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- [00:00]
Joe House
All right, my birdie buddies, my par saving pals, my Eagle enthusiasts, it's Joe House here. Major season is finally upon us. The Masters, the PGA Championship, the US Open, the Open Championship, and Fairway. Rowan is here to break down all of the storylines. Offer a little help on those betting cards for every single major this golf season. Join me and our incomparable accomplice, Artur Boots on the ground, Nathan Hubbard, as we guide you from Augusta all the way to Northern Ireland Royal Port Rush. Away we go.
- [00:44]
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- [01:07]
Derek Thompson
So it all happened like this. Soon after Donald Trump's inauguration, his economic advisors gathered to work on implementing his trade policy. At the top of the list was the question of tariffs or taxes on American imports. Donald Trump promised tariffs throughout his 2024 presidential campaign. He promised tariffs in his previous presidential campaigns. He praised tariffs in dozens of interviews stretching back decades. Trump is for some a confusing and shape shifting figure, but on this matter he has been frank and consistent. Donald Trump loves tariffs, but translating a fondness for tariffs into policy was challenging. For weeks, Trump economists worked on several possible tariff plans which attempted to calculate with some precision each each country's trading penalties against the US Basically how much we were getting ripped off by every country in the world. But on so called Liberation Day last week, just hours before he appeared on tv, Trump personally selected his own esoteric formula for calculating tariffs on each country. These rates were significantly higher than most economists and the market expected. In fact, with this new plan, the average tariff rate in the US would rise to its highest level in 115 years. As a share of the economy, this new tariff duty would be the highest since the end of the Civil War before the creation of the modern car or aspirin or the incandescent light bulb. After a speech in the Rose Garden, the stock market puked. The S&P 500 suffered one of its largest two three day crashes in history. It has since recovered some of these losses. But as I write this open on Tuesday morning, April 8th, the market is down 11% year to date. I want to pause here on the market reaction because a question has emerged that I think deserves an answer. Why do we care why does this matter? Some might argue that it doesn't.
- [03:13]
Matthew Klein
Right.
- [03:13]
Derek Thompson
Not everybody's invested in the stock market. This is true. But most people are. More than 60% of Americans have savings attached to equities, which means a large decline in stock prices implies a decline in wealth for more than half the country. I think that's bad. But the stock market, more to the point, is not just a measure of wealth. It's an indicator of growth. In the last 35 years, the S&P 500 has only declined by 10% year over year, a handful of times. In almost every occurrence, 1991, 2001, 2007, and 2020. What came next was a recession. That's one reason why I strongly dislike this new faux populist argument that it's somehow elitist to worry about the stock market. Stock prices represent information. If investors suddenly believe that the future profit of America's largest companies is about to tank and they're willing to stake hundreds of billions of dollars toward that position, they're making a dramatic and expensive forecast that the US Economy is about to get smacked in the face with a brick. And when employers see profits declining in the face of uncertainty about global demand, they typically stop hiring and even lay off workers. Stock prices are not just measures of other people's wealth. They are indicators of the economy that surrounds you, whether or not you own a single stock. That's one reason why, as some of you may have seen, I had a mild freakout last week on cnbc. What happened was, on Friday, I was asked to talk about the tariffs on TV for their afternoon show. As I was waiting in the virtual waiting room while the producer was setting up my shot on zoom. Right. You know, move a little bit to the left. No, the right. Can you tilt your camera down? Okay, tilt it back up a bit. You know, sit straight. Okay, we got it. As we're working through all these little details, I had the immense displeasure of having to listen to a hedge funder make the argument that declining stock prices might be good for America, that a housing crash might be good for America. After all, he said, we've got an affordability crisis here, don't we? What's the harm in making everything cheaper by obliterating demand? I'm not going to rehearse every word I said on tv. It's on the Internet, I guess. And to be frank, I blacked out with rage and don't remember half of what I said. Top of mind. But let me just summarize my current reaction. This way, growth is Good and rooting for its opposite is bad. A recession commensurate to the stock market sell off that we saw last week would be a terrible thing for America. At the same time, I don't want to get high in my own supply here. Going viral for 24 hours is fun, but it's not important. What's important is continuing to see reality clearly. And to me, that means two things. Number one, judging the President's policy honestly, and number two, seeing the bigger picture of American trade and manufacturing and growth. It would be easy for someone in my position to focus today's show on everything Trump's tariffs got wrong. I've done that. That article is written in the Atlantic. You can go find it. But today I want to have a harder conversation. What if something is wrong with the current economic system? What if China is taking advantage of the US in a way that is causing us to deindustrialize faster than is strategically advisable? What if a new trade policy or a new economic policy would make America richer and better prepared for the next decade? I wanted to talk to somebody I trusted to explain why the current status quo might need fixing, even if what's on the table today is the wrong fix. Today's guest is Matthew Klein. He's the author of the newsletter the Overshoot and the co author with the economist Michael Pettis of the widely acclaimed economics book Trade Wars Are Class Wars. We talk about the Trump tariffs, their place in history, the goal of re industrialization, and why our problem with China is a malady worth solving, even if Trump's medicine is just making us sicker. I'm Derek Thompson. This is plain English. Matthew Klein, welcome to the show.
