economy

What’s Happening Today?

Taken about 8:45 AM EST in the pre-market. In short, this is the PPI coming out hot. 2.9% annual inflation versus and expected 2.6%. For the market this is as bad as, if not worse than, the CPI coming in hot. If the CPI comes in above estimates, that just means rates might rise. But if the PPI comes in hot, and the CPI doesn’t, it means margins get squeezed. It means that for a $100 of revenue, it means less profit. If both CPI and PPI were going up, that’s not good, but businesses are able to hold their margins. As happened earlier in the inflation burst, CPI went up faster than PPI in some cases, and margins expanded.

That explains some of the impact. The other part of it is the idea that AI isn’t playing out the way people hoped it would. We are seeing a concerted push by companies to adopt AI and (despite the protestations of $XYZ – Block), we have yet to see significant changes in productivity. There may be reasons for this that have nothing to do with AI. First and foremost, it’s a new technology. The “recipe” for mixing it into an organization to boost productivity and reduce costs may need to evolve. With a lot of churn, it’s hard to know if chat bots, RAG (retrieval assisted generation), or some yet undiscovered pattern will produce the best outcome. One that doesn’t give away free stuff from vending machines or cite non-existent cases in court filings. (So, how much do you want to trust an LLM to correctly categorize a major business expense that could cost you in interest an penalties?) But until we do it looks like NVidia may be the only winner as they sell more GPUs to companies that may not have the electrical grid power to turn them on?

But let’s get back to macro. Long rates are dropping, but the 2-year is kind of holding in a range. These are bond price futures, meaning when they go down, interest rates go up. (The price of a bond is the inverse of the rate). The bottom two are 10 and 30 year bonds, respectively. Businesses are generally sensitive to the 10 year rate. Prices were falling on the 10 and 30 up to February, ,while the 2 year stayed in its trading range. (I kind of compressed the 2 year graph to give a better sense of how little movement there was in the 2-year, given a similar $3 range in the 10 year). The fact that long bond prices were going down, while shorter term maturities were stuck, meant that long rates were coming down while short rates were holding. (The shorter you go the closer you track the Fed Funds rate).

A normal yield curve has the lowest rates for the shortest maturity debt. Everything beyond that carries more risk. These risks may be interest rate risks (the interest rate falls and so the price of your bond falls), or re-investment risk (the rates go down and you can’t re-invest at the same rate). There’s almost no risk at 30 days to 90 days. At thirty years, there’s almost a certainty things will be different and you might be underwater in your bonds or unable to secure a similar rate when the principal redeemed. The price of the bond is a negotiation between buyers and sellers about future interest rate risks.

When the price of long bonds start going up, it means that people are betting future rates are going to be lower. This is because they expect lower demand for capital in the future – likely because the economy is slowing. A rate inversion, when the rate on the long bond falls below the short rates, is a sign investors expect the economy to be in recession so rates will be reduced to stimulate the economy. That’s why we get yield inversions, and why they tend to be at the start of, or just in front of a recession. Also, in most cases, the short term rates go up because the Fed has been slowing the economy. This last inversion period was both large in scope and did not result in a recession, so far1. (And there won’t be as much borrowing to invest in new businesses). What you want to see is the entire yield curve (the interest rates at various maturities) move down together. Lower rates plus strong future expectations.

Which brings me to this graph, the balance of payments (trade deficit). If you eye-ball a line across the graph, between -60,000 and -80,000, you probably have close to the average trade deficit. Then you have “Liberation Day” in April and a huge spike. What’s that about? Those are businesses bringing in inventory prior to the tariffs taking effect. That inventory was spent down in the next few months, as businesses imported less because their inputs were sitting in warehouses. At some point they are going to have to bring in more product, and that’s why I think we’ll be back to roughly the same (maybe a hair smaller) trade deficit. We’ll have to see how it plays out, but the last reading was in line with the historical average.

That suggests that businesses are continuing to import final goods and inputs for their manufacturing at nearly the same rate as before the tariffs. Some businesses elected to eat the tariffs (note it is businesses that pay tariffs, not governments) rather than pass those costs onto consumers. They were assuming the tariffs would get rolled back and it’s better not to piss off your customers. They might even get refunds. But given the number of businesses that sold the refund rights to Lutnick’s kids at 20 cents on the dollar (yes the same one working for the president as the secretary of commerce), I don’t think they held out high hopes. We’ll have the lovely spectacle of the commerce secretary’s kids suing the federal government for refunds of illegal tariffs imposed by the administration, which they scooped up at bargain basement prices. Ain’t corruption grand?

If businesses are importing as much, and they are paying higher prices, and they have spent down their inventory, we might FINALLY start seeing the consumer level inflation impacts of tariffs. But we’ll first see it at the business level. Businesses have eaten the tariffs, for now, but will either suffer lower margin or start passing on those costs. That means businesses will start cutting costs to deal with tariffs and the easiest way to cut costs is to reduce head-count. When people no-work they no-spend. Block’s hope is the reduction in headcount (maybe over-hiring a few years ago), will result in better margins as costs fall, even if revenue falls. But, like I said earlier, there is no clear indication we’ve figured out how to incorporate AI into businesses or operate an AI provider profitably. It’s all subsidized by giant pools of investor money.

If you expect a softer economy (not radically expecting recession tomorrow), you want to hedge your risk (equity) exposure by buying bonds. Foreign companies have become a lot more wary of buying bonds, except there is no other currency with the depth of the dollar. And therefore US debt is still attractive. (TINA – there is no alternative right now). If short rates hold up because inflation actually starts making its way into the consumer market (not in one quick burst but trickling in as business after business has to raise prices), and the Federal Reserve can’t cut without resuming inflation, you should expect the economy to slow. By how much? I don’t know, but I would not expect long rates to stay where they are. I expect them to come down, or there is an increase that the Federal Reserve would need to step in by shoving liquidity into the system.

