Introduction
Are Markets Crazy? Or lazy? Or, by contrast, are they just well-informed?
How could markets just shrug off President Trump’s July tariff letters that were so aggressive, so MAGA, so strong! Of course, markets do sometimes get it wrong, but not in this case, in my view.
In this factual Friday I'm going to argue that the markets’ calm is rational. That’s because I believe the August tariffs will fall far short of the economic impact the Administration claims, and the media have picked up and amplified.
Sounds crazy, right? How could such important policy announcements not affect the US economy?
Hear me out.
US imports: geo-concentrated so most tariffs are irrelevant (to the US economy)
Even the quickest look at the data shows that about two-thirds of US imports come from five partners: the EU, Canada, Mexico, China, and Japan. See pie chart below.
This means that the impact of the August Trump tariffs (assuming he actually carries through with these July threats) can be roughly understood by looking at just these five. That’s what I’ll do. Simplify to clarify.
In other words, understanding the behaviour of these big players tells us almost everything we need to know about how large an impact the August tariffs will have on the US economy.
The media was quite distracted by the parade of letters – most of which will have no impact on the US economy. Iraq, for instance, got a letter. But since it accounts for only 0.2% of US imports, the tariff it was assigned is essentially irrelevant. The chart below makes this "long tail" point.
Canada and Mexico: Surprisingly duty free
In 2025, President Trump imposed a 25% tariff on all imports from Mexico and Canada, but then he suspended them, then he modified them, and then ... well it’s complicated.
The table shows all the bold moves and rapid retreats that gave rise to the meme that "Trump Always Chickens Out" (TACO).
I think we have all concluded that this Administration’s trade policy does not suffer from an overabundance of staff work – or even fact checks. Why is this?
As I argue in my recent (free) eBook, The Great Trade Hack, the US policy can be understood thusly:
"The foundation is a bull-headed leader who often declares himself to be the world’s greatest thinker on [this space left intentionally blank], and who works in a very closed wishful thinking bubble that his advisors dare not burst. The chaos, in short, is driven by powerful instincts developed in the real estate world and applied unvarnished to running a 26ドル trillion dollar economy. The instincts are untampered by facts, careful planning, or any sort of economic analysis."
What do Canada and Mexico export to the US?
Here we have to distinguish between: autos and parts, steel and aluminium, and goods compliant with the North American free trade agreement, called USMCA.
When it comes to autos, and basic metals, the tariffs are all in place and applied equally to every partner (UK may be an exception, but it accounts for just 2% of imports). The 2 April tariffs are trickier. For now they are mostly 10% for all, but the tariff threats for August 1st vary a lot.
For Canada and Mexico, the last category is the most important. Most of their exports to the US are or soon will come in duty-free under the USMCA category.
Canada exports two very different sorts of things to the US: 1) resource-based goods like oil, minerals, aluminium, and wood products, and 2) manufactured goods. Most of the commodities already enter duty-free under the standard US tariff schedule and so far, POTUS has kept energy imports duty-free. I believe this is to avoid hurting his base at the gas station (as they call it in America).
In Mexico’s US export portfolio, manufacturing is king, driven by deep integration via USMCA and nearshoring. Here automotive, electronics, and machinery make up the bulk. Agri‐food exports are only about a 10th of the size of manufactured goods but include some goods that are highly visible to US consumers like avocados, beer, and tequila. Commodity exports, including petroleum and metals like silver, gold and zinc, are important but small in volume. In short Mexican exports are roughly 80% manufacturers, 10% ag, and 10% mining.
The key point is that unlike tariffs on China or the EU, the USMCA offers a legal escape hatch, if imports meet the USMCA requirements.
USMCA imports are duty free now
In 2024, a hefty chunk of US imports from Canada and Mexico were already flowing in tariff-free under the USMCA. A larger share probably qualified under the rules, but documenting compliance is expensive and the 2024 US MFN tariff rates used to be pretty low (like 2-3%), so many firms ignored the rules-of-origin paperwork. They opted to just pay the duties rather than account for every nut, bolt, and labor hour.
But Trump’s 2025 tariff hikes have jolted exporters into action. According to RBC, Canada’s share of CUSMA-compliant exports rose from 33% in February to 50% in March.
Canadian officials estimate 86% of their exports are likely to already be compliant in structure, even if the paperwork isn’t fully caught up yet. A similar compliance surge is underway in Mexico, where officials are reportedly aiming for 90% compliance by year-end.
The bottom line is that by the time Trump’s August tariffs hit, most of North America’s intra-bloc trade will be shielded from the storm.
That means almost 30% of US imports of goods will come in duty free.
Box: What does it take to be USMCA compliant?
Beneath the surface of North America’s tariff-free promises lies a complex set of rules known as the Rules of Origin (ROOs). These are the gatekeepers that determine whether a good qualifies for the duty-free treatment.
For general goods, the standard is relatively straightforward. A product must undergo substantial transformation in North America or meet a regional value content threshold, typically 50 to 60%. But for politically sensitive sectors, like steel, aluminium, and especially autos, the bar is much higher.
To qualify, steel and aluminium must be "melted and poured" in North America, ensuring the origin claim isn’t merely cosmetic. Automakers, meanwhile, must source at least 70% of these metals regionally.
