11 Things To Know About Trump's Mexican Tariff Threats

Mexico and Canada are merely a warm-up before Trump drops the real tariff hammer on China.

Summary

• President-elect Trump's proposed 25% tariffs on Mexican and Canadian goods are a negotiating tactic and aren’t likely to become law.

• Mexico has already taken substantial steps to assist the U.S. with border security and drug trafficking, and this will be the basis of a deal.

• Mexico's president, Claudia Sheinbaum, has taken a conciliatory approach to the matter, and Trump has already tweeted favorably about Mexico since then.

• Trump's real economic enemy is China, not Canada or Mexico.

• I reiterate my bullish outlook on Mexico, and expect a swift recovery in 2025, just as Mexico bounced back sharply in 2017 following the first Trump scare.

Happy Thanksgiving weekend to all our American readers. My family and I have been quite ill for the past couple of weeks. So, I have a 12,000 word feverishly-written rough draft that has piled up on my hard drive as I've tried to make sense of recent events. Thankfully, I’m feeling a little better, and I’m working on editing that massive draft down into a few more reasonable-length articles that I'll have up in coming days. That said, let's get this week's controversy out of the way: The Mexican tariffs.

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What’s going on with President-elect Trump's North American tariff threats, and how should it affect our view of the Mexican investment theme going forward? This story kept evolving as I was trying to write about it, so I've resorted to using numbered sections to provide order to a somewhat disjointed collection of analysis.

1. The Initial Tariff Threat

For anyone that missed the news, this week, President-elect Trump announced that he is planning to implement 25% tariffs on all goods coming into the U.S. from Canada and Mexico. The 25% tariff, he said, will be in place until Mexico and Canada take steps to secure their borders. Specifically, Trump is demanding that Mexico and Canada clamp down on the flow of undocumented migrants and illicit drugs, such as fentanyl, which are crossing into the U.S.

This wasn't a total shock. After all, Trump had campaigned extensively on the issues of border security and bolstering the American manufacturing sector. This tariff threat demonstrates action on both of those points. That said, the announcement of a day one, 25% tariff against two the U.S.' three largest trading partners is certainly an escalation in the rhetoric.

Stock futures slipped in the evening following the tariff threat, and both the Canadian Dollar and Mexican Peso fell several percent on the news. This came amid a pre-existing downtrend for both currencies; the Mexican Peso has slipped about 20% from its recent peak, meanwhile the Canadian Dollar has quietly slumped to near its lowest point since all the way back in 2003. The days of cross-border parity are long since over, with the U.S. Dollar now buying more than C$1.40 following the latest decline in the Loonie.

Trump's tweet also included the threat of an additional 10% across the board levy against Chinese goods. Some traders seemingly thought China got off easy with that. However, please note that the proposed 10% increase would be on top of the already existing tariffs that Trump began to levy in 2018 against China and which the Biden Administration added to subsequently. (And just days later, Trump threatened a new 100% tariff against China as well)

2. A Hammer, Not A Scalpel

If Trump's initial tweet becomes law, these would be a blunt tool rather than a targeted economic measure. This would be in-line with Trump's campaign messaging, where he declared that "tariff" was the most beautiful word in the English language. A broad sweeping tariff would generate a large amount of revenue and potentially fund Trump's variety of proposed tax cuts, such as ending the taxation of tips, bringing back the deduction for state and local taxes (SALT), and ending the double taxation of American citizens that live abroad, among other measures.

To be clear, tariffs aren't free money. To generate meaningful revenues from tariffs, there would be real economic costs. Most analysis that I've read suggest that this proposal would cause both the Mexican and Canadian economies to immediately go into recession, and take a significant chunk out of U.S. GDP growth as well.

Most analysts had assumed that Trump would use targeted tariffs, aiming at specific products and industries which were viewed to have national security interests or other extenuating circumstances which would make them need protection. A broad all-encompassing tariff, by contrast, would be a blunt tool to bring in income rather than being a specific instrument to target bad actors or mission-critical industries.

3. Crude Oil In The Crosshairs

Some media pundits were making light of the proposed tariffs, with one prominent person calling it a "guacamole tax" that Americans should be happy to pay in return for border security. It's not such a laughing matter, however.

