Tariff targets abound: why Canada?

I am not of the breed of economists who view all tariffs as unpardonable acts of treason to the memory of Adam Smith. Trade policy is a handy tool of economic and political management. It is a useful complement to fiscal, regulatory and monetary policy. History is filled with examples of trade restrictions successfully employed to incubate industries, bolster national security and punish bad actors abroad.

If the Trump administration wanted to run a purposeful tariff strategy, there would be no shortage of worthwhile targets. In Trump’s first presidential term, China was the central focus of US trade policy. Switching tariff heat from China to Canada in Trump’s second term defies logic. China is the primary driver of global trade imbalances, while Canada suffers from the same force-feeding of imports that burdens the US economy.

China’s economic model partly relies on subsidizing exports through cheap government loans and an artificially weak yuan. Without this aggressive strategy of dumping subsidized manufactured goods on other countries — mainly the US, but including Canada — the Chinese economy would struggle to meet the 5% GDP growth target set by the government. Our June 2024 commentary warned that China would lean hard on subsidized exports to achieve growth.

The US bilateral trade balance with China has, admittedly, narrowed over the past decade. The merchandise trade deficit with China is down from 2% of GDP at the start of the first Trump administration to 1% of GDP today. This statistical narrowing could explain why Trump has gone easy on China — relatively speaking — in trade matters. But the observed decrease in US-China bilateral imbalance is all smoke and mirrors.

Chinese exporters are simply making use of re-exporting hubs, such as Vietnam, Mexico and Singapore, rather than sending widgets directly to US ports. Suppose China subsidizes a company to produce a smartphone. That smartphone is then shipped to Mexico, where it is finalized and repackaged, and ultimately trucked off to an electronics store in the US. US statistics tally that smartphone as an import from Mexico, which widens the US bilateral trade deficit with Mexico. But make no mistake, the source of the imbalance is Chinese economic policies.

China sells, the US buys

Trade balances by country/region, billions of constant 2024 USD

China’s trade surplus in goods amounts to 2% of world GDP, approaching never-before-seen territory. Maybe the surplus goods aren’t flowing directly to the US. But they eventually end up there: the US is the only consumer pool large enough to absorb China’s exports, although the UK is certainly pulling its weight.

China is not the only reasonable tariff scapegoat for a confrontational US President, even though it is certainly the largest. Targets abound. The US trade deficit with Vietnam has blown up in recent years, the southeast Asian country being a key cog in Chinese trans-shipments to the US, facilitated by an artificially cheap currency. Taiwan also operates a not-so-subtle strategy of suppressing its exchange rate to boost exports, a practice repeatedly denounced by previous US administrations. Ireland’s low taxes have attracted the offshoring of large American pharmaceutical companies over the past few years. These multibillion-dollar companies pay close to zero corporate income taxes in the US, even if the country accounts for most of their sales.

Hey, Mr. President! Look over there!

Trade balance with various countries as a share of US GDP

The US government could also weaponize its trade policy to exert pressure on geopolitical adversaries. Threatening trade restrictions on those countries bucking US sanctions by buying Russian and Iranian crude — India, Turkey, China — would put additional pressure on these two warmongering oil exporters.

Canada is far down the list of “reasonable” tariff targets for the Trump administration. Last month’s commentary emphasized the inconsequentiality of the US trade deficit with Canada. This time, I'll take it a step further: Canada’s overall merchandise trade balance is much lower than it should be. As an oil- and mineral-exporting country amid an economic slump, Canada should be running a sizable trade surplus! If economic logic were respected, Canada should currently be exporting more than it is importing. Instead, Canada is running a small overall trade deficit.

Canada’s trade balance is “too weak”, not too strong

External balances, % of Canada GDP

The International Monetary Fund estimates that the current account balance for Canada — a broader measure of external balance that encompasses merchandise trade — should be around 2.3%. At -0.5%, Canada’s current account balance is far below its “normal”, expected level. Trump’s denunciation of Canada artificially boosting its exports is upside down: Canada is not the source of US deficits. Rather, it is subject to the same deficit-boosting forces as the US. Export-subsidizing countries — China, Germany, Vietnam, Taiwan, etc. — push manufactured goods onto global market. We buy them, in exchange for our government bonds, real estate and overvalued equities.

In a different world, Canada would be working side-by-side with the US to rebalance global trade. If the US government really wanted to reduce the country’s massive trade deficit, it would narrow its ballooning federal budget deficit and turn the screws on trade offenders. Even if the US eventually “wins”, a trade war with Canada wouldn’t reduce the US trade deficit and could only hurt the US economy.