UBS - Tariffs Report 2024

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The economic and investment

implications of higher tariffs
ElectionWatch 2024
Chapter 1 | Page 2 Protectionism is once again on the ballot in the 2024 US elec-
tion. The choice: sharply higher tariffs—and potentially univer-
Why are tariffs an issue? sal tariffs—under Trump, versus targeted, selective tariffs under
Harris. Assessing the impact of any tariff policy on inflation
and growth is challenging, given the complexity and changing
pattern of global supply chains. As a general rule: the more ex-
Chapter 2 | Page 5 treme the tariff, the more stagflationary it is. We see a roughly
50% chance of a “gesture” policy, 40% of selective tariffs and
Trade and the US election a nearly 10% chance of sustained universal tariffs.
– four scenarios Under a universal tariff scenario, we would expect bond yields
to decline and US equities to fall by around 10%, with the big-
gest impact on retailers, auto manufacturers, tech hardware,
semiconductors, and parts of industrials. Beyond the initial
Chapter 3 | Page 10 risk-off shock, universal tariffs are likely negative for the US
dollar. Uncertainty about the election outcome—and hence,
Economic and financial any specific trade policy—remains high. Therefore, we discuss
strategies to hedge risks.
market impact of higher
tariffs
3 September 2024
Chief Investment Office GWM
Investment Research
ElectionWatch 2024 | The economic and investment implications of higher tariffs
Chapter 1
Why are tariffs an issue?

The world has embarked on what is arguably the most signi- This then builds economic nationalism, a specific form of
ficant structural change in 250 years, and what economists prejudice politics. Politicians can then infer that by restricting
term the “fourth industrial revolution.” Over the past decade, actions of foreign actors, they will be able to bring about a
automation, digitization, social media, artificial intelligence, return to better times. Economic nationalism is thus often
and similar technologies have altered the way economies and visible through trade and capital flow protectionism, as trade
societies function. While investor attention is often captivated is the way that foreigners are most likely to be visible to the
by the introduction of a new technology (e.g., the 3D printer, domestic voter. It is no coincidence that polls show a majority
the computing power of the smartphone, or the connectivity of Americans from across the political spectrum don’t believe
of modern communication), the more serious economic impact that the US has gained more than it has lost from trade, espe-
comes from the upheaval in society. cially among lower-income voters (see Fig. 1).
Working practices, consumption habits, and methods of This is a global phenomenon. Economic nationalism has been
manufacturing shift, changing the demand for labor, transport, rising in Europe, Asia, and the US. It means that the issue of
and real estate. An individual’s relative income, security, and trade protection has become politically salient.
social status all change as the economic revolution unfolds.
This is great for those who find themselves on the way up. For
those who find themselves on the way down in the brave new Complexity and trade
world, things are a lot less satisfactory.
The traditional view of global trade has evolved very little over
Individuals who see their relative economic and social status in the centuries. Many voters (and politicians) seem to regard
decline inevitably want to place the blame somewhere. While trade in quite simplistic terms—goods are made at home from
the true causes are a series of complex structural changes, these domestic materials, packed onto a ship, and sold to a foreigner.
types of explanations often fall upon deaf ears. The simple
solution is to find a scapegoat, but in the world of scapegoat Modern trade is almost nothing like this. Two related trends
economics, some unfortunately see foreigners—who are, by have emerged over the years. First, up to two-thirds of global
definition, alien to the domestic economy—as one of the easi- trade is not taking place between separate entities, but is
est groups to blame. simply moving goods around inside companies with a global
footprint. The rise of global corporations with production faci-
lities scattered across several countries means that trade may
Figure 1
represent moving parts up and down an internal supply chain.
Share of US voters who say US has gained
more than lost from global trade In part because of this, most of the increase in global trade in
in %
goods over the past thirty years has been due to increasingly
complex supply chains rather than necessarily an increase in
70
domestic consumers’ desire to buy “foreign-made” goods.
60 This can be easily seen with the increased importance of
intermediate goods (components, essentially) as a share of
50
overall trade.
40
Thirty years ago, a company might import raw materials
30
from an external supplier abroad, manufacture at home,
20 and export a finished product to a final consumer. Today, a
10 company’s supply chain likely involves its product passing
among different subsidiaries located in perhaps eight or ten
0
different countries before a final sale to an end user at home.
Lower income Middle income Higher income Overall
This trend created large and politically significant shifts in the
Republican / lean Republican Total
location where tradable goods were produced, as well as in
Democrat / lean Democrat
the associated levels of employment, even as global trade
Source: Pew Research Center, as of 29 July 2024 volumes rose.
ubs.com/electionwatch 2
These changes in global trade mean that the impact of tariffs on Figure 2
the global economy has evolved in recent years. The economic Imports have grown as a share of US economy
pain of tariffs may fall on domestic producers as much as over- Real import of goods as % real GDP
seas companies. It means that using past trade taxes to judge the 16
economic impact of future potential tariffs is not very helpful.
14
12
For example, US President Nixon imposed a universal 10% “im-
port surcharge” by presidential proclamation in August 1971, 10
with the aim of forcing other countries to revalue their curren- 8

cies against the US dollar. However, this general tariff increase 6
(the first since the infamous Smoot-Hawley tariff of 1930) was
4
accompanied by government price and wage controls which in
2
the very short term prevented any domestic inflation impact.
0
1970 1980 1990 2000 2010 2020
Ultimately, the price controls were a disaster, triggering product
shortages and helping to fuel a wage-price spiral when they Source: Haver, UBS calculations
imploded; it is unlikely price controls would be repeated today.

