President Trump vs. Economists on Tariff Predictions

WSJ: Why Everyone Got Trump’s Tariffs Wrong 

Economists were right that Tariffs would push up inflation (it went up slightly) and have little effect on the trade deficit (it didn't move much).  President Trump was right when he predicted they would raise a lot of money.

Are we in a stock market bubble?

NYTimes:

Preview of 7th edition: As of late 2025, the U.S. stock market’s cyclically adjusted price-to-earnings (CAPE) ratio has climbed above 40—its highest level since 2000. The CAPE compares stock prices to a decade of inflation-adjusted earnings. In principle, valuations should mirror the present value of expected future profits. High CAPEs can be justified if productivity and earnings growth from artificial intelligence and other innovations materialize—but if those expectations falter, prices tend to revert toward long-run earnings. As of October 2025, the CAPE stands near 39.5, more than double its historical average of 17.

Re-shoring as a response to tariffs?

Google on the re-shoring response to 2018 Appliance Tariffs:

In response to the 2018 U.S. tariffs on washing machines and other appliances, both LG Electronics and Samsung shifted manufacturing operations to the United States, effectively reshoring some production. The tariffs incentivized these companies to establish or expand manufacturing facilities in the U.S. to avoid the tariffs on imported appliances.

...The tariffs were credited with creating 1,800 new jobs in the U.S., but also raised consumer prices by an estimated $1.5 billion, according to one study. The study also concluded that the tariffs resulted in a high cost per job created.

Re-shoring of Nvidia Chips in response to 2025 Tariff threats:

Contract chipmaker Taiwan Semiconductor Manufacturing (TSM) has started production of Nvidia Blackwell chips at its plants in Phoenix.

Contract assemblers Foxconn and Wistron are building supercomputer manufacturing plants in Houston and Dallas, respectively. Mass production at both plants is expected to ramp up in the next 12 to 15 months, Nvidia said.

Reciprocal tariffs as a tit-for-tat strategy in a repeated prisoners' dilemma

Trade policy can resemble a Prisoners' Dilemma game: free trade is the best outcome (no tariffs), but that is not a Nash Equilibrium because any country can do better by imposing tariffs on imports as it helps domestic producers.  The Nash equilibrium is for all countries to impose tariffs on imports.

One way out of this prisoners' dilemma is to play tit-for-tat (do whatever your rival did last period) because it gives foreign countries an incentive to keep their own tariffs low:  if foreign countries put a tariff on imports from the US, their exports to the US will be treated similarly.  

However, President Trump is computing reciprocal tariffs as (Trade Deficit with US)/(Exports to the US).  This measure is determined largely by foreign investment in the US, not foreign tariffs on US goods.  For example, China sells ￥to buy $ to invest in the US to buy US Treasuries.  Such an increase in demand for $ raises the price of a $ relative to the ￥.  The stronger $ makes Chinese exports look cheap to US consumers.  This is both a US Trade Deficit (the US buys more Chinese goods than China buys US goods), and a Chinese Investment Surplus (China invests more in the US than the US invests in China).

As a result of the policy, US tariffs on foreign goods are set to dramatically increase, which will likely lead to tit-for-tat responses from foreign countries which will result in less trade.  From Chapter One, we know that voluntary transactions create wealth, and with fewer of them, we are all poorer.  

It might make some sense to set reciprocal tariffs equal to actual tariffs on a country-by-country basis, i.e.,(reciprocal US tariffs on foreign goods) = (foreign tariffs on US goods). 

BOTTOM LINE: Reciprocal Tariffs, as calculated, would harm the US.  

CAVEAT:  The above analysis ignores: (i) the international nature of supply chains--domestic producers are also importers of foreign goods; and (ii) their harmful effect on consumers. 

HT:  Mike, Donna

Effects of Tariff increases

Article by Joshua Hendrickson

The U.S. dollar is the world’s reserve currency, and the U.S. Treasury security is the global reserve asset. This means, respectively, that the dollar is the primary currency used in international trade, and that foreign central banks and other institutions store wealth in terms of dollars with Treasury securities.

...the dollar, because of its reserve status, tends to be overvalued. This makes foreign goods cheaper for U.S. consumers, but it also makes foreign labor and production cheaper ... a dynamic that has hollowed out America’s industrial base.

...

While imposing duties on imports will raise prices for American consumers, it will also appreciate the value of the dollar, ...

Tariffs might generate some revenue in the short run, but their larger effect—bringing countries to the negotiating table—could help the Trump administration achieve its [other] long-term objectives.

