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Tariff Threat Could Be to Blame for Brick-and-Mortar Retailers Closing at Record Pace

- By Matt Winkler

According to the Wall Street Journal, brick-and-mortar retailers are closing at a record pace. Retailers are, in fact, on pace to shutter even more stores than during the 2008 crisis. Why now? There are many reasons, but one particularly may be getting overlooked. That is, even though President Trump has not been able to enact any border tax or tariff legislation just yet, his mere intention to do so may be contributing to the record collapse in retail.

How so? The purpose of a protectionist tariff is to make imports more expensive so that companies source their products domestically. The effect is obviously making those products more expensive to produce. But an actual tariff need not be passed in order to raise costs in this way. Once an administration projects its mere intention to raise a border tax, companies may, and often do, shy away from importing goods at cheaper costs and instead source more expensive domestic supply lines. They do not want to be caught paying a border tax if and when it passes. So costs, particularly for retailers, can and do rise even before a tariff is passed.

Why particularly for retailers? Because retail is at the top of the economic food chain, or the end of the production structure. Much like toxins accumulate at the top of the biological food chain, the burden of increased production costs accumulate at the top of the economic food chain. But why? Because once costs are raised, companies throughout the production chain try to raise their prices. The closer a company is to raw materials, the easier it can pass costs off to the next level up, and so on and so forth until the final consumer is reached.

Ultimately though, the law of supply and demand dictates prices are not determined by cost of production but by individual consumer valuations. Retailers cannot simply pass off their increased costs to consumers without affecting sales. Retailers are then caught between a rock and a hard place and are the first to be affected, and so on down the production chain. Once a retailer bows out of the picture, the next level down, the supplier, loses a customer.

We can see why retailers are the most exposed through the hard numbers. At the retail level, profit margins are tiny and net income as a percentage of revenues is miniscule even for the strongest retailers. It is typically less than 3%. Amazon.com Inc. (AMZN), for example, had margins of 1.7% in 2016 from revenue to bottom line. Wal-Mart Stores Inc. (WMT) hit the high end of 3%. Costco Wholesale Corp. (COST) is just below 2%. CVS Health Corp. (CVS) is just under 3%.

Speaking of hard numbers, is there any hard evidence that companies are shying away from imports? Yes, there is, though it is only preliminary. Total imports to the United States dropped 1.8% from January to February, precisely when Donald Trump took office. Even more interesting is imports of goods from China dropped a record $8.6 billion. Imports from the European Union, Japan and Canada also fell. While one data point is not enough to prove a trend, if imports from China particularly keep dropping, it will be compelling evidence that the threat of a tariff is causing retailers to shun international markets in favor of more expensive domestic production.

Granted, brick-and-mortar retail woes did not begin with the threat of a Trump tariff. But a tariff, or even the threat of one, is not something the weaker brick-and-mortar retailers can afford, having already failed to compete with Amazon and other online retailers. If a protectionist border tax actually does pass, many of the weakest brick-and-mortar retailers like Sears Holding Corp. (SHLD) and JC Penney Co. Inc. (JCP) could end up closing for good, further increasing online retailers' grip on this convulsing sector.

Disclosure: No positions.

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