Trump's proposed tariffs would hit every good coming in from both Mexico and Canada. The Canadian side is especially interesting, as it would including crude oil and natural gas from that country. The majority of Canada's exports to the U.S. are hydrocarbons. And, overall, 40% of U.S. crude is imported, with the largest chunk of that coming from Canada.

Long story short, this proposed tariff would be an absolutely crushing blow to oil-producing provinces like Alberta while immediately jacking up the price of gasoline and other refined oil products in the U.S. as well. (Refineries make tiny profit margins on gasoline as is, they have zero room to absorb tariffs, so they would pass on virtually the whole cost to consumers)

Why wouldn't Canada just export the oil to other countries? Ask the environmentalists about that. Politicians and regulators' resolute opposition to virtually any new pipelines in Canada has resulted in the country not even having enough capacity to get all its oil output efficiently to the U.S., let alone anywhere else. As British Columbia in particular is overrun with anti-growth greenies, opposition to pipelines has been fierce there, limiting the amount of throughput from the all-important Alberta oil sands to Pacific Ocean ports. To a large degree, Canada exports its oil to the U.S. (paying the 25% tariff) or it stays in the ground. Both of these would hurt the North American economy and drive up energy costs considerably.

4. U.S. Consumers Wouldn't Be Able To Avoid The Tariffs

One common argument in favor of tariffs is that they only harm people who want to buy imported stuff. We often see this line of reasoning when discussing things such as European wine or cheeses, which have been targeted in past tariff squabbles. If you don't want the highfalutin stuff, just buy your cheese from Wisconsin and wine from California like a good American and avoid the extra tax. Fine in theory, and in the past, this was more workable.

In the globalized economy of 2024, however, the U.S. simply doesn't manufacture much or any of a massive range of goods anymore. Something like the textile industry -- excluding a few niche operators -- has no reason to be present in the U.S. when places like Bangladesh or Honduras can operate at a tiny fraction of the cost.

Canada exports other products which are in high demand such as car parts, lumber, various metals and mining products and so on. Slapping a straight 25% tax on all of that would be inflationary and increase prices in the U.S. across a broad variety of goods.

Similarly, Mexico exports a whole host of goods to the United States. And not just avocados and tequila, either. Mexico is a leading vendor for cars, trucks, household appliances, consumer electronics, aviation equipment, medical devices, and countless other goods. In many of these cases, there simply isn't any meaningful domestic manufacturing of those goods left in the United States. Why would you make a cheap household appliance like a toaster in the U.S. at this point? Companies like Whirlpool (NYSE:WHR) outsourced almost all of that to Mexico ages ago.

A good such as washing machines would go up in price following a Mexico tariff because it still wouldn't be economical to manufacture them in the U.S. even with a 25% tariff. The difference between paying a Mexican $4/hour or a U.S. worker $20/hour plus union benefits is simply too large to be made up for with a tariff.

If tariffs go into effect on lower-end goods, manufacturing of those goods still wouldn't return to the United States. Rather, prices would simply go up approximately 25% in line with the tariff to maintain the manufacturers' profit margins. The exception here would be if manufacturers figure out how to build factories that are almost all staffed by robots -- but alas this wouldn't do much of anything to increase U.S. manufacturing jobs either.

In any case, this would be far more than simply a tax on guacamole and maple syrup. U.S. consumers would find it exceptionally difficult to avoid buying goods sourced from Canada and Mexico, including gasoline, cars, appliances, medical devices, paper goods, chemicals and so on, even if they specifically sought to avoid tariffed items. The supply chains are simply too enmeshed after 30 years of NAFTWA -- you can't levy a meaningful tax against two of your top three trade partners without significantly impacting consumer prices.

5. Tariff Proposal Is Unlikely To Become Law Because It Would Be So Harmful

Most economists and political analysts (myself included - I have an econ degree) view Trump's move as a bargaining measure rather than a serious policy proposal.

Here is an analysis from James Bosworth, of Latin America Risk Report, who has lived extensively across LatAm and has blogged about the region for the past 20 years:

"Th[ere are] two options. First, Trump is willfully ignorant of the impact of his proposal and he’s going to learn a tough political lesson as the United States suffers unless his advisors walk him back.

