New tariffs spark economic drama as investor confidence plummets, alliances shift, and experts warn of a self-inflicted wound on America’s global standing.
Trump’s latest tariffs have created what economic analyst Matthew Klein calls a “moron risk premium” on US assets — a tangible cost of policy confusion that’s rippling through global markets.
Beyond the prospect of raising prices for American consumers, these hastily implemented tariffs have sparked unprecedented reactions:
The dollar is weakening when theory suggests it should strengthen.
Allies are rebuilding their economic frameworks to reduce dependence on the US .
Investors worldwide are reassessing America’s reliability as a safe harbor for investment.
Klein — a distinguished economic analyst, co-author of Trade Wars Are Class Wars, and author of The Overshoot substack — explains how Trump’s tariffs represent not just bad policy, but a fundamental misunderstanding of how international trade works: Tariffs actually function as a substantial tax increase on Americans — approximately 2 percent of GDP — which disproportionately affects lower-income consumers.
While Klein states that tariffs previously raised US dollar value, he clarifies why the opposite is happening now – a signali that investors no longer view the US as a reliable investment destination.
The conversation goes beyond typical trade analysis to explore how US allies are adapting to America’s unpredictable economic policies. As examples of how other nations are responding, Klein points to Germany’s constitutional revisions to boost defense spending and to Canada’s moves to eliminate internal trade barriers across provincial borders.
Klein argues that the Trump administration’s approach is fatally flawed because it calls for imposing tariffs based on bilateral trade balances rather than actual trade barriers. He also explains why the current policies are unlikely to achieve their stated goals of American re-industrialization and revenue generation since their conflicting objectives undermine each other.
For anyone trying to understand the economic implications of these trade policies and their potential to reshape the global economic landscape, this conversation provides an indispensable framework.
*Editor’s Note: This conversation was recorded on Wednesday morning, before the latest policy changes. The specifics of Trump’s tariff policy are sure to change again.
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(As a service to our readers, we provide transcripts with our podcasts. We try to ensure that these transcripts do not include errors. However, due to a constraint of resources, we are not always able to proofread them as closely as we would like and hope that you will excuse any errors that slipped through.)
Jeff Schechtman: Welcome to the WhoWhatWhy Podcast. I’m Jeff Schechtman. We are entering a new and dangerous phase in the global economy. The world order that has maintained relative stability since the end of World War II is being upended, not by external forces, but by the deliberate actions of the United States. The latest round of unordered tariffs from the Trump administration has sent markets reeling and created what our guest today calls a moron risk premium on US assets.
Matthew Klein is a respected economic analyst and co-author of the book Trade Wars Are Class Wars. He joins me today to try and help us understand not just why these tariffs are problematic, but why they represent a fundamental misunderstanding of how global trade actually works. In his recent Substack, The Overshoot, he highlights how these tariffs effectively constitute a clear and present tax on national income, hitting the poor disproportionately, while creating substantial costs and inefficiencies for business.
Klein illuminates the contradictions at the heart of the administration’s approach, trying to calculate so-called reciprocal tariff rates based on bilateral trade balances rather than on actual trade barriers. In a world where confusion now reigns supreme and economic uncertainty becomes the new normal, Matthew Klein will try and bring us some clarity. It is my pleasure to welcome Matthew Klein here to the WhoWhatWhy Podcast. Matt, thanks so much for joining us.
Matthew Klein: Thank you for having me.
Jeff: Well, it’s a delight to have you here. I want to talk first about the whole general idea of tariffs, which certainly have their place and have served us well when they have been properly used, but it’s very difficult to think about tariffs and what they can and can’t accomplish when we’re doing it in the context of this rushed and poorly designed operation that’s going on now. Talk about that first.
Matthew: So basically what tariffs do is they’re just about raising the prices of things we’re importing. Most of the time, you don’t want to do that because obviously if we’re importing something, it’s something that we want to something that people like to have, and if you make it more expensive, and that means people have less money to buy other things, and that’s not good for anyone. There might be specific circumstances, rarely, where you want to really protect the domestic industry. Maybe you think it’s strategic or something of that nature, or you think that there’s something going on in other country you want to prevent them from sending essentially dumping, but those circumstances are rare.