The two year has been betting the interest rates will stay about the same. Until February, the long rates were making similar bets (or maybe a little AI optimistic combined with nervousness about the Fed forced to cut rates combined with dollar de-risking). They were holding or going up slightly. Now they’re falling, compressing the yield curve. At the same time business costs may be going up. With a Fed that can’t immediately inject liquidity until the economy gets a lot worse. What a lovely little shit-show we’ve built.

This is not investing or investment advice to you, or anyone. It’s is provided for your entertainment purposes only. And if you are investing, contact a professional before making any decisions. Buying and selling stocks, futures, or any investment is a risky activity and can cause you to lose money, including the principal which you invest.

  1. It may be the ONE TIME that the Fed slowed the economy but didn’t throw it into recession. The so-called soft-landing. Something I did not think could be done and therefore missed out on some returns (albeit at a higher risk). ↩︎

What Are You Looking At?

This is the “cash” index ($SPY) for the S&P 500. That’s different from the index that most people look at, which is actually the price of a futures contract on the S&P 500. The price action is a little different, but not radically different. But the S&P 500 that everyone talks about in the news is actually an expectation of the S&P 500 price in the very near future, traded almost continuously. So there are fewer gaps in the price action. The cash index primarily trades during normal trading hours in the US. The chart below is the futures contract and is smoother, with fewer gaps, but it’s basically the same movement.

But what is it really? It’s the behavior of the 500 companies included in the index. The 500 best companies? The 500 most representative companies? The 500 largest companies? Yes and no to all of those questions. These companies fall into sectors: technology, consumer cyclical, consumer defensive, financial, communication services, healthcare, industrials, real estate, utilities, energy and basic materials. From the heat map below you can get a sense of their relative size and how they’ve performed over the last three months. Sorry, if you’re red-green color blind, but for squares that are large enough, you get the percentage change.

We have different stories about the expected behavior of the sectors under different economic conditions. For example, during a recession, when people are losing their jobs, we expect consumer defensive stocks to hold their value while consumer cyclical stocks to fall. And if we look at the 3 month performance, we can see that defensive stocks have out-performed the aggregate cyclical stocks. These stories aren’t perfect, like maybe TJ Max (TJX) is doing okay because people are bargain hunting more, and maybe McDonald’s (MCD) is doing better because people can’t afford nicer restaurants.

We’ve had a set of contradictory stories. Financials have hit hard, and consumer cyclical and communication services and technology have been meandering to falling. That suggests a slowdown. But material providers, energy, and industrial stocks are rallying. That suggests the early part of a recovery after a recession, when output is picking up. And consumer defensive and utilities are doing great, which is a sign of a slowdown.

What might be going on? I suspect there are two sets of behaviors. Part of the behavior can be ascribed to macro-economic movements and part can be ascribed to idiosyncratic movements. Idiosyncratic is really a short-hand way to say the fish is swimming upstream for a different reason than the current is moving the rest of the fish down stream. I think, in part because the yield curve may be flattening, that the market is anticipating an economic pullback.

That explains the behavior that utilities, financials, consumer cyclicals, consumer defensives, technology, and communication services are exhibiting. I think any strength in technology is coming from the AI bubble. The AI bubble is powering some of the industrials, along with a re-arming of Europe and a possible expansion of the defense spending. The policy chaos and dollar de-risking explain energy prices and basic materials. If the dollar de-values, then the price of commodities and energy will increase for American consumers. If the dollar falls, without doing anything, Exxon Mobile (XOM), Chevron (CVX), etc. will make a lot of money. As will miners.

So here’s the score card. The long term bet being made by most investors appears to be for a weaker economy. That’s not certain. They can be wrong. But that’s what most of the sectors are telling me. (And therefore I could be wrong). My confirmation is that maybe the yield curve is flattening. (But I could be wrong). The dollar is expected to weaken (as per official US policy), and falling interest rates will further weaken the dollar beyond the chaos that is driving countries away from the dollar. That means energy and basic materials have a tail wind. Until such time as we demand less energy because economic activity slows down, and even then we could see prices increasing on net.

Anyway, that’s how I square the circle.

And this is not investing or investment advice to you, or anyone. It’s is provided for your entertainment purposes only. And if you are investing, contact a professional before making any decisions. Buying and selling stocks, futures, or any investment is a risky activity and can cause you to lose money, including the principal which you invest.

Why Silicon Valley Isn’t Freaking Out About China

“The Looming Taiwan Chip Disaster” asks a question many are wondering. If China blockades and invades Taiwan, what is Apple going to do? It gets many of its chips from Taiwan and TSMC manufactures its very custom CPU. A blockade or invasion would cut Apple off from TSMC. That would be the end of Apple products, right? So why haven’t Apple and other Silicon Valley companies diversified out of Taiwan to at least have capacity in the United States. Let me tell ya… business idiots are beyond your tiny brain. They understand a broader, global picture that they have to carefully consider. They had a great press event in the oval office to announce a lot of stuff about sexy advanced chips. They even gave Trump a gold thingy for his desk. They’re saying things and doing things you can’t understand. So let me help break it down for your tiny (non business idiot) minds.

First, let’s start with a larger problem, that you can’t just fabricate (fab) a CPU and you’re done. This is part one of that problem, and it’s packaging. Once the silicon is etched and cut into separate chips, it needs to be packaged. This is not just slapping a bunch of plastic or ceramics around the chip. A poorly packaged chip will show problems that prevent it from operating correctly. And modern packaging is a far cry from the 1970s DIP modules, pictured below. A DIP packaged chip might have 40 or so connections. A modern chip can have hundreds of connections. And it may be housed in the same package with other chips, either support chips, or because they’ve adopted a chiplet design to improve yield (number of successful chips on one 30 cm wafer). Packaging is done in Taiwan and because it isn’t sexy, no one focuses on it. Without packaging, you have nothing. And chips etched in the US have to be flown to Taiwan for packaging. If China invaded tomorrow, and all the etching was done in the US, we would still have to fly the chips over for packaging.

