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Investors, More Than Consumers, Will Pay the Price of Tariffs

U.S. corporations may have to swallow the added costs, cutting into profits.

Corporations warned last week that if the Trump administration imposed tariffs on imports of steel and aluminum, consumers would pay the price. That's wishful thinking in the C-suite.

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Toyota said tariffs "would substantially raise costs and therefore prices of cars and trucks sold in America." Higher costs are undebatable. But can Toyota actually raise prices? That gets to the challenge economists and markets have already been wrestling with. While some industries like housing may be well positioned to pass on cost increases, many others are not. It's plausible that higher metal costs will eat into Toyota's profits instead of driving up car prices.

The relationship between costs to businesses and prices to consumers isn't straightforward. In an industry like housing where supply is low and demand is rising as millennials age into their prime home-buying years, companies have been signaling that they have significant pricing power. Yet in industries like packaged food and restaurants, that's less clear, as I wrote about recently.

When the commerce secretary went on television to explain that tariffs wouldn't have a meaningful price impact, he held up a can of Campbell's soup to make his point. In its most recent earnings report, Campbell Soup Co. noted that profit margins fell in part because of higher aluminum prices, which would go up even more in response to tariffs on aluminum. While the company said it intended to raise prices and increase productivity growth over time to make up for that cost increase and decrease in profit margins, there's no guarantee that Campbell or any other company in its position will be able to do so. If prices rose, consumers might simply buy less soup.

The response from financial markets on Thursday and Friday to the tariff news also suggests skepticism of corporate pricing power. Uncertainty surrounding profit margins increased, and stocks fell, particularly auto stocks. (On the other hand, if markets expected tariffs to lead to broad price increases and inflation, one would have expected interest rates to rise late last week -- but instead they were mostly unchanged.)

Corporations' threats of price increases also ring false because the previous press releases argued the opposite side. Since Congress passed corporate tax cuts, companies have largely told investors to expect that the majority of the tax savings would result in higher profits which would be returned to investors in the form of dividends and share repurchases. Few said that they expected tax cuts to result in industry-wide price cuts with corporations using their tax cuts to compete for market share with consumers. If corporations believe that they would absorb most of the benefit of tax reform, why would they believe that on tariffs the impact would fall mostly on consumers?

Just like those tax cuts, tariffs wouldn't happen in a vacuum. The labor market is around full employment, and signs of broader economic slack are getting harder and harder to find. The policy combination of economic stimulus from tax reform and a negative supply shock from tariffs puts cost pressures on corporations that they haven't felt in over a decade.

Trump came into office saying that he would use tax cuts and deregulation to help American business. Yet the starting conditions of the economy in a new administration shape the impact of policy decisions. Trump inherited an economy with high profit margins and low unemployment. Markets increasingly fear that the impact of his policy choices will mostly be higher wages, higher costs and higher interest rates -- rather than higher profits.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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