I'm a fan of nearly everything Trump has done this year, with the exception of his Terrible Tariffs. As I and many others have explained, Trump's threat to raise tariffs is a terrible idea because they're meant to fix something that isn't broken (Trump's claims to the contrary notwithstanding).
Our trade deficit with China, for example, means that we buy more goods and services from China than they buy from us. The difference, termed the trade "deficit," is evidence, in Trump's mind, that China is "ripping us off." But by the laws of commerce, he who sells more goods and services than he buys must do something with the net amount of money he receives. In the case of China-U.S. trade, the dollars China earns from its commerce with the US must inevitably find their way back to us in the form of investment, security or bond purchases, or simply bank deposits. Simply put: you can't spend dollars in China.
China is not ripping us off because it already spends everything it earns from our trade deficit. In economic jargon, the deficit in goods and services we have with China is completely offset by a surplus in our capital account.
Where Trump has a legitimate beef with China and other countries is their use of tariffs to make US goods and services expensive and thus reduce their demand for our stuff. They would be better off—and so would all of us—if no one used tariffs. Free global trade is nirvana for everyone. Everyone wins when tariffs are zero.
Trump understood this back in 2018 when he said during a discussion with G7 leaders that all countries should eliminate tariffs and subsidies, because that would be "true free trade." Has he forgotten what he once believed in and fully understood?
You might think so after living through the global financial turmoil of the past week or so. It was a nightmare scenario. Trump was a madman determined to wreak havoc among global economies and global trade. I was so anguished I could only think that the prospects were so awful that Trump would be forced to back off. This couldn't go on. And suddenly, yesterday, it didn't. Trump gave everyone except China a 90 day reprieve and markets rejoiced. Today, however, second thoughts were creeping back in.
I agree with what Bill Ackman said yesterday. By waiting until panic set in before announcing a reprieve, Trump forced the world to see first-hand what the results of a global tariff war would lead to. And he also put tremendous pressure on China, the biggest bad actor of global trade, to change its ways. It was a master-stroke of persuasion. Until yesterday I had begun to fear that Trump was making a huge mistake. Now my fears have been assuaged. We're not out of the tariff woods yet, but the prospects for a favorable resolution have improved dramatically. Maybe those tariffs Trump threatened weren't so bad after all, if they help the world understand how bad they can be.
Now let me comment briefly on today's CPI release, which was a pleasant surprise. The chart below says it all:
Chart #1
Chart #1 compares the year over year change in the CPI index with the same change in the CPI index ex-shelter. The ex-shelter version of the CPI has increased by 2.3% or less for the past 23 months (since May 2023), and it has averaged a mere 1.7% per year for almost two years. In the past year, ex-shelter inflation was only 1.5%. Only shelter costs have kept the broader CPI from long ago meeting the Fed's objective, and their impact is continuing to fade away.
To repeat what I said months ago, tariffs don't cause inflation. Only monetary policy causes inflation. So far the Fed has been doing a pretty good job of neutralizing the monetary excesses of 2020 and 2021.
Chart #2
As Chart #2 shows, the M2 measure of the money supply is within shouting distance of the long-term trend growth that prevailed from 1995 through 2019. Excess money has all but disappeared, and Chart #1 goes a long way to proving it.
UPDATES (4/23/25):
The March data on M2 continue the trend described above. M2 is basically unchanged over the past three years, and is up at a modest rate of 4.1% over the past year. Excess money has been drained from the economy. Credit spreads have backed off from their recent highs and are far short of flashing even a modest yellow signal. Bank reserves remain abundant ($3.45 trillion) and the Fed is no longer threatening to make them scarce.
Trump got schooled by the market, so now he's dialing back his tariff threats. This is very good news. Tariffs are taxes, and nobody needs higher taxes right now. Paring back spending by streamlining our bloated bureaucracy is the best way to fix what's wrong with the economy. Let's do more of it.
Meanwhile, I won't feel comfortable until Stephen Marin, Trump's Chairman of the Council of Economic Advisers, and Peter Navarro, his tariff-loving trade advisor, are banned from the White House. Both advocate industrial policy on a global scale (e.g., devalue the dollar to promote US exports, and jack up tariffs on countries that don't buy enough of our goods) that has NEVER worked anywhere for anyone.
