That 70s Show

Trump’s economic war on the world has resulted in the slow-motion disaster many predicted but it is worth revisiting the supposedly valid economic theories that were provided as justifications for it. The primary idea was that higher tariffs would encourage both onshoring of productive capacity by US firms and investments in productive capacity inside the US by foreign firms. While there was at least some grudging admission that higher tariffs would fuel inflation, that would not only be offset by a stronger dollar which would make imports cheaper but also by tariff revenue that would create fiscal room for tax cuts. The already strong dollar would become an even more attractive option as investors sought the comparatively higher US interest rates driven by the inflationary tariffs as well as the traditional safe haven of the dollar amidst economic uncertainty.

Unsurprisingly, that theory has been contradicted by reality, abetted by the shoddy and erratic implementation typical of the Trump administration. Trump’s broad, across-the-board, and excessive tariffs raised inflation expectations faster and more firmly than any kind of reshoring of capacity can counter, even ignoring the fact that we are not capable of producing items like coffee and bananas. His wildly erratic changes to tariff rates and exceptions to them kill any hope of real foreign investment. Traditionally, even when the US creates military instability with its projection of power, it is still viewed as a safe haven because of its determination to maintain economic stability, both a responsibility and a job made easier by virtue of the dollar’s position as the world’s reserve currency. Trump has entirely flipped that script. His threats against the country’s two neighbors, as well as NATO, combined with his extortionate use of tariffs in an attempt to remake the global economic system in addition to his threats against the Federal Reserve, has made the US a source of economic instability rather than the traditional safe haven.

The result has been, well, not good. At one point in the first 100 days of the second Trump administration we saw the greatest collapse in stock market value compared to every other president for a comparable period since records started being kept in 1928. Trillions in admittedly paper wealth were obliterated, here and around the globe. While the markets have recovered slightly since then, the US is still one of the worst performing markets in the world this year. The odds of recession have increased, and the percentage of Americans who think they will be worse off in the year ahead is greater than it was during the Great Financial crisis in 2008. Yields have skyrocketed as inflation expectations get baked in. Contrary to expectation and history, the dollar has plummeted, and, like the stock market, is one of the worst performing currencies this year. While the data is still murky, it appears the reason for both higher yields and a declining dollar are a combination of long-term trades being unwound as they now have become unprofitable and a crisis of confidence in the stability of the dollar as well as the US economy in general, driving the selling of dollar-denominated assets like US Treasury bonds.

The administration has managed to produce a policy almost perfectly designed to undercut its stated desire to restore the domestic production capacity that it claimed the tariffs would instigate. Higher prices will cut consumer spending and therefore capital investment while also driving unemployment higher, creating a downward spiral. Higher yields mean a higher cost of borrowing which will also restrict capital investment by both domestic and foreign investors. The lack of belief that the tariffs will stick, driven by Trump’s already erratic changes, creates a similar result. While a weaker dollar should help US exports, the reality is that the US has now become a pariah state to much of the rest of the world where US products are either shunned or simply removed from shelves altogether. Most foreign leaders have decided that Trump is too unstable to actually negotiate with, and history has shown that any deal he signs isn’t worth the paper it’s printed on. Instead, they are looking elsewhere to fill the void America has left behind.  Any Trump endorsement of a foreign politician is a death knell as recently illustrated by Germany and Canada. Meanwhile, the weaker dollar actually makes US companies attractive takeover targets for foreign multinationals, further eroding domestic control of our own productive capacity.

While all that is bad enough, the real and devastating impacts from the tariffs haven’t really even begun to be felt. Part of what kept the economy above water in the early part of this year was people and companies loading up on goods in anticipation of the tariffs kicking in. Now that inventory is being depleted and there is nothing in the pipeline to replace it. Trans-Pacific shipments, mainly from China, have been cut by over half and the port of Seattle, one of America’s busiest ports, is a virtual ghost town. Domestic producers are unable to get needed raw materials and other inputs while also seeing customer orders dry up. Consumer confidence is at the lows from the height of Covid. While first quarter GDP turned negative, it was mostly driven down by the rush of pre-tariff imports. It is starting in the second quarter of this year that we will see the real deleterious effects on growth and employment from the administration’s policies. Abusive immigration policies have derailed tourism. As we head into May, we will be facing an economic tsunami which will rival the two great crises of our lifetimes, the Great Recession and Covid. Expect to see double, even triple, digit price hikes for normal consumer goods, and that will be if you can get them at all.

