The Economy Still Waits for No One

The recently announced tariffs surprised the markets, triggering speculation about their long-term negative effects on our economy. Before you assume what seems obvious, read last year’s Observations on the Market No. 393: The Economy Waits for No One. A year later, it still directly applies in today’s environment.

 

 

iPhone Pricing Reality Check

With China at the epicenter of our current trade war, one popular example of the possible effect tariffs may have is on your next purchase of an iPhone. Multiple headlines have suggested that an iPhone is about to cost $3,000 or more. If you are thinking of buying or upgrading your iPhone soon, most people will pay attention to these dramatic headlines (which is always the point). However, you don’t have to dig very deep to realize this is highly unlikely.

If you look at Apple’s cost of goods sold, the cost to manufacture an iPhone is about half of what they sell it for. This leads to a simple estimate that if an iPhone has a retail price of $1,000, it costs about $500 to manufacture. Tariffs are calculated on manufacture costs, not the retail price. If you add a 145% tariff to $500, that increases the cost of the phone by $725. This also assumes the entire additional cost is passed on to the consumer, which probably would not happen. A cost of $1,725 is still much less than the $3,000 headline number that has been reported. What is misleading is that $3,000 assumes that the phone will be manufactured in the U.S., which is not going to happen. What CEO would move manufacturing to the U.S. just to have “Made in the USA” stamped on their product if it costs the consumer almost twice as much? Then, when you consider it would take years to move manufacturing to the U.S. and that the tariff trade war will likely be resolved by then, such alarming headlines are nothing but fearmongering.

Long-Term Consequences with Trading Partners

Another persistent speculation is how much damage is being done to our trading partners and if they will still trust doing business with us. All major declines always feature claims that “it is different this time” because each has its own unique catalyst. They may have some similarities; however, they are all different. It is undeniable that our trading partners, including close allies, are not happy. Will there be long-term consequences? History suggests the consequences are not so predictable.

In the book Unbroken, a true story about Louis Zamperini who was held captive by the Japanese in WWII, it describes the brutality the prisoners faced. One story from prisoners was how the Japanese officers would remove a piece of a prisoner’s liver, eat it as a delicacy, and then close the prisoner’s wound to harvest another day.

The kamikaze pilots were notorious for a culture that was created to destroy America at all costs.

We dropped two nuclear bombs, destroying hundreds of thousands of civilians, to defeat Japan at all costs.

Soon after Okinawa was taken, there were Japanese soldiers remaining in the tunnels, still fighting. My father was on the island and experienced a group of American soldiers who captured one soldier and beat him to the point that he was no longer recognizable. It was one of the few stories he ever talked about regarding the war.

We all know about the German concentration camps.

Towards the end of the war, German cities were carpet-bombed on known German civilian targets in an Allied attempt to demoralize the Germans.

War makes people do things that they normally would never do. Both sides had a multitude of reasons for long-term animosity far beyond a trade war, but on April 3^rd, 1948, the Marshall Plan began rebuilding Europe and Germany. Japan formally surrendered on Sept. 2^nd, 1945, and in the same month, we began rebuilding the country that did everything in its power to destroy us. Even after all the atrocities, everyone moved on. Predicting the effects of retaliation is impossible.

Political Context and Economic Adaptation

There are plenty of headlines suggesting this is the worst it has ever been politically. Ask Japanese Americans who lost everything and were placed in internment camps during WWII, or how Native Americans have been treated historically. A study of history shows a plethora of dark events, but it is human nature to think the present is more important than the past—it is called recency bias.

This is not an endorsement for tariffs, which do hurt trade. Is the solution simple? No. The U.S. spends $900 billion on defense while Canada spends $34 billion. Relative to the size of their economy, they spend almost 3 times less. Yet, there is less than a 1% chance we would not defend Canada if it were attacked. Fairness is a complicated issue, but we should not act like a bully.

The midterm elections are 19 months away, and the political fallout will be evident much earlier if the tariff situation does not show some resolution soon. It is not “different this time,” and it’s impossible to predict what the finished puzzle will look like. Fortunately, once again, corporate America is very good at adapting.

Observations On The Market No.406