Nixon lifted the tariff by the end of the year. That would leave
current-day US prices and economic output more exposed Figure 3
to the effects of a universal tariff. US imports of goods were US tariffs diverted some Chinese imports
3.4% of GDP in 1971, compared to 12.7% in 2023 (see Fig. to other countries
2). The economic impact of import taxes (i.e., tariffs) were Change in imports of tariffed goods, versus 2017 average, in USD bn
therefore significantly less than they would be today.
50
President Trump’s imposition of tariffs on selected imports from 40
China may be looked upon as a more modern example of trade 30

taxation. The value of goods imported directly from China that
20
are subject to tariffs has fallen by over 50% compared to 2017
levels. However, the value of these same imports from other 10
countries has risen by more than the value that China’s imports
0
have fallen (see Fig. 3).
–10
The rest of the world has generally replaced China in supplying –20
taxed products to the US. In addition, some of this shift in supply 2018 2019 2020 2021 2022 2023 2024
chains may represent the rerouting of China’s exports via third World imports ex China
countries. An export from China that stops in Canada may have Imports from China
a maple leaf sticker applied to the side of the box and recorded
Source: US Census Bureau, UBS calculations
as a Canadian sale to the US. Mexico, Canada, and the euro area
picked up three-quarters of China’s lost market share in tariffed
goods between 2018 and 2020. The complexity of global supply
chains can make it difficult to identify and tax products that are The nation in which a seller is located has little incentive
small parts of a larger manufacturing process. to devalue its currency. While devaluation could offset the
tariff’s effects, the tariff will increase import costs for the
entire domestic economy (and increase the cost of imported
What do tariffs actually do? components for use in export production, reducing the trade
benefit). We therefore do not think of a tariff as being applied
A tariff is a sales tax that is applied after goods arrive in a to a foreign country, like China, but as being applied to dome-
country. The tax is paid by the domestic buyer—and tariffs are stic buyers of goods made in China.
often applied with the intention of changing the behavior of
domestic buyers. The buyer (importer) is generally a company, Inflation
not a retail consumer. The buyer pays a higher price, either As a tax, a tariff’s direct impact is on price levels. A tariff will
because they pay the tax that the tariff represents or because produce a one-off increase in a product’s price. As such, the
they purchase a higher priced (or conceivably lower quality) direct impact of the tariff is to raise inflation rates for a single
alternative. In theory, the exporter could cut prices in order to year as the price reflects an additional tax burden. A tariff will
accommodate the tax burden. In practice, this rarely happens. not add to prices subsequently, although it may cause behavio-
Analysis of the 2018 US tariffs against China suggests almost ral changes (wage demands, profit-led inflation, reduced com-
the entirety of the tax was borne by US buyers.¹ petition, etc.) that produce second-round inflationary effects.
There is, however, a big difference between the price that is spend a higher proportion of their income. While an income
subject to a tariff and the price that the final consumer pays. tax cut may offset the revenue gains from the tariff, the distri-
There are two reasons for this. In the case of the US, less than bution of the income tax cut is unlikely to exactly match the
one-third of US imports are consumer goods (including passen- distribution of the tax increase represented by the tariff.
ger cars). Almost 70% of US imports are inputs into domestic
production—inevitably, given the role of complex supply chains Tariffs may reduce the competitiveness of domestic firms
in trade. A 10% tariff on a semiconductor used in a washing through the impact on intermediate goods prices. A tax on
machine does not justify a 10% increase in the price of a imported intermediate goods (components like microchips) will
washing machine. increase production costs for domestic producers. That puts
those manufacturers at a competitive disadvantage relative to
Even for consumer goods there is a big difference between foreign competitors. For example, looking at the tariffs from
the import price level and the consumer price level. A lot 2018/19, US users of components from China experienced a
happens to a good between arriving at a port (when the tax one-off increase in costs that Canadian users of those same
is applied) and when the consumer buys it. Costs related to components did not face. Canadian producers were given an
advertising, domestic transport, warehousing, and retailing, immediate competitive advantage. Export Development Canada
not to mention profit margins at each stage, all have to be offered specific advice to help Canadian companies importing
paid for—and these add to the consumer price. As a result, components from China that were subject to US tariffs for use
the import price for a consumer good may well be less than in producing finished goods that would be exported to the US.
half the price paid by the consumer. Even if all of a 10% tax The tariff could not be avoided completely, but as long as there
on a product sitting on the dockside in the Port of Los Angeles was a sufficiently large difference between the component and
is passed through to the US consumer, on average that should the finished product, Canadian firms were making the same
represent something less than a 5% increase in the price the thing as their US competitors with lower-cost inputs.
consumer pays at the store. To give just one example, almost
a quarter of what US consumers spend on goods goes to pay Transnational companies that use imported components may
for the costs (and profits) of the shop or website, and these switch production to foreign locations. That reduces domestic
are unaffected by the tariff. production and potentially domestic jobs. For smaller compa-
nies that do not have the option of switching locations, this
Pricing power is also important. Where imports are intermediate competitiveness challenge will either threaten to reduce sales
goods, there is the possibility that the tariff will be absorbed by or alternatively squeeze profit margins.
slightly smaller profit margins along the supply chain. In 2018,
companies along US supply chains appeared to be nervous Firms that use imported components specifically to make
that they could not pass on price increases, and part of the exports have a more complicated situation. They may be able
tariff increases meant squeezed margins. If the recent inflation to claim Foreign-Trade Zone status. The company effectively
episode has changed the psychology of companies, passing on pretends that its factory sits outside the taxing country. If
price increases may be more commonplace than in earlier tariff components are used to make goods for export, those com-
episodes. A specific, more aggressive form of this is the risk of ponents are not subject to tariff. This is not costless: As might
profit-led inflation, where prices rise by more than is justified be imagined, there is a lot of paperwork involved in this sort
by the tariff. Consumers may think that a 10% tariff means of process. But this can help to reduce the competitiveness
that a 10% increase in the price that they pay is “fair” (when damage of a tariff in a complex supply chain.
it clearly is not).
For example, in May 2024 BMW submitted a Foreign-Trade
Perhaps the simplest way to think about the impact of a Zone request for its factory in Spartanburg, South Carolina
tariff—a tax on trade—is to consider the relative importance of to allow it to import components without tariff, which could
imports to a nation’s economy. In 2023, imports of goods into be used to manufacture cars for export from the US. The
the US were the equivalent of 12.7% of GDP. Had a universal exemptions would apply to a range of components from glass
10% additional trade tax been applied to those imports, and adhesives to crankshaft sensors.
had it been passed along supply chains to the consumer, that
tariff would have added 1.3% to price levels in the US econo- Economic activity will also potentially be affected by retaliation
my over the subsequent quarters. from trade partners. As other countries put in place retalia-
tory tariffs, their own consumption growth will fall, thereby
Growth slowing global growth.
A tariff is a tax, and tax increases are negative for economic
activity because they imply consumers have less money to
spend. It is, of course, possible that other taxes are cut to off- Analysis of the 2018 US tariffs against
set the tariff, making the tax revenue impact neutral. However,
this may still be a net negative. A tariff is a sales tax, and sales China suggests almost the entirety of
taxes will often hit lower-income groups harder because they the tax was borne by US buyers.
Chapter 2
Trade and the US election – four scenarios
Translating the rhetoric of the campaign trail into policies in so ...the economic reaction to trade
complex an area as international trade is never easy. In addition policies depends on the reaction of
to the size and scope of the tariffs, the economic reaction to
trade policies also depends on the reaction of other economies, other economies, currency markets,
currency markets, and monetary policy. A trade tax is like any and monetary policy.
other tax—it is a form of fiscal tightening, but the ramifications
go beyond that. We identify four broad scenarios for trade that
may emerge from the current election cycle in the US:
1. Gesture politics
2. Selective tariffs
3. Universal tariffs
4. Extreme tariffs
1. Gesture politics
Under this scenario, existing tariffs are retained. However, of components subject to the trade tax. However, narrowly
there would be periodic taxes imposed on specific products in applied tariffs will allow for a certain amount of rerouting of
order to make a political point or to emphasize certain policy supply chains to avoid the full effect of the tariff. The initial
priorities. Generally this means that domestic consumers are price increase (when existing supply chains are being used)
paying to subsidize a favored industry or sector of the eco- may even partially reverse as alternative supply chains or tariff
nomy. Because gesture politics is not a universal tariff, supply avoidance measures are implemented.
chains can adjust over time. The effectiveness of such tariffs
will then fade over time as supply chains adjust, but the decli- Growth
ne in effectiveness is likely to be fairly gradual. Raising taxes is a drag on growth, and tariffs are no exception
to this. However, with gesture politics the effect is likely to be
The closest parallel to this is probably the current situation quite limited. Tariffs under gesture politics tend more to the
between the EU and China. Tariffs are being applied very selec- symbolic and are unlikely to create dramatic shifts in overall
tively in industries that have political significance. Most recently economic activity. While they can present more problems for
the EU has applied tariffs on imports of electric vehicles from a specific sector, they are unlikely to have a major impact on
China, and has gone so far as to specify different tariffs for overall growth.
different manufacturers (the additional tax rate ranging from
17% to 36.3%). Retaliation
Retaliation is likely, but will probably be proportional. Gesture
Inflation politics is a form of trade restriction aimed at appeasing dome-
Gesture politics is not especially inflationary. Specific product stic political sentiment. In such cases, neither side is likely to
prices will rise if most of the goods sold are either imported and want a significant escalation of the trade conflict with multiple
subject to the trade tax, or have a relatively high proportion rounds of tariffs being applied in a tit-for-tat approach.
2. Selective tariffs
Selective tariffs are a broader application of trade taxes than The selective nature of the tariff means that tariff evasion is
those that occur with gesture politics. Gesture politics are more more likely. The more that tariffs can be evaded through rerou-
focused on a single sector—whatever the political focal point is ting supply chains, the less damage there will be to growth.
at a particular moment in time. Selective tariffs are more likely And finally, the nature of any offsetting tax cuts must be con-
to target the broader practices of a country and apply across sidered. If tax cuts are designed to help those most negatively
multiple sectors. The 2018/19 US tariffs against China (and affected by the tariff increase, the damage to growth will be
China’s retaliation) are a reasonable example of this pattern. more limited.
Inflation Because selective tariffs are likely to include components

