Why no Tariff Inflation?

And Why Haven't they Yet

We’ve seen essentially zero tariff inflation after 4 months.

Jerome Powell keeps warning it's right around the corner. While Secretary Bessent claims tariffs “cannot” cause inflation.

So who's right.

Inflation and Tariffs

In a recent interview with Larry Kudlow, Treasury Secretary Bessent claimed tariffs "cannot be inflationary."

Because unless you're printing money, when the price of one thing goes up the price of everything else goes down since people have less money to spend on the other stuff.

So it's squeezing a balloon -- tariff-pumped Chinese socks take money from your Taco Bell budget. Socks go up, Taco Supremes go down.

The formal term would be price reallocation under a hard money constraint.

And here’s an example from 2018: PCE inflation went up for tariffed goods, but it dropped for non-tariffed “core” goods.

So does that mean tariffs cannot increase inflation?

In economics there's almost always a difference between short-run and long-run. Because it takes time for companies -- and consumers -- to react.

For example, if you put a hundred percent tariff on Chinese socks it's instant. But Taco Bell will take time to notice the drop in demand from its socks-impoverished customers.

Then it'll take time to decide what do do about it: Will the drop in demand last, is it worth cutting prices and losing customer goodwill and market share.

So socks go up fast. Taco Bell goes down slow.

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The Long-Run

But in the long run Bessent is largely correct -- once everybody adjusts, tariffs squeeze the balloon. Imports go up, everything else gets cheaper.

Including, by the way, Made in America stuff that competes with imports.

Only “largely” correct because even in the long-run you have a permanent hunk of inflation in the form of tariff revenue paid to government.

As in, it's a balloon, but part of the air leaked to federal tariff revenue.

In fact, tariffs could be deflationary if they boost domestic production enough. Because at that point you’ve got more stuff for dollars to chase -- the opposite of inflation, which is more money chasing goods.

Note that this is all theory -- short-term inflation that fades in the long-term, potentially into deflation.

Because at the moment, we're not even seeing short-run tariff inflation. Instead, Chinese and Japanese are eating the tariffs by lowering their prices, just as they did in 2018.

This is probably tactical, as in they don't expect tariffs to last. So they don't want to hike prices and risk losing market share.

But once we do get settled tariff deals — if ever — expect price hikes initially, easing in the long run potentially into deflation.

The Size of the Balloon

Through all of this, note what's doing the real inflation work here: The size of the balloon. Which is the money supply.

About a fifth of the M2 money supply is literally printing money at the Fed -- typing zeros on a spreadsheet and using it to buy government bonds so Congress can waste it.

But the rest of the balloon is commercial banks pyramiding on that typed-up base money. Banks literally magicking up the money for your mortgage, credit card, or business loan.

Now, under Trump, M2's actually been rising faster than Biden, driven by rising bank loans. The balloon’s getting bigger.

It takes time to filter through to inflation -- that short-run vs long-run thing again. But given government spending isn't going down — nor is the Fed’s willingness to finance it — the balloon will keep getting bigger.

And inflation will follow.

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What’s Next

Tariff inflation will be transitory -- if we get it at all.

Even the Fed admits this.

But the larger issue is Congress' failure to cut spending means the Bidenflation balloon is back to growing.

Toss in bank lending that always rises in a boom and we could see inflation start to see inflation grind up through the year. Not from tariffs but from Congress' trillion-dollar gaping wound of red ink.

The only way to outrun that is grow production faster -- something like 3 or 4% GDP growth to soak up the freshly printed money.

If not, we will get inflation. And it will have little to do with tariffs.

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