Background
When Trump first announced that he would build a wall between Mexico and the US, it sounded crazy. When he suggested that the Mexicans would pay for it, the idealized message was clear; though perhaps metaphoric, but it was not a tax. When Trump introduced tariffs in 2018, they were targeted: steel, aluminum and many other products. The total tax increase was $79 billion on goods worth about $380 billion.
Fast-forward to 2025
The new and emboldened president has stepped up his game. He identified Canada, Mexico, and China—which constitute over a third of US imports—and threatened tariffs of ~$270 billion, just under 1% of GDP, on goods worth over $1.3 trillion. It’s about an even split between the three countries, but has a greater impact on Mexico and Canada at 6% and 5% of GDP, affecting 24% and 20% of their respective economic outputs. Now he is shaking a stick with thorns!!
Like Trump’s wall, the key question is who will pay for these tariffs and how does the impact trickle down to our investments?
Key Considerations
Theoretically, in an environment without elasticity of supply and demand, the bilateral exchange rate would adjust, and Americans would pay the same price in USD. Canadians would receive the same price in CAD, and the FX rate would absorb the 25% and move from 1.40 to 1.75 CAD to USD. However, elasticity is available and so is substitution. Oil can be shipped from Venezuela or the Middle East and automobiles can come in from Europe. An irony of tariffs is that it will cause many US-built cars to become more expensive than imports from Europe and Japan, due to the taxed parts coming from Canada and Mexico.
The exporters could also theoretically suffer the whole amount as a margin compression. Heavy oil differentials could get crushed because heavy oil from Athabasca requires upgrading and Canada doesn’t have the capacity. Auto supply chains could take decades to adjust. Lower revenues and higher costs will squeeze Canadian companies.
Or American consumers could just pay more to consume or consume proportionally less. Faced with a substantial increase in the cost of the goods they consume, it is unlikely that consumption patterns continue unaffected.
Takeaways
As always, the answer lies in the middle of all the possibilities. The Canadian Dollar will get hit, margins will get squeezed, other countries will benefit, and the economy will soften—a little in the US—a lot in Canada and Mexico. Inevitably, demand will weaken for all goods and services as the economic spiral starts spinning the wrong way.
Some Further Reflections:
First, whoever pays Trump’s tax, the tax increase typically has a negative impact on growth, and a presumed negative impact on P/E multiples (because tax cuts are positive for multiples). Secondly, the cost of driving will likely rise with the price of WTI and auto parts, and Americans like to drive. Finally, Fentanyl is a red herring. For Trump to control the narrative, tariffs need to target a national security threat, warranting the execution of an executive order. Trump’s narrative threat of choice is porous borders. Though, that is subject to change if his neighbours capitulate. Maybe Canada is too reliant on the American consumer and that is the key learning outcome.
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