Because selective tariffs tend to be applied against a single (rather than finished products, as components form the
country, and generally not against all imports from that country, majority of global trade), there is a risk to domestic corporate
we see a reasonable chance of evasion by rerouting production competitiveness. If companies respond by moving production
and deliveries. For example, a US tariff on microchips from overseas (as happened with some of the 2018/19 US tariffs),
China could be offset by exporting those microchips to a factory that becomes a negative for domestic growth and potentially
in Canada where the chips are used to manufacture consumer employment. However companies operating in a Foreign-Trade
electronics. The subsequent electronic product may be exported Zone, which account for about 5% of US exports, will have
to the US without the selective tariff being applied. The other less reason to shift production (though administrative costs will
option (which may be a political aim of the tariff) is that target increase). For some sectors, like autos, the Foreign-Trade Zone
country exporters are replaced with exporters from non-tariffed is a significant way of avoiding trade taxes.
countries, as eventually happened with China’s exports to
the US in the wake of the 2018/19 US tariffs when Mexico,
Canada, the euro area, and Vietnam took over much of China’s A tariff on basic goods is more likely
market share of US imports. to hit lower-income consumers with
Clearly, the wider the range of goods included in selective less access to savings, creating more
tariffs, the greater the risk of a general price level change. The damage to aggregate economic
higher the number of countries subject to selective tariffs, the growth.
harder it is to evade the tariffs through supply chain switching
(and thus the greater the risk of price changes). Overall, selec-
tive tariffs will increase price levels but less than the tariff alone
might imply.
Growth
Simplistically, the net amount of tariff revenue raised is a
rough indicator of how much GDP will decline after a tariff
is imposed, but that is likely to underestimate the negative
growth impact. Because selective tariffs are limited in scope,
the drag on growth depends on a balance of different factors: Retaliation
Retaliation is almost certain in the wake of selective tariffs.
1. Which goods are subject to tariff (luxury items or basic goods), Of course, the retaliation is only to be expected from the
2. How easy it is to evade the tariff, as it is not a universal tariff, country that is subjected to tariffs, and the pattern of trade
3. What other taxes are cut to offset the tariff revenue. between that country and the taxing country will dictate the
economic impact. Selective tariffs are likely to have more of a
The more that there is a net burden on lower-income political focus to them; the retaliating country will be seeking
households, the more likely it is that domestic consumption to change the domestic policies of the taxing country, with the
will be weaker, and the more probable it is that economic aim of bringing about policy change rather than inflicting eco-
activity will decline. If luxury items are subject to a tariff, there nomic harm. This means that tariffs may be directed towards
is a greater chance that higher-income consumers will maintain industries that matter to voters, rather than to industries that
spending by reducing savings, which is generally growth neu- dominate the export landscape. China’s decision to slap tariffs
tral. A tariff on basic goods is more likely to hit lower-income on imported Kentucky bourbon and Harley Davidson motor-
consumers with less access to savings, creating more damage cycles from the US was a direct response to the US decision to
to aggregate economic growth. apply tariffs on imported steel and aluminum.
Other implications nomists call a “dominant narrative.” A consumer who hears