In general, the easiest way to think about it is it’s a tax increase, it’s a sales tax, basically, it’s a sales tax that only affects certain things. And so the net effect of the tariff increases that have been announced over the past couple of months is something like 2% of GDP as a tax increase, which is pretty substantial and on a relatively small base of goods. So basically, the tariff freight rate on average for everything imported in the United States was around 2.5% before this, now it’s something like 25%-ish. Maybe it’s more now that the extra tariffs have been put on Chinese imports.
The amount of stuff that we import from the rest of the world is not large as a share of national income. It’s about 11% of GDP, but nevertheless, if you have a 25% tax on 11% of our total spending, that’s still a lot. And so that’s understandably why people are expecting to have less money, they’re going to be poor, they’re going to spend less on other things. It’s going to make it more expensive for businesses to produce, as if you make something partly out of imported parts, that’s going to be harder for you to make a profit. And so that’s, I think, part of the reason why people are very upset about what’s happening and why asset prices are reacting the way they are.
Jeff: And of course, one of the things that precipitated these tariffs was this notion that the administration had that somehow there needed to be this balance between what we buy and what we sell. That the idea of bilateral trade deficits were somehow inherently bad.
Matthew: Right. And that’s very problematic. So to be clear, there can be reasons to be worried about persistent trade imbalances. So if you or I consistently spend more buying things than we earn from selling things, we’re going to have to cover that difference somehow. Maybe we’re rich and we inherit a lot of money or something we can sell down our wealth, we borrow against a house, something. But either way, that has to be financed. And so if you’re at the country level, it’s the same thing. And so the question is, if you are in fact persistently buying more than you’re earning, then how are you covering that difference? How are you financing that?
And we’ve seen there have been times in this country and elsewhere where those financing arrangements and the associated booms have led to severe crises and a lot of instability. And so there’s an argument for why you want to avoid that. But there are other times when it’s not necessarily a problem. So one of my favorite examples of this is you look at the development of Norway. Before they discovered oil and gas offshore in Norway in the North Sea, Norway was basically one of the poorest countries in western Europe. They sold fish, and that was about it.
Then they discovered oil and gas, but being a poor country, they didn’t have the resources to develop those fields themselves. So they did what the reasonable thing to do, was they brought in foreign expertise, foreign money to finance the development of those oil fields. And leaving aside the carbon pollution aspect of it, the result, a decade-plus later, was that there was way more oil and gas available for everyone to heat their homes, generally electricity, all those good things, and Norway suddenly had become a very rich country, and they were very easily able to repay the money that they’d borrowed from abroad.
And so that’s a situation where it’s a clearly positive sum outcome for them. And the question you have to ask yourself in looking at the US or any other country is is it more like the Norway situation? Is it more like other situations where you have crises? Trade balances in general are a product of four things. It’s how much you’re producing in your country, how much the rest of the world’s producing, how much you’re buying in your country, and how much people in the rest of the world are buying. And there are lots of different ways of combining those four things that have either trade surpluses or trade deficits, but they’re very different implications for whether they’re benign or dangerous.
Jeff: And some of this imbalance comes from the simple fact that some countries are consistently under-consuming relative to what they produce.
Matthew: Yes, that’s the major problem. And it’s something that Michael Pettis and I talked about a lot in our book, Trade Wars Are Class Wars, which is that’s the thing to be worried about, but it’s not going to necessarily show up in the one-to-one trade relationships, but it’s absolutely a problem. So if your factories are running at full capacity but your workers, for example, are not being paid enough to benefit from the money that’s being generated by selling the things you’re producing, then that money, where is it going? Maybe it’s going to the rich people who own the factories and maybe they don’t like to buy goods and services.
The general rule, this is empirically shown across countries, is that most people over the course of their lives will spend everything they earn. Maybe not at any point in time, but over the course of their lives. That’s generally what happens. The exception are people who are very, very rich, and companies, and governments who do the opposite thing. So what that means is that if someone is very, very rich, there’s only so many goods and services you can buy. And so what people do with that extra if they’re getting that income is they’re going to be buying financial assets.
So what that means is if you have a change in the distribution of income from people who are going to spend everything they earn on goods and services to people who don’t, then that is going to reduce the spending on goods and services unless people compensate for the relative loss of income by borrowing more. And that can happen. We’ve seen that in a lot of different places in a lot of different time periods.
