This is a terrible idea.

We know this because persistent White House arm-twisting of the Fed to compel it to keep money policy too loose in the 1970s was certainly politically convenient. But it created runaway inflation, triggered lunatic action by corporations (think: a cereal company buying a gold mine to hedge risk) and caused Treasury bond yields rising to 20% and home loans at 26%–and a resulting decade of economic suffering–before the federal government could retake control of economic growth.

I remember this time very clearly. My wife and I bought our first house in 1981, when mortgage rates were 17%! My wife had a moving subsidy from her employer, so the rate for us was only 11%.

Unless he’s more severely cognitively impaired than is commonly thought, Trump must also remember the enormous pain that putting a lid on inflation caused in the 1980s, the long time it took to get prices back under control and the immense hit to economic growth that runaway inflation delivered. All because the executive branch had routinely interfered in monetary policy.

Nevertheless. Trump seems to want to bring that very dark time back.

The world has seen this movie before. So too the major international banks who have enormous influence in setting exchange rates. Were Trump to fire Powell, as he’s threatening to do, the financial markets reaction I think we’d see would be very ugly:

–a sharp rise in interest rates

–a substantial drop in the value of the dollar and

–a big selloff in the stock market.

My guess is that any reaction that falls short of Trump’s removal from office by Congress would prolong and maybe intensify the selling.

an ethics question:

Which is worse?

–having ICE seize a legal resident, take him away from his wife and child even though he has not committed a crime, imprison him in El Salvador and refuse a court order to return him to his family and job in the US–and doing this over and over, or

–ending the role of the Federal Reserve in maintaining maximum sustainable GDP growth, causing runaway inflation and capital flight from the US.

The former is more concrete, and contains a terror component that is presumably an important part of ICE’s mission. Not great for bringing tourists to the US, either. But the latter is arguably more evil, since it stands to destroy the economic lives of millions of people.

the 1930s

The modern science of economics developed from attempts to understand the causes of the devastating Great Depression of the 1930s–so that it would never happen again. A principal lesson is that tariffs generally make things worse, and maybe a lot worse, not better. The soybean tariffs of first the Trump administration, from which domestic farmers are yet to recover, were a gentle reminder of this. Oddly, that didn’t deter Trump from repeating the same blunder on an epic scale. Nor did it deter farmers from voting for him again.

the 1970s

I’m not sure exactly when it began, but by the 1970s it was conventional wisdom that the US operated on a four-year business cycle. The main reason for this is that in every presidential election year, the sitting president would arm-twist the Federal Reserve into loosening money policy. This was sort of like filling up the punch bowl again just as the party was getting a little rowdy–not the best idea. But it made everyone feel good as the election was approaching. In the lore back then, it was extra insurance that the incumbent, or at least his party, would be reelected. In theory, also, but less in practice, the Fed would offset the loosening in the first year of the new term. This is the economic (if that’s the right word) basis for the traditional idea of the four-year business cycle.

Highly principled Gerald Ford refused to do this–and lost, underscoring the efficacy of the ploy.

By the time Jimmy Carter was in office, however, the inflation that the cumulative years of extra-loose money policy had engendered was beginning to spiral out of control. Carter appointed Paul Volcker to clean up the mess, and advanced the idea of the independence of the Federal Reserve. Ronald Reagan doubled down on the concept.

Nevertheless, it took about a decade of economic suffering, with interest rates substantially above 20% for an extended period and an enormous amount of overall economic pain before the Fed got inflation under control again and established itself as free from partisan interference.

It’s surprising to hear a president who lived and worked through this period of suffering calling for the country to give up all that progress and return to the bad old days before Carter and Reagan. Yes, triggering rampant inflation would doubtless make it more difficult to distinguish between economic losses due to tariffs and those due to terrible monetary policy. And as investors in the US financial markets, we’d also have to figure out how much of the loss would come through currency weakness and how much through a cratering bond market, and their negative implications for stocks. But investors of all stripes might also have to come to grips with the possibility of the kind of capital flight from the US that is typically the signature indicator of badly run emerging economies.

In 2018, Trump imposed tariffs on Chinese exports to the US. China retaliated by tariffing US soybeans shipped to China. The net result: China shifted its business to Brazil, whose soybean business has grown at the same time the domestic soybean business has shrunk by 10%. In addition, a large part of the import taxes (my recollection is more than 100%, but I haven’t found a citation to confirm this) collected from China went to farmers devastated by the tax.

And here we go again.

I’m a big fan of Paul Krugman, the Nobel Prize winner who recently left the NY Times for Substack so he could speak his mind more fully. He points out that we export mostly agricultural products to China, for which there are easy substitutes elsewhere. On the other hand, we import mostly rare earths from China–for which there are no easy substitutes. Because of this, the US is always going to be at a disadvantage in a general tariff war with China. In the important case of agriculture, we’re most likely to rack up a large net loss, meaning an outflow from the Treasury not a gain. And–this is me, not Krugman–the most stunning aspect of this is not only that the administration doesn’t know the economic theory/experience but also that it has actual experience of this reality from 2018. Yet…

Archimedes, the inventor/popularizer of the lever, is reputed to have said “Give me a place to stand and I can move the world.”