Next part of you can’t just fabricate a CPU. A computer isn’t a CPU. There are other chips on the motherboard that control various features. For example, there’s a chip that controls the attached drives. It’s actually a little CPU in its own right, likely running a variation of Linux. Then there are chips to manage the power through the system. These are not simple voltage regulators, they are programmed to ramp up and down the current to keep the CPU running efficiently and cool. You likely have chips to handle all the slow speed IO, like USB ports. That’s not done directly by the CPU, there’s a separate processor for that. You can’t just make the CPU in the US and make a computer without all these other critical chips. Most are made in Taiwan, some in Japan, some in Korea, and some in China. That’s right, you already can’t assemble most electronic things for the US without Chinese made parts.

Next, you have to understand that Apple would buy chips from China. And so would Google and HP. If China took Taiwan tomorrow and the option was to go under or buy chips from a now Chinese controlled TSMC, Apple, Microsoft, Google, Meta, or whoever would buy the chips. Even if it meant entering into agreements that require more of the design to be done in a Chinese controlled company that would rip off the IP. Because going without sales (and maybe going under) is worse than maybe losing some US government sales. Plus, the US government will come around when there’s no option. In fact, it might make some things easier and they make even more money in the short term. If you go to these companies and say it might cost you a little bit more, but you insure your supply from being cut off, they would choose not to spend a little more. They will just assume they can continue with business as usual, buying chips from a Chinese controlled Taiwan. And they’ll be happy to do it.

Related, is the executives won’t believe it. Just as the Ukrainians didn’t believe the Russians would actually invade, and it was just a war game, as the Russians were setting up field hospitals on the Ukrainian border to treat the expected wounded, these business idiots don’t believe it will happen. I don’t even think it entered Tim Cooks little pointy head, as he sat through a screening of “Melania,” that China views the situation with anything other than a money lens. That’s because, like all business idiots, he views the world in a money lens. Why would China do something that would cost them money? The idea that China has felt humiliated and carved up by the West and this is about national pride is alien to them. Pride? If it costs you money? Tim Cook sat through a screening of what was essentially a bribe from Bezos to Trump to protect his money. Executives periodically line up, lips puckered, to pull down Trump’s piss-stained shorts and kiss his un-wiped ass. Money good. Must get more money. Corruption make more money faster.

For all these reasons, until China invades Taiwan, US tech companies are going to do a goddamn thing. And when China invades Taiwan, they will happily license their IP (their chip designs and process documents) to the Chinese controlled TSMC. The fact China will cut them out of the fucking loop once all the IP is stolen is lost on them. Just as they have done with every step of the way so far. Just as China is learning to cut Western designers out of other products. Why would you buy something at a premium, just because it has a Western label on it, when you can buy from the Chinese factory at a discount? Why would you buy an US branded computer when all the chips come from China, and it’s manufactured in a Chinese factory? It’s not like they’re going to get payback for the US putting spyware into the US networking gear bought by Chinese companies.

Once upon a time, there was a thing called the Marshmallow Test. You take a preschool aged child into a room and tell them if they don’t eat the marshmallow on the table, they’ll get that one and another one later. The idea is to see which kids will become doctors, lawyers, and CEOs, by delaying gratification, and which kids will scroll Tik-Tok and scratch their junk for a living. It turns out the whole thing was bogus, but it made a lot of parents try this at home and weep to see little Johnny gladly stuffing the first marshmallow in his fat little mouth. No delayed gratification. No future. Delayed gratification is not what business idiots learned. They learned to demand more marshmallows or else they’ll stop going potty in the right place. Just as they’ve learned to demand tax breaks, guaranteed loans, or other inducements to do the right thing.

If you think you’re going to get Tim Cook to buy a US made chip for his Macs or iPhones, well… he might. He might buy some from a Fab in Arizona to kiss Trump’s fat ass, ship them to Taiwan to be packaged, and then off to China to be assembled into an iPhone. Because Tim can’t package the chip in the United States. Nor can he make all the other parts of an iPhone in the United States – as just a practical matter. And as far as he’s concerned, it’s just keeping Trump happy. Just like he goes through the press conference (along with many tech leaders) announces a bunch of stuff but does nothing. Just like NVidia was supposed to invest 100 billion… I mean 30 billion… I mean up to 30 billion in OpenAI1. Business idiots just say words that have no meaning. He will do the bare minimum necessary to keep Trump happy so Apple doesn’t have to worry about the administration lobbing trade bombs at Apple. He will make the bare minimum number of chips in the US, though parting with that extra nickle every iPhone makes him weep.

Note that this story from Forbes does not invalidate my point. They will likely have US workers shove motherboards flow in from into a case and call that American manufacturing (because, remember, other parts come from other parts of Asia, including China). On their lowest volume product. And a vague promise for other stuff. All so they don’t have to pay a significant tariff on iPhones (their highest volume product).

  1. Note that $20 in McDonald’s gift certificates counts as “up to 30 billion.” ↩︎

What’s On Tap for This Week

This is going to be a light news week.

Tuesday – Case Schiller home price index.
Friday – CPI/PPI data

The other thing to watch is who is filing for refunds for tariffs paid. There are two levels of tariffs at play. The first are the tariffs in place before we started this descent into stupidity, and the yo-yo tariffs that have come on and off since “Liberation Day.” There is an orderly process for refunds, but not everyone is sure these refunds will be orderly. It may result in a class action suit to compel the refunds, but we’ll see.

CNBC estimates about 175 billion subject to refunds. That’s in line with other estimates from 130 to 175 billion. That’s considerably less than the additional tariff revenue collected since April 2025. That’s because the other tariffs were under different laws, which are still in place. For example, if there’s a finding of an unfair trade practice, a different law is applicable. The process under those laws requires some additional work. Whether it’s all kabuki theater or it will be done in good faith, I can’t say. (Despite my suspicions). I’m not an expert, but my guess is the section 122 tariffs (the sudden imposition of a 15% tariff on “global” imports that expires in 150 days) will be a bridge to get all the paperwork complete for other tariff statutes.

