Hello and welcome to the Download. I'm your host, Dave Richardson and we are joined by Canada's hardest working economist. That's Eric Lascelles, who you all know and love if you've listened to the podcast regularly over the years. Eric, how are you doing today?

I'm doing just fine. It's a busy day and we'll get to that in a moment. But, doing fine, thanks.

Well, Eric actually refused to appear on the podcast today, but I threatened to slap him with a 25% tariff and here he is. Who knew a tactic like that could create so much action and activity and uncertainty. How would we even describe that, Eric? You just didn't feel like it today?

Precisely. I'm a busy man. Wake me up when you get to a 50% tariff is my attitude.

Oh, gee. So I should have come in even harder. Which actually I think is where we started. We started with a 60% tariff on China and now we're down to 10%. Up to 25% in Canada and Mexico. So the question we're going to deal with today is tariffs. Just talking to some advisors, instantly they started getting questions from their investment clients about a few things. Investing in Canada? How does this impact the Canadian economy and my investments in Canada? What happens currency wise? Because we did see almost an immediate move with the announcement of the threatened tariffs, I should say. And I think one of the key distinctions that we would draw right out of the gate is this is a proposal. The Trump administration does not start until January, so it could be viewed as not an enacted policy. But generally, Eric, as we talk about tariffs in general, because they're going to be some part of what the Trump administration is going to bring to the table very clearly and with the announcement of the Treasury Secretary who was quasi supportive of tariffs or at least had a different view of the impact that tariffs have. But you as a hardcore hard-working economist, what do tariffs do? How do they work? Why do they work or not work? Just from an economic perspective, economics 101, explain the tariff and the impact that it has.

Right. So the idea of a tariff is to really shield domestic production and to disadvantage foreign production. When a country imports something, governments have the ability to essentially lay a tax on those imported products and it discourages the imports and/or renders them more expensive, among other things. In terms of who pays for it? Well, that's heavily debated. It does depend on the circumstances. I think you could say, realistically, it's spread across four or five different parties. The foreign producer is probably affected in some capacity, whether it's less demand or they have to cut their price a little bit just to render it at all palatable to the American audience. The currency often absorbs a bit of the blow too, in the sense that usually a country imposing tariffs sees its currency strengthen and so that kind of absorbs a little bit of the price increase blow as well. And then you've got wholesalers, and you have retailers and you have the consumer at the end of the day. And so, some fraction of the tariff gets absorbed by everybody. In practice — and this seems to have held true in the 2017-2020 era of tariffs, that was the first Trump term — it did disproportionately accrue to the American consumer. So it wasn't 100%, but a pretty significant fraction was. And so that's why people are rightly a bit nervous about inflation. In other words, the cost of things goes up in that context. So that's pretty central as well. And there's a bit of economic pain that comes when things get more expensive. Obviously, there's a partial offset in the government's collecting more revenue, so they're making money from that tariff. There's a partial offset in that some companies are then in a position to produce more domestically. It is shielding domestic production. But again, you usually end up with higher product prices. You usually end up with a stronger currency, which is a slight competitive hit, you usually end up with less selection because some of those foreign products aren't precisely replicated domestically. And sometimes less specialization. So you're a domestic firm and you're really good at what you do because you focus on a handful of things. And now you're incented to spread yourself a little bit too thin. There can be some cost to that. And obviously, if and when tariffs are applied, at least in the short run, there are some supply chain headaches, like the usual supply of this is no longer available and it just takes time for other companies to ramp up and for producers to figure things out and that sort of thing. So certainly, there are some costs. The way we would put it — and this is just conventional kind of economic theory — a tariff applied by a country is usually a net negative economically. It depends on where that price increase accrues to. But usually it's a net economic negative. If the other country reciprocates, then it's guaranteed to be an economic negative. And that is probably a realistic proposition, if we get tariffs. I do want to revisit the «if we get tariffs» part of this conversation, by the way, but that's the theory.