All things being equal, the tax revenues from tariffs will about a 10% tariff is likely to believe that it is “fair” that con-
reduce a government's deficit. However, this is not necessa- sumer prices rise by 10%. However, the tariff is being levied
rily permanent. Revenue from income taxes is fairly stable. It quite a long way up the supply chain and the consumer price
will, of course, move with the economic cycle, but it can be level increase from a 10% tariff should be less than half that.
predicted for any given level of economic activity. Selective However, the popular perception that a 10% tariff equals a
trade tariffs are unstable and the revenue earned is likely to 10% consumer price level increase may allow wholesalers and
decline over time as supply chains shift. The revenue earned retailers to improve their own profit margins.
is stable only if supply and demand patterns do not change.
Therefore, the risk is that an initial improvement in the taxing If there is a profit-led price increase on top of the tariff
country’s fiscal position weakens within a couple of years as increase, then obviously the change in inflation will be more
import patterns shift. dramatic. Even if profit-led inflation is confined to finished
consumer goods only, this would suggest that a US universal
A more serious fiscal position might arise if tariff revenues tariff of 10% would raise price levels by 1.7%.
were used to finance other tax cuts. For instance, income tax
reductions are likely to lead to a more lasting decline in reve- As a one-off tax increase, a universal tariff does not have to
nue (because their implication is politically difficult to reverse), produce inflation in subsequent years; further price changes
while the shifting trade patterns suggest that a selective trade would require some other cause. Because of the growth
tariff only lasts as long as trade patterns remain stable. What implications (below) it is unlikely that there would be a strong
starts out with the appearance of fiscal balance can shift into a pay bargaining position for workers, making a wage-price
larger fiscal deficit over time. spiral less likely. However, there would be shifts in the level
of competition in the domestic economy with foreign market
Retaliatory tariffs and declining competitiveness caused by share declining. Less competition may lead to higher inflation.
higher component prices may also reduce other sources of tax The US 2018 washing machine tariffs are an example of this.
revenue. This will depend on how easy it is for the country to These were a universal tariffs applied to a single product. Des-
evade the retaliatory tariffs—the mirror image of what hap- pite shifts in supply chains (with increased US production) the
pens to domestic tariff revenues. tariffs reduced competition. US washing machine price levels
rose far more than similar price measures in other countries.
Once the tariffs ended in February 2023, US washing machine
3. Universal tariffs prices converged towards those of other industrial countries.
However, the damage to competition wrought by the tariffs
A universal tariff, like that applied by US President Nixon in means that US relative price levels are still above those paid in
1974, has a very important distinction from selective tariffs. other countries (see Fig. 4).
Under a universal tariff, it is not possible to legally evade the
tariff. Shifting the source of components or changing produc- Figure 4
tion locations will not help, as all imports into a country are
Americans paid higher prices for washing
subject to the tariff.
machines aer tariffs were imposed
Washing machine prices, 2017 average = 100
Inflation
The initial impact on prices of a universal tariff is straightfor- 150
ward. Unless profit margins are very high, the price increase
140
is likely to be passed on completely to the end consumer. The
tariff is a well-publicized external shock which consumers can 130
be forced to accept. The ultimate impact (taking into account 120

components, basic materials, and finished consumer goods)
110
should be the percentage increase in the tariff multiplied by
the share of imports in the economy. Thus a 10% universal 100
tariff applied to imports to the US should raise overall price
90
levels in the US economy by 1.3%. The direct effect is a one-
time price level change. 80
2018 2019 2020 2021 2022 2023 2024
However, there is a real risk of profit-led inflation adding to US UK