That said, the random 100% today and 20% tomorrow and then 55% the day after tariff announcements were under the International Emergency Economic Powers Act. That’s what the Supreme Court said was unconstitutional, because under their reading, it did not grant tariff authority. Section 122 requires Congress to reauthorize the tariffs in 150 days. I think Republican support for that is far from automatic. That means going into Labor Day (when most people start to think about elections), Congress people would have to explain why they authorized more taxes on American businesses.

Senate Seats Up for Grabs

The ability for Trump to set up a primary challenge to House and Senate candidates will have been long past, and it will be the Democrat challenger that candidates will be the big concern for Republicans. If the administration wants section 122 tariffs (the 15% just imposed) extended beyond late July, it will have to convince the Republican House and 22 Senate Republicans to vote for it, knowing they will hand their Democratic opponents a blunt instrument which will be used to beat them, repeatedly. Or, they will have to explain why tariffs on French wine and cheese is a national security issue.

This is an administration that is threatening Netflix with “consequences” if they keep Susan Rice on their board, given Netflix needs government approval for their upcoming merger with Warner Brothers. Their willingness, and the willingness of the billionaires who are ideologically aligned, to use every legal and possibly illegal means to keep at least the Senate will be used. These people realize if the Democrats do come to power, they won’t retaliate in the same way the Trump administration will retaliate. A Democrat president will probable drag their feet on firing the partisan hacks, like Brendan Carr, when they get into office. So why should they care about what Democrats might do them, should power change.

Nor is it clear that the election will not result in massive chaos. As was evident in the 2020 election, claims of fraud went forward even though it (implicitly) invalidates Republicans that won down-ballot. They might have a Democrat win a House race, and a Republican win the Senate race, but still claim the vote was fraudulent. And the 40% or so of the country that’s “ride or die” with Trump, they may even be more amped up than 2020. Along with the fact social media execs have shifted right, ff not captured by a system of patronage, that suggests they’ll be protected if they help Trump. For example, showing they are willing to exempt Apple ICs from tariffs, but also “mentioning” that Apple News appears to favor a left-wing liberal agenda.

2026 is not in the bag for a Blue Wave. Nor is 2028 in the bag for a transfer of power. At this point Trump is still respecting the decision of the courts, if only grudgingly, and sometimes completely with contempt. If the energy is to impeach and prosecute him for stealing billions of dollars (for example, transferring US funds to his board of pieces of shit), he may pull off the last guard rail. A lot of his supporters among the elite are not ride or die. They know they may not go to real jail if caught for criminal activity, they may lose a lot of money. But if the deal is better to back Trump over the US constitution, they may back Trump.

I would like to think that between tariffs and immigration enforcement Republicans would be handed a soul-searching political ass-pounding. But social media feeds can have an insidious impact on political opinion. Just like Tik-Tok’s algorithm fed several many times more images of murdered Gazans than murdered Israelis, and helped from the initial push for protests of Israel. Then Israel managed to provide more than enough reason to protest their invasion of the Gaza strip and continued occupation of the West Bank. But that’s for another day. The point is, that among Tik-Tok users, those videos were very effective. And I think, with the transfer of Tik-Tok away from China to Trump’s friends, I think the feeds will be manipulated to stunt what should be an epic smashing.

A side note if you think other governments pay tariffs. You are ignorant. Many people have explained how tariffs work and it’s the company importing the good or service that pays the tariff. Since China doesn’t import anything into the United States, it’s US companies like Wal-Mart that import Chinese made goods, it’s the US company that pays the tariffs. There are so many explanations of this around that if you don’t understand it, you’re a fucking idiot.

On Tap for This Week

This week is a lighter week.

  • Monday – Markets are closed
  • Wednesday – Housing starts and FOMC minutes
  • Friday – GDP

Housing starts I don’t think are as critical as they once were. It used to be that sales of houses were tied to a lot of other economic activity from buying new furniture to updates to existing homes. It used to be more a headline number and market mover.

Here we see the last couple years of starts, compared to the historical numbers for housing starts. Although housing remains unaffordable for many, we don’t see a huge increase in starts over the last three years. From the chart above, we can see a jump shortly after the COVID lockdowns, but nowhere near enough of a bump to deal with the lack of housing created after 2008. And if you have to ultra-stretch your budget for a house, that doesn’t leave a lot for new furniture or trips to Home Depot.

The FOMC minutes, however, will be interesting to see. We’ll get a view of how hawkish or dovish the over-all committee is. And remember, even if Trump installs a rate-cut happy lunatic as Fed chair, that lunatic doesn’t set policy. It’s voted on by the full committee. Which is why Trump is testing his ability to fire other Fed members. In the presence of tax cuts and proposed spending increases, a Fed that cuts rates will be adding stimulus on top of stimulus when the employment rate is in the range of full employment. Which would attack the debt level by devaluing the dollars in which the debt had been issued. But then interest rates (should) climb, or the dollar (should) fall to offset the devaluation of the dollar. When the dollar falls, oil and other commodities climb in price, pushing more inflation. And there is no guarantee that the increase in wages would outpace inflation. We would almost certainly all be worse off.

A quick note for folks that think 0% unemployment is full employment, that’s not how it works. Inflation has a statistical relationship with unemployment known as the Philips curve. Below a certain level, like 7% unemployment, a decrease of 1 percentage point of employment has no impact on inflation. At lower levels of unemployment, a 1 percentage point decrease in unemployment drives higher inflation. Why? Because when the labor market gets tighter (and everyone is immediately swept up into a new job), companies wind up bidding up wages to attract workers.

Those workers have more money for cars, food, vacations, and so on, and that drives inflation from the demand side. Also, as wages get bid up, more workers come off the sidelines into the workforce. These range from moms who no longer see it economical to stay at home, or retired people seeing opportunities, or people who left the job market to write a cook-book, etc. You can get a month to month increase in unemployment as these people come back into the workforce, while having a very tight labor market. As we pushed down toward 3% unemployment post-COVID, that contributed to an increase in inflation. It was great because everyone’s salary was jumping, but few people feel it outpaced the impact from inflation.

