Estimated Reading Time: 4 minutes

One of the Left’s defining characteristics is its tendency to accuse others of what it itself is doing.  For example, the Left prattles on about “misinformation” and “disinformation” when the Left itself is one of the major purveyors of misinformation and disinformation.  But nowhere is the Left’s disinformation and misinformation more apparent than in the case of tariffs and the Left’s war on tariffs.

We hear again and again from the Left that “tariffs are inflationary and therefore bad policy.”  When we reflect on this statement for more than a few moments, doubts begin to creep in.  The much-reviled Smoot-Hawley Tariff is often cited as one of the primary causes of the Great Depression of the 1930s.  So, this means that the Smoot-Hawley Tariff contributed significantly to inflation in the 1930s, correct?  Well, no, wrong.  It was the precise opposite:  prices fell during the 1930s; they didn’t skyrocket.

So there’s your first clue, Sherlock.

Let’s think this through.  Let’s assume that Trump imposes a big, fat tariff on widgets, which we’ll consider are made in India and China.  The widgets are imported into the United States, and the tariff becomes payable to the federal government.  Who bears the cost of the tariffs?  There are only three possibilities:  (1) the widget maker in India or China, (2) the company importing the widgets into the U.S. or the retailer selling the widgets, or (3) the U.S. person and end-user buying the widget at retail. (Of course, it can be some combination of these three).

Suppose the Indian or Chinese company manufacturing the widgets bears the entire tariff cost and doesn’t raise the price of the widget to the company importing it into the U.S. In that case, there will be an economic impact in India or China, but not in the U.S.  The Indian or Chinese manufacturing company’s gross profit on the widget sale will diminish.  Theoretically, that could reduce the manufacturing company’s ability and wherewithal to buy products from the U.S., but that probably doesn’t happen much (or at all).

If either the U.S. importer or the U.S. consumer (or the two in some combination) bears the entire cost of the tariff, the effect is very close to the impact of a federal tax.  Money flows to the federal government, and the importer and/or consumer have fewer dollars in their proverbial pockets.  Let’s say the consumer bears the full cost of a 25 percent tariff, paying $125 for a widget that before the tariff was imposed cost $100.  That consumer now has a widget (as before) but also has $25 less in his pocket than before the tariff was imposed.

Having fewer dollars to spend in your pocket is neither contractionary nor expansionary in economic terms.  You can’t spend money that you have paid to Uncle Sam.  This is why no one advocates raising taxes during a recession or depression.  It will only exacerbate the recession or depression. Economic activity declines — fewer purchases of goods or services because everyone (except Uncle Sam) has less money if taxes are raised across the board.

Well, how about Uncle Sam, who now has more money?  In a kind of Law of Conservation of Money, Uncle Sam, for all practical purposes, will spend the tariff money one way or another, either to pay down existing debt, to spend on new programs, or to lower income or other taxes.  (We can safely ignore the theoretical possibility that Uncle Sam will collect the tariffs in paper dollars and bury all those paper dollars in one of the National Parks or underneath the Capitol).  Inevitably, Uncle Sam will recycle those tariff dollars back into the U.S. economy. 

Now here is where we get into Milton Friedman’s famous maxim that “inflation is always and everywhere a monetary phenomenon [of too much money chasing too few goods and services].”   Inflation occurs when the government prints too much money, causing the money supply to grow faster than the economy.

Let’s say the Federal Reserve’s policy of printing money to finance federal government budget deficits remains the same and, further, that the federal government spends all of the collected tariff money (but no more or no less) to fund an across-the-board federal income tax credit that reduces people’s income taxes dollar for dollar.  What happens then in terms of the direct effect of the tariff?

Well, the people who bought the widgets and paid the tariffs collectively have less money — in X amount, let’s say —and the people who collectively reduced their taxes in X amount have more money.  Some people have more money, while others have less, but inflation should neither increase nor decrease because the level of printing money in excess of economic growth hasn’t changed.

In other words, tariffs won’t cause inflation, but increased budget deficits and increased printing of money by the Fed will.  Note especially that the budget deficit will narrow (perhaps even be eliminated) if the tariff revenues are used to pay down federal government debt, rather than to expand spending programs or reduce other types of taxes.  If that were to occur, inflation would decline, interest rates on government debt would fall, and the economy would likely boom.

Keep in mind that the term “inflation,” as used by Milton Friedman, is broader than merely consumer price inflation.  It extends to all things that can be purchased, including real estate, stocks, bonds, precious metals, and Bitcoin, among others.  When this is understood, the mystery of why consumer price inflation remained relatively tame from around 1982 through the beginning of the Pandemic in 2020, despite enormous printing of money by the Fed, is solved:   the inflation generated by excess printing of money largely went into stocks and real estate (and bonds —until about 2020).  Not much of it went into consumer price inflation.  This occurred because of policies implemented to reduce labor costs, including massive legal and illegal immigration (i.e., importing labor); relocating high-paying manufacturing jobs to countries such as China, Vietnam, and India; and other measures.

Over time, the tariffs are likely to lead companies to build manufacturing plants in the United States rather than elsewhere.  American citizens will find better-paying jobs.  An economic boom is expected to result as long as the tariff revenues are not frittered away on social programs, but instead are used to narrow or eliminate the budget deficit and, therefore, to rein in the printing of money by the Fed.

Already, there have been some indications that Trump’s cost-cutting measures and tariffs are narrowing the budget deficit and stimulating increased economic activity, all without causing a rise in consumer price inflation.  In the future, all eyes should be on the federal government’s budget deficit.