High US interest rates strengthen dollar, weaken Asian equities

Economist: Jan 13, 2025

The dollar reached a two-year high against a basket of major currencies, bolstered by a strong jobs report, released on Friday. The data dampened expectations that the Federal Reserve will cut interest rates aggressively in 2025. Share prices in Asia fell, as investors fear that prolonged high interest rates in America will draw capital to the dollar, draining funds from weaker currencies and emerging markets.

Mortgage debt is rising, but lending standards are strong

From CalculatedRisk:

The bottom line is there will not be a huge wave of distressed sales as happened following the housing bubble. Most homeowners have significant equity, were well qualified, and have a mortgage with low rates that they can afford.

Russian ruble is falling, but no one is buying its exports

 From MarginalRevolution:

...I also strongly disagree with those who say that cheaper ruble is “good” for exporters and the budget. Exporters have yet to make good use of devaluing ruble – which they can’t do, because Russia is under all sorts of embargoes, and China and other Global South countries are not opening their markets to most Russian goods.

...China is only buying our most basic commodities at heavy discounts, while keeping its market closed for other Russian goods. There’s no investment or technology coming into Russia from China and other Global South countries. Everything is dependent on state subsidies – but the government’s financial reserves are running thin.

Along with their low fertility rate, 1.52 (source), and it appears that Russia's future prospects are dim.

Higher interest rates in the US strengthen $ (or depreciate ¥)

Economist: The Japanese yen fell to around ¥160 against the dollar, its weakest level in almost 40 years. The currency has been falling because of the large gap in interest rates between Japan and America. 

• Investors earning 1% in Japan liquidate their investments, sell ¥ to buy $ to invest in the US where they can earn 5%; or
• Carry Trade:  Investor's borrow in Japan, sell ¥ and buy $ to invest in the US and earn money on the spread between the cost of borrowing (1%) in ¥ and what they earn on $ investments (5%).

 In both cases, the increase in demand for $ drives up the price of a $ (FX) relative to the ¥.

Is globalization over?

The Economist on what we might lose:

It is fashionable to criticise untrammelled globalisation as the cause of inequality, the global financial crisis and neglect of the climate. But the achievements of the 1990s and 2000s—the high point of liberal capitalism—are unmatched in history. Hundreds of millions escaped poverty in China as it integrated into the global economy. The infant-mortality rate worldwide is less than half what it was in 1990. The percentage of the global population killed by state-based conflicts hit a post-war low of 0.0002% in 2005; in 1972 it was nearly 40 times as high. The latest research shows that the era of the “Washington consensus”, which today’s leaders hope to replace, was one in which poor countries began to enjoy catch-up growth, closing the gap with the rich world.

But the political consensus behind globalization is breaking.

As we report, the disintegration of the old order is visible everywhere. Sanctions are used four times as much as they were during the 1990s; America has recently imposed “secondary” penalties on entities that support Russia’s armies. A subsidy war is under way, as countries seek to copy China’s and America’s vast state backing for green manufacturing. Although the dollar remains dominant and emerging economies are more resilient, global capital flows are starting to fragment, as our special report explains.

Higher interest rates in the US make the dollar stronger

The Economist: The yen has been falling against the dollar because US interest rates are 5% points higher in the US than in Japan.  This increases the demand for dollars, as Japanese investors sell ¥to buy $ so the price of a dollar appreciates.

In the chart above, we see the price of a dollar (inverted scale) has risen to about ¥160.  

Why restrict US exports of natural gas?

 The answer, of course, is politics:

To stop the war in Ukraine from disrupting energy markets, [Biden's] administration has overseen a big expansion in domestic fossil-fuel output. As well as being the world’s top LNG [liquified natural gas] exporter, America continues to be the biggest oil producer. That angers the climate-anxious left wing of Mr Biden’s Democratic Party. ...

But US restrictions wont help:

...the impact of the pause on global markets—and thus on global emissions, which is what matters to the climate—will be minimal. Forgone American exports will be offset by fresh supplies from Qatar, Australia and elsewhere. “I think there is an opportunity,” declared Jonathan Wilkinson, Canada’s energy minister, on January 30th.

BOTTOM LINE: President Biden's virtue signaling is worse than empty, as it is harming US producers by shifting US production to Qatar, Australia, and Canada. 

Link to Economist Article

Apartments vs. Single Family

Housing is good for illustrating the market forces of chapter 8 because everyone has housing and, due to construction lags and the durability of housing (30 years), market adjusts slowly to equilibrium.

In the graph above from Calculated Risk, we see single family housing starts increasing (RED), but apartments (BLUE) decreasing.  The market is adjusting to the high prices for single family by building new supply; and to the expected low future prices for apartments due to the big supply of apartments under construction due to come to market this year and next by reducing new supply.

