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Tariffs Do Not Cause Price Declines

Adding to a good’s price does not make its price decline.

It’s worth repeating that a couple of times, because it seems to be getting lost in the discussion about tariffs – in particular, in the discussion about tariffs levied on US commodities. Grains prices have been plummeting, as the chart below showing front corn and soybean prices (source: Bloomberg) illustrates.

There are many reasons that grains prices may be declining, but if “tariffs have been levied on US production” is one of them then there is some really weird economics happening. Corn and soybeans are commodities. Specifically, this means that they are essentially fungible – corn from site “A” is essentially the same as corn from site “B.” So what does this mean for the results of a tariff?

If China stops buying soybeans from the US altogether, it means that unless they’re going to stop eating soybeans they will buy soybeans from Brazil. But if Brazil sells all of their soybeans to China, it means that Germany can no longer soybeans from Brazil. So where does Germany buy its soybeans from? Well, it seems that the US has beans that are not spoken for in this scenario…in other words, when we are talking about commodities a tariff mostly just reorganizes the list of who is buying from whom. If soybean prices are falling because China isn’t buying our soybeans, it means a great deal for Russia or Germany or whoever else is going to buy beans from us instead of from China’s new supplier. More than that, if global soybeans prices are falling because of tariffs then it means that everyone is getting cheaper soybeans because China is changing who they’re buying from. If that’s the case, then we really need to slap tariffs on everything and watch prices decline!

Let’s go back to elementary microeconomics. Adding a tariff is reflected in our product market supply and demand curves as a shift in the supply curve to the left: the quantity that producers are willing to supply at any price declines, because the price to the producer declines. Put a different way, the market price required to induce any particular quantity supplied rises by the amount of the tariff. Now, whether that causes market prices to rise a lot or a little, or quantity supplied to fall by a lot or a little, depends on the elasticities of supply and demand. If demand if fairly inelastic (which seems reasonable – you may be able to substitute for “beans” but it’s hard to substitute for “grains”), then you will see more of a price response than a quantity response, at least in the short run where the supply of beans is fairly inelastic. But that price response is up, not down.

By the way, this gets a little hard to illustrate with supply and demand curves, because with a tariff what you have are now two separate markets and separate prices for the same good. This is what confuses some people – if China is no longer buying from the US, doesn’t that mean that demand for US beans has declined, and therefore prices should decline? The crucial point is that we are talking here about commodity goods, and supplies are fairly interchangeable. If we are talking about Harley Davidson motorcycles, the answer is different because if Europe stops buying Harleys, they have to buy a different product altogether. In that case, the global price of “motorcycles” might be relatively unaffected, but the price of Harleys will rise (and the output decline) relative to other motorcycles. So, a tariff on Harley-Davidson motorcycles definitely hurts the US, but a tariff on soybeans – or even “US soybeans” since that is not a universal distinction – should have virtually no effect on US producers. And certainly, no effect on the global price of soybeans.

There are other reasons that grains prices may be declining. Since Brazil is a major producer of beans, the sharp decline in the Brazilian Real has pushed the US dollar price of beans lower (see chart, source Bloomberg). In the chart below, the currency is shown in Reals per dollar, and inverted. This is a much more important factor explaining the decline in grains prices, as well as one that could easily get worse before it gets better.

I think the discussion of the effects of tariffs has gotten a bit polluted since the decline in grains seems to coincide with the announcement of tariffs from China. I think the price decline here has fed that story, but it’s bad economics. Piecemeal tariffs on commodity products are not likely to appreciably change the supply and demand outcome, although it will result in rearranging the sources of product for different countries. Tariffs on non-commodity product, especially branded products with few close substitutes, can have much larger effects – although we ought to remember that from the consumer’s perspective (and in the measurement of consumer inflation), tariffs never lower prices faced by consumers although they can lower prices received by producers. This is why tariffs are bad – they cause higher prices and lower output, and the best case is no real change.

DISCLOSURE: Quantitative/systematic funds managed by Enduring Investments have both long and short positions in grains, and in particular long positions in Beans and Corn, this month.

  1. July 12, 2018 at 2:32 pm

    Or, it just means that there is a world wide bumper crop of soybeans, and that Brazil and the Black Sea areas have ramped up ‘production’ such that the loss of American product on the world market is made up for by increased production everywhere else. Germany will just look to the Ukraine for soybeans now, not America. The world supply is increasing to meet demand, and decreasing demand from China means supply is more than matching demand. Trump picked the wrong year to risk a tariff war in soybeans.
    Incidentally, China is the world’s largest importer of soybeans, to the point where any German purchases of US soybeans, or any other country, for that matter, just won’t come even close to the complete cessation of Chinese imports of American soybeans. $16 billion dollars was just ripped out of the American economy.

    World-wide supply and demand.

    Despite NOT buying soybeans from America, and despite American soybeans being 25% more expensive to the Chinese, the prices that China is paying for soybeans is actually going down.

    Really, China was buying US soybeans only as a favor to the US, to ease the balance of payments deficit.

    How can China LOSE the trade war, when they are winning? They no longer have to coddle up to America by buying American preferentially, just to appease the Americans.

    • July 12, 2018 at 2:40 pm

      Worldwide bumper crop of all grains? That seems somewhat unlikely, and also somewhat unlikely that there was such a huge surplus that the US production is not needed anywhere in the world and will rot at low prices. If China is the world’s largest importer of soybeans, it means that trade flows will rearrange … not that no one will buy US beans. If China chooses to buy all of their beans from Brazil, then unless Brazil had that many beans sitting around it means SOMEONE other than China will need to look elsewhere for beans. Only if almost everybody has a tariff on US beans would the local price of beans differ much from the world price of beans. There will be no meaningful medium- or long-term effect on US output, production, or prices of a commodity such as this.

