Moneycontrol Pro Panorama | Tariffs and the cobra effect

The tariffs slapped by America are on any and every trading partner, irrespective of whether the nation is a friend or a frenemy.

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Policy actions of governments often end up having unforeseen effects or consequences that they did not want. These are part of the law of unintended consequences, a term that Tim Harford’s lovely piece in the FT, free to read for Moneycontrol subscribers, introduces us to. While Harford mainly highlights the perverse incentives generated by environmental laws, the concept can be applied to almost everything.

This week has been all about America’s tariffs on trading partners as President Donald Trump’s deadline of July 9 came and went. Trump has now given countries time till August 1 when the tariffs would take effect. The tariffs slapped by America are on any and every trading partner, irrespective of whether the nation is a friend or a frenemy. It doesn’t even matter what size, shape, or silhouette the country has. If Trump can say the name of the country, it will be tariffed. But there may be some method to the madness behind why tiny nations such as Brunei are being targeted. Manas Chakravarty reveals the possible method in his piece here explaining that US is getting back at China through these tariffs. The countries that faced steep tariffs are all part of China’s ambitious Belt and Road Initiative (BRI) through which Beijing is gaining significant power.

Acrimony with China for all purposes looks like a consequence the Trump administration has chosen, hence intentional. But whether tariffs on countries linked with China is intentional will only be revealed if Beijing feels the pain. As Chakravarty writes, “Whether such bullying tactics work, or drive these countries into the arms of China remains to be seen.”

But is there a cobra effect to the tariffs? The cobra effect, for the uninitiated, is a story that describes how the British Raj rewarded presentation of cobra skins to rid Delhi of the snakes, but ended up generating a thriving cobra farming operation.

America’s tariffs have ended up eroding faith in its currency, the dollar. So much so that the world must now think about a monetary system without its dollar as the anchor currency. The move away from the dollar was already under way a decade before Trump was elected, but the US President became the accelerant, as this FT piece, free to read for Moneycontrol subscribers, puts it. The end of dollar’s hegemony was definitely not the intention of the Trump administration. In contrast, the supremacy of the US is intertwined with that of the dollar to a large extent. What Trump’s tariffs along with other policies have done is dethrone the dollar and create a global currency market constantly in flux.

As the FT piece points out, we may see currency warlordism where multiple currencies vie for a sizeable share of the market (the Chinese renminbi is already winning here). Multipolarism in currencies may have its own unintended consequences. But one outcome is certain: Everything will get expensive.

As globalisation lurches towards its end, inflation would seep into the crevices that the tariffs have created. But remember that much of economics is about laws cancelling out each other. Prices increases can hurt anyone, but not necessarily everyone to the same degree; cobra farmers were big beneficiaries of the Britishers’ supposedly subsidised snake-assassination.

America’s trading partners, including the largest nation itself, wants to reduce the inflationary effect of the tariffs. Trump wants to avoid a recession as well and a sell-off in the markets from the tariffs. Perhaps that explains why the President has still given time until August for nations to strike a deal with him. Beyond the deadlines, the political commentary is essentially flexing for power.

While the leader of every nation is trying to offset the negative effects of tariffs, Indian officials are furiously trying to reach a deal with Washington and investors are watching. That explains why domestic equity indices aren’t showing outsized moves lately. Both Sensex and Nifty have played it modest over the past months and investors are now more willing to focus on earnings than tariff noise.

Perhaps, the cobra effect is on the minds of investors. What unintended consequences occur will only be known once they show up.

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