So in the 1920s, the United States, for example, what essentially ended up happening was that you had the shift in the distribution of income towards people at the very top end of the distribution. And what effectively happened was that the rich people were lending money to everyone else so they could buy things. And so overall, spending on goods and services was rising, but it was becoming increasingly fragile because it was depending on borrowing by people who were not going to necessarily be able to repay that debt. And we’ve seen that in other situations as well.
And so that is a real problem. The question is, if you are a policymaker in the United States now where the problems are underconsumption elsewhere, what do you do about it? Tariffs does not seem to me to be the obvious answer because tariffs, what they’re going to do is they’re going to reduce the spending power of Americans. So that might mean fewer imports, but well, it might not. It just means less spending by Americans. Alternatively, if there is less spending on imports, it also means less spending power by foreigners. But if the problem is foreigners aren’t spending it up anyway, how does that help either? So the way it translates into a change in the trade balances is far from obvious, and it’s often and very well might be counterproductive.
Jeff: Isn’t China the penultimate example of this, a country that’s consuming something like 12% of global consumption but manufacturing 35% of global manufacturing output?
Matthew: Yes, absolutely. We talked about this in the book, and I think that it is absolutely fair to look at China and how the impact of China’s domestic economic imbalances affect people in the rest of the world. It’s an absolutely legitimate point of discussion and a legitimate thing to be having policy around. The question is, are putting tariffs on Chinese goods a solution to that problem? It’s not clear to me that that is the case.
I mean, you’re absolutely right. So one thing you can look at, something we talked about in the book is the share of value added, so like you think about what companies in China are producing, how the income that those companies generate, how it’s distributed, the share that goes to workers in China is much lower than it is in other countries, much lower. And the flip side is that the investor share, whether it goes to interest payments on debt or profits or whatever, is much higher, which is part of the reason why foreign companies and other companies like to operate there.
It’s not so much that Chinese wages are so low, because they’re not, globally, they’re in the middle of the distribution, but the profit share is much higher. For a whole host of reasons, Chinese workers are underpaid relative to the value of what they produce, which means, of course, that most people in China have less money to spend on things. On top of which there’s a lot of other things. The way the tax system is structured, the lack of a welfare state social security system in China, the fact that hundreds of millions of people in China are effectively treated as like illegal immigrants from the countryside to the cities, and there are rules there.
The hukou system basically means that people in the cities on the coast, many of them, they pay taxes to get things like healthcare and education, and unemployment insurance, but they’re not eligible to actually receive those benefits. They have to go home to the countryside and get anything. Unions being illegal. There are a whole host of things that reduce the consuming power of Chinese people relative to what it should be. And that primarily hurts people in China. But it also means because they’re buying fewer things, that it hurts people in the rest of the world.
So, for example, recently there’s been a big source of concern in the United States and even more so in Europe about the rise of Chinese– the auto industry in China in particular, motor vehicle exports from China. If you look at the Chinese data, and these come out once a month, the total amount of motor vehicles produced in China, cars, trucks, buses, things like that, is not actually higher now, barely any higher than it was in 2018. In 2018, China was a net importer of motor vehicles. The difference is that domestic demand in China is a lot lower now.
And so even though they’re not producing any more vehicles than they were before, they’re exporting far more because the domestic market has been so weak basically since COVID. And so that’s what’s creating problems for everyone else. I think that example is really a microcosm of what’s going on in China as a whole, which is production is fine. It’s not so much that Chinese production is just incredibly growing faster now than it was before then. It’s not.
It’s just that domestic demand has been so weak and the difference has been made up by selling things at relatively low prices, what you call dumping or not, whatever into the rest of the world economy and that’s creating problems for producers elsewhere. And that’s why you’re even seeing Europeans who generally are not in favor of trade restrictions compared to this administration. Nevertheless, in the past few years had been thinking about what they could do to protect their auto industry from what they were seeing as a flood of imports from China of electric and non-electric vehicles.
Jeff: Isn’t part of the problem with respect to the current regime of tariffs that the administration has been talking about, that there really are conflicting arguments for them. That on the one hand we hear about re-industrialization as being a reason for the tariffs, that there are negotiating tool to accomplish other things in certain countries that they’re supposed to be a revenue generator for the US, and that they also are going to have an impact on the dollar as reserve currency. The problem with all of these arguments is that they all conflict with each other.
