Craig Pirrong's Blog, page 5

The Drones Are Coming From Inside the House

The first new development in the Groundhog Day-esque Russo-Ukrainian War occurred Saturday, when Ukrainian operatives launched numerous FPV drones from within Russia to attack Russian air bases. Ukraine claims that 41 long range bombers and other large aircraft (e.g., an A-50 radar plane) were destroyed. The Russians admit some losses, but not so many.

As in war generally, and this war in particular, all assertions must be treated with deep skepticism. It is clear from video evidence, however, that multiple planes were hit at multiple airports.

What are the consequences?

Operationally they are modest, though material. Russia uses these rather antiquated and maintenance-hungry planes to launch cruise missiles at Ukraine. Many are pooh-poohing these losses because their utility vs. the US is highly limited, and because Russia relies on other means (drones and MiG-31s) for most of its strikes. But the fact that Russia has been shuttling these planes all over the country–from SIberia to the Kola Peninsula–evidently in an effort to make a Ukrainian strike difficult, and despite the wear and tear that puts on these temperamental beasts indicates that it considers them a useful military asset.

The biggest consequence is the demonstration that Russia has a huge internal security problem. These drones were assembled in Russia, and transported to their launch sites (again, in Russia) in semis contracted for by Ukrainian agents. No doubt the security apparatus dogs are fighting viciously under the carpet to attribute blame. Internecine warfare within the government, and especially among rival security agencies and officials will distract Putin and his minions from the front. Moreover, this will no doubt result in a substantial diversion of resources to maintaining internal security.

A horror movie trope is “the call is coming from inside the house.” Well, here the drones are coming from inside the house. That’s pretty scary.

Ironically, in this regard Russia’s massive size is a handicap. So much territory with so many targets to monitor. Not just military bases but refineries, railways, and other economic resources essential to the war effort. In a place so huge, hitting it where they ain’t is easy. They can’t be everywhere, because everywhere is immense.

A security state that cannot provide security has no legitimacy. It has lost its reason for being and the justification for its oppressive measures. But the typical response is to double down on the repression. It’s all they know how to do.

The US disclaims foreknowledge. Ukraine claims it did not tell the United States. I call bullshit. Zelensky knows Ukraine is on a short leash with Trump. Further, an operation that gestated for so long (18 months, supposedly) would almost certainly be sniffed out by US intel. Further, (a) we know (per the NYT) that the US is deeply embedded in Ukrainian targeting, and (b) the fact that the Russians have been shuttling these planes around means that US intelligence on their location on any given day would be vital to successful strikes.

The timing is fascinating for another reason. Trump has been trying to play nice with Putin to get him to the table, and to make concessions. Putin has responded with a smirking chimp routine, doubling down on his demands for Ukrainian concessions, refusing to make any of his own, and ramping up strikes on civilian targets.

My read is that Trump decided, OK, if that’s the way you are going to respond to my playing nice, I’ll let Ukraine undertake highly embarrassing (to Russia and Putin) strikes throughout the width and breadth of Russia. You want the war to continue Vova? You think you are winning? You think we will let you win?

Think again, bitch.

It is unlikely that a strike so long in the making just became feasible Saturday. Instead, Putin’s intransigence and smirking arrogance exhausted Trump’s patience and he greenlighted an operation that had been held in abeyance.

On the same day as the drone strikes on the bases, two bridges were (according to the Russians) blown up right when trains were underneath. In what I consider a case of the US feeding Putin his own medicine, Rubio and Vance expressed their condolences. Awww. We’re soooo sorry about that, Vova.

It was actually sorry, not sorry. Get your mind right.

Whether this will materially affect the trajectory of the war is doubtful, given who Putin is. Both sides, but especially Putin, are locked into a sunk cost mindset: “I must have total victory to justify the waste of the last 3 years!” With Putin this is accentuated by the need to maintain the illusion of dominance necessary for a dictator, which would be damaged, perhaps fatally, by concessions.

It was this mindset that drove the combatants in WWI to perpetuate a pointless war. Neither side would give in, and a growing body count only made them more intent on waging the war to the bitter end. The war only ended when one side could no longer continue–and even then, elements within Germany wanted to continue.

Putin has been betting that side will be Ukraine, in part because of a potential withdrawal of US support. But his holding out for complete victory has likely convinced Trump, albeit reluctantly, to continue and perhaps increase US support, and to permit Ukraine to take actions that the US had heretofore prohibited.

The lesson being, that when you demand everything, you can end up with nothing. The tragedy is that so many more will have to die to get to that point.

Trump and Harvard: Pour Encourager Les Autres

Trump’s ongoing war against Harvard is fascinating. As is typical, I largely agree with his choice of target (the “objective” in military parlance), and find his tactics over the top. But these tactics are typical of him. As with tariffs, immigration, and pretty much everything else, he is making maximalist demands, for a variety of reasons.

One reason is that the process is the punishment. Forcing Harvard to fight on many fronts is draining, financially and psychologically, and inevitably creates intense tensions within the university. This sets up a battle of wills that Harvard is not well positioned to win.

Another is that like almost all legal confrontations, this one is a framework for negotiations. And Trump’s negotiation style is to make myriad maximalist demands not in the expectation that all will be met, but that enough concessions will be extracted that he will be satisfied, even though his apparent concessions will lead to idiotic TACO taunts.

As for the substance of the demands that have been made and sanctions that have been imposed, there are deep ironies. One irony is that like the rest of the elite, Harvard harrumphs about Trump trampling the rule of law, but the justification for Trump’s assault is that Harvard flouts the law. In particular, the Supreme Court ruled that Harvard nakedly engaged in Constitutionally barred discrimination on the basis of race in admissions, but continues to engage in discrimination in other policies. Another legal issue is whether Harvard is in compliance with laws and regulations regarding disclosures about foreign funding and foreign students.

Substantively Harvard is on weak grounds on these issues. Whether the sanctions levied by Trump will survive legal challenge is doubtful, but again the mere litigation of these issues is very problematic for Harvard.

Another irony, which has received little attention, is that the richest educational institution in the world, with the richest endowment and richest group of alumni, and which is institutionally a big proponent of redistributive policies, as is the vast bulk of its almost uniformly leftist faculty, somehow thinks that it deserves billions of funding wrested from the US taxpayers. That is, Harvard and its acolytes are outraged that Trump is trying to stop taking from the poor to give the rich. How dare he!

And Trump very cleverly has cast a bright light on this hypocrisy by threatening to provide the funds taken from Harvard to trade schools.

Harvard of course frames this contest as one over academic freedom. But this argument only betrays Harvard’s sense of entitlement. It is entitled to government money, and how dare the piper call the tune!

Harvard and its defenders also decry the great advances in knowledge that will be sacrificed if it is denied these funds. I for one am skeptical about the return on many of these grants, especially given the large overhead allocations that go to funding administrative bloat, and to subsidizing the leftist indoctrination that pervades the university.

So rather than being served up a dog’s breakfast of anecdotes, we would be better served by a rigorous, scholarly evaluation of the knowledge bang we’ve gotten for the taxpayer buck.

Amusingly, Harvard’s pose as a bastion of the pursuit of truth is rather seriously undermined by a recent anecdote, namely, the defenestration of star researcher Francesca Gino, whose research was proved to be fraudulent. (NB: Gino’s salary was a cool $1 million).

Harvard revokes tenure of Francesca Gino, once a star faculty member—a severe and rare penalty in academia https://t.co/6Vg3JnNq1R

— The Wall Street Journal (@WSJ) May 28, 2025

The treatment of another star–this one legitimate, in contrast to the fraud Gino–Roland Fryer, also gives the lie to Harvard’s pose as being the defender of the pursuit of truth regardless of where it leads.