SINGLE FAMILY HOMES (RED LINE): "...The weakness in 2022 and early 2023 was in single family starts. However, single family starts have now picked up, helped by limited existing home inventory."

APARTMENTS (BLUE LINE): "...we should see ongoing weakness in [apts] based on less household formation, falling asking rents, rising vacancies, and tighter lending. ... A near record number of multi-family housing units are currently under construction due to construction delays. This suggests a large number of multi-family housing units will be delivered in 2024."

Equity risk premium for stocks at all time low

 

WSJ:  Whatever happens to change it, there is a consensus on Wall Street that the equity-risk premium can’t stay this low forever.

ANALYSIS:  This is the Chapter 9 logic to value stocks relative to bonds, and right now it looks as if the stock market is over valued relative to bonds. 

DISCLAIMER:  if I really knew, I wouldn't be teaching school and I would charge you for the information.

House prices going up again

 

• Home prices came in exceptionally strong in August, rising a seasonally adjusted +0.68% from July; August’s non-adjusted gain (+0.24%) was more than 60% larger than the 25-year same-month average (+0.15%)

Dollar Stronger against Euro and Japanese Yen

 

Source:  Laffer Associates

A stronger $ helps US consumers, but hurts US producers.  

Speculation: It may be a consequence of fear (flight to safety?) and/or trade restrictions against China.  

China is selling US Treasuries, increasing interest rates

When China sells US treasuries, it affects both the exchange rate and US interest rates.

• Exchange rate:  China receives dollars, buys yuan, which rises the price of yuan in dollars, an appreciation of the yuan or a depreciation of the dollar. 
• US Interest rate:  Selling treasuries represents a reduction in the supply of loans to the US, which increases the price of loans to the US, i.e. the US interest rate. 

Source ZeroHedge

TRUTH IN BLOGGING: I am a micro-economist, so I am wrong about small things.

Why is the Russian rouble falling?

 From the Economist:  

Russia’s rouble slumped to a 16-month low of 100 against the dollar, having lost around 25% of its value this year. Deteriorating foreign trade conditions and an escalation in military spending have accelerated its fall in recent weeks. The currency was already suffering from western sanctions and European countries’ diversification away from Russian energy supplies.

The exchange rate is the "price" of the rouble which is set in a "market" where quantity demanded = quantity supplied. If the price falls it must be because 

• Demand has fallen (Europeans who sell € (euros) to buy ₽ (roubles) to buy Russian Goods or invest in Russia).   In this case, European sanctions has reduced EU demand for Rusian Gas.  
• Supply has increased (Russians who sell ₽ to buy € to buy EU goods or invest in EU).  The article mentions increased military spending which could represent and increase in demand for €.  More likely, though the article doesn't say this, Russians could be trying to invest in the EU or US to get their money out of Russia because they anticipate a depreciation in the ₽

Note that the Economist talks about depreciation against the $, but we are using € instead of $ because the EU is a bigger trading partner with Russia than is the US.  The depreciation against the € would track the depreciation against the $ if the exchange rate between the EU and US is stable.

UPDATE:  Russia Hikes Rates To 12% In Emergency Move To Halt Rouble's Collapse

By hiking rates, Russia hopes to make investing in Russia more profitable, so that investors will sell € to buy ₽ to invest in Russia, which makes the ₽ appreciate

Where are housing prices headed?

 

From CalculatedRisk.com:

Inventory is pushing up prices, and affordability (the change in monthly payments) is pushing down prices. And it appears this battle will continue … there is no relief in sight for inventory or for mortgage rates.

...

First, we can be very confident - barring another crisis - that we will not see a large wave of distressed sales and cascading declines in nominal house prices. Lending has been reasonably solid over the last decade, and most homeowners have substantial equity in their homes.

From Chapter 8: In the short run supply of houses ("inventory") is low, but so is demand (due to high interest rates) so we don't know which way price will go. 

From Chatpers 9, 11: Over the longer run, home owners have enough equity in their houses that they will be able to refinance without selling so supply is not going to flood the market as it did in 2009 when a big housing bubble popped. 

And over the longer run

When the baby-boom generation starts moving to retirement homes or warmer climates, inventory will likely increase. But that is mostly a 2030s story, see 

Are the Left and the Right converging on Economics?

The left-leaning Economist thinks so:

Both sides agree that the old order that prized expertise, free markets and free trade—“neoliberalism”, usually invoked as a pejorative—was a rotten deal for America. Corporations were too immoral; elites too feckless; globalisation too costly; inequality too unchecked; the invisible hand too prone to error.

• ... Both find competition with China to be a justification for industrial policy; 
• but the new right does not find the threat of climate change to be nearly so moving. 
• [No desire] reform [Social Security and Medicare] before the trust funds [run out]