I choose to interpret this, rightly or wrongly, as meaning that I don’t need to know everything, or even a lot, about the way the world economy is working. All I need to have is some economic fact/hypothesis/development that I think is correct, and that I can monitor, to be the foundation on which to build my portfolio.

As a citizen, I’m disturbed that our national aspiration to be a shining city on a hill is in the rearview mirror and that we’ve elected a national administration of limited competence and cognitive flexibility, whose trademark move so far seems to be performative acts of intentional cruelty.

As an investor, though, simply thinking this gets me pretty close to nowhere.

my stock market approach today

We can break down real GDP growth into a function of:

–having more workers, and

–productivity improvements, meaning better education and better tools.

The administration’s attack on science education will most likely have no immediate negative effect, although it’s probably a long-term minus.

The more serious issue, I think, is Washington’s efforts to shrink the number of non-citizens working here.

The domestic workforce is aging, with growth at about 0.6% per year. We need capital investment + education to increase productivity and immigration to boost that to, say, +1.0%. At present, however, the administration has launched an attack on many of the country’s premiere research universities + discouraging immigration + very publicly arresting and deporting foreign students and workers already here.

So real GDP is being capped at around 0.5% per year. Who knows what the actual figure will turn out to be, but 0 for this year is as good a guess as any. Even if not, it’s my guess. I also think that there’s more downside risk than upside potential and that the way the tariff situation develops has the potential to make things worse.

This is my Archimedean leverage point.

In consequence,

–non-US economies will likely be stronger than the US, meaning multinationals will do better than pure domestic plays

–foreign markets will probably continue to outperform the US

–the dollar will likely be a weak currency. This is a plus for companies that make stuff in the US and export it, and a negative for importers. Maybe the best will be foreign firms whose business is purely outside the US. Generalizing, success =non-$US revenues and $US costs

–the US will likely be like swimming upstream. But discount retailers (the dollar stores?) and special situations (think: deep value) will probably be at least ok and maybe stars.

“risk parity”

This is an idea discussed in academic circles (something that should send shivers down any investor’s spine). The main assertion is that in a portfolio consisting of (risky) equities and (not so risky) bonds, you can get better overall returns, and better downside protection) by upping the risk in the bond portion of the portfolio by buying a bunch more bonds on margin.

The idea was popularized by Bridgewater Associates in the 1990s, when a portfolio borrowing money to buy Treasuries while interest rates were in secular decline seemed like a license to steal. It was/is widely used by traditional pension funds (mostly for government employees) eager to address their chronic underfunding without calling on state legislatures to inject new funds. This even though the collapse of the bond fund Long Term Capital Management in 1998 was a case study in what can happen to illiquid assets in a time of political uncertainty.

Here we are again today …in another time of high uncertainty and political upheaval, where the illiquidity of many Treasury issues and the opaque nature of the leverage that private equity funds have used to assemble Treasury portfolios has become a worry. This time, however, the source of political fears is not Russia but the United States. The underlying issue is the same, though–again, the public doesn’t know how big these funds in the aggregate are or how highly leveraged they may be.

In a sense, here we are again.

Kilmar Abrego Garcia

As I guess just about everyone in the US now knows, Mr. Garcia fled El Salvador for the US, which he entered illegally to avoid gang violence in El Salvador. He has had legal status since 2019, however, and is now a productive worker, a taxpayer and a member of the auto workers union. Nevertheless, he was recently seized by ICE and deported to a jail in El Salvador.

Despite court orders to return Mr. Garcia to the US, the Trump administration is refusing to do so.

To my Wall Street-hardened mind, the most likely reason is that Mr. Garcia has been killed in prison by the gangs he was fleeing all those years ago. I may just be too cynical, but what other reason could there be for not correcting what the administration admits was an error? Could conditions in the prison be so hellish that the administration doesn’t want word to get out? If so, what would this say about the possible fate of other prisoners?

This stance by Washington has some relevance for Treasuries, as well. Ronald Reagan, the father of the modern Republican party, referred to the US as the “shining city upon a hill.” In his farewell address to the nation, he said:

“I’ve spoken of the shining city all my political life, but I don’t know if I ever quite communicated what I saw when I said it. But in my mind it was a tall, proud city built on rocks stronger than oceans, wind-swept, God-blessed, and teeming with people of all kinds living in harmony and peace; a city with free ports that hummed with commerce and creativity. And if there had to be city walls, the walls had doors and the doors were open to anyone with the will and the heart to get here. That’s how I saw it, and see it still.”

It’s hard to evaluate how damaging Trumpism to the US, but it’s certainly far different from Reagan’s vision. Arguably, this dramatic change embraced by the ruling Republican party has the world worrying about the safety of lending to the United States.