Let The Market Work

Many economic misperceptions about inflation stem not just from misunderstandings about macroeconomic policy, but, more broadly, from a lack of appreciation for the important functions of market prices in general.” – The War on Prices

President Trump’s key economic strategy to return manufacturing and drive new business to the United States is tariffs.  Under Trump’s policy, tariffs are used to address trade deficits while increasing revenue for the federal government.  Like all price controls, however, tariffs interfere with the market that continuously adjudicates people's wants and needs with suppliers' products and services, both domestic and international.  Most protectionist policies favoring tariffs are implemented to save jobs by protecting domestic industries from foreign competition.  Most, at best, shift jobs from one sector to another. 

In Ryan A. Bourne’s edited book, “The War on Prices”, Bourne explains the difference between why market prices rise for individual products versus why inflation increases prices across the board for all products and services.  Not understanding the underlying reasons for these economic conditions results in misguided policies leading to worse outcomes.  Along with refuting the misconceptions about changes in market prices, Bourne also addresses the continuing confusion on political issues like the gender pay gap, CEO pay, and whether or not there is a pink tax on female products, among others.   

Trump may be calling his tariff policies “reciprocal tariffs”, but the formula he used instead reflects a country’s trade deficit with the United States.  In a deficit, Americans bought more products from a particular country than that country's citizens bought from us.  Trade wars that occur when protectionist policies escalate between countries typically result in the enactment of more and more trade barriers, with increased adverse economic impact on citizens of both countries.

In a free and fair economy, market prices rise and fall as producers determine how best to allocate scarce resources.  That is, prices continuously reflect knowledge of what consumers are buying and willing to pay for products and services.  As supply and demand shift, prices adjust, at times rising and at other times falling.  For instance, if supply decreases, prices rise.  If demand increases, prices go up. 

Competition alone keeps prices in check, stopping firms from charging arbitrarily higher prices.  Prices settle where supply intersects with demand, with goods naturally aligning with the interests of the buyers and sellers in the market.  Therefore, both prices and wages in a free market are determined by the product or service, the skills needed to produce the product or service, and what consumers are willing to pay for the product or service.    

There are many reasons that prices rise and fall.  Demand increases or falls, a change in consumer tastes, new taxes and regulations, or disruption in the supply chains can all affect the ongoing prices of goods and services.  Not understanding how prices work can lead to citizens demanding government intervention to control market prices, usually at their own expense.    

Prices may also rise due to inflation, a sustained increase in the prices of all industries.  Inflation is not a general increase in the price of goods and services in the economy.  Inflation only comes from one place - the monetary and fiscal mismanagement of the federal government.  By arbitrarily increasing the money supply without production, inflation results from the depreciation in the value of money.  That is, when Fed policy injects money into the money supply, the market is left with too many dollars chasing too few goods.  For example, the COVID response caused fewer people to work, resulting in lower productivity, all while the government pumped massive amounts of dollars into the economy.  The ensuing inflation often creates calls for price controls, that is, central planning of prices by the federal government. 

Price controls include both price ceilings and price floors, that is, the maximum and minimum that a business is allowed to charge.  Both interfere with market prices and affect what people buy and sell.  Price ceilings, like rent control, often result in shortages, rationing, and a reduction in quality, while price floors, like minimum wage laws, result in supply gluts and unemployment.  Price controls also replace natural trade patterns with policies backed by politics. 

Between 1992 and 2020, inflation in the United States averaged 1.9 percent, within the 2 percent target of the Federal Reserve.  Then, beginning in March 2020 through March 2022, the Fed increased the money supply by 39 percent.  By June 2022, annual inflation was at 7 percent, the highest since 1981, showing how the central banks are the initiators of inflation, not the destroyers. 

How will the Trump tariffs end?  Countries will likely either cede their own tariffs to level the playing field between nations, with tariffs from both sides removed, the best-case scenario, or Trump's audacious risk may put the nation and the world into a recession.  Interference with market prices by any government should be strictly discouraged.  Businesses and consumers already produce the best prices by allowing markets to do their job spontaneously.