A Not So Quick Note on Jobs Report

The fun thing about the jobs report is re-interpreting it to better suit your political leanings. “Yes, but they’re not good jobs.” Estimates were in the 70k ballpark and the number came in at 130k. There was also slight wage inflation. This makes a rate cut less likely in the next few months, Warsh or no Warsh. The bulk of the jobs came in health care and education, with the government losing jobs. We’ve been assuming that the interest rates have been a drag on the jobs market but the economy may have adjusted to having any number other than zero as an interest rate. In fact, there’s a case for an interest rate increase in the coming year.

  1. The last mile on inflation is sticky, which may mean rates are not high enough.
  2. If the economy is expanding and pushing up wages at 3.5% funds rate, the neutral rate may be higher.
  3. Inflation may accelerate if GDP continues at its current clip and wage pressure continues to rise.
  4. Aggressive spending (like a 45% increase in the DoD budget) may fuel more inflation.

But here’s the thing. Don’t read too much into one report. Next month could surprise down by 50k. Who knows why – there are some long-standing data collection issues. The numbers will bounce around, especially as they get revised. There’s the table of year end revisions to the 2025 reports and it’s illuminating.

We created (revised) 181k jobs net last year. Maybe the yardstick of over 100k per month for a growing economy doesn’t make sense in a country that may start to experience population declines (as we shut off the immigration flows). That’s been the number I’ve used to evaluate jobs reports, but net migration to the US (by policy) is intended to be zero. We’re not fucking enough to make enough new kids. In fact, if the population isn’t growing, and it’s just aging. Wouldn’t slight job losses, but more jobs concentrated in healthcare, be a good jobs report? Maybe the yardstick should be net zero jobs near full employment? And only shrinking and growing during recession or post-recession recovery?

As I think about this, I start to think about the elasticity of wages with respect to growth. Once we push up against full employment, wages need to rise to get more workers into the job market. How much do wages need to rise once we get more workers into the job market? If we go from 4.3% unemployment to 4% unemployment (very low, historically), do we see wages shoot up enough to drive inflation? But if we get not much more slack than 4.5%, do we see wages falling? That would suggest wages are inelastic with respect to employment near full employment. I suspect the same isn’t true in a recession, if unemployment spikes to 7% or 8%, and much smaller (if any) increase in wages are needed to bring down unemployment. We go from having a Philips curve to a Philips hockey-stick.

It also has some implications on growth. A shrinking population suggests that growth that’s slightly too fast results in inflation. With a growing population, part of growth simply goes to absorbing new workers. You need to grow, otherwise you quickly accumulate large masses of unemployed people. And I suspect it favors younger, less experienced workers, as you can hire more of them to replace older workers. They are cheaper and plenty of them. But what if a shrinking population size makes you risk averse, preferring to stay with proven workers rather than bringing in new, lower return, unproven workers from a smaller (and therefore not much cheaper) pool? Maybe that’s why Europe has had a persistent youth unemployment problem?

Hear me out on this brain fart. In a fixed population (or shrinking population), you basically trade one worker for another. When Bob retires, Alice steps in. You knew what to expect with Bob. Bob was very well trained. In Bob’s cohort, unemployment is like 2%. To balance that, in Alice’s cohort, unemployment needs to be higher, say 10%, so on average, we have that magic non-inflationary level of unemployment. But Bob is old and Alice is young. Alice would be much cheaper, if we had a larger pool of Alices than Bobs.

But there aren’t a ton of Alices sitting at home, vaping and playing Call of Duty. Alice is a risk. You could bring in Alice, train Alice, and then lose Alice as she’s offered a better job by your competitor. In addition to the fact you need (say) 1.5 Alices to equal one Bob until Alice gets a few years of experience. Whereas they are not likely to poach Bob, and Bob would probably not get a better deal if he moved. You have an incentive to hold on to Bob and only hire Alice, if Bob leaves. And if one Bob leaves, a slightly younger Bob would be preferable.

Once Alice’s cohort comes into jobs, their unemployment also drops to some low number. But in order for that to work, the unemployment among new workers has to stay fairly high. Maybe I just made a realization labor economists have known for years. In any case, I think we’re going to have to get used to flat jobs reports and more of our workforce moving into healthcare. Otherwise you wind up with inflation pressure and Boomers dying on the side of the road.

How to Weaponize Your Own Mess

What links the working class elements of Brexit and anti-globalist American right is a belief the world order has exploited them. The messaging and thinking isn’t precise, because these are not informed opinions. David Ricardo has been right for the last 211 years, from 1815 to today. Trade makes both countries wealthier. What Ricardo didn’t say is how that wealth would be distributed (although I think he assumed it would be a broad lift in living standards). Also implicit in the reasoning around trades is that other aspects like environmental or human rights protections would be respected. In the ideal view, one country doesn’t become the efficient supplier of a good because it’s willing to work enslaved people to death in toxic conditions.

There’s an old economics joke. Stick your head in a 400 degree oven and your feet in liquid hydrogen. On average, you’re fine. A lot of inequality is elided away in mass averages. It comes to light when we break these statistics into quintiles, quartiles, or the top/bottom X percent. There are are so some synthetic measures, like the Gini co-efficient for the US is 41 while 29 for Germany, while the GDP per capital in the US is about 90,000 while Germany 57,000. On a per-capita basis it’s better to be an American. But the likelihood that you share in that wealth is lower. It’s kind of like people wax poetic about medieval times but forget that in all likelihood they were a peasant working as a near slave for the feudal lord.

What has happened in the UK and the US is that the distribution of benefits from trade have not been distributed evenly. There was a belief that the system would work it out in the end. You lose your job in the industrial North of the UK or the rust-belt of the US but something else comes along. Like you leave the assembly line and start designing AI accelerator chips or turn to writing software. In fact, what was needed, was a re-distribution of wealth by the state so the benefits of globalization were more evenly distributed. By the way, the Gini coefficient for the UK is about 35.

The benefits of trade were delivered unequally, benefiting capital more than labor. That capital also became militant about not raising taxes or wealth redistribution. After all, are you advocating for class warfare by asking billionaires to pay a reasonable tax rate? Why do you want to tear society apart this way? Go back to your squalid little pens and rejoice in the social order, you troglodytes. Oh, and breed more little troglodytes because we’re running out of consumers.