Targeting grants that may well support beneficial research serves a tactical purpose, related to the internal tensions mentioned earlier. The rigorous faculties and researchers have a tremendous incentive to rise up against an administration dominated by non-rigorous ideologues.

The battle over funding points to a larger issue, specifically, the problematic nature of the codependence between science and the government, an issue that Eisenhower pointed out before I was born.

The most recent Trump fusillade relates to foreign students. But this matter demonstrates that Trump’s war on Harvard isn’t just on Harvard. It is on American academia.

Hard on the heels of the restrictions on Harvard specifically, Secretary of State and acting National Security Advisor Marco Rubio announced a pause on the granting of all student visas, to prepare for a far more inquisitive (not to say inquisitorial) vetting process. Moreover, he announced that Chinese applicants would be subject to special scrutiny, and that those connected to the CCP, and those planning to study sensitive subjects (i.e., scientific disciplines, rather than fluffy ones) would not receive visas.

To which the CCP lost its shit, claiming that this targeting was discriminatory.

Well, yes, yes it is! And justifiably so. Discriminating between friends and enemies is essential to survival. China is (by its own declaration) an enemy of the US, and uses students as soldiers in its asymmetric war against America. Specifically, the CCP uses students as a major component of its expansive espionage and IP theft efforts in the US. (This article in the Stanford Review about Chinese espionage there is quite interesting, but not necessarily that revealing–such espionage is an open secret).

So cry more, CCP. The more you cry the more you reveal that this hits you where it hurts.

Trump’s attack on foreign admits at Harvard is therefore not a one-off. It is part of a broader agenda. And as I’ve written before, with Trump it’s all about China.

And in fact the entire assault on Harvard is not about Harvard per se. It is pour encourager les autres. Making an example of Oberlin would hardly make a ripple outside Ohio. Making an example out of Harvard gets everybody’s attention. Meaning that this is a highly, highly leveraged battle.

It is a battle in a wider war. American academia is an isolated, elitist enclave largely out of step with the country as a whole. Indeed, it is not hyperbole to say that American academia–especially in the social sciences and humanities–is at root anti-American. And Harvard is the prime example of isolated, elitist, anti-Americanism in academia. By fighting Harvard Trump is trying to wrench academia into the mainstream, or at least closer to it.

So like pretty much everything Trump does, the purpose and ramifications go far, far beyond the policy specifics that attract virtually all the attention. Those are just tactical elements in a far broader, and in fact socially revolutionary, strategy.

A Few Components of the Trump Gamma Trade

“Haven’t seen you around recently. So what’s up?”, says you. “Same old, same old: Just the Trump gamma trade”, says I. (After the 2016 election I wrote that a Trump presidency meant you should be long gamma. That’s even more true after 2024).

So the tariff two step has continued. Trump caved! Xi caved!

Whatever. If you believe (as I said literally on day 1, AKA Liberation Day) that the initial tariff salvoes were a negotiating tactic, the outcome was expected. Make maximalist demands, negotiate down from there.

NB. The negotiations continue. This ain’t over.

I only remark that if Trump had announced the current (interim) levels on 2 April, the frenzy would have no doubt been about the same as it was with the 125 percent charge for China, etc. But now these levels (30 to 50+ percent, depending on how you calculate) are greeted with a huge sigh of relief and a complete reversal of the market selloff that greeted the initial announcement. In other words, if you panicked, you were played.

Another fairly recent development has been the prescription drug EO. The initial (over-) reaction has been that Trump is ordering price controls. Well, not exactly. (The irony here is that the right has been critical, and the left hypocritically silent, because Trump).

At the outset, let me say that (as I will explain in more detail below) I am ambivalent about overall policy framework. But the reason I say there has been an overreaction is that all it is right now is just a framework. The only real action item is a direction that HHS formulate a set of rules that will require pharmaceutical companies to allow consumers to purchase directly from them at “most favored nation” (“MFN”) prices. We know how long the rule process takes. We also know that the devil will be in the details of the rule, and those details will be determined in a highly politicized environment where the regulated have a huge say, so it is impossible to draw conclusions about what effects it will actually have, or when it will have them.

Trump’s basic attack–that comparisons between US and foreign prices for the same drugs prove that Americans are being ripped off–is an old one, and ironically was a talking point of Hillary in 1992-1993. The policy piece I wrote in 1993 (“Political Rhetoric and Stock Price Volatility”) addressed this very issue. (Ironically, it was that piece that put my on Hillary’s Hit List, the figurative one at least; it didn’t cost me my life, but did jeopardize my career).

Defenders of this pricing structure claim that it is purely economic conduct by pharma, specifically, price discrimination. More elastic demanders pay a lower price than inelastic American ones.

Yes, this might be why some drugs are dirt cheap in Africa, say, but it is hardly the entire story. Drug companies have to offer big price cuts to high income countries (European countries, Canada, etc.) whose demand is likely about as inelastic as the US’s, so that their national health services will buy them. One interpretation is that these countries are free riding off the innovation paid for by US consumers who pay full fare.

Which raises another issue. Presumably Trump believes that the MFN rule he has outlined will result in drug makers dropping US prices to match foreign ones. But no doubt some of the movement will go in the other direction–the companies will raise prices in other markets, and in some cases will decide to forego some smaller markets altogether rather than have their prices drive those in the really big market. Meaning that the ultimate effect on US price levels is hard to determine.

One part of the EO actually addresses this issue. It directs the U.S. Trade Representative and the Secretary of Commerce to ensure that foreign governments are not taking actions to undercut US prices. (The order incorrectly states that such undercutting raises US prices). That is, this is really a trade issue, and in particular a non-tariff barrier/IP expropriation issue that is more properly addressed in the context of trade negotiations.

The EO–as is the case with most policy proposals directed at drug prices–ignores the real drivers: patent protection, R&D costs, and third-party payments. If you think drug prices are too high, that is, the prices are in excess of what is required to induce the efficient level of innovation, then go after these issues. Examine whether drug patent protection should be attenuated (not extended as it was in recent years). Whether regulatory burdens unnecessarily inflate R&D costs. Cross-country price comparisons tell you nothing about these issues.

Insofar as third-party payment is concerned, the EO does address that issue to some degree. Specifically, the direct purchase option (subject to MFN provisions) is intended to “cut out the middleman,” namely, the Pharmaceutical Benefit Mangers (Caremark Rx, LLC (CVS), Express Scripts, Inc. (ESI), and OptumRx, Inc. (OptumRx) being the Big 3). These are accused of (a) charging high markups on drugs, and (b) excluding many drugs from their formularies.

The first issue is again related to relative prices, not price levels. That is, it is really about who captures the monopoly rent that ultimately derives from patent protection. The main concern is double marginalization–the inefficiency that results from back-to-back monopolists. Double monopolization can lead to prices that are higher than monopoly prices. Another concern could be that the PBMs exercise monopsony power, thereby reducing the returns to R&D and suppressing innovation. (This makes PBMs analogous to foreign governments).

I am always skeptical of “cut out the middleman” arguments because they ignore Chesterton’s Fence: why do the middlemen exist in the first place? If they bring cost but no benefit, how can they survive?

I don’t know the answer in this case. But (a) I am sufficiently skeptical based on long experience so as to not fully credit the seductive cut-out-the-middleman argument (which is almost always wrong, unless the middleman is a government creation), and (b) relatedly, would not be surprised if PBMs are ultimately the creation of the baroque (and broken) regulatory structure in the US. If my suspicion (b) is correct, going after middlemen attacks the symptom, not the cause, and the underlying problem will persist.