Matthew: Yes, that’s absolutely right. If you want tariffs to be a stable source of revenue, you’re not going to be able to negotiate them away. That’s just a basic, fundamental problem that they have. They are going to be. Potentially they could be a meaningful source of revenue. I don’t know. It depends on how much you think. US imports adjust. That’s the big open question, but assuming naively that import demand from Americans does not change, then they’ve just raised taxes by 2% points of GDP, but it also means they’re not going to cut tariffs. So if they are going to cut tariffs, then it’s not going to be a source of revenue.
And then of course, there’s the other point which you mentioned, which is, what is it they’re asking for anyway? So they say they want it’s reciprocal. They’re trying to remove tariff and non-tariff barriers. Non-tariff barriers are potentially meaningful. Tariff barriers that other countries have are basically zero. Tariffs are not the way countries affect trade. And then the bigger point is even if you do think there are non-tariff barriers, which might very well be legitimate, as I was saying, and as we talk about a much more detail in the book, the bigger issue is domestic policies that have nothing to do with trade policy.
Trade policy can matter, but what matters a lot more are things like, what’s the distribution of income in your country? What is the level of spending in your country relative level of production on the whole? And so focusing narrowly on trade policy is not going to get at that. The things I talked about with regards to China, which are significant and have a major impact on the rest of the world, none of those things count as trade policy.
I don’t think you can imagine a world in which people are saying, oh, well, China’s going to increase its unemployment insurance benefits in exchange for a tariff reduction. It might be good for Chinese people. They’re plenty of people in China who say you should do that anyway. But it doesn’t seem like something that anyone’s actually talking about. I would be very surprised if this actually ends up working the way people want it to.
Jeff: Talk a little bit about the impact that it’s having on the dollar as a world reserve currency.
Matthew: One thing that’s been interesting to watch is that the dollar has not gone up since the most recent round of tariffs were announced. So the standard theory is that if you put a tariff in place, then an investment in the United States to manufacture for the US market becomes relatively more attractive than it was before, and especially compared to an investment outside the United States to sell to Americans. So if you put a tariff in place, you would think that because of the change in the relative attractiveness of where you want to invest money, that the dollar would appreciate.
And that’s what happened in 2018/2019 and that’s what happened in the beginning of this year with the threats and actual imposition of tariffs on Canada, Mexico, and China, that the US dollar appreciated against the Canadian dollar, against the peso and against the yuan. And what happened most recently is that’s not what happened, that they put these very large tariffs on, and yet the dollar went down. Well, first it was flat and then it went down. Again, the exact opposite of what you’d expect. And I think there are a couple of reasons you can think about why.
But if we zoom out, it’s that clearly the tariffs did not increase the relative attractiveness of investing in the United States, which is what you think they were going to do. And I think it’s pretty clear why that would be the case. The way these tariffs were designed and introduced was reflective of a policymaking process that we’ve pretty consistently seen over the past few months, which is capricious and which, in other words, it can change very quickly. There’s no guarantee it’s going to stay this way. And everything else the administration has been doing has been very bad for business.
The attacks on scientific research funding. The attacks on foreigners coming to this country. I’m not talking about people who maybe came here illegally years ago and are being deported. I mean people coming in legally from Europe and then getting locked up somewhere. Some ICE detention center. The attacks on the rule of law more broadly. The fact that the US has basically done a heel turn on its foreign relations, threatening to annex Canada and Greenland, and abandoning the Ukrainians to the Russians, or potentially doing that. All the things put together, it does not make it seem obvious that the US is a more attractive place to invest than it was.
And if you don’t think the tariffs are going to stick around either because you think they’re a negotiating tactic or because they might very well be illegal, they’re only able to do this because Congress passed a law saying that in a case of an economic emergency, there’s discretion for the president to impose tariffs. But it’s not clear there actually is an emergency and there are already lawsuits about this. So given all that, why would you want to invest more in the United States?
And so that is, I think, significant because it means that, first of all, the strategy is not going to work on its own terms. If the goal is to re-industrialize the United States, and then you’re doing all these things that discourage the re-industrialization of the United States, that’s bad. That clearly means that you’re failing your own terms. It also means, what is it going to do for other asset prices? It explains why stocks have been doing so badly, explains why bond yields have not been going– They went down briefly, but now they’ve been going back up.