Absolutely. But you know what? And this is where I come in. Our marketing folks have asked me to do more of this. So watch this one, Eric. This is my job. So for those of you who are new to the podcast — and there's so many of you — this is why so many Canadians listen to this podcast. That was the best explanation that I think I've ever heard. And I went to the University of Toronto for economics. I went through all of the different economics classes for four years. I've never heard a better explanation of all of the impacted parties around a tariff as what Eric just shared with us. That was brilliant. So if you like that, give us a five star review. Subscribe to the podcast. Watch us on YouTube and apparently on LinkedIn as well. So we'd love to have more. Tell a friend, because we'd love to have more people learning from Eric Lascelles about tariffs and their impact. So Eric, that does come to the next question you wanted me to ask, so I'll oblige, which is: hey, is this really ever going to happen?

I would step back for a half moment and say, there's been a real Trump honeymoon so far, at least in a market context and even an economic forecasting context. People getting pretty darn enthusiastic and excited about tax cuts and deregulation and the revival of animal spirits. I'm looking at the S&P 500 that — at least as we're recording this — just went through 6,000 and all sorts of excitement exists there. We've always known there are some prickles associated with some of those market friendly policies and those are less immigration and higher tariffs. And so those are the more negative elements, at least from an economic standpoint. And so we've always known they've been coming. We've made our assumptions and the market's made its assumptions about just how much of those things we're likely to get. And we're still of the view that we're probably not getting the full Trump 60% tariff on China, 10% tariff blanket on the world. We're still skeptical of that, but there is some uncertainty. And so now, we're getting maybe a little bit of a hangover effect, and we're seeing some of those scarier proposals continue to be put forward and get a little bit twisted, too. It's actually a bit confusing how suddenly Canada and Mexico are being threatened with a 25% tariff. I thought that was the 10% tariff they were talking about. And China, I thought was meant to get 60%. And suddenly there's a 10% number in there as well. So we'll see where this ultimately settles. But I would stick with that view that it'd be surprising if we got the full 25% tariff in this case on Canada and Mexico, certainly not in a blanket fashion. And, you look at the likely next Treasury Secretary, Scott Bessent, and he is talking about using tariffs as a negotiating strategy. And I think that's the right way to think about this. This is an open negotiation, and that's how it worked out in 2017-2018, and we didn't ultimately get the full tariffs that had been threatened then. I think it's likely to be a similar story today. By the way, that proposed treasury secretary has also talked about, if there were to be tariffs, applying them gradually to avoid it being a large shock. And of course, I'd rather there just not be tariffs. But that matters too. It doesn't necessarily happen on January 20th. But looking at what Trump was saying, do note that he very explicitly tied those threatened tariffs to essentially border security. And he talked about illegal drugs, and he talked about illegal immigration. And so I guess there are two thoughts there. One would be that, to the extent these other countries can make the US happy on those fronts and help to control those sorts of flows, then the tariffs are back off the table or in a diminished or more targeted form, which I think is pretty likely. And then the other thought is just when you think about this, okay, we talked about Mexico and Canada in the same breath, and that makes sense. Of course you've got this USMCA trade deal, and of course they are all tied together to some extent. But realistically, when we're talking about the flow of illegal drugs and illegal immigrants, it is disproportionately a US/Mexico phenomenon. Not to say it's 100%, but it is heavily disproportionately in that direction. And so I think that is very much where the focus is going to be. Do note, because there is a USMCA trade deal, technically