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Trade disputes are about economic leverage — using the size and strength of your economy to both impose and absorb economic punishment. The punishment comes in the form of tariffs, or taxes, imposed on imported goods. Tariffs make these foreign goods more expensive, thus reducing their demand by domestic consumers and businesses.

In America’s ongoing trade disputes, President Trump has used that economic leverage as a hammer, forcing weaker nations to renegotiate more U.S.-friendly trade agreements. The strategy is simple — foreign nations must renegotiate or be willing to place their national economies at risk by engaging the world’s largest and strongest economic powerhouse. But America’s latest tariff dispute does not involve any sort of trade agreement. Instead, it involves the U.S.-Mexico border.

In response to the illegal immigration crisis at our southern border, on Thursday, May 30, Trump announced a series of tariffs on Mexican goods. The tariffs start at 5% on June 10 and increase by 5% each month to as high as 25% on October 1 — or until Mexico stops the flood of illegal immigrants into the U.S.

Trump has grown frustrated with the failure of both Congress and Mexico to address the border crisis, which continues to escalate. According to the U.S. Customs and Border Protection (CBP) agency, from January-May, 439,895 people were apprehended illegally entering the U.S. across the southwest border. This comes to an average of almost 88,000 apprehensions per month, a 166% increase from the 2018 fiscal year monthly average of 33,048. In April, CBP reported 99,304 apprehensions. In May, the number skyrocketed to 142,887.

To force Mexico to regulate its northern border, Trump has initiated a brutal assault on Mexico’s economy. Unlike the rest of America’s tariffs on foreign nations, which target specific goods or industries, the tariffs on Mexico are on all Mexican goods imported into the U.S. Last year, the U.S. imported about $346 billion of Mexican goods, second only to China. However, this represents just 13% of America’s total imports. For Mexico, a massive 80% of its total exports are shipped to the U.S. In other words, Mexico is almost exclusively reliant on the U.S. to sustain its economy.

Economic size and strength help absorb the negative impact of trade disputes. With the world’s largest economy of more than $21.3 trillion, America’s economy remains relatively strong despite entering its second year of global trade disputes. Economic growth increased from 2.2% in 2017 to 2.9% in 2018. In the first quarter of 2019, economic growth was reported at 3.1%.

Mexico has the world’s 15th-largest economy, but at $1.24 trillion, it is a far cry from that of America. Also, Mexico’s projected economic growth rate this year is just 1%, half of what it was in 2018.

The severity of these tariffs on Mexico is reflected in the immediate aftermath of Trump’s announcement. Within two days, a delegation of Mexican officials — led by Foreign Secretary Marcelo Ebrard — quickly ascended upon Washington, D.C. to help negotiate a settlement.

So far, Mexico hasn’t announced any retaliation. With an already fragile economy, Mexico is in a very precarious situation. Trump would likely respond to any retaliation by immediately escalating the tariff to the full 25%, sending Mexico’s economy into further dire straits.

If Mexico does have any leverage to retaliate, it might be in disrupting or delaying the U.S.-Mexico-Canada Trade Agreement, which is set to replace the NAFTA Treaty. Trump will likely want this completed before the 2020 election cycle. But going toe-to-toe with the U.S. in a full-blown trade dispute is not a viable option. Mexico’s economy would be decimated — something Trump, as well as Mexican President Andres Manuel Lopez Obrador, fully realize.

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Mark Grywacheski spent more than 14 years as a professional trader in Chicago, where he served on various committees for multiple global financial exchanges and as an industry Arbitrator for more than a decade. He is an expert in financial markets and economic analysis and is an investment advisor with Quad-Cities Investment Group, Davenport.

Disclaimer: Opinions expressed herein are subject to change without notice. Any prices or quotations contained herein are indicative only and do not constitute an offer to buy or sell any securities at any given price. Information has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. Quad-Cities Investment Group LLC is a registered investment advisor with the U.S. Securities Exchange Commission.

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