And that suggests that you could say, “Oh, well that’s bad for growth, so bond yields go down.” That’s normally what happens. Stock prices go down, bond yields go down. That’s nice, by the way, if you have a diversified portfolio because those partly cancel out, the bond prices go up. It shields you from the impact of the falling stock prices to an extent. That’s not what’s happening now. And so one way of looking at it is that the inflation impact expected from tariffs is going to dwarf any growth impact.
The other thing though is like, it’s there’s an overall risk premium now coming on US assets that didn’t exist before, that people think, it’s less safe to invest in the US for whatever reason than it was before. And that would be very bad. And so that, I think, is going to be reflecting a lot of potential– I don’t think it’s a permanent phenomenon necessarily, but I think as long as we have the current crop of people in charge, and there’s not a lot of reason for the business community writ large to trust them, I think that could be very well a persistent problem and a drag on growth and living standards.
Jeff: The other thing we see in terms of global instability and the Chinese have been talking about this already, adjusting their own currency to deal with and adjust for the tariffs that the US is putting on.
Matthew: That could happen, and you are seeing that in China, but you’re not seeing that elsewhere. If you were seeing that elsewhere, the dollar would be going up, not down. So that hasn’t really happened yet. But that’s the trade-off. So one of the arguments that people in the administration had made before the tariffs are put in place is that it wouldn’t be as expensive for American consumers as one might naively think, because foreigners would adjust either by letting their currencies appreciate, or by reducing their selling prices to maintain market share in the US. But so far, that’s not happening.
I said China’s starting to adjust their currency. They have their own reasons to be careful about letting their currency adjust too much, because they don’t want to have a situation where people in China try to move all their money out. But on the aggregate, so far, this is not happening. I mean, partly this is a function of the strength of the euro and the yen, and the Swiss franc, and other things. But so far, the dollar, it’s not, in the aggregate, gone up, which is sort of what the flip side would be if countries do decide to respond when their currency is depreciating.
Jeff: Talk a little bit about the broader economic consequences of all of this and the fact that we are looking at a situation where we have potentially rising prices, where we have significant inflation, and slowing growth.
Matthew: It’s not good. Again, I think there’s a first approximation. There are two big effects. The first one, as I said, is it’s a big tax increase on Americans. And how exactly that tax increase is propagated to specific economic sectors and countries in the rest of the world, that’s actually an open question. But which countries are tariffed the most may not necessarily be the biggest losers from this, I don’t know.
But clearly absent some other offsetting force, you’re raising American taxes by a meaningful amount. No one else in the rest of the world is offsetting that. That’s going to be less purchasing power globally, and that’s bad. On top of that, you have this impact on business certainty or business confidence, an increase in uncertainty, a sense in which policy is more capricious, a sense in which the people who are a loss of confidence in the quality of governance of people in charge.
And that is also going to be a drag on investment, on spending, on hiring, and all those things. So those two things combine and you have, as you said, you have less investment, you have less spending, you have less growth, you have higher inflation. The exact mix of those things partly depends on how the Federal Reserve chooses to react. But it’s definitely going to be negative, and people are going to be getting less relative to what they put in in terms of their work. And that’s going to make everyone worse off.
Jeff: To what extent are we going to see products being essentially chased around the world, where we get into this whole issue of rules of origin and the impact that that has?
Matthew: I think that’s entirely possible. One thing I’ve been looking at, I mean you can see this with the tariffs in China that are put in place in 2018, 2019, where you suddenly see basically there never had been imports of certain kinds of goods from Vietnam before, and then suddenly you have a lot of imports in Vietnam of those kinds of goods. Now, maybe it’s possible that Vietnamese factories magically appeared overnight and started selling these things in size to the United States. But I think there are other possibilities that could explain it.
And so that is an argument, by the way, that some people in the administration use for saying why you want to tariff every single country. It doesn’t explain why you’d have differential tariff rates, because as long as the rates are different in different countries, you create this incentive. But I think it’s entirely possible. The tariffs on China now, I believe are 104% as of we’re talking now. And so that is extreme. That’s not extreme enough to it will necessarily lead to the wholesale relocation of production from China to the United States. But it is extreme enough that you’ll probably see a rerouting of goods made in China through third countries to the United States.
