Trade Wars: Episode IV - A False Hope

Dollars and tariffs and stocks, oh my!

Well that was another eventful week and not in a good way. The stock market had one of its wildest weeks ever, the bond market went berserk and investors might be starting to see the US as resembling an unstable, third world country. The climax happened on Wednesday when Liberation Day became Semi-Liberation Day. Apparently, Trump was fine with his tariffs causing a recession, but he drew a line at them causing a depression. How kind of him. Dear Leader always has our best interests at heart.

The tariffs and semi-reversal fit into a familiar pattern with Trump. We saw it many times during his first term. It’s a play with four acts.

Act 1: Trump manufactures a crisis for no reason

Act 2: Trump makes outlandish and impossible to meet demands

Act 3: Trump gets little to nothing

Act 4: Trump caves, but says he got a total victory

During his first term, he was obsessed with the stock market, but now it’s the bond market that has his attention. His aides insisted that his semi-reversal on tariffs had nothing to do with the bond market’s reaction and then he said that’s exactly why he did it. God bless his sycophants. Each one thinks they will be the one he doesn’t undercut and humiliate and each time they get proven wrong, but, surely, this time will be different.

While it was good that he somewhat reversed course on the tariffs, let’s keep in mind some things. First, the pause is temporary and is only on for 90 days. There is no guarantee it will last that long. For all anyone knows it may not even last another day. Trump is like a box of chocolates. You never know what you’re going to get. He could wake up one day and decide all the tariffs are back on and do a 180 the next day.

Second, even though some of the tariffs are on pause, the level of tariffs imposed are still at the highest in over a century. There is a universal 10% tariff on all imports that is in effect. The tariffs imposed on steel, aluminum and cars are in effect. The selective tariffs imposed on Canada and Mexico are in effect as well. Most importantly, tariffs of 145% on almost all imports from China are in effect.

Third, the uncertainty is still there and it’s awful for any kind of business planning. I don’t know how anyone can make any kind of long-term investment plans with Trump going back-and-forth all the time. The pause may last for 90 days, but during that time nobody will know what comes next. The easiest thing is to just sit tight and do nothing, but that’s going to be very bad for the economy, i.e., less hiring and spending.

The worst part is that uncertainty is going to be a problem no matter what happens. In the best case scenario where the tariffs all are taken down and trade resumes, the threat of tariffs coming back will still be there. Trump is not someone who can ever trusted. As long as he has the ability to impose tariffs at will, there is going to be a big cloud of uncertainty hanging over everything.

For Trump, uncertainty is a feature, not a bug. He loves nothing more than being in the limelight. The daily chaos of his first term got him plenty of attention, but it was mostly domestic. Tariffs take his daily chaos global. Now, it’s not just the entire country that has to pay attention to him all the time. The whole world has to.

The only way the uncertainty will be removed is if the authority to impose tariffs is taken away from him. Maybe the Supreme Court will rule that he has to go to Congress to get approval. I have no idea whether such a lawsuit would succeed, but it’s one possibility.

The only other possibility is for Congress to take back tariff imposing authority. That would be much better, but it’s kind of a catch-22. The only way it could ever get to the point where Congress, let alone a Republican-controlled Congress, would take away that authority would be for the economy to fall off a cliff. In that case, it would be good that it was taken back, but bad because we would all be living in cardboard boxes. The flipside is if Trump backs off or somewhat backs off like he did on Wednesday, then things aren’t as bad and the incentive to take it away from him evaporates.

The madness of King Don

Nobody knows how this will be resolved or even if it will be. We could spend the next few years going through one pointless charade after another. Tariffs may only come into effect for some countries and on some items, but the threat of it will likely remain. It may all come down to who can flatter Trump the most. No matter what happens, the future does not look great.

On Friday, the University of Michigan’s consumer confidence index showed it to be as low as it was in the first of half of 2022, when inflation was at 9%. It also showed inflation expectations to be over 6%, which is the highest read since 1981. The main reason why that’s bad is because it can become self-fulfilling. If businesses and consumers believe prices will be higher in the future, they may start buying things in advance, which will have the effect of raising their prices via higher demand.