While Americans are clearly prepared for things to get bad, I don’t think anyone is prepared for the scale of the price hikes or how widespread the shortages of regular goods will be. Around 20% of consumer goods are imported from China, but, for certain more high-end products, that percentage rises to over 80. Untold number of small businesses that rely on cheap Asian manufacturers will find the tariff costs now make their firms unprofitable and impossible to continue as an ongoing enterprise. Farmers are already in full crisis mode due to the retaliatory tariffs. Layoffs are already starting. The economic carnage will be compounded by the administration’s destruction of federal governmental capacity – massive cuts to public health, education, transit, infrastructure, and even disaster preparedness and relief, with a tax hike for everyone except the 1% and no chance of additional unemployment support for the states.

For the moment, the markets seem remarkably calm in the face of such an economic onslaught, but it appears that the so-far silent business leaders are hoping the GOP can forge some kind of budget framework that locks in their tax cut in the next few weeks before the debt limit is breached and then hope Trump can “negotiate” some kind of roll-back of the tariffs. That frankly sounds delusional, primarily because once these supply chains are broken it takes far longer to rebuild them, as we saw during the pandemic, and few countries seem even interested in negotiating with Trump anymore. In fact, much of the market seems to be deluding itself that the tariffs’ impact will be minimized. Stocks are only down around 7%, yet major companies across multiple industries are significantly lowering earnings estimates and even refusing to put out guidance going forward. The 10-year bond yield higher than it has been since 2007 and inflation expectations are increasing, yet the market seems to believe the Fed will be cutting interest rates multiple times this year. Yes, the market is always right, until it isn’t.

We are a consumer-driven economy and will soon be facing an economy with little to consume. The combination of increasing prices and borrowing costs as expressed by higher yields, along with cratering consumer spending and a probable recession driving increasing unemployment, is setting us up for a repeat of 1970s style stagflation. While the myth of 1970s stagflation is that it was largely driven by a wage-price spiral and was only broken by the Fed basically creating a deep recession and mass unemployment, the reality is that the true underlying cause was two disruptions in both the global food supply and supply of oil, one in the early part of the decade and one at the end. While the Fed did eventually raise rates to over 20%, studies have shown that inflation was already receding rather quickly as those two supply chains were restored. We saw a miniature version of this story in the aftermath of the Covid supply shock. While the Fed did raise interest rates in response to inflationary pressure, the real reason for inflation falling back to near the Fed’s 2% guideline had more to do with the restoration of the supply chain than any action of the Fed.

The difference today is that the supply shock is totally self-inflicted. The coming stagflation and its ancillary economic destruction are this administration’s policy choice. The Fed is in the same bind it found itself in the 1970s. Inflation will drive yields higher, but the Fed hiking interest rates in response will only deepen the inevitable recession and drive unemployment higher, all the while being blamed for the lack of new investment in productive capacity by Trump. If the Fed cuts rates to stimulate investment and jump-start the stagnant economy, yields may actually move higher as the bond market revolts, and the dollar craters as confidence in the management of the US economy further erodes. As we saw in the late 1970s and late 1980s, a weak dollar fueled a binge of foreign takeovers. The Fed’s problems and declining confidence in the dollar may be exacerbated if Republicans appear to be having difficulty raising the debt limit at some point this summer.  It won’t help when Trump again threatens to fire the Fed Chairman or makes it clear his term won’t be renewed next year. In the end, however, it won’t make much of a difference what the Fed decides to do because, as we saw in the pandemic, monetary policy cannot solve a supply chain problem in today’s global economy.

The administration is engaged in a wide-ranging program of self-immiseration and self-isolation that will make Brexit look like a walk in the park. The 21st century will probably belong to China, much as the 20th belonged to the US. Like post-World War I Britain before it, the US is an aging superpower whose ability to project military power compensates and covers for its declining economic power, led by a sclerotic and out-of-touch gerontocracy that still believes it retains the power and the politics of the prior century or even the one before that. Like post-Soviet Russia, it is devolving into a kakistocracy looted by oligarchs. Worryingly, history has also shown that it is not uncommon for aging empires losing their economic might to think they can restore their prestige militarily.