I would also like to see gold fall back to $2,500/oz. The current level of $3,300 is just way too high, reflecting extreme levels of discomfort and fear that are incompatible with a healthy economic environment.
Thank you!
ReplyDeleteBest guess on the move in yields this week?
There is something lost in translation between the economics textbook argument for free trade... sure... we give them bonds they give us cheap stuff..awesome. But there is little thought about how that plays out over time and Buffett as usual did it in his folksy way back in 2003 analogy of Squanderville and Thriftville... https://www.berkshirehathaway.com/letters/growing.pdf
ReplyDeleteThis comment has been removed by the author.
ReplyDeletelol great title Scott!
ReplyDeleteUS is stirring the pot on global trade barriers so the world is forced to re-evaluate policy, most likely in the end should be a net positive.
ReplyDeleteThe demand for money has recently risen, velocity fallen.
ReplyDeleteAssets and Liabilities of Commercial Banks in the United States - H.8
Large CDs
Nov -5.5
Dec -3.1
Jan -14.0
Feb 1.3
Money Market Funds; Total Financial Assets, Level (MMMFFAQ027S)
https://fred.stlouisfed.org/series/MMMFFAQ027S
- I'm sure the administration leaders have discussed outcomes of the tariff (and other) policies/executive orders. Among those outcomes are potential financial market turmoil, and a 90 day pause was implemented. According to plan, most likely.
ReplyDelete- "Free" trade has many prerequisites/requirements for it to "work" as described in the economic textbooks. Among those are identical (or at least similar) economic structures within which the trading partners operate. Clearly in the real world, this is quite difficult to accomplish. To argue from the extreme case, "free" trade where one partner uses slave labor is great from a financial perspective for the powers that be in the trading partners, but so much from the slaves' point of view. There are other issues with "free" trade in the real world...
-It appears that the current administration holds the "quality" of the US labor market in higher priority than the financial markets. My advice: Invest accordingly.
Thanks for your work, as always.
An additional observation about trade deficits: The trade deficit is arguably the most meaningless statistic ever produced by a government. In fact, the world would be better off not knowing what it is. Politicians can't resist attributing it to the whims of human nature (i.e., a country with a deficit is not as virtuous as one with a surplus), when in fact trade stats are nothing more than a snapshot of the voluntary actions of hundreds of millions of individuals. It is easy to show that nations, like the US, with consistent trade deficits are very likely to be more successful than those with persistent trade surpluses.
ReplyDeleteDitto
DeleteI judge a nation based on the average weight of it' citizens
and their shoe color!
'
For anyone interested in understanding what needs to be fixed with our China trade relations, listen to to Kevin O’Leary’s recent testimony before congress explaining the present threats to Americans.
ReplyDeleteI think the messaging could be improved, but we also seem to be in an intentional information war at the moment:
ReplyDelete1. Everyone agrees a global free trade zone is utopian.
2. The 10% baseline tariffs are questionable for that mission.
3. The administration is going above and beyond to emphasize that tariffs target “unfair trade practices,” which include red tape, tariffs, taxes (VAT), backdoor deals, dumping, etc. The Trump administration is signaling that tariffs are the best tool to counteract these anti-free-trade measures.
My theory is that the USA will not bring back as many jobs as claimed. Instead, they are trying to reduce all “unfair trade practices” before rolling out AI/robot factories to replace the arguably exploitative labor currently in use.
Tariffs...they're on. They're off. No, now they're back on. Now they're off. Now they're back on but delayed for 90 days. This is absurd but it keeps the spotlight on the dear leader while all anxiously await the next decree. This results in loss of confidence and trust in the financial system.
ReplyDeleteThank you foreigners for lending us government $8.5 trillion at average interest rate of 3.34%
ReplyDelete"Thank you foreigners for lending us government $8.5 trillion at average interest rate of 3.34%"
ReplyDeleteThis is of course an absurd comment.
The US goverment does not need "foreigners" to lend it its own currency.
Technically the US government doesn't even "need" to issue debt in its own currency. It can just create more of its own FIAT currency. The reason it does it is probably more of a political and institutional choice, not strictly an economic necessity.
Regarding Scott's comment "when in fact trade stats are nothing more than a snapshot of the voluntary actions of hundreds of millions of individuals."
ReplyDeleteI think this is a very interesting sentence that sheds light on many of the posts here.