Here, I’m going to lay out my case for what I think inflation, the stock market, the bond market and currency markets will look like between now and 2029. Just kidding, I don’t have a clue. All that is way beyond my expertise and I’m hesitant to predict anything. If you’re looking for a world renowned soothsayer you’ve come to the wrong place.

What I do know is the US is in a very bad place. The last week really seems to have shaken investors around the world and undermined the belief that the US is a safe place to put their money. Whether it’s a blip or a trend, nobody knows, but it shouldn’t be happening at all. One writer I read on Substack, Noah Smith, wrote a great post yesterday explaining what has been going on with US Treasury bonds and how unusual and ominous the events of the last week were.

For decades, US Treasury bonds have been the safest investment in the world. Not one of the safest, the safest. In the scariest of times like in 2008 and 2020, when stocks were tanking and other kinds of investments were going south, people everywhere flocked to US Treasury bonds. That’s because they knew their money would be safe there and they would not have to worry about it disappearing.

Having our Treasury bonds as the safest investment in the world has been great for us. It has allowed our government to borrow at low interest rates to finance all kinds of things. Thank god our government had the ability to spend as much as it did in 2020-21 and to do it so cheaply. Were it not for that our economy would have been much worse off.

It’s not just our government that benefits from treasury bonds being widely sought after. Businesses and consumers benefit as well. When there is a high demand for bonds, the interest rate they pay out is lower. That means businesses and consumers can borrow much more cheaply than they would otherwise be able to.

Because I know virtually nothing about bonds and currencies, I’m going to highlight the following passage from Smith’s post. It will give a much better explanation of the situation we’re in than I can provide. “Usually, Treasury yields and the dollar move together, because usually, when investors look at U.S. government bonds, they don’t ask ‘How risky is this bond?’ — instead, they only ask ‘How much money will this bond pay me?’ When yields rise (because of Fed policy or economic conditions), investors buy more Treasuries in order to get those higher returns, and this buying drives up the dollar. When yields fall, investors sell, and the dollar goes down. So yields and the dollar move in the same direction.”

What happened over the last week is investors are dumping US dollars and treasury bond yields are still going up. The value of the US dollar is going down, but bond yields are not going down with it. There is one common explanation for why that has been happening, but even as someone who is clueless about this subject, I’m not convinced of it.

The idea is that a bunch of hedge funds made some bets that went bad. Apparently, they made levered bets on where US Treasury bonds would go and because of the bond market’s volatility their bets went bad. To get money to pay back what they borrowed, they sold off their US Treasury bond holdings, which is what caused the demand for those bonds to go down. I’m not denying those events happened, but considering what else was going on there is no way that’s the main reason why investors are dumping Treasury bonds.

What’s going on, as Smith explains, is the US is experiencing capital flight. In English, that means investors no longer see the US as a safe place to put their money and so they are pulling it out. That has happened before, but not in stable, developed countries. Examples of places where it has happened in the past are Southeast Asia and Latin America in the 1990s.

Obviously, the tariffs have a lot to do with the US losing investor confidence, but I think it’s more fundamental than that. Smith and other writers have argued this and I believe it, too, and that is the main reason we’re seeing investors flee from the US is the realization that we’re run by a mad king. The tariffs are the most consequential action he’s taken, but we have a president who is increasingly acting like a dictator.

Trump has extorted and attempted to extort universities and law firms into doing what he wants. He has all but claimed he can deport whoever he wants for whatever reason he wants without any due process. He is purging the federal government of anyone who is not a MAGA true believer. The level of corruption he’s engaging in is off the charts and out in the open. To top it off, he routinely talks about taking over other countries and running for another term even though he clearly cannot.