All that said, just as the case with foreign-benchmarked MFN pricing, it is naive to think that the direct purchase mandate will lead drug companies to reduce direct-to-consumer prices to the level they charge PBMs. The rules would totally change the negotiating dynamic between them. And again–and this is crucial–this is mainly about how monopoly rents will be distributed/split, not the amount of the rent (and thus not the final price to the consumer), which is driven by the underlying market power inherent in patent protected medicines.

In sum, I think this EO’s significance has been vastly overstated, because (a) it is essentially a “mission order” that sets out a broad objective, and the effects of which will be driven by the tortuous politicized rulemaking process required to carry it out, and (b) does not touch the underlying drivers of pharma prices.

Another major issue of the past few weeks is the (in Trump’s words) “Big Beautiful [budget] Bill” working its way through the House.

First off, let me say that it is almost certainly the case that nothing Big in government is really beautiful. Hell, who even knows what’s in it, precisely because it is so big? It be like “Yeah the chick in the burkha is really beautiful! And she’s actually a chick! Take my word for it!”

Its main attribute is that it will–if the legislative legerdemain works–mitigate the logrolling and secret last minute deals that corrupt the standard budgeting process. Mitigate, not fix.

The “beautiful” bill has some real warts. Hell, cancers, maybe. A sample.

An elevated state and local tax (SALT) exemption. Elevated so high as to be virtually non-binding. A sop to high income, high tax states which seriously undermines their incentives to control spending and taxation. If California, New York, Illinois, etc., want to raise taxes and spend more, let them fuck their own citizens, not the rest of us. Maybe that will force their citizens to get their minds right, and set their governments straight. Serious backsliding on the rollback of Biden’s grotesque, and grotesquely named, “Inflation Reduction Act.” It should be terminated in its entirety, with extreme prejudice. But this bill–which mind you cannot bind future Congresses–delays implementation of subsidy cuts and mandates until four years from now, at the earliest.

Gee, why four years, I wonder?

The renewables subsidies and mandates make energy excessively costly in return for no meaningful environmental benefits. They are also unaffordable given America’s parlous fiscal situation.

Notably, Rumpublicans are among those pushing to save these monstrosities.

Virtually noting meaningful on entitlement reform. Even extremely modest changes to Medicaid have elicited shrieks and wails, and not just from Democrats.

The US fiscal situation is far and away the greatest danger our to economic prosperity and national security. But nobody–least of all Trump–is taking it seriously. Like Scarlett O’Hara, they will think about that tomorrow.

Except, apropos CCR, that day never comes.

So we seem destined–doomed–to go bankrupt like Hemingway’s Mike Campbell, “Gradually and then suddenly.”

DOGE and Musk held out the (false) promise of preventing this fate by attacking “waste and inefficiency.” Even if such massive inefficiencies exist, DOGE didn’t go through them like a buzzsaw: instead, DOGE has been buzzsawed and Elon has slunk away, achieving a dime on the promised dollar at the very most.

And at the outset, I expressed skepticism–though not enough–that the supposedly “easy” route of restoring fiscal sanity through attacking waste would actually work. The brutal fact is that without addressing entitlements we are on the highway to fiscal hell.

The most depressing takeaway is that the supposedly transformative and revolutionary Trump presidency is at most tinkering with an unsustainable status quo, and even that elicits frenzied, and indeed unhinged, opposition. The nation is as unserious about addressing its existential fiscal problems as was France in the 1780s, and just as politically poisonous.

And we know how that worked out.

Normal Accidents. Again.

Debate is swirling about the cause of the Great Spanish Grid Failure of 2025. One major driver of this debate is an almost crazed desire to shield renewables from any blame. Spanish PM (and Socialist knob) Pedro Sanchez (who barely managed to get elected, perhaps due to a lack of help from Napoleon Dynamite) is especially crazed, given that Spain had become Exhibit A in the greatness of renewables, and that he has been a huge supporter of them.

All sorts of theories have been bandied about. For his part, Pedro is going with Induced Atmospheric Vibration, in which extreme temperature variations caused frequency fluctuations. (Which the grid could not handle, ahem ahem.).

Every electrical grid is a complex, highly interconnected physical system with myriad feedback mechanisms, and is characterized by “tight coupling” (everything must work together in a specific sequence or the system collapses). Indeed, the electricity grid is arguably the most tightly coupled major system in the modern world.

This is the kind of system in which “normal accidents” occur. I’ve written about them several times (hence the “again” in the title).

Normal accidents mean that there are myriad combinations of events, each one of low probability, that can combine to cause a systemic collapse. Though any individual combination may have a low probability, the vast number of possible combinations means that the probability of collapse is non-trivial.

The ex post forensics of the Spanish collapse–if not fatally compromised by politics, which is a big if–will no doubt establish a one-damn-thing-led-to-another causal chain. It is quite possible that not all of the links in this chain will be related to renewables, which no doubt Pedro and others will seize upon to vindicate their baby.

But recall from my earlier discussion of normal accidents that these links are necessary conditions–absence of any one of them would have prevented the collapse. The more links in the chain that are renewables-related means that greater reliance on renewables implies a greater probability of systemic failure.

Perhaps Pedro is right and the original shock was an IAV, which is not itself directly attributable to renewables. But as it stands now, crucial elements in the causal chain definitely appear to include tripping off of two major solar facilities in Spain, and a very small share of power production from spinning resources (due to a high renewables share) that resulted in a deficiency in system inertia. Thus, two major elements of the causal chain likely strongly implicate renewables.

Many “normal accidents” involve causal chains that came as a complete surprise to those reviewing them ex post. This is definitely not the case with respect to the electricity grid and renewables. There have been many Jeremiahs warning of impending doom from over-reliance on them. Indeed, the Spanish grid operator itself sounded the alarm as recently as February.

Will this almost real time validation of the warning lead to a major rethink of the advisability of continuing to push renewables ahead of the complementary investments (batteries, greater transmission capacity, technical mitigants of the inertia issue) necessary to prevent a severe degradation of grid reliability? Will it lead to a sober evaluation of the costs of these complementary investments and/or the cost of degraded reliability, and a recalibration of renewables plans that takes these costs into account?

Given the huge political and ideological investments made in the renewables push, I highly doubt it. Not in Europe, anyways.

In another normal accident-related story, the New York Times did a major tick tock on the Reagan Airport helo-plane collision that resulted in the deaths of 67. Again no doubt due to its massive political and ideological investment, it all but buried a crucial necessary condition. Specifically, the failure of the pilot undergoing an evaluation flight to heed the specific directions of the Warrant Officer performing the evaluation to (a) reduce altitude, and (b) make a left turn. Instead she–and that’s the important detail–continued to fly straight, high, and level right into a descending passenger jet.

If she had followed the WO’s directions, the tragedy would have almost certainly been avoided. Here, human error was a necessary condition. But since that human error was committed by someone of a protected class–a female military officer, one who had been a Biden aide no less, and noted in her obit as being an advocate for sexual harassment victims–the NYT (and myriad other media outlets) downplayed that detail.

The valence of this issue is particularly great in the current environment, where SecDef Peter Hegseth is challenging DEI in the military generally, and the role of women in the military specifically.

The lesson from these episodes? That in these abnormal times, honest assessments of normal accidents are nigh on impossible. Which means that their likelihood will be tragically higher than necessary.

The Brooks Bros Uprising!

David Brooks–the NYT’s (very poor) simulacrum of a conservative–is calling for an uprising to resist The Orange Fascist. But David, you wouldn’t want to ruin that perfect crease in your trouser leg!