you're not meant to be applying tariffs to each other. And so that's in theory illegal. An extreme scenario — that I do not foresee — the US or any country has the ability to give six months’ notice and leave the trade deal. But do keep in mind Trump did make this trade deal. So he's not quite as negative on it, you would think, as some of the other trade deals that exist out there. Do note — and I'm a little blurry on the interplay of these things — but the US does have some legislation that does permit them — as Trump did the prior go-around — to implement tariffs under certain circumstances, if that makes sense. For instance, national security is a prominent one. Anti-dumping. And countervailing tariffs. If someone hits the US with a tariff, they'd be allowed to do a tariff. That's not the scenario here. Anti-dumping. Well, that's been an accusation against Canadian softwood lumber. And I'm not sure entirely fair. But nevertheless. Do note, Canadian softwood lumber currently pays a 15% tariff, and I do believe it actually increased not that long ago. So there are some tariffs in play. And that sort of thing does happen. And I'm not sure Canadians would agree that it is dumping. And it's tricky because it's crown land and there's stumpage fees paid, and it gets very confusing very quickly as to what the proper market rate would be. But the bottom line is there are some there. But the big one is this national security question. And so it can be interpreted pretty expansively. And so we saw in the first Trump term certainly steel and aluminum being interpreted as national security relevant, if that makes sense. If you want to make tanks and guns and other things, I suppose you do need the capacity to have a reliable steel and aluminum supply. Canada was threatened with that in the first go-round, and it didn't ultimately get hit by that for any period of time. And so again, I suspect, to the extent that tariffs were to be maybe more concretely threatened, you could imagine it going in that approximate direction. I'm assuming in the end it doesn't happen. And Canada adjusts to a number of US demands, be it opening the supply chain management sectors a little bit more, be it dairy or otherwise. And that was a pressure point last time. Softwood lumber is likely to be a pressure point again. Increasing Canada's military spending significantly, likely to be a pressure point. Seems like maybe increasing border security as well could be one. There's a certain irony there, to the extent, of course, seemingly a large fraction of the illegal ammunition and guns in Canada come from the US into Canada. And similarly, the thought process is that there might be some risk of a surge of undocumented immigrants from the US to Canada. And so arguably the border security is more acute from a Canadian perspective than a US perspective. But the bottom line is you would think there'll be some pressure to do that, and those are probably things that Canada can do. And that probably allows Canada to dodge significant tariffs, to make it all about Canada. I will say we did some modeling and it's still in flux. In fact, we literally started to redo some of it today, just with some slightly altered assumptions. But if you assume Canada has a few sectors that are indeed hit by some tariffs, but most are not, which I think is reasonable, we do have it subtracting up to about a third of a percentage point off economic growth over the next couple of years, which is a real hit and undesirable. And we're certainly scrounging for growth these days and wouldn't want that needlessly, but that was about what the hit was. Undesirable, but not recession inducing or destroying of markets or anything like that. You think about the Canadian stock market, if I can expand to that. It is heavily skewed in a certain number of sector directions and those don't seem to be overly affected. At a minimum, you think about the financial services industry, and it doesn't seem like these tariffs are particularly service oriented. And so that's certainly helpful. You think about the resource sector, and it gets a little bit blurry there. I've seen one analyst suggest maybe base metals could be affected or something like that in a tariff. And we'll see. I'm quite dubious of that. But the main takeaway would be, it's not quite as direct a drive for Canadian markets as you might think.