First, China's population is about 1.3 billion people. If Scott is implying that it's only the American population whose decisions lead to the deficit, this is of course wrong and contradicts the original post.
In short, China has a massive current account surplus because of certain decisions by its Central government (its households share of GDP is very low, a historical low for an economy of this size). As an accounting identity, this surplus has to be matched by a deficit in some other countries. Again, this is an accounting identity. It just so happens that, because of the economic and political structure of the USA, it is on the other side of this coin and has a significant current account deficit.
In other words, this can be resolved by decisions made by the Central government in China.
I am not going to write a whole article here, but I think a reason that so many people have issues grasping the current situation is that they look at a country like China and simply are unaware or unable to comprehend that China's structure, including its capital structure, the way they calculate GDP for example, and so on, is fundamentally different from the USA. It's also, naturally, difficult to comprehend the sheer size of this place: 1.3 billion people. High-tech, biopharma and industrial zones the size of cities. Subsidies and incentives that would dwarf the GDPs of some countries. And so on.
My last comment is missing perhaps the most important aspect: on the US side, the current account deficit is created by capital inflows (hence the capital account surplus). While looking at this balance, it might indeed seem like a non-issue, after all it balances out. However, the most important aspect here is that these capital flows have different impacts on different sectors. This is missing from the discussion. Some sectors would benefit and some would face challenges, which can create unhealthy financial dynamics, structural distortions in the economy, and other problems. This is, of course, not a hypothetical situation.
ReplyDeleteDonald Trump is a mercantilist. That's all you need to know about his thinking. Trump and the whole MAGA movement have a 17th Century economic mindset. It also explains why Trump is so interested in annexing Greenland, Canada and the Panama Canal Zone. Like 17th Century mercantilists, he believes it is necessary to have territorial control of natural resources and important trade routes for economic security and dominance of his nation over others. He does not understand that buying things from other countries is no big deal.
ReplyDeleteIt’s only a big deal when it becomes a national security concern - like it is now.
ReplyDelete"He does not understand that buying things from other countries is no big deal."
ReplyDeleteMy friend, you really need to research what "things" the USA is dependent on via imports. It might shock you.
You also need to research China expansionism and what it has going on in Panama and other places around the world.
You need to understand that the post WWII order is over, and not because of Trump.
That there are all type of "countries" just like there are different types of drugs and sports.
I would have preferred Trump to declare a national emergency to appropriate funds to expedite construction of pharmaceutical and semiconductor factories in the US so we are no longer dependent on China and Taiwan and also pout billions into new naval ship yards to counter China’s growth in warships. I would also use emergency funds to expedite our mining of rare earths and the purchase of Greenland. China is getting ready for war and we need to spend the money to counter it like we did in WWII to counter the Germans and Japanese. I think this plan would garner bipartisan support.
Delete"Trump was a madman determined to wreak havoc among global economies and global trade." ... "It was a master-stroke of persuasion." Scott... :-)
ReplyDeleteI think finally there is a bipartisan agreement that Trump is a madman (always has been). Though one party still believes that madman could also be a hidden genius?
The “madman” is all part of the show for negotiation. Behind closed he is anything but. Relax and watch the show.
DeleteI don't know if Trump is a madman. But clearly he's a low IQ, highly narcissistic lout, surrounded by a mix of sycophants and lackeys. I agree tariffs "rollout" has been his biggest economic blunder. But sadly, what he's done re Ukraine/Russia is morally far more repugnant. And these criticisms come from a self-described free-market classical liberal, who always voted Republican ... until he came along.
ReplyDelete"Trump was a madman determined to wreak havoc among global economies and global trade." ... "It was a master-stroke of persuasion."
ReplyDeleteThe attempts to rationalise the shambolic tariff-focused antics of the Grifter-in-Chief, as if part of some genius masterplan, are somewhat tragic. Yes, Trump's actions are triggering a re-ordering of global trade, as the RoW reevaluate their relationship with the US in light of the greatly diminished - & diminishing - regard in which they now hold it. Allies alienated, partners turned on, all while enemies are being embraced and cozied up to. The RoW - including its consumers who have up to now poured money into US service exports - looks on in horror and quietly sets about reordering their affairs - a re-ordering that will be very much to the US's disadvantage. Tragic!