Tariffs, Overstretch, and the Geopolitics of Risk

- I think the fate of the Trump administration historically will be determined by this, whether or not there is a Taiwan semiconductor crisis at some point between now and the end of President Trump's term. And if it happens, how he deals with it. So let me start with the economic problem first and then the geopolitical problem and then we'll go to questions. I understand the way that President Trump is using tariffs because it lies beyond the realm of economics textbooks. At some points he uses them as a kind of super sanction. At some points he talks about them as a personal permanent source of revenue. They give him power and in that sense, one can't understand them strictly in ricardian terms. But there's an economic cost to turning the clock of American trade policy back to let us say 1933 or 1934, which is where we currently are. If you just estimated as the yield budget lab has what the effective tariff rate, what the effective level of protection is. We haven't seen this kind of protectionism in the United States since Smoot Holly names the ought to strike terror in the heart, the hearts of economic historians. And that will have an inflationary impact. It will have an impact on growth that we should not underestimate just 'cause it hasn't made itself felt yet. Actually, I think the inflationary impact's already beginning to manifest itself. If you saw the most recent PPI data, you would see what I mean. There's also in my mind a question mark over how far tariffs can achieve the ultimate goal of re industrializing the United States. These charts here are from an excellent paper by Ong Hin. Ong Hin is the economist at the Bank for International Settlements. He and I were essentially roommates 115 years ago at Oxford when he had just finished South Korean military service. And I had just escaped from Glasgow and I don't know which was worse. But the, the key point in this paper is that the international trading system is a radically different thing from the International Trading System of President McKinley's time or Smoot Holly. It an incredibly complex network of interlocking balance sheets. You can depict it in these network charts as a series of international nodes and edges. And I think the lesson already obvious from the first trade war is the tariffs are like this blunt instrument and you kind of go back onto the International Network of trading arrangements and it just reconfigures itself incredibly quickly and it reconfigures itself in ways that optimize for the new regime that's been put in place. So after trade war one, the Chinese goods arrived in the United States, they just arrived via Vietnam or India or Mexico. And some version of this will happen even with measures to try to penalize those who engage in transshipment of Chinese goods. 'cause the network is too complex and adaptive, a mechanism to be easily restrained by the policy tools of the 19th century. If we are worried about the United States' current account deficit, it will persist as long as we run a fiscal deficit of six to 7% of GDP at full employment. And no number of bilateral trade deals will change that if we carry on with this fiscal policy, there will be a current account deficit because Americas will consume more than the rest of the world. That's why there's a relationship between the fiscal deficit as this chart shows and the current account deficit. That's the reality of economics. And the one big beautiful Bill doesn't do anything to change the fiscal trajectory that we were on under Joe Biden. If anything, it raises the steepness of the gradient of the projections for the federal debt in relation to GDP. You can offset some of the losses on the O-B-B-B-A through tariffs, but it doesn't fundamentally take the deficit anywhere close to equilibrium. Trumponomics so far has delivered a smaller shock than economists thought back in April when many people looked at the liberation tariffs and said The world is ending. We're now back to tariffs a lot like April 2nd and the markets are up. The main consequences of Trumpism so far have been a modest depreciation of the dollar and oil prices are significantly down, but that's, that's really what we've seen so far. Another 1970s illusion for you, John Conley was treasury secretary to Richard Nixon. He came up with the line, our currency, your problem. Ken Roff, my old friend from Harvard, has a new book out Our Dollar Your Problem. It's just to me striking that in the long-term perspective, the dollar hasn't weakened that much despite all the talk of a Margo Accord. Since Steven Miran came into the administration, the dollar move, if you take the story right back to when I was born, is trivial so far. These are looking at effective exchange rates, which are the things that matter. We've seen big dollar moves in the seventies and big dollar moves down in the mid eighties. What we've seen date is nothing like that. Now it may yet come, but I begin to wonder if we are really going to see a weak dollar policy in addition to the tariffs. It hasn't materialized in the way that some people thought it would. I said there were two problems. I've told you the economic one. Now let's talk about the geopolitical one. You sometimes hear it said that Trump is attempting a reverse. Nixon, our colleague Russell Berman published an article with Karen Skinner making this argument a few months ago. What they mean is that what Trump is trying to achieve is a little bit similar to what Nixon achieved by going to Beijing. Nixon exploited the sign of Soviet split. It completely threw the Soviet Union onto the back foot that he would be prepared to cozy up to Maze Don. The theory here is that somehow Nixon is gonna lure Putin away from Xi Jinping, hence reverse Nixon. You pitch the Russian leader not the Chinese because these days the Chinese are the senior partner and the Russians are the junior partner. That's the theory of reverse Nixon. I'm not sure how much President Trump really thinks about this himself, but I do know that he senses the possibility of deals with one or other of these guys as a solution to the geopolitical problem the US faces. I never enjoyed reality tv. It's not my thing. Watching it happen in the Oval Office has been fascinating. Seeing European leaders in a kind of episode of The Apprentice was one of the highlights of the year so far and didn't end well for the contestant from Ukraine. President Trump has power over Europe. He has real power over Europe because the Europeans for the better part of 80 years have relied on the United States for their security. That gives him leverage in all negotiations including trade negotiations. That was why at the NATO