Euro area South Korea
the price level increases in this situation. A universal tariff is
a high-profile media story, and is likely to become what eco- Source: Haver, UBS
Growth mies in the post-war era. While the tariff would be directed at
A universal tariff is likely to drag growth lower via three goods, it may have implications for global capital flows.
mechanisms: Countries that initiate a trade tax process are generally current
account deficit countries. Current account deficit countries
1. Reducing domestic consumption, export assets to be able to import goods and services. One
2. Reducing competitiveness of domestic producers, consequence of this is that foreigners may own a lot of the
3. Impacting exports through competitiveness and retaliatory tariff country’s assets. That gives foreign governments a poten-
measures. tial source of leverage.
Lower-income consumers will be harder hit by a trade tax than In 1995, US President Clinton’s administration was on the
higher-income consumers, because sales taxes are inherently brink of a significant trade conflict with Japan. One of the
regressive. Because lower-income consumers spend a higher concerns that began to emerge at that time was that the Ja-
proportion of their income, consumer spending is reduced. panese government might pressure Japanese investors to sell
Unless very carefully constructed, tax cuts implemented in their holdings of US financial assets. The US dollar fell sharply
conjunction with tariffs are more likely to favor higher-income as the dispute continued. Global capital flows are more impor-
consumers who have a higher propensity to save. tant today than they were thirty years ago, and weaponizing
capital flows in a trade war is a real threat. A decline in US
Firms that rely on imported components will experience an asset values caused by capital flow shifts would have negative
increase in manufacturing costs. Costs will increase with the effects on US consumers via the wealth effect and possibly
tariff, and this will reduce the domestic price advantage that a higher mortgage rates.
tariff offers. For example, a 10% universal tariff would increase
the cost of US washing machine components. It would also
increase the price of imported washing machines. If (hypothe- 4. Extreme tariffs
tically) 30% of the manufacturing cost of a US washing ma-
chine is made with imported components, the 10% universal In the US, an extreme form of trade taxation has been sugges-
tariff would increase the cost of a US washing machine at the ted—not perhaps entirely seriously—as worthy of considerati-
factory gate by 3%. That has to be compared to the cost of a on. This is the idea of scrapping income tax and replacing the
foreign washing machine at the docks (the same point in the lost revenue with a suitable tariff rate. While countries have
supply chain) increasing by 10%. While there is a relative price depended on tariff revenues in the past, including the United
advantage for the US manufacturer (their costs rise by less than States in the nineteenth century, depending on such revenues
for the importer), there is still an absolute price increase. Fewer is normally associated with far smaller governments than any
people will be able to afford domestic-made washing machines modern society has. The tariffs were also applied to a very
as the foreign component element will add to those prices. different, less integrated trading system.
Retaliation It is hard to know what level of tariff would have to be applied

A universal tariff is almost certain to lead to a universal retalia- to generate enough revenue to offset US income tax receipts.
tion—and an equal tax increase is likely to be imposed on for- This is because the volume of trade would react violently,
eign consumers of domestic manufactured goods. This is not reducing the revenue by reducing the tariff’s tax base. The
what happened with the Nixon shock in 1971, but that was a economic hit to growth would be sizeable and presumably also
universal tariff with a very specific aim (currency revaluations). affect other possible tax revenues (including state and local tax
Although retaliatory tariffs were not imposed while foreign revenues). To put some context on the idea, in 2023 mercantile
exchange negotiations were underway, retaliatory tariffs were imports into the United States were USD 3.1tr. and individual
being planned in case these negotiations had not led to a income taxes raised USD 2.2tr. Replacing income tax would
lifting of the Nixon trade tax. require a tariff tax increase in excess of 100% and probably
closer to 130% to 150%.
While very specific items may be excluded, it is highly likely
that a universal and indiscriminate trade tax by one country The scenario of replacing income taxes with exceptionally high
will be met with an equal trade tax in all other countries. As tariffs is unlikely, but a more dramatic universal tariff is possible
with selective tariffs, this may be tweaked so as to maximize if economic nationalism takes hold. Several countries have
the political damage. The more retaliatory tariffs are tweaked, demonstrated that rampant populism can lead to counter-
the greater the risk of an escalating tit-for-tat trade war. productive economic policies and self-inflicted harm: the UK
voted to increase barriers to trade in a national referendum, for
Other implications instance. In the event that a universal tariff provoked a tit-for-
A universal trade tariff is a very aggressive move; Nixon tariff tat retaliation from other countries, the extreme tariffs would
aside, this has not been seen in advanced industrialized econo- be the direction of travel.
Inflation The scenario of replacing income

The price level increase in this scenario would be extreme, at taxes with exceptionally high tariffs is
least initially. However, reported inflation would rapidly cease
to reflect inflation reality as consumers would shift consump- unlikely, but a more dramatic universal
tion significantly (and some goods may not be available at all tariff is possible if economic
because of the ensuing supply chain disruption). The fixed nationalism takes hold.
weights of different goods in the inflation basket would not
match up to this adjusted consumption pattern. While the
tariff would affect price levels in a one-off move, it is quite
possible that there would need to be a sequence of tariff
increases in order to raise the required revenue if tariff revenue
were to replace a tax on income (and with the volume of
imports falling).
The extreme nature of this sort of price move would also likely
produce second-order effects. Anyone who has wage bargai-
ning power would be sure to exercise it. Small businesses in few alternative sources. But there would be a relatively swift
non-traded sectors would also likely raise prices, e.g., the self- adjustment of supply chains, and there are also relatively few
employed plumber or the nail salon pushing up prices so that areas of modern trade where the US has the sort of market
their owners can maintain their real living standard. dominance that provides immunity from retaliation.
Growth More seriously, from the US perspective, at some point the

Although it is possible that the extreme tariff scenario is tax- dollar would almost certainly lose reserve status. There are
revenue neutral (income tax cuts offsetting the increase in many motives for holding a specific currency in reserve—rule
taxes on trade), the combination of a) almost certain aggres- of law and liquidity being significant. But ultimately there has
sive retaliation and b) the redistribution of the tax burden to be an assumption that the reserve holder will want to buy
will make this a negative for growth. The motive for extreme the output of the reserve currency country in the future. If
tariffs (i.e., revenue raising) gives the tax an aura of perma- there is dramatic trade war between the US and the rest of the
nence. If companies do not regard tariffs as a short-term world, this assumption becomes implausible. The US has, for
negotiating tactic, they are likely to start to restructure their many years, exported its assets (often its government bonds) to
businesses in a way that would reduce potential growth in the purchase the goods exports of other countries. If the US seeks
US. The exit of the UK from the EU (also regarded as per- to effectively halt the purchase of foreign goods, foreigners are
manent, and increasing trade barriers in a far less aggressive likely to respond by halting the purchase of US assets.
manner) hints at potential implications.
Other implications
Retaliation Any attempt to replace income tax (broadly progressive) with
In such an extreme scenario the United States would face a sales tax (broadly regressive) would increase inequality in a
significant retaliation. This may not be a universal tariff, as country. The social implications of this would be quite negative,
countries would prioritize US-produced goods where there are and it is possible that social mobility would be further reduced.
Chapter 3
Economic and financial market impact of higher tariffs