Brooks has been roasted to a crisp by many others so I’ll forego adding fuel to the fire. (Here’s a good one). Suffice it to say that his article is the most unintentionally hilarious thing I think I’ve ever read.

And wait. I thought insurrection was the worst thing ever! Another example of rules for me, not for thee, eh, David?

I am particularly amused because when we were both students at the University of Chicago in the early-80s, Brooks tried to chat me up a few times to recruit me to some conservative group. College Republicans or somesuch. I’m not a joiner, so I demurred. Besides, he was really cringey and I figured I definitely would not want to belong to his group, seeming political alignment or no.

Our paths have obviously diverged over 40 years!

Brooks is not alone in his call for insurrection. (They call it an uprising, but I will call it by its real name). Fatass rich boy and presidential aspirant JB Pritzker wants to take it to the streets too. Can the streets handle the weight? Sounds like a lot of extra work for Streets and Sanitation in Chicago.

All this tough talk proves one thing: the left really doesn’t believe all of its scare talk about dangerous right wingers with all their guns. If they did believe it, they’d know that they’d be the ones bleeding out in the street, which would surely temper their enthusiasm. Perhaps they should recall that people like them were at the forefront of the first stage of the French Revolution, and almost none of them survived the latter stages with their heads attached to their necks. In other words, be careful what you start. You might not like how it ends.

One of the sacred institutions that Brooks thinks he is fighting for is higher education, especially elite status higher education, namely schools like Harvard and Yale that are in Trump’s cross-hairs.

If there was ever a cause calculated NOT to cause a groundswell of popular support, it is that. I doubt it would have been all that popular even when academia was held in high esteem. But now that it has fallen from its pedestal its travails are only lamented in the bobo enclaves Brooks inhabits.

The proximate threat is the administration’s pausing, and threatening to terminate, billions in grants flowing to Harvard. An unconscionable threat to academic freedom!

Allegedly.

Universities that take federal money have to obey civil rights laws and constitutional protections. Harvard’s and other universities’ admission policies have already been found to be discriminatory, and therefore in violation thereof. An immediate implication is that the entire panoply of DEI policies are similarly discriminatory and illegal. The administration is demanding that Harvard terminate those discriminatory policies, and since money talks, is using the threat of withholding money to coerce compliance. And they have a point. Schools don’t have the freedom to discriminate. Not if they take federal dough, they don’t.

Harvard is fighting in court. Do they really want to do that? Discovery in the admissions cases was damning. No doubt it will be here if it persists in its lawsuit.

Universities also have to worry about another threat: their acceptance of large sums from dubious foreign sources (notably China and the Middle East) and their flouting of laws regarding the reporting thereof.

On the issue of hostility towards higher education more generally, universities and their defenders like Brooks are trapped in their own self-referential bubble. In particular, they fail to understand that they are widely–and correctly–viewed as aloof, pampered, hypocritical, and underperforming. They are also apparently oblivious that these factors when combined with the impending demographic rip tide make their future dim, at best. They are living in the past. To extend the French Revolution example, a la the Bourbons, they have learned nothing and they have forgotten nothing.

I have been in academia for over 35 years–close to 40 if you want to count graduate school. I have been a beneficiary of the higher ed wave in those years, but I have also been witness to the developments that bring to mind Herb Stein’s aphorism that if something cannot go on forever, it will stop.

One of those developments is the reliance on federal funding that Harvard is so desperate to retain. That money has been a corrupting influence. It has also given rise to the classic effects of free cash flow problems–bloat and inefficiency.

That is most evident in the fungal growth of administrators, who now outnumber faculty at many (if not most) schools, and who often outnumber students at some “elite” schools. I’m reminded of Ross Perot’s joke about the Department of Ag staffer being asked why he was in tears who responded “My farmer died.” It is certainly the case that even at large state universities, administrator growth has far outstripped faculty growth.

And what are they producing, exactly? Part of it is the self-licking-ice-cream-cone phenomenon. You need more administrators to get more grants, and more still to administer the grants. Similarly, various government mandates–which the feds know that they can impose because they hold the purse strings–have fed the educational administrative state. (Case in point: the various sexual harassment and non-discrimination “trainings” given by administrators that I have been required to attend).

But a lot of it is just the typical bureaucratic dynamic of bureaucrats wanting to expand their fiefdoms. And that is possible because of federal money–grants, other forms of aid, and student loans–rolling in. The free cash flow problem mentioned above.

The student loan issue is particularly disturbing. I remember Sherwin Rosen–whom I admired tremendously, and still do–saying in his labor econ class at Chicago that due to the high return on education, he favored generous loans even if they were not paid back. I think he might reconsider if he were still alive, because ceteris has not been paribus.

It is becoming clear that the returns to education are sharply diminishing, at least in the way that the scale of education has expanded since Sherwin expressed that opinion. (That is, current higher education is not just a scaled up version of circa 1980 higher education on all levels).

There are several reasons for that. One is that expanded access has meant going further down the ability scale.

Another is that the composition of degrees is quite different. There are more degrees being offered that are utterly useless.

Case in point. I saw this sign on campus earlier this year:

That is perpetrating a fraud. LIfe is the antithesis of a gender studies course. If you major in it you will not be prepared for any productive activity that you would not have been prepared for if you had dropped out of high school. In fact, it’s likely that you are less qualified. And what will happen when that reality kicks in?: more resentful and bitter people burdened by debt that they cannot repay, members of the reserve army of the barely employable.

And this is not the only fraud.

Further, another consequence of going deeper down the ability scale is that those students are more likely to pick skate majors and skate classes because that’s all they can hack. But those departments sing the sirens’ song of the wonderful careers that await.

Another is that the rigor of instruction has seriously degraded. This also reflects the lower mean ability of the student population. It also reflects the pressure on faculty to keep students from dropping out (due to bad grades) to keep the gravy train rolling. You have to teach to the middle (below, actually), and if the middle declines, rigor must decline accordingly.

There is another insidious factor at work that exacerbates all of these effects. Knowing that a far larger fraction of their students will go on to college, secondary schools feel less pressure to produce graduates capable of earning a living with a high school degree only. They figure that college will provide the instruction that high schools used to.

Case in point: Harvard and Stanford–yes, even them–offering remedial algebra courses.

(As an empirical matter, the returns to higher education are measured based on the earnings differential between college graduates and high school graduates. That overstates the returns to increasing the scale of college education because that increase in scale has reduced the qualifications and hence earnings of high school graduates).

This kicking the can also allows secondary schools–and even primary schools now–to indulge in highly politicized instruction instead of teaching real subjects.

This all has knock-on effects right down the line. I have only taught graduate courses for the past 25 years or so, and during that period I have seen a marked decline in the preparation and skills of my students. As a result I’ve had to throttle back significantly on the difficulty of the material I cover.

In sum, higher education has grown far too large, mainly due to federal largesse. The impending demographic drought, combined with a growing realization among young adults that the benefits of college are vastly oversold, will greatly exacerbate the excessiveness of the size of higher ed. The inevitable stopping point Stein mentioned is nigh.

Timing is 90 percent of life, and my timing has been pretty good. I do not envy the next few cohorts of junior faculty. The future is grim.

Insofar as hypocrisy is concerned, it is sickly ironic that universities are wrapping themselves in the flag of academic freedom when they have been at the forefront of censorship, cancel culture, and intellectual narrowness. And if they are looking for political support, the fact that they are wildly unrepresentative of the opinions and beliefs of most Americans, and are in fact sneeringly dismissive of those opinions and beliefs, means that they are very much unlikely to find it. In this, as in many things, Trump’s instincts for what will sell politically are far superior to those of university administrators and faculty–and the likes of David Brooks. It’s hard to imagine a less sympathetic group than the denizens of modern American academia.