summit, mark Ruter told him, daddy, not entirely ironically. And that was why Ursula Fondle had to go to Turnbury and not quite, but nearly kiss the ring. The Europeans are over a barrel. They don't have anything in the trade negotiations like the Chinese have rare earths. What are the French and the Germans gonna impose export controls on that. Americans would really care about wine. I just read that Americans have stopped drinking wine. In fact, they've stopped drinking. This is an alarming development. Nations are often at their most dangerous when most sober. So there's nothing on the trade side that the Europeans could do. And there's nothing on the national security side since they've been free riding on NATO all my life. And the extraordinary thing is that Trump has changed that love him or hate him. He's the first president ever to get the Europeans to make a significant commitment to the financing of nato. The problem he faces, the problem the Europeans face is that it's very, very hard to persuade Vladimir Putin to end the war that he stands a decent chance of winning one chart. Just to illustrate the point, the air raids that Ukrainian civilians have had to endure in the last several months are the worst of the war so far. By far. Not only that, but Russia is also mounting offensives in places like POV on the Russian Ukrainian front that are though very costly in terms of bodies increasingly putting pressure on the Ukrainian armed forces. So it's not clear why these guys would oblige President Trump by getting a divorce and why under these circumstances Putin would agree to peace in Ukraine. I don't know what's gonna happen in Alaska tomorrow. I don't know that anybody really knows, maybe do Donald Trump himself doesn't know. But I'll be very amazed if out of these talks tomorrow we get peace in Ukraine. The incentives are too obvious for Putin to keep fighting this war in the expectation that Western fatigue will set in that Ukrainian political division will set in. And that the overwhelming superiority of manpower and resources that Russia enjoys will ultimately prevail. Final things I wanna say to you, relate to the other countries Americans. They changed the things they hate quite frequently. So we really kind of hated North Korea was kind of one of our favorite things to hate back in 2018. Now, who thinks I'm a little rocket man? So American public perception of threat has shifted quite a bit so that China is now clearly regarded as the number one threat. And Russia's number two in Iran and North Korea don't really loom that large, even though they are as much parts of the access of authoritarians as China and Russia. And that explains why Trump's decision to bomb Forough wasn't that on, wasn't that popular except with the MAGA base. And the MAGA base surprised many contemporary observers by being quite positive about this show of strength. Trump campaigned on an old Ronald Reagan slogan of peace through strength and he delivered it. Peace through strength is popular. And to many Americans, what it means is exactly what he did. Stealth bombers fly from Missouri, bomb the crap out of a Iranian nuclear facility, turn around, come home, done no forever war there. So that's popular with a part of the electorate, but the wider electorate is not enthusiastic about supporting Israel as a broad strategic goal. On the contrary, a huge shift of sentiment against Israel is happening right now amongst young Democrats, the President and people around him, including the vice president and others in the administration, as well as people outside the administration who have influenced like Tucker Carlson who went over to the dark side some time ago for reasons that one day will be explained wanted, I think to throw Ukraine under the bus quite badly. But it, it's hard to do because Ukraine's not unpopular as a cause with ordinary Americans. There isn't a huge appetite in this country to see Putin win, which I think is good. But the big issue is, is none of the above. The big issue is Taiwan and China. And here the polling is fascinating because it turns out that Americans feel quite strongly about this issue because China is their number one adversary. And when the Chicago council polls Americans and says, asks some very specific questions like this one, in the event of a Chinese blockade of Taiwan, would you support using the US Navy to break the blockade quote, even if this might trigger a direct conflict between the United States and China? 42% of Republicans say yes, 37% overall. So two fifths roughly speaking of Americans are willing to risk war with China to break a blockade of Taiwan. That's quite amazing, especially when you consider how incredibly risky it would be for the reasons we've already discussed for the United States to go to war with China, to go to war with the manufacturing superpower that, as Professor kin pointed out yesterday, has all the ships, the United States in war games that I'm aware of. Of course there are classified ones I don't know about, but in war games that I'm aware of, the United States runs into a significant problem early on, which is that it runs out of certain categories of precision missile really quickly. In particular, long range anti-ship missiles, which would be crucial in the kind of naval war that there would be are gone within a week. That doesn't seem like a great basis for a strategy of deterrence. So the great geopolitical vulnerability of the second Trump administration is the Taiwan contingency, the big crisis of Cold War. I was the Cuban Missile Crisis when we nearly had World War III over an island off the US coast that we blockaded and the Russians contemplated running that blockade. The Taiwan semiconductor crisis is different in two ways. One, Taiwan is the most important bit of economic real estate in the world because that's where all the GPUs get made for Jensen, Wang and Nvidia. And therefore, for the hyperscalers doing AI not far from this campus. And the importance of of TSMC just keeps growing. Whatever anybody may tell you, it's more important now in this ecosystem than it was a few years ago. Admiral Sampa is the probably the single most important officer in the US military, not by rank, but by role 'cause he is the commander of Indo-Pacific command. His job is to deter China from making a move against Taiwan by threatening what he calls Hellscape. I think the fate of the Trump administration historically will be determined by this, whether or not there is a Taiwan semiconductor crisis at some point between now and the end of President Trump's term. And if it happens, how he deals with it. That's all folks. Now I'd like to invite you to ask me difficult questions. Thanks very much.