It cost Bezos a mere 75 million to produce the Melania movie as a not-so-under-the-covers bribe to the Trumps. That money was found when Jeff turned his couch over and collected what fell out. That’s how much money he has. He has been a principal beneficiary of freeing trade and intends to keep every red cent he’s ever earned from it. For Microsoft or Apple to put up money for vanity projects like the destruction of the East Wing of the White House to make way for a gaudy ballroom, it is not a sacrifice. These are companies that don’t worry about millions of dollars. That is a rounding error in their day to day change in capitalization, and the personal wealth of their founders and leaders.

But… But… But… Look at the tariffs! Those are anti-trade. True, but you also need to look how they’ve been turned into a patronage system (by offering individual companies a way out in exchange for obsequiousness or out-and-out bribes), and the loopholes and exemptions lower the effective tariff rate. But for the Trump backers, it means they will pay a lot less money in taxes. If a Harris presidency might mean an extra 50 million in taxes, spending 5 million on PACs is a reasonable investment. Which is how the rich view politicians. As investments. In fact, they got a boon with Trump.

Those same people who benefited from trade. Who were the main beneficiaries of the 2008 bailout, and seemed to wind up with the lion’s share of the COVID stimulus, have weaponized far right parties to prevent any attempt at redistribution. Making people so angry they put the party of the oligarchs and plutocrats in power is a master-stroke of genius. And all the while absolutely castrating the opposition, who is just as needful of their patronage. They are like the clever player that starts the NPCs combating with one another while they watch and plunder the resulting treasure. Exploiting the lack of social cohesion, and the politicians desperate for money, keeps them in effective power and keeps their money safe.

Before you start reaching for the revolutionary pitch-forks, keep in mind that a bulk of these folks seem to survive each revolution. They are the cockroaches during upheavals. Whether it was the Russian revolution, or the French revolution, or the American revolution, a lot of these folks wind up on top. Our best bet is not revolution. It’s putting aside our emotions, our clever memes and slogans, and our sense of “team” to actually look around. Using our clear-eyed view of the world around us to vote for change. I don’t expect a lot from Mamdani, but he is the result of the ‘establishment’ left foisting an unpopular candidate that preserves the status quo. People gave the establishment left the great, big, stanky middle finger rather than support a sex pest.

Take in the world with a fresh eye. Look at the fact Amazon and many other companies benefit handsomely from trade, that trade will bring in wealth, but maybe that wealth shouldn’t be concentrated into so few hands. Look at the private equity players who purchase companies with debt, load those companies with more debt, sell them, bank their proceeds as capital gains or income, to do it all over as those companies declare bankruptcy. Minting their income through debt, massively reducing their tax burden, but in the process devastating the lives of millions of individuals. And realize they’re the ones priming the coffers of groups like the Heritage foundation.

At the end of the day, nothing changes until we change. We continue to be the NPCs screaming at each other about this or that issue, while the players sit on the sideline and laugh. Red team versus Blue team, while the green players reap the rewards. If you want any better evidence, in the first Obama administration, the democrats had both congress and the White House could have easily fixed the loophole that allows private equity partners to earn their money at a top rate of 15%. They did not. Because the private equity partners are the people the phone banks staffed by your congress person call to raise money. Now those same groups have decided their future money interests are better served in an autocracy, and they’re using the misery of millions of Americans to do that. A misery they created in the first place.

Tech Bros Are Going to Lose Europe

The Guardian asks. First off, it’s not that the European version of these services do not exist or need to be built from scratch. But that’s not the reason to switch. Until now, US elections, even 2016, produced reasonable outcomes for Europe. Now they have an agent of chaos more than an ally. A country that foments division among its alliances and has stated that a weaker Europe is in American interests. And so much of their communication is funneled through American companies. Companies that have shown a willingness to cooperate with an administration that shows a willingness to use the levers of government in a retaliatory manner. This retaliation could be illegal, but there has been little interest in the Republicans to stop it and there seems little ability (either talent or power) for the Democrats to put an end to it.

Even if the cost is a little higher (with the US being the low cost producer), it is the insurance you pay for having a functioning society. For the same reason you might choose the Grippen over the F-35. Maybe have some F-35s, along side a mix of other fighters. Should the relationship with the US result in a suspension of the contract for maintaining the F-35, or the US out-and-out prohibits their use in the defense of Europe, there is a plane Europe can fly. The resulting insurance against being effectively disarmed by America may be worth additional cost. As would be securing broader sources of many products and services.

But let’s say the 2028 election produces a left-of-center Democrat who is able to assume power. What is the guarantee they don’t pursue some of these policies because of political expediency? There are many instances where a policy unpopular with the winning voter coalition are continued. There is no guarantee that the new administration drops those policies on its first day in power. And what if it loses power to the ideological continuation of the Trump administration? What happens if, in four years, Marco Rubio decides it’s better to rule in hell as a populist autocrat than to serve in heaven? At this point, from an outside observer, I would imagine even Donald Trump Jr. would not be an impossible outcome in 2032.

But there is something coming with AI generated search results I think Europe underestimates. They can be primed to deliver answers that promote division and fringe movements. This could include AI summaries of documents or the generation of material from AI. These could be over-the-top, cringe inducing, obvious trolls to very subtle wording or choosing what information to present. And should Europe complain, threats of tariffs or outright cut-off of these services follows. Or EU leaders are sanctioned and cannot access their digital (or financial) assets.

So yes, Europe needs to figure out what would help. Making it cheaper to start businesses in Europe? Sure. Ensure these companies have guaranteed revenue through government contracts? Maybe. Changing the laws to withdraw from the anti-circumvention features foisted on the EU by previous trade negotiators? That’s a good idea. If Apple threatens to cut off iPhone access to the UK, for example, return the favor by making it legal to jail-break your iPhone and install alternate services. Tax the profits of tech companies to help pay for it? Even if you wind up taxing your own tech companies, the money might come back to them in other grants or contracts.