Tariffs fit in very well with most of that. Because he has broad authority to impose tariffs, he can also grant exemptions. There is huge potential for corruption and we’re already seeing it. Although we have high tariffs on Chinese imports, it looks like everything Apple makes there is now exempt. I’m not accusing Tim Cook of anything nefarious, he’s just doing his job. That’s what happens when you have a president who believes in almost nothing other than himself. Businesses are going to have to either beg for mercy or, more likely, pay to get it.

An economy that depends on the whims of any one person is not going to work well. More and more, the US economy is looking like that. No, we’re not going to have literal central planning, but it’s going to be difficult to make investments of any kind here when one person could mess it up at any time.

Economies grow when they are dynamic. Big, established companies can be innovative, but it usually is startups that come up with new ideas, products and services that raise productivity. Tariffs are very bad for that because they favor big players. Companies that are large and have deep pockets and can afford to hire lobbyists may be able to get around tariffs. Startups are not like that and unless they have deep pocketed investors they’re going to be at a big disadvantage relative to their bigger, more established rivals.

It’s not just that we’re ruled by a mad king. Our fiscal situation is very bad and nobody in Congress seems to care. If anything, there is a bipartisan consensus that it should be made worse. The desire to deal with the biggest sources of spending is zero and the desire to raise revenue is minimal. The Senate Republican budget resolution that was recently passed, if enacted, would add another $5 trillion to the federal deficit over 10 years.

The US’ fiscal situation has not been great for a while, but it has been manageable until recently. Contrary to what some might believe, running a budget deficit is not at all per se bad. For the last 50 years, the US has had a budget deficit every year except for a brief period in the late 1990s. As long as the deficit remains at 3% of GDP or lower it’s manageable. In cases of emergency like a pandemic, it’s okay for it to temporarily rise above that. The problem is the emergency is long over, but the deficit is hovering around 6% of GDP.

In the early 2010s, there was a big focus on the federal deficit and the need to reduce it, which was a mistake. It wasn’t a serious problem then and it wasn’t the most pressing issue. In part because of that mistaken emphasis, the recovery from the financial crisis was sluggish.

My guess is a lot of people in positions of authority internalized the wrong lesson from the Simpson-Bowles era. Ever since Trump showed up, the desire to do anything about the federal deficit has been zero. It was wrong to worry about it 15 years ago, but it’s right to worry about it now. A lot of people were burned by the experience of the early 2010s and concluded there was no point in trying to push for fiscal responsibility.

The Democrats’ response

Unsurprisingly, Semi-Liberation Day has not been good for Trump’s approval rating. During his first term, his handling of the economy was always better than his job approval rating, but it’s now the opposite. His approval rating is underwater, but his economic approval rating is a good bit worse. There haven’t been that many polls taken since April 2, but the ones that have been taken have shown his numbers way down from a short while ago.

I wrote at the end of my first election post-mortem last year that I was optimistic about the Democratic Party’s electoral prospects. I feel even better about it now than I did then. Even before Semi-Liberation Day, Democrats were doing well in special elections. In the biggest election this year so far, the Wisconsin Supreme Court race, the Democratic-aligned candidate killed it. That wasn’t a surprising outcome considering who makes up their current coalition, but it was a big morale booster and proof that just because Democratic voters were unhappy it didn’t mean they were checking out.

It’s funny because I keep seeing hot takes about how much trouble Democrats are in and how toxic their brand is. Maybe that’s true in the abstract, but it clearly isn’t preventing them from winning elections and that’s what counts. Having followed elections obsessively since 2004, just looking at that small sample, I can tell you the best piece of evidence that a party’s fortunes are about to surge is when the chattering classes write its obituary. It happens almost every time after a presidential election. The losing party gets written off for good only to come roaring back in the midterms.

There has been some handwringing over the response of some Democrats to the tariffs during the last week. Some of the responses I like and others I don’t like. Whatever you think of what Democrats in Congress and elsewhere are saying now, the key thing to keep in mind is it doesn’t matter. Whoever Democrats nominate in 2028 will have plenty to say on trade, but until then it’s not going to make any difference.