The consequences of tariffs for
the economy
The trend toward protectionism is likely to continue regardless policy, 40% of selective tariffs and a nearly 10% chance of
of who wins in November, but the US election has implica- universal tariffs.
tions for the scale and scope of potential measures. Former
President Trump has expressed skepticism regarding foreign In thinking about the economic impact, we focus on the
entanglements, and a preference for bilateral negotiations two higher-impact scenarios involving selective and universal
over joint action. He has also proposed a universal tariff of tariffs. In the accompanying table, we forecast the cumulative
10% on all imports into the US and 60% on imports from impact to GDP over three years relative to a baseline for a
China. By contrast, Democratic nominee Kamala Harris’ foreign selection of regions and countries. We assume the following:
policy will likely seek to preserve the transatlantic alliance
and leverage traditional institutions to promote US interests. • Under selective tariffs, we apply a 15% tariff to specific sen-
Nevertheless, the Biden-Harris administration has overseen the sitive imports, which would allow some trade to reroute and
introduction of targeted tariffs on imports of Chinese electric thereby avoid tariffs. This is similar to Trump’s first-term tariffs.
vehicles, advanced batteries, solar cells, steel, aluminum, and
medical equipment. • Under universal tariffs, we apply a 10% tariff to all imports
into the US regardless of origin, meaning rerouting is not a
We think the status quo for tariffs is highest under a Demo- practical option.
cratic administration, but we still see a one-in-five chance of
selective tariffs being imposed (see Fig. 5). By contrast, we view Three key observations stand out:
selective and universal tariffs as far likelier under a Republican
administration given the stated views of both the presidential 1. A universal tariff will be more serious than a selective tariff
and vice presidential candidates. Universal tariffs become more because it cannot legally be circumvented.
likely in a Red Sweep, as such a scenario raises the chances 2. The economic impact to exporters should be measured by
that a presidential declaration of a national emergency would trade in value added, not absolute export volumes.
go unchallenged by Congress (see the box on page 11 for 3. Estimates depend on perceptions of how permanent the
more information). trade taxes would be, retaliation, policy response, etc. The
process is somewhat reminiscent of trying to forecast the
Combining this with our expectations about specific election economics of the pandemic lockdowns in terms of complexity
outcomes, we see a roughly 50% chance of a “gesture” and multiple outcomes.
Figure 5 Figure 6
Election outcomes and tariff Cumulative impact to GDP over three years in two
scenario probabilities tariff scenarios
In % In %
Gesture Selective Universal Extreme Selective Universal

Red Sweep 10% 60% 25% 5% US –0.3% to –0.5% –1.0% to –1.5%
Trump/Divided Congress 10% 75% 10% 5% China –0.5% to –0.7% –0.6% to –0.9%*
Harris/Divided Congress 80% 20% 0% 0% APAC (ex Japan) –0.8% to –1.6% –1.2% to –1.8%
Blue Sweep 80% 20% 0% 0% Japan –0.4% to –0.6% –0.7% to –1.2%
Note: The scenario corresponds to where we end up. If, for example, Trump were to Euro area –0.2% to –0.5% –0.5% to –1.0%
implement temporary universal tariffs but then de-escalate to selective tariffs, the
scenario outcome would be “selective tariffs.” Universal tariffs may require Note: Considered independent of proposed US tax law changes and other large
congressional approval, which explains the low probability of universal tariffs in our Red macroeconomic policy proposals, and also assumes a like-for-like reciprocation. *If a
Sweep scenario and an even lower probability in the case of Trump/divided Congress. Red sweep materializes and if the US imposes a targeted 60% tariff on all imports from
Source: UBS China, with a universal 10% tariff on the rest of world, we would expect cumulative
Chinese GDP to decline 2% to 3% versus baseline.
Source: UBS
Are universal tariffs constitutional?

Article 1 of the US Constitution grants exclusive authori- Once the national emergency is declared, the president
ty to Congress “to lay and collect Taxes, Duties, Imposts can then “investigate, block during the pendency of an
and Excises, to pay the Debts and provide for the com- investigation, regulate, direct and compel, nullify, void,
mon Defence and general Welfare of the United States.” prevent or prohibit, any acquisition, holding, withhol-
Congress is also explicitly granted authority “to regulate ding, use, transfer, withdrawal, transportation, impor-
Commerce with foreign Nations, and among the several tation or exportation of…or transactions involving, any
States, and with the Indian Tribes.” property in which any foreign country…has any inte-
rest…respect to any property, subject to the jurisdiction
However, starting in the 1930s—and to a more signifi- of the United States.” In doing so, the president must
cant degree after 1960—Congress delegated increasing “in every possible instance, consult with the Congress
authority to the president to manage trade. Congress before exercising any of the authorities granted by this
did not—and cannot—permanently cede constitutional chapter and shall consult regularly with the Congress so
authority to the executive branch, but US presidents have long as such authorities are exercised.”
accumulated greater authority over trade practices. This
is usually accomplished on the basis of national security, The language governing consultation with Congress
where presidential authority is extraordinarily broad. is imprecise, and likely would be litigated, but former
president Trump could rely on this statute to initially
For a universal tariff, the Trump administration would impose a universal tariff. An emergency declaration by
likely rely on the International Emergency Economic the president could face judicial scrutiny. In a Red Sweep
Powers Act of 1977 (IEEPA). The relevant section says scenario, Congress could pass a resolution in support of
the president can declare a national emergency “to deal the emergency declaration, which might sway the fede-
with any unusual and extraordinary threat, which has its ral courts to uphold the presidential authority. Converse-
source in whole or substantial part outside the United ly, if the Democrats hold the House and pass a resolution
States, to the national security, foreign policy, or econo- stating that the president has exceeded authority, the
my of the United States.” court might declare the move out of scope.
Congress did not—and cannot—permanently cede constitutional

authority to the executive branch, but US presidents have accumulated
greater authority over trade practices.
Investment implications of universal tariffs

