is 25% of that, and your steel is now 25% more expensive, then your steel fraction costs have increased from $2,500,000  to $3,100,000, and you now have to sell that machine for  $10,600,000.  But, if at the same time the US Dollar has devalued by six pennies, then Caterpillar comes out exactly the same.

So Jan, what happens when the US dollar does not devalue by 6 pennies?  Six months ago, the dollar index was at 88.  Now it is at 94.  That is a change of over 6 pennies, and it's going in the wrong direction!  (100x94)/88= +6.8 pennies  

Of course, there is also the 800lbs. gorilla in the room.  Assuming the Fed does allow the dollar to devalue by 6 pennies (well actually, it would have to be 12 pennies now), then the average US worker just got a 12% pay cut on $2,700,000,000,000 products they buy every year (12 penny reduction on each dollar earned = 12% pay cut when buying foreign goods, which for the US is $2.7 trillion). This calculates out to be a $324 billion pay-cut for the US worker.  Ouch.  So instead, it seems that any country which buys a lot of foreign goods should seek to strengthen its currency in order to protect its workers.  It should avoid devaluing it, which happens only at the worker's expense.  Of course, by strengthening the currency you run a risk of harming US businesses that export goods, which would, itself harm those workers, but that's where tariffs come in. 

Or am I missing something here?

Jan, if you have any more insight on how foreign exchange rates and tariffs work to affect both trade and income, I'd be interested in reading more.  This is a complicated topic and I don't fully understand its effects.  Even more so, I get the feeling that a lot of people (including politicians) do not understand it either.  I also think the media often purposely distorts these facts in order to help support whatever their agenda happens to be that day (as we all know, distorting the facts is the easiest way to earn those click-through revenues!).   

[Jan van Eck + 7,558]

11 hours ago, Epic said:

So Jan, what happens when the US dollar does not devalue by 6 pennies?  Six months ago, the dollar index was at 88.  Now it is at 94.  That is a change of over 6 pennies, and it's going in the wrong direction!  (100x94)/88= +6.8 pennies  

Of course, there is also the 800lbs. gorilla in the room.  Assuming the Fed does allow the dollar to devalue by 6 pennies (well actually, it would have to be 12 pennies now), then the average US worker just got a 12% pay cut on $2,700,000,000,000 products they buy every year (12 penny reduction on each dollar earned = 12% pay cut when buying foreign goods, which for the US is $2.7 trillion). This calculates out to be a $324 billion pay-cut for the US worker.  Ouch.  So instead, it seems that any country which buys a lot of foreign goods should seek to strengthen its currency in order to protect its workers.  It should avoid devaluing it, which happens only at the worker's expense.  Of course, by strengthening the currency you run a risk of harming US businesses that export goods, which would, itself harm those workers, but that's where tariffs come in. 

Or am I missing something here?

Jan, if you have any more insight on how foreign exchange rates and tariffs work to affect both trade and income, I'd be interested in reading more.  This is a complicated topic and I don't fully understand its effects.  Even more so, I get the feeling that a lot of people (including politicians) do not understand it either.  I also think the media often purposely distorts these facts in order to help support whatever their agenda happens to be that day (as we all know, distorting the facts is the easiest way to earn those click-through revenues!).   

Your points are well taken.  If the exchange rate goes against the US, then the US manufacturer takes it in the shorts.  To illustrate this situation, review the dilemma faced by Bombardier, of Montreal, in attempting to build subway cars and heavy transit railcars for the US Market.  Those contracts take years to complete; at one point, the Canadian Dollar  (called the Loonie, after the image of a Loon stamped on the Dollar Coin) went from 60 cents to par, or a 40% increase.  You get totally hammered when that happens and you are left paying your US customer money to take your product. 

The ancient British approach to that, as Britain historically had a very strong Pound Sterling, was to make their customers captive, a trade style known as "mercantilism."  In that, the customer is treated as a colony and is restricted to only buying British goods - at British prices.  So you had for example railways in South Africa and Kenya and India buying their rails, tieplates, locomotives, and cars all from England.  As those were very expensive goods, in effect the earnings of those colonized areas were expropriated and handed over to the Mother Country, England.  It kept England rich, at the losses and forced poverty of the colonies.  Perhaps to no surprise, eventually that led to independence movements, in some cases by war. 

China is now using a similar approach, substituting capital for guns. For example, the Chinese approached the govt of Ceylon  ["Sri Lanka"] and offered to finance a huge port expansion. That was then built, with Chinese capital, but used Chinese contractors and Chinese materials.  When it was all done, the expected port volumes did not materialize, the port fees never came, and Ceylon defaulted.  So the Chinese then took ownership of the entire Port, and now they control whose ships go in and out.  You can bet those are only Chinese ships, and so you now have to buy Chinese products - at Chinese prices.  In this way, the Chinese hope to dominate the world - and extract world wealth to China. Is that a good strategy?  Of course it is. 

Tariffs will alter the dynamic by removing purchasing power from the sales relationship, converting that to the government.  In effect, tariffs are a substitute for income taxes or property taxes, and become another way to finance the government.  They have the advantage of shutting out the outsiders and forcing domestic industrial expansion.  The hidden cost is that there is no real incentive to innovate; you can get fat and lazy. 

For example, at one time the State of Maine dominated the production of mens' shoes.  Maine had all these shoe and boot factories scattered about and if you wore leather shoes in the USA they usually came from Maine.  The shoe industry was protected by the US tariffs, which I think were set at either 17-1/2% or 22%.  That provided this great shield, and while there were specialty shoes coming in from Italy, the bulk of the US market was from Maine.  Along comes the "most favored nation" tariff reductions and the Maine shoe industry collapses.  Other than one boot manufacturer, I don't think there are any left.  All gone.  But the trade-off is that before, Maine shoes would cost  you $90 a pair and now US consumers can buy shoes for $25.  Is the USA better off without the Maine shoe industry?  Probably is.  But you will have a hard time convincing the unemployed in Maine of that!

