The "Trump put" is back

It's good to be the king

It feels good when you stop beating your head against the wall.

It took only one day for the prediction in my recent Econlog post to be confirmed. In that post, I suggested that China had the upper hand in the negotiations:

So, how did the administration miscalculate so badly? Perhaps they relied on a flawed economic model. Economists understand that the greatest benefits from international trade go to the country that imports goods. But most average people believe that it is exporters who gain the most from trade. Those holding that view are likely to wrongly assume that our trading partners hold a weak hand. Based on their public comments, Trump administration officials like Scott Bessent seem to suffer from this misconception.

Here's today’s Bloomberg:

Xi Jinping’s decision to stand his ground against Donald Trump could hardly have gone any better for the Chinese leader. . . .

The deal ended up meeting nearly all of Beijing’s core demands. The elevated “reciprocal” tariff for China, which Trump set at 34% on April 2, has been suspended — leaving America’s top rival with the same 10% rate that applies to the UK, a longtime ally.

The US met Beijing’s call for a point person for talks by setting up a mechanism headed by Treasury Secretary Scott Bessent. And the two sides agreed to take “aggressive actions” to stem the flow of fentanyl, which could eventually lead to the elimination of the additional 20% tariff.

Of course the fentanyl issue is a red herring. No sane person believes that China plays any significant role in America's drug problems. Most of the fentanyl doesn't even come from China; it comes from Mexico, where Chinese precursor chemicals are turned into fentanyl:

In their quest to build fentanyl empires, Mexican criminal groups are turning to an unusual talent pool: not hit men or corrupt police officers, but chemistry students studying at Mexican universities. . . .

The cartels “know we are now focused on the illicit trafficking of these precursor chemicals around the world,” said Todd Robinson, the State Department’s assistant secretary of the Bureau of International Narcotics and Law Enforcement Affairs.

Those efforts are driving the cartels “to try to bring this thing in-house,” Mr. Robinson said. “The practical result of that is their ability to more easily and quickly transfer those drugs to the United States.”

I've watched the US engage in a war on drugs for my entire adult life—for 50 years— and nothing has changed except that drugs are getting ever more plentiful. A recent Brookings paper perfectly encapsulates the insanity of the drug war:

If China continues to reject KYC laws, the United States and its global coalition partners should raise the costs of China’s KYC noncompliance by denying Chinese suppliers and industries market access, undoubtedly an expensive policy but one that recognizes the fentanyl epidemic’s immense and multifaceted costs.

However, the United States should not judge the extent of China’s cooperation by the number of deaths in the United States. Even if China were to robustly cooperate, deaths may not dip: In illicit drug markets, there are always lags of months or years between effective supply measures and retail changes. Besides, Mexican cartels have stockpiles of precursors; they can source them from other sources, such as India or South Africa.

In other words, please fight an extremely cost drug war even though it won’t work.

When President Trump took office it was widely assumed on Wall Street that there was a sort of "Trump put". Then stocks fell sharply for a few weeks after Liberation Day, as Trump actually seemed serious about his protectionist agenda. Now the Trump put is back. It seems that Trump doesn't want to take dolls away from little children right after receiving one of the largest gifts in world history, a $400,000,000 jet provided by Qatar, decorated like a palace. It's good to be the king!

Here’s how I began my very first post after Liberation Day:

The tariffs will likely be scaled back. I will discuss the impact of the proposed tariffs, but these should NOT be viewed as unconditional forecasts of their impact on the economy. (FWIW, markets seem to expect a bit of stagflation.)

And even when stocks crashed over the following few weeks, I cautioned people that:

This certainly does not mean “armageddon”

Here are some points I made in an April 30 Econlog post:

Most economists overestimate the impact of “real shocks” such as tariffs on inflation and the business cycle. . . .

There is “a great deal of ruin in a nation” and hence even large real shocks usually have seemingly small effects on long run growth. But those seemingly small effects are actually quite important. A 0.2% decline in long run growth is far worse than a 2% fall in GDP for a single year.

Put these nine points together, and you have a recipe for widespread misunderstanding regarding the recent trade war. I don’t know how much monetary offset we are likely to get, and I don’t know how much the administration will adjust tariffs in the weeks and months ahead. Thus it’s impossible to offer unconditional forecasts on inflation and the business cycle. But I will offer a few tentative observations.

1. The current level of tariffs, by itself, is probably not enough to trigger a recession. Nonetheless, a recession is possible due to the interaction of tariffs and monetary policy. . . .

The administration faces an interesting dilemma. It can avoid recession by backing off on the trade war, at the cost of failing to address the trade deficit.

If the level of tariffs on April 30th “probably” was not enough to trigger a recession, then the revised level is certainly not enough to trigger a recession. If there is a 2025 recession, it will be caused by monetary policy.

The “interesting dilemma” I mentioned a few weeks ago now seems to be resolved. The Navarro/Miran wing of the administration lost. Trump blinked. He decided not to try to address the trade deficit, and instead is focusing on the health of the economy and the stock market. There will be no attempt to “bring back manufacturing”. That’s good!

In the end, Trump took a “soft” approach. I expect he’ll do the same with fiscal policy—trying to please everyone. For some time, I’ve been predicting that the GOP will produce a horrifically bad budget this year, and I’ll do another post when that prediction is confirmed. (By horrifically bad I mean the trifecta of blowing up the deficit, making the economy more inefficient, and making the economy more unequal.)