How Could Mexico Retaliate Against President Trump’s Proposed Tariffs?

The 2016 United States general election brought about a new era of American leadership, along with a rejuvenation of debate regarding U.S.-Mexico relations. The future of immigration and free trade between the two nations have been hot topics of discussion during the administration of President Donald Trump.

In early 2017, tensions grew between the governments of the two countries. Contrasting viewpoints regarding existing trade deals in addition to the construction of a border-wall threaten the future of commerce between the U.S. and Mexico. New tariffs, the renegotiation of existing trade deals and subsequent economic retaliation may be future possibilities. Valuations of the U.S. dollar (USD) and the Mexican peso (MXN) may experience diminished stability furthering the strain on U.S.-Mexico relations.

Trade And Immigration: Trump's Policy Towards Mexico

In his bid for the presidency, Donald J. Trump built a successful campaign based on prioritising domestic prosperity and national safety behind the slogan "Make America Great Again." Perhaps the most frequented target of Trump's campaign-trail rhetoric were the business and immigration practices of Mexico.

As outlined during his campaign, Trump promoted the following policies towards U.S. trade with Mexico:

• Immediately renegotiate the North American Free Trade Agreement (NAFTA)
• Eliminate Mexico's "one-side backdoor tariff," the value added tax (VAT)
• End "sweatshops" in Mexico that undercut American workers^[1]

Perhaps the most controversial of Trump's views are those pertaining to illegal immigration. In order to combat the flow of illegal immigrants from Mexico into the U.S., he has promoted the building of a wall spanning the two nations' border via executive order.^[2] The wall's construction will be an expensive endeavour, with the necessary capital outlays estimated in the billions of dollars. The project's funding has been a point of contention within political circles.

To fund construction of the wall, the Trump administration has pursued the following modes of raising capital:

• Budgetary allowance of taxpayer funds made by the U.S.
• Direct capital contribution from Mexico
• Comprehensive tax reform including a 20% tariff on Mexican imports to the U.S.^[3]

The border-wall between the U.S. and Mexico is a divisive issue both domestically and internationally. However, it is only one aspect of the new approach to trade and governance championed by the Trump administration that will bring change to the current socioeconomic environment.

Mexico's Ability To Retaliate

Mexican President Enrique Peña Nieto has taken a public stance against the construction of a border wall and his country's funding of any such project. In January 2017, he cancelled a scheduled meeting with Trump in Washington D.C. and issued the following statement showing his discontent: "I regret and condemn the United States' decision to continue with the construction of a wall that, for years now, has far from united us, it has divided us."

As the statement by Peña Nieto implies, Mexico is not officially supportive of the wall or stated trade policies of the Trump administration. However, given the level of dependence upon commerce involving the U.S., is there anything that Mexico can do to deter a border tax and the possible elimination of NAFTA?

The following methods of economic retaliation may be implemented by the Mexican government to alter future U.S. policy towards trade and immigration:

• Restrict agricultural imports: Mexico is the third-largest destination for U.S. agricultural exports, estimated to be worth US$17 billion annually.^[5] Increased tariffs and restrictions on U.S. agricultural imports could have a substantial economic impact upon the U.S. farming industry as a whole.
• Impose travel restrictions: Tourism between the two nations is a large industry. Citizens of Mexico spend around US$10.5 billion in visits to the U.S. annually.^[6] In addition, Mexico remains a popular vacation spot for U.S. travelers. A moratorium on free travel between the two countries will impact the tourism industry severely.
• Reduce security allocations: Drug trafficking, and the related violence, has been a hot-button issue in Mexico and the U.S. for quite some time. Billions have been spent by both sides in an attempt to remedy the problem.^[7] Widespread divestiture in security by Mexico may destabilise the region, compromising public safety domestically and in the U.S.
• File a trade dispute: In the event that the Trump administration withdraws the U.S. from NAFTA, Mexico could file a formal dispute with the World Trade Organisation (WTO). As a result, financial penalties and sanctions may be recommended by the WTO to be placed on the U.S.^[8] Although getting the WTO to act unilaterally against the U.S. will be a challenge, political pressure may be applied from trading partners, allies and competitors to encourage re-entry into NAFTA.

The above listed actions may be avenues by which Mexico can retaliate against the U.S. for any undesired changes in policy. Although the U.S. economy is vast and capable of generating growth in other areas, the loss of Mexico as a trading and economic partner will certainly have a measureable impact.

Summary: Impact Upon The Markets

Over time, the U.S. and Mexico have become economically interdependent. The partnership is considerable, with the trade-related statistics being a prime illustration of the degree of interrelationship:

• 81.1% of Mexico's exports are to the U.S.
• 47.3% of Mexico's imports are from the U.S.
• 13.2% of U.S. imports originate in Mexico.^[9]
• 15.7% of U.S. exports go to Mexico.^[9]
• Mexico is the U.S.'s third-largest trade partner, averaging US$1.5 billion in bilateral trade daily.

A potential trade war—or prolonged strain upon diplomatic relations between Mexico and the U.S.—will have a considerable economic impact upon both nations. Any perceived change in the trade-related dialogue between the U.S. and Mexico will have dramatic implications upon USD/MXN valuations.

A prime example of this was the behaviour of the USD/MXN and equities markets in the days and weeks following the 2016 U.S. general election:

• In the aftermath of the election, the MXN experienced a decline in value of 13%.
• The USD/MXN faced heightened volatility in the period after the U.S. presidential election, trading from a low of 18.3226 on November 8, 2016 to a high of 21.9544 on January 18, 2017.
• The MXN made record lows against the USD, triggering a sell off in Mexican bonds and equities.
• On January 25, 2017, the DJIA closed above 20,000 for the first time ever, with the S&P 500 posting a rally of 6.57% since the November 8 election.

Traders and investors have recognised the uncertainty surrounding economic relations between the two countries. In the event that relations remain strained, volatility facing the USD/MXN is likely to continue in addition to turbulence within Mexico's equities markets. Also, the U.S. may experience periods of unexpected stagnant GDP growth as a result of retaliation from Mexico. This may adversely affect commodities, equities and USD valuations.

Ultimately, only time will tell if the new American policies towards Mexico will foster prosperity and stability within the marketplace.

Any opinions, news, research, analyses, prices, other information, or links to third-party sites are provided as general market commentary and do not constitute investment advice. FXCM will not accept liability for any loss or damage including, without limitation, to any loss of profit which may arise directly or indirectly from use of or reliance on such information.