The selective tariffs imposed during Donald Trump’s first Figure 7
presidency occurred alongside a Federal Reserve (Fed) that, Bond yields initially rose in 2018 and then fell as
at least initially, was steadily raising the fed funds rate from Fed ended rate hikes
post-global-financial-crisis lows. Then, as now, the Fed was US 10-year note yields, Midpoint of Fed funds target range,
also shrinking the size of its balance sheet in its first round of tariff announcement dates
quantitative tightening. Long-end bond yields declined steadily 3.5
from late 2018 to the middle of 2019 as economic activity
3.0
softened when the Fed paused rate hikes and eventually
shifted to rate cuts (see Fig. 7). According to a Federal Reserve 2.5
staff research report looking at the financial market impact of 2.0

tariffs during this period, US stocks declined on days when the
1.5
US administration and Chinese officials announced meaningful
new trade protections (see Fig. 8). Moreover, the most-affected 1.0
companies underperformed those that were less affected.²
0.5
This recent historical precedent offers some limited directional 0

Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20
insight into the short-term impact of selective tariffs on the
economy and financial markets, but the economic shock from 10-year Treasury yield Midpoint of the fed funds target range
the global COVID-19 pandemic short-circuited any potential Note: Vertical bars represent days when China and the US announced new tariffs.
understanding of the long-term implications. In our view, a Source: Amiti et al (2024), St. Louis Federal Reserve, UBS calculations
more aggressive move to universal tariffs—admittedly a lower-

probability outcome in our assessment—poses much greater Figure 8
downside risk to the US economy and financial markets. Even
US stocks reacted negatively to 2018/19 US-China
a short-term imposition of universal tariffs would likely disrupt
tariff announcements
trade flows, raise uncertainty and undermine investment, with
S&P 500 Index, tariff announcement dates
direct consequences for financial markets.
3400
Interest rates 3200

In our view, the reduction in economic activity due to universal
tariffs is bullish for US Treasuries. Under the universal tariff 3000
scenario, slower economic growth will likely outweigh the

2800
impact of a short-term rise in inflation expectations on interest
rates. We see lower US rates with 2-year Treasury yields falling 2600
to 2% to 2.5% and 10-year yields declining towards 2.5% to
2400
3%. This forecast assumes lower growth rather than higher
short-term inflation as the primary driver. 2200
Jan-18 Apr-18 Jul-18 Oct-18 Jan-19 Apr-19 Jul-19 Oct-19 Jan-20
We expect the Fed will turn more dovish than hawkish to Note: Vertical bars represent days when China and the US announced new tariffs.
prevent a recession and larger downside risks to growth, and Source: Amiti et al (2024), St. Louis Federal Reserve, UBS calculations
will look through the short-term inflationary consequences