Or, second, this is a negotiation position. Perhaps he believes the threat of 25% tariffs has value, the political theater is good for his domestic image, and then he can force Canada and Mexico to make concessions to demonstrate his ability to make good deals. Trump likes to negotiate by making absurd threats and then forcing his counterparts to make concessions back toward reality.

Either way, in the same way so many analysts are convinced that this threat can’t possibly be serious, they are also convinced that Mexico can’t engage in a tit-for-tat trade war with the US. For however much the US economy will suffer, Mexico’s economy will suffer much more given how large US exports factor into the country’s GDP. In facing this threat, Mexico’s government must do more to cooperate on migration and other issues because they can’t win this trade war."

I agree with this analysis.

Mexico derives more than 20% of its GDP from manufacturing. This is a huge figure compared to most economies in the Americas. The United States, Canada, and Colombia and Peru, to name four other diverse economies in the region, are all right around the 10% manufacturing as % of GDP mark. Mexico is at least twice is reliant on manufacturing as most peers -- and in reality the reliance is even higher still since Mexico relies on manufacturing exports to bring in hard currency (aka dollars) whereas a country like Peru largely manufactures stuff for internal consumption.

Furthermore, Mexico sells 80% (eighty percent!) of its manufacturing exports to the United States. There's no reasonable alternative if the U.S. cuts off that free trade bloc -- no other country in the region is large enough nor shares the infrastructure/logistics ties to sop up all of Mexico's manufacturing capacity if it doesn't go to U.S. consumers. Also, there's no possible Mexican pivot to China -- China doesn't need anything Mexico is selling. They are both export-driven models aiming to sell stuff to the United States. China is happy to make deals with countries like Bolivia and Brazil since those countries produce raw goods essential for making value-added Chinese manufactured goods. There is not, by contrast, much room for economic cooperation between Mexico and China. Mexico's fate is inextricably tied to the United States for better or worse.

That said, Boswell went on to argue that Mexico might elect to play hardball against Trump's threats despite the obvious economic harm that would result. Remember that Mexico's President, Claudia Sheinbaum, is extremely popular. She just won her presidential election by a 61% to 28% margin over the nearest competitor. Literally more than twice as many votes. She has an approval rating over 70% today, and her party is massively popular.

If there was ever a time for a left-wing president to take a stand against the United States, it would have been now.

Instead, she made the pragmatic move, taking a conciliatory approach. She wrote a lengthy and well-reasoned letter to President-elect Trump (English translation here) that turned down the temperature.

Sadly, much of the English-language media incorrectly reported on the letter, taking a tiny fragment out of context to make it seem like Sheinbaum was gearing up for a tit-for-tat trade war. If you actually read the letter, she spent most of the time discussing concrete steps that Mexico is taken to help the U.S. in terms of reducing migration, fighting drug trafficking, and building closer ties between the two countries.

At the end of her letter, she said that it was regrettable that the U.S. would threaten tariffs against and damage the operations of companies like GM and Ford which have operated in Mexico for 80 years now and have generated tremendous prosperity for both Americans and Mexicans over the decades.

Within that context, she said that Mexico would be forced to respond with tit-for-tat tariffs in the event the U.S. went ahead with them, but that this road would lead to economic pain for both countries.

She concluded, writing:

"Why impose a tariff that would jeopardize [companies like GM]? Such a measure would be unacceptable and would lead to inflation and job losses in both the United States and Mexico.

I am convinced that North America’s economic strength lies in maintaining our trade partnership. This allows us to remain competitive against other economic blocs. For this reason, I believe that dialogue is the best path to understanding, peace, and prosperity for our nations. I hope our teams can meet soon to continue building joint solutions."

It's bizarre that folks like the writers at ZeroHedge read this and somehow concluded that Sheinbaum was clamoring for a trade war. That was entirely the wrong conclusion, yet a distressingly high portion of Twitter users somehow came away with this mistaken viewpoint.

In any case, her letter clearly indicated that Mexico was looking to maintain open free trade between the countries rather than looking to escalate the tension.

6. Mexico Already Has Taken Substantial Steps To Assist The U.S.

What else was in Sheinbaum's letter?