Jeff: And then that gets into this whole issue of country of origin, and whether or not we’re going to take on the immense complexity that goes along with that.
Matthew: It’s tricky. One thing that’s interesting in that is a lot of goods, especially more sophisticated goods, have parts in them that come from other places. One of those strange example, the tariffs on car motor vehicles and parts, which are separate from the tariffs that were announced last week, those have actually significantly harmed supposedly American car companies because a lot of American cars are actually filled with parts that are made in Canada and Mexico, and to a certain extent places elsewhere. Even oftentimes more so than cars by foreign-owned companies.
So an example I like is Hondas are much more American, or like most Hondas are much more American in terms of their US content than, say, a Ford F150, even though we think of one as being more American-made than the other one. And that’s true for everything, especially anything remotely sophisticated. And so it’s going to be a real challenge. It also puts American manufacturers at– it can put American manufacturers disadvantaged.
So one of the manufacturing industries in the US that we have historically and we’ve been very competitive and very successful in is aerospace. So basically, at this point just Boeing, but aerospace, generally speaking. But airplanes are incredibly sophisticated. They have lots of different parts, and a lot of the high-value parts are made in the US, or they’re made in other rich countries, or countries we’re comfortable. But some of them aren’t.
And if you raise the tariffs on the Chinese-made rudder for a Boeing aircraft as much as they have, if you’re Airbus, you think, great, either my profit margin goes up or I can undercut them on price and they can make it up on volume. Either way, that’s just hurting American producers that way. Unless you’re really committed to having a rudder manufacturing industry in the United States, maybe that’s worth it. But since so many of the Boeing airplanes are not sold to America, it’s one thing if we only sold those airplanes to consumers in the United States, but since we don’t, that’s going to be a real cost for us. And there are a lot of other examples like that.
Jeff: Also, for that kind of manufacturing to happen, for that kind of re-industrialization to happen, there have to be consistent tariffs over a protracted period of time. Certainly not in the framework that we’re looking at today.
Matthew: That’s right. And again, there is an alternative approach to all this, which we actually saw in the Biden administration, which I think had the right perspective, which is you don’t need to have tariffs necessarily. What you just need is to give businesses the incentives and the confidence that it makes sense to make things in the United States. There are lots of ways of doing that other than tariffs.
So you look at the CHIPS and Science Act, which was passed, it was a bipartisan bill that was passed in 2021. And the goal there was, among other things, to make sure that America retained the leading edge of semiconductor manufacturing. There were other things in it as well. And that actually, it worked. They basically, they spent a few tens of billions of dollars, which in the grand scheme of things is not a lot of money compared to the size of the federal budget or the US economy.
They got very smart people who had industry experience to come into the government, and they basically worked out of bespoke deals with different companies, and say, “This is what we expect you to do. This is how you’re going to prove to us that you’re doing it. And if you hit your performance targets, we’ll give you money, and we’ll make sure there’s demand for your product and all these things.”
And four years later, every leading-edge company in the world is either in the middle of building, or has finished building new capacity in the United States. And you can look at the data that’s published every month by the census on construction spending, and construction for manufacturing facilities for computers, electronics, which includes semiconductors, just skyrocketed in a way that we just never seen. Unprecedented in the history of this country over the past few years. And that’s pretty neat. We haven’t yet seen that flow through to more production. But these things take time. That worked.
But now you have a government, as I said, that’s actively alienating foreign talent from working here, that is trying to cut scientific research funding, which is very important for the kinds of manufacturing that we want in this country, that is creating a lot of uncertainty about the investment environment in a whole host of ways. So, as you said, the tariffs, people don’t have confidence the tariffs are going to stick around. But on top of that, there are all the other things that are happening simultaneously. And that is going to be, I think, very destructive to business sentiment. And it’s already seen that in surveys of businesses. We haven’t yet seen it in the hard data, but that takes time to flow through.
Jeff: I want to come back to something you touched on before, which was the Fed, in this kind of environment where we’re having slower growth, potentially a great deal of inflation as a result of these tariffs. What kind of policy should the Fed be looking at? And does Jay Powell have an impossible job trying to balance all of this?