of tariffs. Currently, market pricing reflects expectations for
200-basis points of rate cuts and a terminal rate of 3.3%. We Even a short-term imposition of
do not believe that the potential short-term rise in inflation universal tariffs would likely disrupt
expectations will prevent the Fed from cutting rates unless
there is another variable pushing inflation higher, such as rising trade flows, raise uncertainty and
wages or housing costs. undermine investment, with direct
consequences for financial markets.
Although the bond market may initially sell off on the higher in-
flationary impacts of tariffs, we see the trend over the medium
term to be toward lower rates, as the higher cost of imported
items weighs on growth, consumer spending and productivity.
Equities gain against its major trading partners, whose exports to the
The implementation of a 10% universal tariff, as well as US could take an initial hit from the tariff announcement with
corresponding retaliatory measures by US trading partners, a negative outlook on their respective economies.
would likely lead to downside pressure on US equities. Our
economists’ estimate of a cumulative 1-1.5% drag on US GDP The positive short-term USD impact has its limits, both in
growth in this scenario, translating into roughly a mid-single- magnitude and duration. Besides a currency adjustment, some
digit decline in the expected level of S&P 500 profits. Tariffs part of the higher cost is likely to be borne by US consumers,
may also lead to an increase in policy uncertainty, which would while the other part would be absorbed by lower corporate
weigh on US stocks. Consequently, implementation of universal margins. This leaves us with three absorbing forces of a
tariffs could lead to a ~10% pullback in US equities. We caveat potential tariff increase. If we then consider that substitution
that it is difficult to estimate the impact with precision; changes forces are limited in the very short run, the impact to trade
in consumer and corporate behavior, as well as currency fluctu- flows has its limits as well. So where does this leave us on
ations due to the tariffs (see discussion below), will be impor- the USD impact? As a base line, we would expect the USD
tant drivers of the ultimate size of the downside in US stocks. to gain ground in the low-single digits—assuming an equal
absorption of the tariff costs.
Companies would be impacted both from a higher cost of im-
ported goods and higher tariffs on exports. A higher cost of im- Beyond the initial shock effect, US tariffs are likely to be
ports would most likely impact retailers, automotive manufac- USD negative as time progresses. With a high probability,
turers, tech hardware, semiconductors, and parts of industrials. the rest of the world would probably retaliate with a 10%
In terms of US exports, many US multinationals produce goods tariff against US imports, while not increasing tariffs on their
in the markets in which they are sold, rather than export them other trading partners. With the US being confronted by
from the US. Still, automotive manufacturers and some indust- 10% tariffs from all its trading partners while these trading
rials do export from the US and would be negatively impacted. partners only feel the pain on their US imports, keeping the
On the other hand, purely domestic companies that compete remaining imports unaffected, the US economy could face
with imports, such as steel producers, would stand to benefit. greater disadvantages. If this results in a larger US trade def-
icit, we expect the USD to come under pressure. Since trade
Outside the US, cyclical and trade-oriented equity markets flows form a rather small part of global USD trading volumes,
would probably suffer most in this risk-off environment, while broader financial market dynamics should play a bigger
we expect defensive markets with a strong domestic exposure role in the trajectory of the USD. Hence, it is challenging to
would be more resilient. quantify the net impact of universal tariffs on the USD over
the longer term.
China: With close to 30% of its production exposed to the US,
the Chinese consumer electronics industry would be most at Overall
risk, followed by traditional manufacturing industries. However, We think investors are best advised to avoid significant
despite the numerous headlines, the Chinese electric vehicle and portfolio shifts today based on predictions about the election
renewable power supply chains have limited exposure to the US. outcome a few months from now. Uncertainty about the
election and hence about any specific trade policy remains
Japan: Japan is a highly cyclical market that would likely come high. We therefore favor various strategies to hedge risks. For
under pressure in a risk-off environment. In terms of revenues, example, gold can be an effective hedge against concerns over
the US accounts for about 10% of the Topix sales. This rises geopolitical polarization, the US fiscal deficit, or a weaker US
to over 30% for automobile and pharma sectors. Although a dollar. Similarly, the Swiss franc offers safe-haven qualities amid
significant fraction of these sales would be exempt from tariffs political uncertainty in the US and Europe.
given they are produced in the US, these sectors are likely to
be the most impacted. We also see a potential portfolio role for structured invest-
ments with capital preservation or yield-generating features,
Europe: With almost 25% of STOXX 600 sales coming from for single stocks or for cyclical sectors like energy, industrials,
the US, Europe would also be vulnerable. Consumer and tech- and financials.
nology sectors would be among the most vulnerable sectors
in our view. While the short-term path for global trade policy remains
uncertain, it seems fair to assume more protectionism and
Currencies obstacles for free trade over the medium term. This could acce-
In the case of a universal 10% tariff, we would expect the lerate investment trends like friendshoring and nearshoring.
USD to initially gain ground on a broad basis. This can be Against this, regional and sectoral diversification remains a key
explained by two factors. First, such a move would most likely element of any investment portfolio. Sectors that benefit from
come with a risk-off move in global markets, leading to safe- nearshoring are, for example, infrastructure and robotics, as
haven-type flows into the USD. Second, the USD is likely to countries build up their own production capabilities.
Endnotes
1
Boer, L. and M. Rieth (2024). The Macroeconomic Consequences of Import Tariffs and Trade Policy Uncertainty, IMF Working Paper
available at https://www.imf.org/en/Publications/WP/Issues/2024/01/19/The-Macroeconomic-Consequences-of-Import-Tariffs-and-
Trade-Policy-Uncertainty-543877.
² Amiti, M., M. Gomez, S. H. Kong, and D. Weinstein (2024). Trade Protections, Stock-Market Returns, and Welfare. National Bureau
of Economic Research available at: https://www.nber.org/papers/w28758.
Authors
(in alphabetical order)
• Samuel Adams, Economist
• Daiju Aoki, Chief Investment Officer Japan and Head Macroeconomics Japan
• Daniil Bargman, Analyst
• Constantin Bolz, FX Strategist
• Fabian Deriaz, Investment Specialist
• Paul Donovan, Chief Economist
• Dirk Effenberger, Co-head of Investment Management & Risk
• Leslie Falconio, Head of Taxable Fixed Income Strategy
• Yifan Hu, Chief Investment Officer Greater China and Head Macroeconomics APAC
• Daivd Lefkowitz, Head of US Equities
• Thomas McLoughlin, Co-lead of ElectionWatch
• Frederick Mellors, Head Fixed Income GAA
• Kurt Reiman, Head of Fixed Income
• Brian Rose, Senior US Economist
• Dominic Schnider, Head CIO Global FX & Commodity
• Matthew Tormey, Equity Strategist
• Dean Turner, Eurozone and UK Economist
• Philip Wyatt, Macro Strategist
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The economic and investment

Why are tariffs an issue?

with the aim of forcing other countries to revalue their curren- 8

imploded; it is unlikely price controls would be repeated today.

President Trump’s imposition of tariffs on selected imports from 40

China may be looked upon as a more modern example of trade 30

Trade and the US election – four scenarios

Inflation Because selective tariffs are likely to include components

Other implications nomists call a “dominant narrative.” A consumer who hears

be forced to accept. The ultimate impact (taking into account 120

However, there is a real risk of profit-led inflation adding to US UK

Retaliation It is hard to know what level of tariff would have to be applied

Inflation The scenario of replacing income

Growth More seriously, from the US perspective, at some point the

Economic and financial market impact of higher tariffs

Gesture Selective Universal Extreme Selective Universal

Are universal tariffs constitutional?

Congress did not—and cannot—permanently cede constitutional

Investment implications of universal tariffs

staff research report looking at the financial market impact of 2.0

This recent historical precedent offers some limited directional 0

more aggressive move to universal tariffs—admittedly a lower-

Interest rates 3200

scenario, slower economic growth will likely outweigh the

will look through the short-term inflationary consequences

Generic investment research – Risk information:

Additional Disclaimer relevant to Credit Suisse Wealth Management

Version B/2024. CIO82652744

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