Yeah. And if the ultimate strategy here is to drive US growth, which is really the bottom line, the people who are surrounding Trump from an economic perspective are very much what they would self-describe as growth-oriented individuals. And so the objective here is to drive growth. And then if you look from a political standpoint, he campaigned around the economy and illegal immigration. Those would be, if you look at some of the exit polling, two of the key drivers in terms of people who voted for Trump. So not surprising that you mesh the two together. It's kind of a perfect mix. You're not in power, so you can use it as a negotiating ploy. It's a threat at this point, because it's not becoming a policy right away. We do have a trade deal, the USMCA, which I believe Trump has often referred to as the best trade deal ever negotiated. So you're working outside of that. You start to piece it together, and as you said, the overall impact is not zero, but it's not enormous. And then it's the case of, is it really even comes to pass? But nevertheless, we saw the Canadian dollar weakened. We've seen a reaction at least with people going, oh, now we're a little more worried than we were. As you said, honeymoon period. And now it's like, okay, where exactly is this going?

And then we'll see what actually gets implemented. And we might end up feeling a little better about things in the end. In particular, we just had a whole campaign where a 10% tariff was being talked about, and suddenly the 25% has come a little out of the blue. And so I think maybe a bit of skepticism might be appropriate there. I did see some pundits speculate — and this is pure speculation — that maybe Trump threw Canada in the mix — Mexico being the more obvious target — in part because, of course, North America does have this trade deal, but in part because he might be sticking it to Trudeau, who, reportedly, he's not a big fan of, with election coming up. So we'll see if that's the case or not. To me, the focus is surely going to be on Mexico in all of this. And we'll see where all this goes. You may know that in 2026, there is an opportunity to revisit the USMCA deal in general. And probably the best single guess is it survives with some tweaks. And it might be tweaks that demand minimum labor standards or minimum wage costs or something, and indirectly minimizing Mexico's ability to get a real big advantage over its developed world brethren. But it's not inconceivable that you were to walk out of this in a number of years time and find the USMCA doesn't exist. But you have a bilateral deal between Canada and U.S. And then a different deal, including Mexico that is much less friendly toward Chinese production that gets exported to the US as an example. That's speculation too. But we could see that kind of debate. But Canada has very similar cost base to the US Canada is very similar trade balance to the US as well. It's not the obvious huge target. One of the saving graces for Canada is, it is the number one trading partner of a very large fraction of US States as an example. So there are any number of American businesses and American politicians who will be in Canada's court making arguments in favor of keeping those trade ties with Canada.

And some of those are swing states in the presidential election, we should note. I do want to come back to something very important and make sure that the people listening to the podcast really caught that as you move through it, which is the makeup of the Canadian stock market. It has a lot of financial services, a lot of resources, and those areas are largely not affected by this particular proposal. And some of the policies around deregulation — «drill, baby, drill» — as one of the policies articulated, these are things likely for the renewal of the Keystone XL pipeline, which he's also said he's going to sign the first day. These are generally things that are going to help those sectors of the Canadian economy and since they're such a major part of the Canadian index and the Canadian stock market, this announcement really shouldn't impact the way you think about investing in Canadian stocks and Canadian companies.

Yeah, I think that's right. It provides that extra layer of protection. But again, back to the main point, which is just that I suspect if Canada gets hit by tariffs, it will be likely very narrow. The threat right now is a great negotiating strategy to start the conversation and to get some concessions perhaps out of Canada as well.

Just one last thing. Let's just talk about the dollar. And again, you saw some initial weakness in the dollar off the announcement. Let's pop back a little bit today, the day after. But if these policies and any policies as we move into the Trump administration were to significantly weaken the Canadian dollar, does that impact what the bank of Canada may be willing to do from an interest rate perspective? Or do you think those two things are divided?

Yeah, I mean, they all do connect together. This is the problem. And everything affects everything. You just go round and round and you end up with quite muted, dampened implications every which way. And that's probably the way to think of this as well. So the threat of tariffs is to Canada's disadvantage, which weakens the currency. Weaker currency does maybe increase a bit of inflation, perhaps at the margin. But equally, it provides a competitiveness boost as well, which does help the economy to some extent. But just keep in mind why the currency is weakening. It is weakening because of concern that a portion of the Canadian economy suddenly won't see the foreign demand it normally enjoys. And so there are some economic challenges that come from there. And so, to say that that currency decline means that the bank of Canada has to cut rates less, which I guess is kind of the thought behind it, it would be to suggest in a sense that maybe the currency has moved too far, if that makes sense. And it's hard to weigh these things and judging probabilities and the exact magnitude of tariffs and so on, but I would say we're seeing movements of a percentage point or two here and there. I'm not seeing anything that in a huge way changes the path for monetary policy for Canada. The fact that maybe the Fed is on a slightly slower journey perhaps says a little bit. And we've all ratcheted back slightly our rate cutting expectations on the basis of a number of developments. But I don't think the currency move itself changes it too much at this point.

Yeah, and that's been a moving target too. We've had big expectations for lots of rate cuts and then shift to fewer expectations of fewer rate cuts and all that stuff. So, yeah, anyways, Eric, thank you. Thanks for hopping on late. This is one of the great things that we can do with the podcast and with Eric, because he is so generous with his time, in all seriousness. Through a number of sources, we start to hear what's bubbling up on the minds of Canadian investors and we can get them to hop on very quickly and address some of those issues. And again, I thought that explanation at the front end around the impact of tariffs on the different stakeholders was absolutely brilliant. And Eric, just thanks as always for being so fantastic and always saying yes when we invite you on.

My absolute pleasure. Thanks. Bye, everybody.