Navigating the mechanics of tariffs
A tariff is a tax imposed on imported goods. This policy is intended to reduce imports, increase exports, and stimulate economic activity.
A tariff raises the price of foreign goods hence domestic goods become cheaper for domestic consumers. As a result, consumer demand for foreign goods falls causing a reduction in foreign currency demand and an increase of the domestic currency.
Import tariffs cause a reduction in imports, rise in exports and an improvement of the country’s balance of payments.
When a government decides to reduce or remove import tariffs, consumer demand for foreign goods rises leading to an appreciation of foreign currencies, depreciation of the local currency and a deterioration of the country’s balance of payments.
However, protectionist strategies like import tariffs stop working in the long-term since exchange rates adjust by the amount of taxes imposed.
Donald Trump recently imposed import tariffs to Chinese goods. The effects of Trump tariffs where an improvement of the United States balance of payments deficit, reduction of imports and a rise of the US dollar. However, since tariffs are protectionist in nature hindering global economic activity, Trump tariffs also led to a weakening global economy.
Moreover, the Chinese government retaliated by weakening it’s currency (the Chinese Yuan CNH) and also imposing import tariffs to United States Goods.