The toughest ROOs, however, apply to autos and their parts. For a finished vehicle to enter the US duty-free under USMCA, 75% of its value must be sourced within North America. On top of that, 40 to 45% of the vehicle’s content must be produced in high-wage facilities defined as those paying at least 16ドル an hour. Auto parts also face thresholds. It’s 75% for core parts, 70% for major components, and 65% for complementary inputs.
The table summarises the discussion.
Japan: 40% already tariffed
In 2024, Japan’s top exports to the US were vehicles (36%), machinery (23%), and electronics (11%), combining to a subtotal of nearly 70%. Mid-tier exports included medical devices (6%), pharma (2%), and plastics/rubber (3%). Steel and iron made up 2%. See Table below.
Japan has already been hard hit by Trump's tariffs. But not so much his April 2nd tariffs – the famous "reciprocal tariffs". Rather, it has been hurt by the 25% tariff that he put on autos and auto parts in April and May. Additionally, there is a 50% tariff on steel and other metals, as well as related products, which make up approximately 2% of Japan’s exports to the US.
Taking those out, there are approximately 60% of Japanese exports to the US that could face significant tariff increases in August. If the US president's threats are to be believed, Japan will be hit with a 25% tariff from August 1st onward which will be a big step up from the 10% they are facing right now.
How big of a hit to the US economy would that % be?
Not much. Japan’s share of US imports was only about 5% of total US goods imports and so we are talking about a tariff rise from 10% to 25% on about 3% of US imports. That’s not nothing, certainly not for the affected Japanese exporters, but it won’t move the dial much on US inflation, US growth, or US corporate profits.
China: high but stable due to its counter threat
You may have noticed how POTUS has announced nothing with respect to what he's going to do with tariffs on China in August.
No letter for China! And this despite the fact that China is by far the largest concern for the US on almost every level. When the US President says America has been victimized by the trade system, the first image that appears in his mind’s eye is probably that of Chinese manufactured goods undercutting US factories. China is by far the largest single source of the US trade deficit. China’s impact on the American middle class even has a name: The China Shock. It is also by far the largest competitor to US industry.
So why no threatening tariff letter for China?
I believe that China has neutralized the US tariff weapon with its own weapon, namely export controls on critical mineral products, especially critical mineral magnets. I’ve written a whole Factful Friday on this, indeed two.
Here’s a snippet that explains the standoff. Writing about the US vs China conflict, I said:
"The outcome could be viewed as an armed truce. A situation where actual escalation is avoided because threatened escalation deters it. This mutually face-saving equilibrium resembles the Cold War’s MAD peace. Both sides possess powerful economic weapons. The US has its tariffs, and China has its rare earth export controls. But both understand that full deployment would be devastating."
– How Does the Trade War End? Richard Baldwin, 29 June 2025.
The US President has always treated China differently in his trade war. In their last exchange, the suspension of the 2 April tariffs was pushed back to 12 August. My guess is that Tuesday 12 August will come and go with nary a whisper about tariffs. Both sides are, I believe, hoping that everyone just forgets about that deadline, and the 2 April tariffs stay at 10% on Chinese goods and 10% on US imports into China. After all, once you stack the 10% on top of all the pre-April 2nd tariffs, the US is charging China a tariff that is about 55% on average. Specifically, the 10% April 2nd tariff is stacked on top of a 25% base tariff held over from the 2018 Section 301 duties, plus the "fentanyl tariff" of 20% introduced in February.
Markets may read China’s and Washington’s silence as confirmation that neither side wants to break the détente.
The EU: the only real target left
The EU is one of the largest suppliers of imports to the US and the largest destination for US exports. Right now, it pays 25% on about 13% of its exports due to the US auto tariffs that are already in place for everyone. And 50% on about 1.5% of its exports due to the US metal tariffs. On the rest, it pays 10%.
POTUS has threatened to raise that 10% to 30%. But his threat used to be 50%, and before that it was 20%.
As I pointed out in a recent post, Trump’s tariff threats don’t just shrink in size, they slip in time. Again and again, his "hard deadlines" dissolve into delays. Each time, he sells the retreat as strategy. But once you line them up chronologically, a pattern of bluster and back pedalling becomes obvious. See the table below.
Who knows where the tariff will be in August?
What share of US imports are exposed to be August tariff hikes?
So let’s roughly add up the fresh tariff hits we are likely to see in August.
The August tariff hit from America’s top five import sources is modest—roughly 4 percentage points. Why? Imports from Mexico and Canada remain mostly duty-free under USMCA. Japan sees tariffs on about 40% of its exports to the U.S., and only 85% of EU exports are newly affected (non auto, non steel). Meanwhile, China has effectively offset US tariffs through its own targeted concessions.
The table below show my work.
Summary and concluding remarks
My calculations are crude, back-of-the-spreadsheet estimates, focused only on the five big players. Surely someone can do a better job than this.
But as my father, Robert Baldwin, always used to say: Simplify to Clarify. And that’s what I’ve done. Maths is just logic with numbers; even rough maths can reveal simple truths.
Here the simple truth is that the August tariff hikes won’t affect a big enough swath of US imports with a big enough tariff hike to make much of a dent on US macro indicators. It’s not that tariffs don’t matter, but the shock coming August is likely to be small. That’s probably why markets have responded with a shrug.
And that’s it for another Factful Friday!