I could go on, but you get the point. As usual, one might question Trump’s choice of means, but you can’t really question his choice of target, either on the merits or the politics.

Similar considerations apply to the other subjects of Brooks’ angst–big law is a particular example, as is the administrative bureaucracy.

And this all gets back to a fundamental point that I have been making for almost a decade. Trump is a symptom. An effect. Not a cause. The underlying cause is the failure of the alleged elite and the institutions they dominate. An elite for which David Brooks is the perfect poster boy.

Iberian Electricity Roulette: Russian Roulette With an Automatic

Today the Iberian peninsula returned to a state like that experienced by previous occupants like the Carthaginians or Umayyads: electricity free. Around 1238h local time, the grid crashed in Spain and Portugal: parts of France are affected too.

In brief, frequency crashed suddenly, indicating that generation was insufficient to meet load. And here’s the deal with frequency crashes in renewables dominated systems: when the frequency falls, it can’t get up.

In conventional power systems that rely on thermal and nuclear generation spinning generators absorb most fluctuations through the inertia inherent in large numbers of massive spinning machines. Having other spinning machines on standby is also essential to absorbing shocks. Renewables dominated systems lack this inertia, and have inadequate backup, and are thus extremely brittle: they cannot absorb sharp fluctuations in generation or load, and such shocks can cause the system to collapse.

Today, “can” became “did.”

Perhaps the shock was weather-driven, due to a sudden drop in wind or solar production. Or perhaps it was a sudden increase in load due to a temperature shock: Portugal’s grid operator mentioned “extreme temperature variations” and a “rare atmospheric phenomenon.” That could be interpreted as either a weather driven load shock, or a weather-drive generation shock, or both. Or perhaps a transmission problem cut off power from an important source.

Whatever the initial shock, the ultimate culprit is either directly or indirectly an over-reliance on renewables. Directly in the case that generation volatility inherent in renewables caused the frequency drop. (I am currently working on a project to quantify renewables output in various US markets). Indirectly in the case of a shock to demand that a renewables-heavy system could not absorb due to its inherent lack of inertia.

The grim irony here is that Spain had just bragged that it obtained 100 pct of its power from renewables.

If that’s victory, what does defeat look like? (And that claim not completely honest, by the way: nukes and thermal generators were supplying spinning reserves and other ancillary services).

This was inevitable, just as it is inevitable that playing Russian roulette with an automatic will end badly. In other words, Iberia just found out the consequences of fucking around with renewables.

The question is whether lessons will be learned. Given that this isn’t the first time this has happened, and countries around the world have doubled down on their renewables death ride regardless I am skeptical: these people NEVER admit error. At least the Trump administration is pumping the brakes, though not hard enough for my comfort. But Germany, the UK, Australia, etc., appear to want to pursue the “energy transition” in the worst way. The worst way being a transition to no energy that occurs with probability one in finite time.

It is thus particularly hilarious to read this from Bloomberg. Great timing!

Today’s Green Daily newsletter looks at how the US has become further isolated from other rich nations that are continuing to push towards net zero https://t.co/zHdOhacsYj

— Bloomberg (@business) April 28, 2025

On noes! Not isolation from the lemmings plunging over the renewables cliff! Anything but that!

Yeah, we’ll be enjoying our isolation from you all shivering or sweltering in the dark.

And speaking of the dark, Spain has to black start its grid. You know, just like that modern economic powerhouse Cuba has had to do several times recently.

Good luck black starting in the black of night in a system loaded with solar. Hell, even when the sun is shining solar generation declines throughout the afternoon–just when Spain needs more generation to get things spinning again.

Perhaps you find my schadenfreude in poor taste. Well, after being lectured and hectored for years about how I and others of like mind are evil because of our Cassandra-like warnings about the idiocy and insanity of renewables, I really don’t care Margaret. Just like with COVID, the oh-so-superior bien pensants have declared their moral and intellectual superiority over and over to justify destructive policies regarding climate change and energy, and to beat dissenters into silence and submission. They should feel grateful that demonstration of their manifest inferiority results in only scorn, rather than lampposts. And as for the non-bien pensants who are suffering, well, they have voted for these politicians and enabled these policies. If they feel betrayed or deceived, hopefully bluntly pointing out whom is really to blame will rip the scales from their eyes, even if it doesn’t drive them to fitting ropes to said lampposts.

Imitation Is the Sincerest Form of Flattery, Treasury Dysfunction Edition

Kashyap, Stein, Wallen, and Younger have attracted a lot of attention with their recent Brookings paper, “Treasury Market Dysfunction and the Role of the Central Bank.”  Their pathbreaking findings: (a) Treasury basis trades are systemically risky; (b) the rapid growth in the amount of US bonds and notes outstanding increases this risk; and (c) Fed intervention is required to prevent the systemic risk in basis trades from crystalizing.

Wow! Who knew?

Oh, right. I did. Five years ago. (First draft, 7 August 2020). (The lack of a citation is very bad form, guys).

A year and a half ago I provided an answer to a question that most analyses of the basis trade begged: why does it exist in the first place? My answer: constraints on money managers ability to buy cash Treasuries directly, especially leveraged purchases. They achieve implicit leverage through futures, which is mirrored by the explicit leverage of basis trading hedge funds.

Kashyip et al tart up their paper with a simple model. The most important component of this model is money managers’ demand for long futures, but that is really assumed, not derived from a model that specifies the underlying constraint. They merely say: “In our model, asset managers pay the basis for the convenience of holding Treasuries off balance sheet.” Whence that “convenience” arises is left to our imaginations. (They also say “there are specific stories we have in mind” but apparently they’d have to kill us if they told us).

The only real contribution of the paper is their proposal that the Fed engage in hedged bond buying to absorb a (margin induced!) unwind by hedge funds. But that’s just a particular way of doing this: “As a consequence, the soundness of the U.S. financial system continues to depend on the prompt and effective intervention of the Fed as lender of last resort, with all the attendant moral hazard problems.” (They do discuss the moral hazards inherent in their proposal).

By way of faint praise, I do acknowledge that they don’t advance clearing as a nostrum. But I am somewhat startled by this statement: “Although clearing may have significant benefits, these benefits are largely orthogonal to the issues of concern here.” Especially since they also acknowledge that “when volatility increases margin requirements can increase as well, potentially triggering forced unwinds.”

Orthogonal? Hardly: margining, of both the futures and repo legs of a basis trade, is THE source of instability. It is at the heart of these issues. “Can increase”? Does increase. “Potentially triggering forced unwinds”? That’s exactly what triggers forced unwinds.

Their proposal–again, not really novel–that the Fed intervene is necessitated by two things: clearing, and the constraints that induce money managers to launder leverage via futures, rather than take leverage on their balance sheets. Meaning that they let off clearing and regulation far too easily.

Tariffs: Geopolitical Realpolitik, Inflation, and Monetary Policy

The tariff tremor has subsided, though the aftershocks linger. Again, most of the discussion is off-point because it is framed in strictly, or at least primarily, economic terms when in fact this policy is first and foremost an economic weapon in a much deeper great power conflict, one between the US and China/the CCP.

It is not correct to say that Trump started this war. The reality is that he has decided to fight back in a struggle for supremacy that China has been waging quite openly for years, especially during the Xi years. All the blather about Trump destroying the “American dominated rules based international order” is utterly ridiculous because China (seconded by Russia) has been quite blunt in its expressions of dissatisfaction with that order, and its intent to overturn it.