So, if the US dollar sinks (or tariffs are installed), does that strip purchasing power from US consumers?  Yes, at least in the short term.  But remember that a market vacuum will induce entrepreneurs to set up new manufacturing plants, to sell inside the USA at the non-tariff price. That will increase domestic employment and incomes, although at the expense of some of the disposable income of other US consumers.  Can that be done on a large scale?  You bet, because the US market is so huge.  The US is unique in that the huge consumer (and industrial-goods_ markets are so giant that they can run just fine without imports. It will have some fringe costs  (limited availability of Dutch cheese, Greek yogurt, and Vietnamese shirts)  but it will transplant underused assets and unemployment from within the USA to outsiders.  And that is what Trump is aiming for. 

[John Houbion + 31]

Eliminating import duties won't help much in leveling the playing field for autos, the VAT is the problem as shown in the example below for the same auto manufactured in Germany and South Carolina:

A vehicle at a German dealership with a MSRP of $100,000 will sell at a SC dealer for $83,325.00

($100K - 19 % VAT abatement + 2.5 % import duty + $300 SC sales tax).

 

The identical vehicle selling at a SC dealership with the same $100,000 MSRP will sell at the German dealership  for $131,495.00

($100K + 10.5 % import duty + 19 % VAT).

 

Consequently, the US consumer will save $16,675.00 and the German consumer $31,495.00 by buying a German-made auto!

 

The VAT abatement on exports is an insurmountable non-tariff trade barrier that is manipulated by foreign countries to favor their exports, and it comes on top of currencies manipulations.  With their ginormous annual trade surpluses with the US, the euro has been kept lower than its US$1.19 inception value in 2002.  Go figure!  

[John Houbion + 31]

In my above example a 20 % tariff levied on German imports would  level the playing field, and the MSRP of autos made here or in Germany would be the same to the consumer.

As an aside, it is the tariff proposed by Trump, and the sooner it is levied the better.

[Epic + 390]

52 minutes ago, John Houbion said:

A vehicle at a German dealership with a MSRP of $100,000 will sell at a SC dealer for $83,325.00

($100K - 19 % VAT abatement + 2.5 % import duty + $300 SC sales tax).

 

The identical vehicle selling at a SC dealership with the same $100,000 MSRP will sell at the German dealership  for $131,495.00

($100K + 10.5 % import duty + 19 % VAT).

 

Consequently, the US consumer will save $16,675.00 and the German consumer $31,495.00 by buying a German-made auto!

Thanks for this.  It is just too bad that the entire collective media industry in the US together is not as smart as you individually, or else they would be able to clear this whole mess up for everyone like you just did for me.

Just to clarify:

German "tariffs" on US manufactured cars sold in Germany = 31.5% penalty to US car manufacturers.  

US "tariff" on German manufactured cars sold in US = -16.7% bonus to German car manufacturers.  

And Germany is the one that throws a fit when Trump suggests that trade isn't fair.  Ha!  I guess Germans have never heard of math.     

[Epic + 390]

1 hour ago, John Houbion said:

A vehicle at a German dealership with a MSRP of $100,000 will sell at a SC dealer for $83,325.00

($100K - 19 % VAT abatement + 2.5 % import duty + $300 SC sales tax).

 

The identical vehicle selling at a SC dealership with the same $100,000 MSRP will sell at the German dealership  for $131,495.00

($100K + 10.5 % import duty + 19 % VAT)

Ok, so I did some more research into this because this is the first time I have ever heard about the VAT and how it affects trade.  Apparently, some economists disagree with the numbers John has given by claiming that the VAT actually has no effect on trade whatsoever.  Here is their argument, more or less:

"Since the VAT is collected as the car is being manufactured at each stage of production, the final MSRP cost of the car is actually higher than that exact same car would be, had it been manufactured in a country without the VAT.  So, for example, the $100,000 German car is not really a $100,000 car since the VAT has already been applied to it.  It is actually a $83,325 MSRP car.  In other words, manufacturing the car in a country with a VAT creates an illusionarily high MSRP for that car.  On the other hand, the US car is not manufactured with a VAT, and so a $100,000 MSRP car made in the US is actually a $100,000 MSRP car.  Therefore (or so the argument  goes), since this car is a $100,000 car in the US, but since no VAT was collected as it was being manufactured, then if that car is sold in a country with a VAT, it has an unfair advantage of avoiding taxes in that country.  Therefore, the VAT must then also be applied to imports so as not to give the imported car an unfair advantage in countries that apply a VAT."

At least this is the argument of many people who have PhDs in economics.  And using the "all other things being equal" argument, the above argument seems to make a lot of sense.  However, I have never thought that people with PhDs are really that much more intelligent than anyone else, and in reality, there are very few instances where all other things are actually equal.  So here is my question, which seems to have been missed or ignored by those "super smart" guys with PhDs: if the US car manufacturer sells the car in Germany, and Germany places a VAT on that car, but then the US government also places an income tax on the US manufacturer's profits from that sale, then is not the US manufacturer being taxed twice?  After all, it is being taxed once by Germany through the VAT and again by the US through the income tax.  Moreover, if the Germany manufacturer gets to deduct the VAT from their exports into the US, and since the US is not then allowed to place an income tax on the Germany manufacturer's profits, then is not the Germany manufacturer the one that is actually getting a huge advantage by avoiding taxation altogether?  In this sense, it seems that all other things are not actually equal, and the VAT is actually acting like an extra tariff like John explained.

Or am I wrong?

 

...it is days like this that I really feel like the US education system has failed the good people of the USofA.