When the tariffs’ effects start to hit, prices will go up and growth will slow. That’s something people will see with their own eyes. For Republicans, it will be a big problem and not one they can make go away with the right messaging. Being the party out of the White House, Democrats don’t need to say much of anything. By not being Republicans, they will reap the electoral benefits of the tariffs’ impacts.

That works in non-presidential elections. Presidential elections are different. 2028 is so far off it’s really not worth dwelling on, but I’m going to do it anyway.

The boring truth is we have no idea what will be going on then. What we can be confidence of is if Trump continues on his current path, he’s going to be toxically unpopular and whoever the Democratic nominee is will likely be the favorite to win. Conversely, if he reverses course, the economy does well and he doesn’t become unpopular for other reasons, then Vance or whoever Republicans nominate will likely be favored to win.

I presume trade and tariffs will be a big issue in 2028 and I really would like the Democratic nominee to be a free trader and an opponent of tariffs in general. If the response from their nominee is “Trump’s tariffs are bad, but mine will be good,” I’m going to have a nervous breakdown. If he/she says, “Trump won’t bring back manufacturing jobs, but I will,” I’m going to jump off my balcony.

Once again, with feeling, the US has a service-based economy like all developed countries do. Even in states where manufacturing is a big part of the political culture, it’s only a minority of people who work in that sector. Even in manufacturing, tariffs are usually not good. Which state’s economy has been hit the hardest by tariffs so far? Michigan.

That’s right, the state where manufacturing is arguably more central to its identity than any place else is being hurt the most by what you might think would benefit it. That’s because car makers rely on suppliers from other countries. Tariffs make those parts more expensive, which increases costs for car makers and leads to fewer sales and/or layoffs.

Recently, The Washington Post surveyed 500 workers in the manufacturing sector about the tariffs. The results were not what you would expect from listening to the political discourse. A large majority of the workers surveyed said they believed the tariffs would have a negative impact on them. It’s popular in the abstract to say everything should be made here and to rail against bad trade deals, but trying to act on that is very different.

Many seem to picture manufacturing workers when they think of the working class. People like that exist, but they are a minority. Most working class people work in the service sector. Imposing tariffs on imported goods could help some workers in some situations, but it does nothing good for workers who are providing services. All it does is hurt them because it makes prices go up.

The bipartisan consensus of the last decade that trade needs to be curtailed, protectionism should be pursued and manufacturing jobs should be prioritized over other jobs needs to die. It’s going to make us all worse off and do nothing to bring back the economy of the days of yore. What our economy needs is more dynamism and productivity. The current bipartisan consensus has promoted stasis, scarcity and higher prices.

It’s absolutely legitimate to want there to be well paying working class jobs. But trying to bring back jobs that no longer exist and doing so by imposing tariffs is completely wrongheaded. As someone who has been writing about abundance a good bit lately, you might think I would suggest that as a better alternative to helping working class people than protectionism. You would be right.

Earlier this month, Matt Yglesias wrote an excellent post on how to help working class men. That is who had worked in manufacturing jobs when they were the dominant employer. The best way to promote good paying jobs for working class men (and women) is to cut back on zoning and other restrictions on building housing. Nationally, there is a shortage of several million homes and if that gap could be closed it would create tons of jobs in construction.

We can also pursue permitting reform for energy. That would allow for the construction of wind and solar farms, transmission lines and smaller nuclear reactors, all of which would create plenty of jobs for working class people. If geothermal energy takes off, that, too, will be a big source of jobs for working class people and would allow those who currently work in oil and gas to continue using their knowledge and skills.

Taking the abundance route does not require protectionism nor does it involve raising prices or having the government tax and spend more. It’s as close to a free lunch as you’ll ever get. It would be nice for there to be a bipartisan consensus on that, but Republicans aren’t going to do that as long as Trump is around. That leaves it to Democrats. I really hope to see more Democratic candidates and elected officials promote that and talk about it as a way to help working class people. I especially hope to see that from 2028 aspirants. They will have a big opportunity to present themselves as being the ones who care about lowering prices and allowing people to enjoy higher living standards. It would be foolish of them not to take it.