Right now the US companies have market dominance. Let’s say they have 95% of the office software market. The EU shouldn’t try to retake the 95% at once. It should just focus on reducing dependence on the US to 85%. From 85%, 75% feels possible. Because a lot of tech is based on network effects, as other companies plug in to the services of other companies, each tranche becomes an easier target. Just start with critical pieces, like your ability to share documents securely and e-mail. And start with the easiest part to control, your own bureaucracies. At some point you’ll need to worry about other cloud services, or even the content on social media, but it will be from a stronger place.

PPI Came in Hot

What we have now is the PPI coming in a little hot. What I’m looking at specifically is core PPI came in hot. (Stripped of the more volatile components. This is what I would expect from tariffs. We tend to think of tariffs as impacting just end user commodities, like wine or automobiles. But it also impacts goods used to make goods, such as the input steel or the machine needed to punch that steel.

Is it really from tariffs, which would definitely be a competing factor. There are multiple mechanics at play. One is how sticky producers expect tariffs to be. If you see a TACO moment coming, or a Supreme Court about to throw out the tariffs, you don’t want to annoy your customers with a sudden price hike. Especially if the court allows you to recoup your tariffs from the treasury. You could eat the costs and burn down the inventory built up prior to the tariff being applied, hoping to replenish it in a low or no tariff environment. This strategy has a limited life span. We’ll know February 20, whether it’s a realistic strategy.

Next is the swiss-cheese nature of the tariffs. There are significant exemptions or carve outs that lower the effective tariff rate well below the statutory rate. Just ask Apple. You say it’s a 25% tariff but then exempt several sub-products or specific companies, meaning the macro effect of the tariff might be 10%.

Then we have supply chains re-adjusting. Some companies may have imported part of something from China, like the motor, castings from Mexico, shipped it up to Canada for paint and assembly, and then back to the US for the electronics, partly imported from China and assembled in Mexico. They might look at that machine and decide it’s better to just make it in Canada and pay one import tariff.

Next, some companies just paused imports for a while, meaning you couldn’t buy the imported thing, as they were figuring out how to file the paperwork for the product. Now they’ve figured it out or adjusted their supply chains and can now start importing those goods.

There are a set of reasons as to why the tariffs may have had delayed impact. And those impacts sit on top of the month to month noise in the PPI. That noise is a product of both problems in data collection (with respondents more likely to be late in their replies) and just variability in behavior. It could very well be that the tariffs would have had a more noticeable impact over the last few months, except for noise. Or this month is the aberration and the actual tariff impacts have been swiss-cheesed into a nothing burger. And as we get 12 or 18 months of data, it will become more clear.

Back Door Default

The price of gold used to be fixed as a matter of law. The price for gold was set by the US at $20 an ounce. A one ounce gold coin was worth $20. During the depression, Roosevelt raised it to $35. That was not the same as a default on US debt. But it was a default on US debt. The day before the change you could trade $20 for an ounce of gold and an ounce of gold into French Francs. The day after, it would take $35 to buy the same amount of gold. Since the Franc had not been depreciated, it meant you could buy fewer French Francs. But international trade and finance was much smaller in 1933. If you were an American sitting on a pot gold, you were suddenly 75% richer, but you were forced to sell your gold to the US government at the stated price.

Within the United States it meant the Federal Reserve could print more money, as the same amount of specie backed 1.75x the amount of dollars. (At a time when the supply of dollars was fixed to the amount of gold held by the government). In addition, it made US exports cheaper, as the same amount of French Francs netted your more dollars to buy American made goods. The United States continued to pay the coupon on their debt. But, could do so with cheaper dollars. If I recall, this was eventually ruled by a court as a default, but it wasn’t a default in the sense you stop paying your bills. You just made it easier to pay your dollar denominated bills.

The US is a reserve currency. Meaning that instead of gold, countries are willing to hold dollar denominated assets (along with dollar deposits) as something freely convertible to Euros, Rials, Drachmas, Lira, or however the local Sheckel is denominated. There are few people or few countries that would not take the US dollar as they can sit on it or turn it over immediately for something else in a highly liquid market. And US issues government bonds are both dollar denominated and pay interest, accumulating more dollars. Holding gold as a reserve does not cause the gold molecules to generate more gold. In fact, the dollar gets more valuable when the Federal Reserve raises interest rates and more people demand more dollars to buy more US bonds. As long as the value of the dollar holds, the reserves are safe.

The problem is the United States is indebted to the tune of 125% of GDP (compared to Europe’s average 85% and Japan’s over 200%). There is no magic number that says X% of GDP is a threshold above which a reserve currency falters. And the rules of the United States (with the primary reserve currency) may be different than the reality for Japan’s Yen (when is in the ‘other reserves’ category). Since the US makes the dollars in which its debt is denominated, you don’t have a repayment risk like you have with, say, Argentina. Argentina can’t (legally) make more dollars to pay its dollar denominated debts. It has to trade real good for those dollars. Meaning a default and devaluation of the peso by Argentina largely makes the population poorer (as a whole) although some individuals (with big dollar holdings) richer.

This is why the analogy to a household budget or comparisons to Argentina don’t work with America. A household that could print its own currency, if widely accepted as a reserve currency, could borrow as much as it wants. Dad could buy a Mercedes Benz S class, promising to repay in “family bucks.” They family prints “family bucks” so repayment risk isn’t a problem. The problem is they flood the market with “family bucks” and the currency gets devalued. This also breaks down because the size of the market for US dollars is incredibly huge. It’s well beyond the needs of the United States, as China and Australia may use dollars in their trade (for example). It would be more akin to everyone everywhere using Family Bucks, so printing a few extra Family Bucks is not a problem. The market absorbs it like pissing in the ocean.

So the holders of US dollars and debt are perfectly safe, right? No, they are not. There are risks for investors. In order of my belief in their likelihood are devaluation through inflation, and a partial default. These are “cut off your nose to spite your face” solutions to America’s fiscal and social problems, but we have an administration that wakes up every day with a nose cutting cleaver in hand. Right now the world is searching around for alternate reserves. Gold has almost doubled in price in the last year. And as much as gold can skyrocket in value, it has also crashed. It is much more volatile than holding Euros or Swiss Francs. No sane person wants much gold exposure as a stable reserve, but the Euro and Yen aren’t ready to take over the dollar. So why are people moving away.