The genius behind the CCP strategy is that it has used, judo like, the order’s institutions against it. Most notably, it has ruthlessly exploited the WTO to advance its geopolitical objectives. It is quite sickening to read what the uniparty said about China’s ascension to the WTO. It was gonna make China all open and democratic, dontcha know. When admitted to the trading system, they would become just like us! Kumbaya! The End of History!

Wrong.

The desolation of industries outside of China, rampant IP theft, aggressive actions in Asia, Covid, and (if anything) an increase in domestic repression is what the gauzy sentiment about the “rules based international order” actually achieved. Perhaps too late, Trump is fighting back.

Then why not just tariffs on China then? Why impose punitive tariffs on the rest of the world, including our alleged allies, the Europeans?

Trump wants to isolate China and stem, and indeed reverse, the inroads it has made around the world, most notably Europe. The threatened tariffs on Europe (and other countries) are a way of forcing them to choose to cooperate in countering China, or kowtowing to it.

The Europeans, morons that they are, are leaning towards kowtowing. Even though they recognize that an avalanche of Chinese goods heretofore destined for the US will descend on Europe.

Lenin said that capitalists would sell communists the rope by which they will be hanged. The Europeans say: “That’s nothing! Watch this! We’ll buy from the communists the rope by which they hang us!”

All that said, I don’t think all of the measures Trump is adopting make sense. One about to go into effect is the special fee imposed on Chinese built and/or operated ships visiting US ports. The alleged purpose for this is to restore US commercial shipbuilding. As I wrote some weeks ago, this is a forlorn hope, and US efforts should focus on fixing its dysfunctional military shipbuilding rather than diffusing its resources with little (or no) chance of success.

Another downside of the monomaniacal focus on China is that it means that other areas that have greater potential to rejuvenate the American economy may be slighted. Two stand out.

The first is the T Rex in the living room–the budget and the national debt. The administration has made some encouraging moves in that direction, but those efforts appear to be slipping, and such as they were, they strike at the edges of the problem at best.

Musk promised that DOGE would save trillions. He has since faded those promises, and recent indications are that the realized savings will be 10 percent or so of those initially promised.

That’s so Elon. His business MO from Day 1 has been to overpromise and underdeliver. Remember the Solar Roof? Yes, Tesla eventually sort of caught up to his hype, but years after the promised delivery date. The lesson is–and I should have heeded it myself: always discount Elon’s promises.

I further remark that Musk’s prominence has faded noticeably in the last couple of weeks. No doubt there are multiple reasons for this. One is likely not wanting to be called out on his overpromising. Another is that his Face of DOGE routine unleashed hell on Tesla and he wants to tamp down those fires. Another is that he has no doubt tread on many toes and bruised many egos–including Trump’s.

Even a DOGE as promised would unlikely be enough to address the staggering budgetary issues confronting the country. Without confronting entitlements and effectively reversing the Covid spending splurge those issues will continue to pose an existential threat.

The second issue is regulation. One could reasonably argue that matastasizing regulation is one blade of a scissors that has cut American economic performance, China being the other.

Yes, the administration is making inroads here. Lee Zeldin’s zealousness at EPA is a particularly encouraging sign. As are Trump’s efforts to seize control of the “independent agencies” (a constitutional oxymoron). But these forays are being vigorously contesting in the courts, courts that harbor numerous intense Deep State/Administrative State partisans. Ultimately these battles will wind up in the Supreme Court, which is unlikely to resolve them definitively, let alone definitively against the bureaucracy. (Note that my prediction that the Court would dodge ruling on substance by deciding on narrow procedural grounds proved true in the first immigration case that reached it came true. Expect that to become a pattern).

The newest front in the battle for institutional control involves the Fed, with Trump ratcheting up his attacks on Chairman Jerome Powell. On the day that Trump announced the tariff salvo, I told a friend that he had to worry most about an internal foe–Powell and the Fed. My reasoning being that Trump is antithetical to the Powells of the world, and that the latter would therefore be highly likely to adopt policies that hurt the economy, just out of spite for Trump.

Powell’s remarks on Wednesday–which are what triggered Trump’s outburst about “terminating” him–confirm, or at least do not contradict, that suspicion.

Powell’s rationale for not cutting interest rates (something that the ECB has done and continues to do) is that Trump’s tariffs will be inflationary. That conclusion, if based on the simplistic reasoning that dominates discussion of this topic, is wrongheaded.

Tariffs affect the prices of imported goods relative to other goods. I repeat: they affect relative prices. Inflation relates to the level of prices. It is possible to have relative prices go up and the price level go down. Or the reverse. You cannot–I repeat, cannot–argue that there is a direct line between relative price changes and the price level.

Here I am reciting John Cochrane’s catechism about the sin of mistaking relative price shocks and price level shocks. I recommend reading the original in more detail: here is a good start.

There are causal channels that connect tariffs to the price level. But they are indirect. Both go through the effect of tariffs on real income.

The monetarist/neo-Keynesian channel is that tariffs reduce output, which reduces the demand for money, which leads to an increase in the price level.

The Fiscal Theory of the Price Level (my current preferred theory) is that tariffs reduce real income, which reduces tax receipts, which reduce primary surpluses, which causes an increase in the price level (since the real value of debt equals the present value of real primary surpluses). One wrinkle in this story is that tariff revenues affect primary surpluses, though I consider it likely that at least the punitive levels initially announced are not revenue maximizing, especially when taking into account their effect on income and corporate taxes.

But note: these causal stories are implicitly based on a projected final outcome in which the high tariffs persist for some time. That is by no means clear. The initial salvo is, as I opined at the very outset, likely a negotiating tactic that could result in reduced trade barriers, at least for countries other than China. The pause and announcements of numerous countries approaching the administration to negotiate certainly supports the art-of-the-deal interpretation.

And if it does, the same arguments that could be used to argue that the tariffs, if they remain in place, would be inflationary would be turned on their head: tariff threats that resulted in reduced trade barriers would be anti-inflationary.

Which brings me back to my earlier observation (which has achieved some resonance): tariff threats as a negotiating strategy don’t work unless there is uncertainty about whether they are a negotiating strategy. This creates uncertainty about the ultimate result, which creates uncertainty about ultimate effects on inflation.

Regardless, the legitimate potentially inflationary channels relate to the effects of tariffs on real incomes. And here perhaps the best analogy is with Fed policy responses to oil price shocks. An oil price shock is a relative price shock, just as tariffs are a relative price shock. As documented Bernanke et al, in the past the Fed has responded to this relative price shock by tightening policy, and that tightening has caused the recessions and stock market declines that Hamilton (and others) had documented previously.

Will Powell–unless Trump defenestrates him–follow the old–and discredited–Fed playbook of tightening in response to a relative price shock? I consider that likely, either because of intellectual error (compounded by institutional biases), political spite, or both.

If Trump indeed “terminates” Powell, it will have effects on the economic impact of tariffs, whatever they end up being, and will have potentially seismic consequences for America’s governing institutions (going well beyond the Fed). Thus, we are witnessing yet another game of chicken for high stakes. Does Powell think that his cause is so righteous that he will trigger this potentially cataclysmic collision?

Another imponderable that just compounds the uncertainty.

Trump’s Tariffs: A Political World Turned Upside Down

In my previous post, I argued that the bulk of the debate over Trump’s tariff bomb was misplaced, indeed pointless, because it is stuck in the frame of first-best textbook economics, and ignores the game theory of how one achieves a strategic objective. Saying that most of the criticism is off-point is different from saying there is nothing to criticize, or that the tariff gambit is a good one on a risk-adjusted expected value basis. In other words, just because the critics are largely wrong doesn’t mean that Trump’s strategy is the right one. Herein I set out some of my reservations, but also expand upon the point of identifying what the real issues are.

