I taught university operations and supply chain courses for several decades. Since the US was deeply committed to free trade throughout that period, the subject of tariffs seldom surfaced in our syllabi. Now, one of the worst aspects of the incipient trade war is the ignorance that most writers display about what tariffs are and how they work. It has taken several months just to get most people past Trump’s absurd claim that the producer country will pay the tariff. Some still haven’t come around.
Worse, I have seen very little written about two other critical factors: the impact of tariffs on exports and the role that currency exchange rates play in moderating or amplifying the effects for both imports and exports. All of these factors are on full display in the current trade war with Mexico and Canada.
Impact on US Imports
First, everyone now seems to accept that putting tariffs on imported products will lead to higher prices for consumers. The empirical questions are: “how much?” and “who will pay it?”. Yet, even at this basic level, the answers get interesting. For importers, the key number is the “landed cost” that a US importer pays to get a product safely into the country. At its simplest, it is:
Landed cost = (foreign producer price) * (currency exchange rate) * (1 + tariff rate).
If we’re talking about a 25% tariff on Mexico and a dollar worth 20.5 pesos, 1000 pesos of Mexican goods will cost 1000 pesos* 1/20.5 dollars/peso * (1 + 25%) = $61. So far, so simple. Except, exchange rates constantly change and that makes things more interesting … especially with Mexico.
Exchange rates for US Dollar vs Mexican Peso
This graph shows the exchange rate between the Peso and the Dollar since 2021. The Peso started around 20 to the dollar, then appreciated until it was only 16.5 to the Dollar in early 2024. Since then, the Peso has fallen back down to 20.5 per Dollar as this is written. If you are an American importer and you want to purchase goods worth 1000 Pesos, the following calculations show how your purchasing power has risen just from the exchange rate shift. If you inked a purchase contract around a year ago (probably not uncommon for big importers), you have been dancing your way to the bank over the past year. You are paying
Importer landed cost before, after and with tariffs
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Exchange rates can impact cross-border purchases in different ways, depending on how the purchase contract is written. If they’re afraid the Peso will strengthen, importers might set the contract price in Dollars. Otherwise, they might agree to a contracted exchange rate that might be anything the two parties agree on. However, I suspect that most US importers are shopping for bargains in Mexico, so they will likely contract in Pesos. Nonetheless, the currency effect could be different with every import contract.
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Now if Trump applies a 25% tariff on those imported Mexican goods, it just about equals your currency gain over the past year. Your landed cost is pretty close to what it was when you signed the purchase contract. If your budget could handle the cost last year, you can probably work with it now. Therefore, in the case of Mexico, adding tariffs shouldn’t necessarily force you to raise your costs and needn’t be so inflationary. Of course, as a true blue capitalist importer, you won’t admit any of that. Rather, you’ll scream blue murder about the tariff’s impact and use it as a heaven sent opportunity to raise (and lock in) a higher sales price from your customers. So we will see some inflationary effect … just maybe not quite as much as most people fear.
Unfortunately, Trump’s tariffs won’t be terribly effective in protecting domestic American manufacturing. If the landed cost of Mexican goods with the tariffs is about the same as it was a year ago without them, many American companies can continue to buy from Mexico. They probably won’t have a big enough incentive to switch to American suppliers. There will be a few gains for American manufacturers, but not as much as tariff proponents hope.
Impact on US Exports
Let's pivot to the export side. You’re an American exporter and you’re trying to sell your goods to Mexican customers. About a year ago, you invested to be in the Mexican market on a long term basis. With the exchange rate shifts, even without a tariff, you’ve been struggling to keep your Mexican customers as their Peso purchasing power has steadily dropped (ultimately by 25%). Your international sales manager was run ragged and your Board was on your back.
Exporter landed cost before, after and with tariffs
Now, Trump’s 25% tariff has triggered a totally predictable reaction from the Mexican government. They impose a retaliatory 25% tariff on American exports … including the stuff that you sell. Unlike American importers, exchange rate shifts don’t help you. Rather, the Mexican tariff stacks on top of the exchange rate shift to intensify your sales pain. Compared to a year ago, your exported products are now 55% more costly to Mexican customers. Your Mexican sales fall off a cliff and your investment in the Mexican market hovers on becoming a write off.
Recent exchange rates for tariff-targeted trading partners
The Mexican example is an extreme case, but it is not alone. This figure shows the recent movements of the currencies for the four trading partners that Trump says he is targeting. Canada’s Dollar (aka “Loonie”) has moved 7 or 8% in a similar direction to the Peso … still significant. Add a 25% retaliatory tariff and Canadian customers must pay 35 or 40% more in Loonies. China has a complex currency system that makes it easy for it to devalue its internal currency at will. They can soften the American importer’s pain without hurting their manufacturers very much. Only the Euro has not shown signs of weakening against the Dollar, but that could quickly change.
The Tragic Irony
Adding exports and exchange rates into consideration paints a very different picture. Call me old fashioned, but I have always admired American exporters. They operate in one of the highest wage countries of the world, yet they have scratched and clawed and innovated to earn $2 Trillion per year in export markets. To me, they are the genuine heroes of American commerce. Yet, with the situation that Trump is creating, they’re the ones who will suffer the most. Many probably won’t remain exporters if his policies last too long.
Do we really want to punish these $2 Trillion heroic exporters just so we can artificially protect a smaller number of domestic manufacturers who can’t compete effectively on the world stage? Worse, under the security blanket of protective tariffs, how likely is it that any of these domestic manufacturers will ever raise their game to a world-class level? How many will rise to replace the hero exporters that this policy will inevitably crush?
Nothing I have written should come as a surprise to any semi-decent trade analyst. Yet it seems totally opaque to almost everyone who is pontificating about the tariffs.
Makes me depressed.