Let’s start with inflation, which I think is the more likely avenue. It’s not quite the same as the dollar being devalued against gold in 1933, but similar. Easy money and an inflation causes the value of the dollar to fall. For example, if you have 6% inflation, it will take about 12 years for goods and services to lose half their value. If you paid $30,000 for a car, in 12 years the same car would cost $60,000. (Your mileage may literally vary as different goods and services will respond differently). But it also means if you buy a 12 year bond for $1,000, it will only be worth $475 in current dollars at the time of redemption (when you get the face value of the bond back). By comparison, it would be worth $785 (in current dollars) if we stayed with 2% inflation.

When inflation risk is seen as a temporary aberration, interest rates do not move much. If bond buyers suspect sustained inflation they will need a combination of coupon payments an final redemption that is worth the risk. The US has no repayment risk. If bond buyers suddenly believe that inflation will be sustained and around 6%, they will pay a lot less than $1,000 for the bond. Or, if it’s a new bond, they will want a much higher interest rate on the bond. In the long run it is not a great strategy for dealing with debt. In the short run it is a way of reducing the value of the existing debt. But it would reduce the debt to GDP ratio as nominal GDP would expand much faster than real GDP. Inflation is up, interest rates are up, our exports are cheaper, and foreign imports more expensive.

As I’ve indicated, it’s assumed the US would always pay its bond interest and principal. (What actually happens to the principal is a new bond is issued to pay the principal). But the fact a default hasn’t happened in living memory does not mean it won’t happen tomorrow. The vast majority of US debt holders are US organizations or individuals. I hold some number of US bonds. But a portion are held by foreign governments, organizations, or persons. Sometimes it’s hard to determine if something is truly a “foreign holding,” but the government of France holding treasury bonds as a reserve is a pretty clear example. In this case, the nose severing instincts take over and interest payments to foreign holders are capped or stopped.

This doesn’t help with the over-all level of the debt, but the interest payments on that debt. It could cut those interest payments by as much as a 25%, if completely stopped. This would present a weird market situation, as a US buyer does not immediately see the value of their US bonds deteriorate. They bought the bond thinking a 4.5% rate was good enough for the next five years and that’s what they’ll get. A foreign buyer, however, sees an immediate impairment to the value of the bond. If they sold it to another foreign holder, that buyer would require a heavy discount on the bond. They would have to sell it to a US holder for the best price.

The destruction of value as a US bond holder would happen as foreign sellers cause the price of bonds to plummet and I need to hold to maturity to avoid a capital loss. Second, the foreign sellers would want to convert back to their local sheckel, meaning they sell dollars. They want to sell the US bond, for example, and buy Euro bonds or Korean bonds. (Japan is an interesting question right now). As they convert dollars to Euros, that drives down the value of the dollar and drives up the value of the Euro. This is another form of devaluation. Suddenly, our exports are cheaper, foreign imports are more expensive, interest rates are higher, but internally not much has changed.

Of course there’s nothing stopping them from pursuing both policies by destroying the independence of the Fed to lower rates and raise inflation, while capping foreign bond payments at 2%. Not to mention some bond holders may be afraid that if sanctions are applied for political reasons, as has happened to the ICC, they may not be able to access their reserves. In addition to the possibility the US economy may be impaired in the long term from civil unrest or a breakdown in the rule of law. In short, the once sober and boring US financial system is approaching shit-hole country chaos. That boring, law respecting, dullness helped make the US *the* reserve currency to hold in a world that has largely moved away from gold (other than a kind of last resort medium of exchange).

While the impact of import prices and export demand is not critical to the United States the same way it is for Germany (about 25% of US GDP is trade related versus 80% for Germany), it higher import prices are inflationary. US exporters would benefit, but would also face higher interest rates and higher prices for their input materials. Of course, all the US would feel the higher interest rates, driving up mortgage rates and car loan rates. I think it would be similar to the oil shock of the 1970s, which contributed to stagflation. In a strange way oil is like another currency (although you can’t hold it forever like gold). As the dollar devalued against oil, it helped stimulate inflation. (It was not the sole or primary cause – but it was a notable contributing factor). We might get stagflation or a recession we can’t spend our way out of (because of high debt levels) and nor can we stimulate using monetary policy (without risking hyper-inflation).

But at the end of the day, it only deals with existing debt. Newly issued debt would adjust to the new reality, with foreign holders seeking higher rates or avoiding the US. If we pursue either of these bad ideas (or some other policy that is effectively a devaluation that I’m missing right now), without reducing the persistent budget deficit, we will just wind up accelerating the slide to economic ruin. Not that it isn’t a long slide. There may be investors that still buy US assets, just ones that are inflation resistant and not bonds.

I don’t think people just switch to gold. For one thing there is the volatility of gold, which can have big swings relative to currency markets. Second, the supply of gold is fixed in the short term, meaning it’s possible to be unable to enter into a gold denominated transaction not because you lack the goods, but because no one can come up with the gold. This currency crunches would happen in the US prior to the adoption of modern banking and the Federal Reserve. People wound up trading scrip (IOUs) until enough currency returned to that region so they could settle the debts. It created unnecessary boom-bust cycles. But it can be recession inducing when these runs happen. What about 21st century gold? Crypto-currency is likewise fixed and even more volatile than gold, making it an even worse choice.

The current off-ramp may be the Euro, the Yen, and a basket of other currencies of other trading partners. It will likely need to be a diverse basked, since not everyone wants to hold some of these currencies. It will make transactions more expensive and balancing reserves trickier than it is today. And the dollar will continue to participate in that basket. It took decades for the British pound to stop being a widely held reserve currency from the time it was evident the UK was becoming a middle power. But it will mean the US will lose its cheap finance, its leverage, and its low interest rates.