Matthew: But it’s tough. But at the same time, at one level, it’s actually straightforward, which is you just wait and do nothing, I think. And that’s what they have been saying. So before this most recent and largest round of tariffs was announced, you go back to March, I guess it was 21st, I think, is when they had their last meeting and they published their projections, and they’d already had seen a sense of what kind of things were happening with this administration.
And the difference between the forecast they published then and the forecast they published back in December, before we had any sense of what was going to happen, or any firm sense of what was going to happen, I should say. I mean, some people could have said it was going to happen because they talked about this on the campaign trail. But anyhow, you compare December to March, what they said was going to happen is, we’re going to have more inflation than we thought we’d have and less growth.
So that’s clearly like more trade. But their interest rate forecast was going to be the same because basically their view was that the negative growth impulse and the positive inflation impulse are going to balance out. And so the actual projected path of monetary policy, what they call under-appropriate monetary policy, where they’re going to do interest rates, would be the same. So nothing changed.
Now the question is, is that nice and even split between growth and inflation going to continue, or do they think it’s going to continue? So again, they just do what they were going to do anyway or not. But I think at the moment that’s of how they– in some ways, it’s very easy for them because they can just say, “We don’t know what’s going to happen. This looks challenging. Let’s just wait and see. Nothing has shown up yet in the hard data. We’re not going to deviate. We’ll just be cautious.”
So leaving aside the fact there might be external pressure on them to do things that are different than that, it seems– in some sense, it’s easy. In the other sense of, how are you going to get a good outcome? There is no good outcome. So it’s a question of how you divide the bad outcome up in different ways and how it’s going to be split between inflation, unemployment, and all that stuff.
Jeff: How is there a good outcome from all of this? Not so much from the tariffs, because that’s certainly one part of it, they can be added to, they can be taken away, but from the damage that this uncertainty has done.
Matthew: I don’t think there is. Ultimately, it’s going to take a lot of time. And it’s like, I don’t want to use, I wouldn’t say regime change is a loaded term. But basically, I don’t think people are going to be confident until you have a different set of people in charge, because I think it’s been very clear what happens with the current set of people being in charge. You have a reputation, you developed reputation, then how do you alter that?
I don’t know why someone, having seen what’s occurred in just the past two and a half months, I don’t know what would have to happen for anyone to think that with the current crop of people making policy, that you’d expect something meaningfully different. And so, they might have to wait a while, which is unfortunate. And even after that, there’s still the question of like, could you get people like the current group of people in charge in charge again at some future date? And what does that mean?
And so, there might be a persistent– I don’t know, that’s a very speculative thing. You can look at it in how countries– there’s certain emerging market countries that they’ve had challenges over the years of who’s been having bad governments and then they switched to better ones and they’re going to have big whipsaws and things get better, but they are nevertheless persistently poor than places like the United States are now. The question is, are we going to converge to that? I don’t know. It’s pressing to think about, to be honest.
Jeff: How do you respond to the argument we’ve heard so much from defenders of the current policy, the administration policy, that what the markets are doing right now, particularly the equity markets, is really a correction, that markets were oversold and that this correction was inevitable and was going to happen at some point, this is just the catalyst for it, but potentially it’s a positive thing?
Matthew: What I will say, if I’m being charitable, it is fair that valuations were high before, so it wouldn’t have taken a lot to make stock prices either go down or not go up very much more from where they were. The burden on companies to deliver the earnings growth that would be necessary to justify those prices and give investors a kind of return that they would have expected historically. That burden was high. So, okay.
Nevertheless, I think it’s pretty clear that if you announce a policy that’s very different from what people were expecting, and then immediately after that, you see stocks go down 5% a day for three days in a row, that that’s probably the fault of your policy. So I think there’s a mix of things going on. By the way, also, the US was unusual in that situation of valuations. That was not the case for stock markets in other countries, and yet they also had big losses. Even if we acknowledge that valuations were relatively rich for US stocks going into this, that in and of itself is not a compelling explanation.
And by the way, these are the same people who were saying that stocks had been going up this entire time up until mid-February because they were optimistic about the pro-growth initiatives that this administration was going to unleash even before the actual election. So you can’t take credit for both. You can’t take credit for one and then deny it for the other one. I think even if you acknowledge that stock prices were elevated, it’s still, I think, fair to say that it’s entirely their fault that they’ve gone down as much as they have, when the day.