First, as noted in the previous post, I highly doubt that the tariffs will achieve the stated objective of reducing trade deficits. Trade deficits are mirrored in the capital account, and IMO it is capital market factors–namely, the strong bias in the US for current consumption, especially government consumption or government-financed consumption, over future consumption–that drives the current account deficit. The best way to address that issue is to pursue the DOGE initiatives with fervor, and to restore fiscal discipline more generally.

In this regard, the revenue aspect of the tariffs-something Treasury Secretary Bessent has emphasized, but which have largely been ignored–deserve far more attention. The choice between income and consumption taxes is an important issue, and it is at least possible that some level of tariffs in excess of the current level is a more efficient way of raising revenue than alternative means, such as higher income or especially capital taxes.

Second, and relatedly, (a) trade deficits are a crude proxy for the impact of inefficient trade and industrial policies in foreign countries (notably China) that have harmed US industries, and (b) these policies cannot be offset by trade policy alone.

As a concrete example of (a) the recent Chinese dominance of shipbuilding emphasized in an earlier post did not happen because China imposed restrictions on the purchase of US-built ships by Chinese firms, or taxed such purchases. It resulted from massive subsidies. Thus, tariffs do not attack directly the cause of many of the policies that have disadvantaged American industries.

Another issue related to (a) is that trade patterns are also affected by comparative advantage. A low wage country (as China was for years, less so today) should dominate production of labor-intensive goods. That benefits both it and the countries to which it sells them.

With respect to (b), by framing the issue of, say, the hollowing out of many US industries, and their displacement by foreign firms, as a result of unfair trade practices alone, or charging higher tariffs on US goods than we charge on theirs, the administration is likely inadvertently limiting its negotiating position. If China says, “uncle–we’ll cut tariffs on US imports to zero!”–the other policies that have much more materially contributed to China’s replacement as the leader in many industries will remain. These include financial repression, massive subsidies, IP theft, and the like. But if China makes that concession, will it be politically feasible for Trump to say “that’s not enough!” since he has focused on discriminatory foreign tariffs in justifying his policy? And is it really feasible to use tariffs as negotiating leverage to extract concessions on all the other Chinese policies that are the real drivers of the deleterious impact of China on US industries? I am deeply skeptical.

Meaning that I consider one very likely outcome that Trump will win a victory (reduced Chinese import protection) but it will be a Pyrrhic one because it will not address the real issue–Chinese export promotion.

Third, I italicized the word “stated” in reference to Trump’s objectives for a reason. Namely, I don’t think that reduction of trade barriers is truly Trump’s ultimate goal. I think his goals are much, much more ambitious. As some others have noted, and in particular as Bessent and VP Vance have stated explicitly, Trump really aims to transform fundamentally the American economy.

When Trump first emerged in 2016, I characterized him as a Jacksonian, something that is highly anomalous given his pedigree. Since then, many others have adopted the Jacksonian framing.

That matters here because what Trump is doing now has no real historical parallel other than Jackson’s populist war on the eastern elites, a war that was epitomized by his battle with Nicholas Biddle and other financial elites over the Second Bank of the United States. Bessent and Vance have explicitly described what Trump is doing as an attempt to wrest control of the country and its economy from Wall Street and restore it to Main Street, in much the way that Jackson attempted to wrest control from Philadelphia and other East Coast bankers in the 1830s.

That is, this is really another front in the culture war. Perhaps the biggest, most impactful front of all.

This brings to the fore another problem with analyzing this using purely Econ 101 textbook tools. Like most policies, the main driver here is redistributive, not economic efficiency–or at least economic efficiency as crudely characterized in a textbook where everything is done at an aggregate level.

The standard argument against retaliating against inefficient promotion of industries by foreigners is that yes, these policies reduce total wealth (foreigners and Americans combined), but increase the wealth of “Americans.” That is, if Chinese policies result in them selling things at less than cost, “we” benefit from getting to buy cheaper things.

I put “we” and “Americans” in quotes because it is likely true that aggregate real income and wealth of Americans has gone up, courtesy of China force feeding exports like a goose destined to be foie gras. But certainly not every American has benefitted, as a visit to any dead or dying industrial city or town in the Midwest will demonstrate.

That is, the seismic changes caused by China’s industrialization, especially to the extent it has been advanced by industrial policies, has not represented a Pareto improvement among Americans–a Pareto improving policy being one which makes some better off, and no one worse off. In theory, the aggregate gains would make it possible to compensate the losers in, say, Middletown, Ohio (Vance’s hometown). But that’s another textbook concept that is unachievable in the real world.

Distributive issues drive politics. This should go without saying, but it doesn’t.

And given that the impacts of China’s policy-driven emergence have been highly unequal, and not Pareto improving, there is not a purely economic basis to reject policy measures to offset it. The welfare triangles in textbooks or the theoretical possibility of compensating the losers do not provide a principled basis for rejecting offsetting measures that may reduce aggregate American wealth or income, but benefit many, especially those harmed by Chinese policies. Indeed, there is something of a let-them-eat-cake vibe given off by those who make such arguments

Nor do they explain the political support for such retaliatory measures. I believe Trump is a conviction politician, and one whose convictions align with the interests of those who have lost, first from Japanese competition (which Trump railed against in the 1980s) and now, and more severely, from Chinese competition. What he says and does resonates deeply with many. The Forgotten Men (and women) of the 2000s.

And this is a big reason why Trump has been so disorienting generally, and with the tariff issue in particular. He is seizing what has been a hallmark issue with Democrats and the left–equality. He is aiming to redistribute and reshape economic outcomes on a scale not attempted since FDR in the 1930s. And the constituency for these policies is that of traditional Democrats.

Thus we see Democrats adopting Chamber of Commerce arguments to hurl at Trump, and the supposed champions of income equality and fairness pointing to declines in stock prices that harm mostly the very well-to-do as proof of the evils of Trump’s policies.

A world turned upside down.

Obama used to brag about trying to bring about “a fundamental transformation” in America, to the rapturous acclaim of those on the left. Well, Trump is actually moving much more boldly than Obama ever did to achieve a transformation much more fundamental than Obama ever dreamed about.

So it’s clearly not “fundamental transformation” per se that matters, it’s what kind of fundamental transformation, and who is making it.

Will he succeed? For reasons including those outlined above, it is doubtful: deliberate fundamental transformations are inherently difficult to achieve in a world characterized by entropy and hysteresis. Criticizing a policy whose objectives you agree with but which you believe is unlikely to succeed is principled. But at least then you are making relevant arguments, based on an evaluation of the desirability of the objective, and the likelihood of achieving it. Which represents a vanishingly small fraction of the people speaking the loudest at present.

One last thing. Everything Trump does is about China. Canada is about China. Mexico is about China. Greenland is about China. Panama is about China. Tariffs are first and foremost about China, and perhaps counterintuitively their universality is also about China.

Again, Trump is a conviction politician about the threat from China, just as Reagan was a conviction politician about the threat from the USSR. So yet again, you need to address your arguments to the real underlying issues of whether China is truly such a threat, and if so, whether the array of Trump initiatives is the best way to deal with it.

Trump’s Tariff Bomb: The Pointlessness of the Ongoing Debate

On my annual teaching sojourn in Geneva, I had the opportunity to watch the European (French, specifically) reaction to Trump’s tariff speech. Watching with closed captioning (I can read French fine, my ear sucks) was especially illuminating, because it allowed me to focus on the body language and vocal pitch of the various commentators. Both clearly betrayed extreme anxiety, not to say hysteria.

