Down but not out

The world order and American exceptionalism are being tested, but will prevail

Photo by Adrian Kusznirewicz on Unsplash

Hello,
Welcome to Known Unknowns, a newsletter that is reminding itself—again and again—that it’s a long-term investor.

Well then

So tariffs are a very big thing in America now. For now.

On the one hand, it really bothers me that such a big, consequential policy—for the country and the world—was done through executive order. One person should not have that much power, at least not the way America was designed.

On the other hand, it also means this can all go away as fast as it came. And I imagine it will, eventually. Either through a legal challenge or Trump backs off. He’ll claim to have made some good deals (and maybe he will get some), and then he’ll let it go when it all gets to be too much. Or whoever is in charge next will drop the tariffs. (If tariffs do stay for the next few years, I have a feeling JD will not be President.) The longer this goes on the worse the damage will be, and the harder it may be to recover because you’ll have more vested interests in protectionism and distortions to the supply chain. But who knows—some countries are already lowering their tariffs in response, like Vietnam. Just not China...

At the very least the uncertainty is indeed bad. And I reckon that’s what is driving markets, even more than the prospect of higher tariffs. Based on what I hear from people on the Street, no one still can accept that this will actually happen or thinks it’ll last. What else can explain the bond market?

On the one hand, there’s the flight to safety, so bond yields are down—especially on the 10-year—and investors are paying a premium for more certainty. On the other hand, if we really do enter a high-tariff world, we can expect much higher bond yields—and these bond buyers today will certainly lose money. I guess the call is they’ll lose less than in riskier assets. But to me, this says no one knows what to expect.

Perhaps this is something we need to experience. I did spend the last several years wishing people would appreciate how great neoliberalism was, and well, I think I got that wish. Perhaps our resolve that freer trade is better will come out stronger than ever.

And, to be honest, with the right tax reform—American consumers may not suffer so horribly (their 401(k)s, a different story). Trade is not that big a part of our economy, and more pro-growth policy could offset some of the tariff costs.

Though I wrote for Bloomberg that the tariff rates Trump is floating would be a total disaster for developing countries. Trade is a huge part of their economy and their development strategy. High tariffs could throw them into a depression and reverse the wonderful trend of falling extreme poverty. It is, to me, so much worse than cutting aid or eliminating USAID.

Alternatively, if these countries drop their tariffs—and we do too—that could ultimately be a better outcome. It could even accelerate growth. But given that the tariff rates we’re floating are based on the volume of trade (the more a country exports to America, the more they must pay), that is looking less likely.

Is this how it ends?
It is remarkable that in just a few months—with one person in charge—so many people are writing the obituary on American exceptionalism. And it’s true: things are changing, and some change was overdue or simply unsustainable.

But before we write off America, we need to separate short-term from long-term exceptionalism. Part of what made the American economy exceptional is short-term—for example, the very expensive dollar and the stock market that put all others to shame. Those are now looking iffy.

But what makes the American economy truly exceptional, and has been the case for more than a century, is an openness to risk and innovation, and our many institutions that support risk-taking—by making it more profitable and limiting downside risk.

That is why the most innovative companies are here. It is also why we’ve been the richest economy and the fastest-growing developed market. I’m still bullish on America long-term, though we are ceding some of our advantages.

Even still
There are, of course, things that threaten that dynamism. Many people are cheering this JD Vance speech where he argues that we can have the most innovative companies in the world in Silicon Valley—and that can co-exist with populism.

As he sees it, Silicon Valley will innovate and get rich, and everyone else will have a guaranteed job engineered through tariffs and subsidies.

It doesn’t work that way.

First of all, everyone—rich and poor—is entitled to upside risk. Also, as I wrote for City Journal, this whole reshoring movement is just the Republicans’ answer to the Green New Deal. Both are industrial policy to satisfy some fetish of the government in power. With Biden, it was the desire to make everything environmentally friendly. Now with Trump, it’s the desire to make things here.

For both, there was some legitimate issue—say, security or some environmental benefit. But with Biden, all we got was trillions in spending, distorted markets, higher interest rates, and about 60 EV charging stations. But we did enrich lots of special interest groups and politically well-connected people who always manage to benefit from government largesse.

History suggests reshoring through tariffs will face the same fate.

It seems like the whole world is getting a lesson in international economics. Everyone I speak to—most are non-economists—are upset about tariffs, but many of them aren’t sure why they’re so bad.

The immediate answer is: higher prices and less variety. And those are both bad. So is making our companies—large and small—less profitable.

But for me, the real cost of tariffs is the waste, the corruption, the bloat—and that our industries become less competitive and innovative, and we divert capital away from the most productive uses.

One look at the market last week should tell you: we can’t have populism and growth and innovation.

And this is the delusion that may be our undoing.

Until next time. Pension Geeks!
Allison