What Next?

Predictions are hard, especially about the future. Paul Krugman has been trying to figure out what the hell is going on in financial markets. The reason it's been hard to say "This is what is happening" seems to be two reasons. The first is that so much of this is being driven by the chaotic nature of Trump and his decision making. It's just very hard to know what will come next. The second is that we have a limited number of historical case studies to model, and this one is kind of unique. Theories can be applied, but theories sort of depend on perfect information, and Trump is not a source of perfect information.

For instance, after the tariffs went into effect, we had what looks like a liquidity crisis AND a financial crisis. The really weird behavior of the bond markets and the strength of the dollar was what had economists confused. When stock prices fall, bond yields go down as investors seek safety. Instead, bond yields went up, because US debt wasn't seen as safe anymore, because we have a mad man as president. The dollar should also have gotten stronger, and instead it fell.

I have to wonder if this is a form of covert economic warfare, with European and Asian economies divesting from America's bonds and currency. This could be a decoupling from the dollar and US debt as the world's reserve currency. If that happens, it will have really negative effects on the American economy.

Stock markets have seemed to stabilize, because - as Nathan Tankus suggests - those markets are not so much processors of information as conventional wisdom. That would be Keynes' "animal spirits." Markets reacted favorably to Trump's tariff modifications, even though those modifications are pretty minimal. The overall tariff rate didn't really change, but it gave the impression that Trump was listening to market feedback, even though he launched genuinely insane tariffs on China.

It's the bond and currency markets that are still signaling that things are fucked. 

Back in 2008, we had the collapse of Bear Stearns in the early spring, but then we went through a weird few months. Gas prices spiked in the early summer. (My theory is that financial institutions were monkeying about creating a bubble in gas prices to restore balance sheet problems. It is only a theory.) Gas prices usually fall in a recession (like they are falling now). We had a few more smaller financial institutions like IMG go under that summer. Then September came and the shit hit the fan. Lehman fell and AIG nearly did. 

The markets were very imperfect predictors of the coming financial crisis, and I think the stock market is not going to be very helpful this time. The recession that is likely coming late this summer or fall will be a recession caused by these tariffs. In fact, the timing is fine, because while Trump will blame the recession on Biden, that will be untenable even for him, given that timeline. 

The idiots profiled yesterday said that they would be willing to accept short term pain for long term gain. 

They are lying. 

What's more, what they see as short term pain is barely above normal inflation. They are OK with prices rising 4%, wait until they spike by 10-15%. Wait until store shelves go empty. The long term gain they think they are getting - increased manufacturing jobs and "respect" - aren't going to happen either. If the bond and currency markets are seeing a massive sell-off of US debt and currency, then that's a clear sign of people not respecting us! The jobs aren't coming back because no one actually wants to do them. 

If the midterm elections were next month, I think Democrats win the House. If we have a full bore recession this fall, they will win the Senate in 2026.