Jeff: How does all of this realign global economics? Certainly, it is upended trade policy, and that’s where a lot of the focus has been, but there’s a larger change that seems to be taking place as a result of all of this.
Matthew: That’s where it’s too early to tell. In some ways, the biggest change we’ve seen so far actually precedes the tariffs. It’s more from the end of February, and that’s what the changes we’ve seen in Europe. That’s not so much about the trade policy, so much as the change in foreign defense policy that we’ve seen coming from this administration. So the extent to which this administration has basically abandoned the Europeans and basically switched to being pro-Russian, or at least proceeded to being pro-Russian, has led to really big changes in Europe, particularly in Germany.
And shortly after the German election, the chancellor, Friedrich Merz, basically said, “You know what, we campaigned on maintaining a degree of fiscal responsibility and not borrowing too much, but now we’re seeing what’s happening with the United States, we’re seeing what’s happening in the international environment, we’re going to have to change things.” And they passed a constitutional amendment, or not an amendment, excuse me, they changed the constitution.
The constitution, they had changed back in 2009 and basically limited how much the government could borrow. And they then went back and changed that to say, now actually, the limit on borrowing is going to essentially exclude military spending, which is a big difference. And military spending now essentially, you can borrow as much as you want to cover that. And then in addition to that, they said, we’re also going to do a special carve out to borrow €500 billion euros to upgrade infrastructure, because that had been neglected over the past 25 years, or maybe even more, but definitely the past 25 years. And that is a big change.
And on top of that, they then went to Brussels and told the European Commission, “By the way, we know that previous German governments have repeatedly tried to limit what other European countries could do in terms of borrowing to invest in infrastructure and defense, and we’re sorry. We changed that. Please make it easier for everyone.” And that had a really dramatic immediate impact. And I think it will continue to have a big impact. I think it’s constructive. I don’t like that it took what it took to make that happen, but I think that actually, if that proves to be a lasting change, will actually be very significant.
Jeff: It seems to go deeper than that. Not only is there a sense of needing to spend more in terms of military spending, but there’s a kind of reawakening that seems to be going on, particularly in the tech area and in a number of other areas in Europe in terms of catching up in areas where they’ve been, to say the least, economically complacent in the past several years.
Matthew: The European Commission had asked Mario Draghi, who was the former head of the European Central Bank, former prime minister of Italy, to come up with a report to basically explain how to make Europe grow more. And the Draghi report came out, I think it was the beginning of this year. It’s either the beginning of this year or the very end of last year. And basically made a lot of points saying, look, there are a lot of things we can do differently.
And he actually wrote an opinion piece in the Financial Times a month or something ago, basically saying that tariffs that the US are thinking about putting on Europe, as bad as they might be, are actually not as bad as the effective trade barriers and other regulatory restrictions we have in trade with each other within Europe. And so there might be moves to change that. Actually, with Canada too.
So one thing that I think always surprising to people and surprised me when I first learned it is that Canadian provinces have trade barriers with each other. We got rid of that with the Constitution. They never did that. So they actually have big trade barriers with each other. There’s always some friction and conflict between various Canadian provinces about what they want to have go through each other’s borders and stuff. British Columbia blocking Alberta in oil exports or things like that.
And one of the things that might be changing in Canada’s response to this with the US– which again, it pains me as an American that we are doing this to our friends and neighbors. I think it’s really stupid and harmful. But it is interesting that Canadians are responding in part by saying, this is a chance for us to fix things in our country that we should have fixed 200 years ago and potentially removing those trade barriers. If you really want to find a silver lining to this, then they are there to be found. I still think that the net effect is negative, but it is certainly true there are positive– It’s not 100% negative.
Jeff: I think the silver lining may be a good place to end. Matthew Klein, his book is Trade Wars Are Class Wars. Matthew, I thank you so much for spending time with us here on the WhoWhatWhy Podcast.
Matthew: Thank you very much for having me.
Jeff: I appreciate it. And thank you for listening and joining us here on the WhoWhatWhy Podcast. I hope you join us next week for another WhoWhatWhy Podcast. I’m Jeff Schechtman. If you like this podcast, please feel free to share and help others find it by rating and reviewing it on iTunes. You can also support this podcast and all the work we do by going to whowhatwhy.org/donate.