      Now, US finished goods are a different story.

      • July 12, 2018 at 4:10 pm

        Yes, America may pick up SOME sales from other countries.

        But here is a breakdown of world-wide soybeans imports


        Every other country is no more than a wide line compared to China’s solid block. Exactly what country is capable of making up for China’s imports? China is not just the BIGGEST market, it is effectively the ONLY market. If every other importing country in the world bought exclusively from America and no other source (unlikely) the US exports would STILL drop by half. Of course, there is always bio-diesel.

        It is very hard to find non-American-centric views of the situation, so let’s get the figures directly from China.

        ‘Nation can find more soybean sources’

        ‘China National Grain and Oils Information Center said China’s 25 percent import tariff on US soybeans will increase US soybean import costs to between 700 yuan ($105) and 800 yuan per metric ton, which is around 300 yuan higher per ton than the same shipments from Brazil.’

        ‘The center forecast that China’s reduction in soybean imports from the US can be offset by Brazil’s bumper soybean harvest, and the growing soybean production acreage in South America and Central Asia.

        ‘Even though customs data show that China imported 32.85 million tons of soybeans from the US in 2017, experts said soybean oil and soybean meal are replaceable, thanks to the world’s sufficient supplies.

        ‘Yu Xubo, president of COFCO Corp, China’s biggest agricultural products supplier by revenue, said the nation can boost domestic soybean output, and broaden its sources of meat, soybeans and meal imports to ensure supply from other countries, while strengthening research on feed formula and cutting dependence on soybean meal demand to make up the import gap from the US’


        In other words, if China is able to change its demand metrics, and other sources are able to change their supply metrics, supply can adequately meet demand and the price will remain stable, or even drop, despite the tariffs.

        American soybeans will rot, not because of low prices, but because of absolutely no demand. The effects of making something no one wants to buy, at ANY price.

        In effect, China did not just place a 25% tariff on American soybeans, China effectively banned the importation of American soybeans completely. And if a 25% tariff does not do it, then well they will go to 50%, 75%, 100%. Whatever it takes to shut off American soybean imports completely.

        China has absolutely no intention of imposing tariffs that will jeopardize its own economy more than the American economy.

      • July 13, 2018 at 9:15 am

        Don’t want to get into a long discussion about basic economics here but here’s how it works math-wise:
        Worldwide demand = China + X (demand for all other countries=X)
        Worldwide supply = US + Y (supply from all other countries = Y)
        China imports from US = z
        This means that worldwide supply to countries other than China is (US-z) + Y; so
        X = (US – z) + Y
        Suppose China demand from the US goes to zero (z=0). Then
        X = US + (Y – z)
        That is, the z is supplied from the rest of the world, and none from the US. But the US figure hasn’t changed. Why is that? Because the quantity demanded by China OVERALL and the quantity demanded by the rest of the world OVERALL didn’t change. It’s just that the US now supplies countries other than China, and China buys from countries other than the US. In fact, the US might supply countries that then sell to China, circumventing the tariff.

        But what I know is that unless China buys fewer beans from the world, the world will supply the same amount of beans, and approximately the same amount will come to world supply from the US.

        That’s my last word on this subject! Thanks for writing.

  2. July 13, 2018 at 9:22 pm

    Your math is interesting, and correct as long as your assumptions are correct.I have no issue with the math. It is your assumptions that are in question.

    You are assuming demand from China is constant, and Y is constant. You must have missed the fine print. In 2013, Chinese imports were 55 m m tons. In 2017, they were 91 m m tons (depending on data source). A difference of 36 m m tons, or almost equal to US exports to China. If China reverts back to 2013 levels (only four year rollback) and world supply goes UP, which it is, the total cutback of China is equal to the total US exports to China. There is no need for world trade patterns to shift.

    So what is China using all of these soybeans for? Animal feed, particularly pork. Why? Because the Chinese taste for pork and other meat has gone up, And with rising incomes, the average Chinese citizen can afford it. Please note the fine print in the quote – ‘the nation can boost domestic soybean output, and broaden its sources of meat, soybeans and meal imports’. On other words, China can substitute for soybeans. Instead of using soybeans for animal meal, it can directly import the meat itself. Or it can import other meal. Pigs are not really that fussy.

    ‘The country could also buy more rapeseed, sunflower seeds, and bring in more soybean meal, rapeseed meal, sunflower meal and fishmeal to fill any supply gaps. Increasing meat imports was also an option, he said’

    from https://www.scmp.com/news/china/economy/article/2154793/china-can-turn-south-america-replace-us-soybean-imports-industry

    From my post ‘In other words, if China is able to change its demand metrics, and other sources are able to change their supply metrics,’.

    If China does not buy from the US, and it does not replace this source from anywhere else, except for their additional production, there is no need for the US production. Yes, the price for soybeans may go down, as US producers seek market share, and other countries try to maintain it, but China has a lot of influence in the price, simply because of China’s lopsided demand. Incidentally, China and Brazil are now trading using the renminbi, not the greenback, which Brazil can then use to buy Chinese product. The bottom line is that US producers will have soybeans rotting in the field because of lack of demand.

    Like I posted, there is a REASON why China selected soybeans. Over simplistic analysis based on untested assumptions leads to incomplete conclusions.

    • July 15, 2018 at 7:34 pm

      Perhaps! And overconfidence based on analysis that also relies on a few untested assumption also leads to incomplete conclusions, with the additional issue of overconfidence which leads to larger losses. But good luck!

  1. October 31, 2019 at 10:03 am

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