I guess that hysteria is warranted, because what Trump has done is indeed unprecedented and likely to have seismic effects, intended and unintended. And these effects will be global in scope, and indeed, impact Europe more than anywhere, even more than the US and perhaps even China.

I am an economist, and I obviously understand the conventional argument against trade protection. Much of the criticism of what Trump has done adopts the economist’s conventional framing. But it should be blindingly obvious that the administration’s policy is based on a totally different vision. A vision that finds the conventional approach far too blindered and narrow-minded. And it has a point.

Therefore, the question is: which vision is correct? The conventional wisdom, or Trump’s heretical alternative?

Much of the criticism has focused on the issue of the “reciprocity” of the tariffs, and specifically the formula that the administration used to calculate tariff rates by country. The critics say that the tariffs the formula generates are far larger than the tariffs that the target countries impose on US goods, so that Trump’s claim of reciprocity is a lie.

Viewed narrowly, these criticisms are correct. But in his speech, and elsewhere, Trump alluded to a nexus of non-tariff policies that are either nakedly or implicitly protectionist to justify the rates he is demanding. These policies include “currency manipulation,” among other things.

In essence, what the administration is doing is using bilateral trade deficits as a proxy to measure the total impact on the US of this nexus of policies (going beyond tariffs) of each trading partner. Yes, this is obviously a crude proxy. Bilateral deficits are driven by many factors other than asymmetric protectionist measures, such as comparative advantage, but such measures do also matter.

The formula thus results in false positives–charging tariffs that are based on trade deficits driven by non-protectionist factors. But it is clearly focused on avoiding false negatives–i.e., not punishing those whose surpluses with the US are driven by the nexus of protectionist policies.

Put simply, the tariffs are a bludgeon, and if the skulls of some innocents are smashed, Trump gives no Fs as long as the skulls of the targets (yeah, I’m looking at you, China) are well and truly pulverized.

Given the parameters used in it, specifically the elasticity of US import demand with respect to prices, and the fraction of tariffs passed through, the formula spits out a tariff level for each country that would cut the trade deficit in half. There’s a lot of snarking about these two parameters (remember all large calculations are wrong!) but it’s likely that they were chosen largely to achieve this objective.

Two observations that are well outside the conventional framing that is dominating the criticism.

First, I do have doubts that tariffs, even as punitive as those being implemented, will affect the overall US trade balance. In a one period world, there are no trade deficits: the value of imports must equal the value of exports. However, with multiple periods and capital markets, trade deficits can exist, and they are the mirror of capital flows.

In essence, foreigners are willing to sell a greater value of goods to the US than the value of goods they receive in return only under the expectation that they will receive a greater value of goods on net in the future, and where the net is zero in present value terms. The US pays for the surplus of goods imported today with IOUs.

One implication of this is that trade deficits are largely driven by US budget deficits. The deficits generate IOUs, much of which are taken up by foreigners in exchange for the goods they sell us today.

Meaning that the efforts of DOGE will be more material in reducing trade deficits than the tariffs will be.

Second, the conventional framing implicitly assumes we are in a “first best” world. That is, economies are currently efficient, and operating with no distortions. Edenic, in other words. Introducing a distortion like tariffs into Eden creates a fallen world.

But, of course, we are decidedly not in a first best world. Indeed, the entire rationale for the tariffs is that we are in a very, very fallen world in which foreign nations–again, I’m looking at you, China–implement a vast complex of distortionary policies. With respect to China these include, inter alia, capital controls, currency management, financial repression (a big one), restrictions on foreign investment, widespread subsides (e.g., shipbuilding as laid out in an earlier post) and a plethora of regulatory policies that favor domestic firms over round eyed devils.

In such a world, it is categorically incorrect to conclude that an aggressive tariff policy is bad, based on the effects of tariffs in a first best world, which is not the world we are in.

Are Trump’s tariffs what economists call a second best policy? That is, a policy that is welfare improving because it offsets pre-existing distortions? I don’t know: the world is very complex, and tracing through all the effects is a daunting task.

But what I do know is that this is the question that must be addressed, but which virtually everyone is ignoring. Meaning that the hysteria is utterly pointless, and the current debate is totally off-point. And it will be until the we’re-not-in-the-first-best-world nettle is grasped.

The misdirection of the hysteria is even more pronounced due to a widespread failure to determine whether the tariffs are a tactic, or a strategy based on a conviction that tariffs are good per se. Knowing Mr. Art of the Deal, it is highly likely that the tariff bomb is a tactic, and specifically a negotiating tactic in which Trump exchanges concessions on the punitive rates for foreign reductions in their protectionist measures.

If that’s the case, and the tactic works, ironically the end state would be closer to the classical liberal economic outcome that the critics assert Trump is destroying. That is, when all is said and done there will be less protectionism in all forms, tariff and non-tariff.

The imposition of tariffs on pretty much everyone (including islands inhabited mainly by penguins!) has important implications for the negotiation game.

One implication is that this is a divide an conquer strategy. Although the rest of the world’s collective interest would be to cooperate to counter the US strategy, collective action problems abound. Indeed, there is a prisoner’s dilemma in play here. Countries realize that they can get a better deal if they bend the knee early. Hence the rapid actions by Vietnam, Cambodia, and Israel. They may be the first, but no doubt the last. Indeed, there is likely an unraveling dynamic here: who wants to be the last to genuflect?

Or consider our “friends” in Europe. They are now confronted by the ugly reality that US tariffs on China will result in a redirection of goods to Europe that will hit European industries hard. So Europe may be sorely tempted to raise unilaterally its tariffs on Chinese goods–which would suit Trump just fine, since the tariff policy, and as is the case with almost all other Trump foreign policies, is all about China, China, China, and specifically weakening China. And even if Europe doesn’t unilaterally respond to a surge in Chinese goods by raising protective barriers, it may well agree to do so as part of a deal with Trump to reduce the tariffs they pay in the US. (Even though European consumers would benefit from this influx of Chinese goods, the political economy of protectionism favors producers-concentrated interests-over consumers-a diffuse interest).

The confusion over whether this is actually a negotiating tactic, or whether Trump is in fact a true believer that tariffs are great policy is actually necessary for it to be an effective negotiating tactic. Game theory long ago demonstrated that a reputation for doing seemingly irrational things requires that there be a positive probability that someone is in fact irrational. So the uncertainty over whether Trump is truly crazy is a necessary condition for him to implement a crazy-like-a-fox negotiating strategy. Even if he is really just bluffing, he has to credibly signal that he’s not, and he does that by proclaiming his love for tariffs.

In sum, the cramped vision of those melting down and freaking out over Trump’s démarche precludes a serious analysis of it. Econ 101 says–tariffs are bad economic drugs, M’kay. Agreed!–in an otherwise first best world. But since we are clearly not in that world, and that Trump has identified (inarticulately, as is his wont) ways in which the world is fallen, it is not necessarily the case that the extraordinary measures that he has put forward are bad. Especially if he is using them to extract concessions that eliminate or at least mitigate the policies that currently distort world trade, production, and consumption.

That is, contrary to the critics, one cannot conclude that the tariff bomb is destructive a priori, based on Econ 101. One must grapple with the much more daunting challenge of evaluating its effect in a decidedly fallen world.

Alas, there seems to be little ability or inclination to do so. Instead we are likely to be be bombarded with a continual stream of hysterical rants rooted in textbooks not reality, and amplified by the pre-existing hatred of all things Trump among the soi disant elites.