- [08:22]
Matthew Klein
Thank you very much for having me. Derek.
- [08:24]
Derek Thompson
We're about the same age. I'm 38. You're 38?
- [08:28]
Matthew Klein
38 too, yeah. I'm also 38.
- [08:29]
Derek Thompson
We're the exact same age. We've been writing about economics for the same amount of time. You remember 2007, 2008, the housing crash. You certainly remember 2020, the pandemic crash. Why is this time different? What do you think makes this moment unique in the last generation of financial crises?
- [08:50]
Matthew Klein
I think not just in this generation of financial crises, at least within the US but ever is the fact that this was induced deliberately by policy, without any obvious direct sort of preceding cause or concern. The financial crisis obviously had a lot of causes, but it was something that was building up in the system. There were lots of things happening that made it happen. Covid was obviously it was a financial crisis that was associated fundamentally with a real phenomenon, which was a pandemic that was killing a lot of people and making a lot of other people sick? This is not that. This was a set of choices that were made very recently that could have not been made and we would have been in a very different world. And so that makes it a very different phenomenon. I will say, though, that I said among rich countries, there are other places generally, not the kinds of places we think of as being comparable in the United States that occasionally have done things like this, various kinds of policy experiments to. You have sort of a radical regime come into office and say they're going to change things a lot. And there is a precedent there in poor countries. And so we've seen that. We just don't think of that usually as being associated with the United States.
- [09:56]
Derek Thompson
Do you have an example, top of mind, of a poor country having a regime change, a policy experiment leading to, say, a financial crisis?
- [10:05]
Matthew Klein
In terms of financial crisis, maybe not necessarily. But I mean, recently, for example, we've seen in Turkey, and they've actually had a bit of a change more recently since then. But a couple years ago, there was a view among Erdogan and some of the top people he put into economic and financial positions that the way to deal with inflation was to lower interest rates and that if you lowered interest rates, you could have less inflation than you otherwise would and also more growth, which obviously, true, that's great, but you should try that. And they did try that in particular during a period of time when the rest of the world, including Turkey, was having a lot of inflation associated with the pandemic and reopening everything. And it did not work the way that would have expected. The Turkish currency, the lira, crashed against other currencies. They had a very rapid acceleration in inflation. And more recently, they did a pretty big turn of high interest rates. And now things are different. But that was a period of time when things were pretty dramatic. You could look at Argentina, I think, is an interesting example. Under the curve for the past 25 years, arguably the past 100 years, Argentina kind of engaging in various sorts of policy experiments. Actually, I think there's a connection between now and Peronism. I don't think we need to get into that level of old history of the way that the government tried to basically say we're going to bring industry to a country, that industry is to a country that didn't have it. But we've seen this kind of thing before and it has not generally worked out well. Usually In British countries, you don't see that.
- [11:33]
Derek Thompson
So Peronism in Argentina, Erdogan ism in Turkey. The fact that those are the best comps for what's happening in the US Right now is very interesting. The White House announced their tariff rates last week, and the methodology has received quite a bit of scrutiny. The White House seems to have arrived at their country by country tariff rates by dividing the US Trade deficit with a given country by how much the U.S. imports from that country and then doing a rough adjustment. So, for example, you take a country like Lesotho, small landlocked nation in Africa, very poor, got slapped with one of the highest tariff rates in the world, 50%, not because of its trade barriers, but because Lesotho sells us a lot of diamonds and they're too poor to buy most American goods. So if you look to the trade deficit to determine if we're being ripped off by Lesotho, it's going to look like Lesotho, where the Average citizen earns $5 a day and is ripping off the U.S. that's the methodology that we settled on, the meth formula at the heart of this moment's crisis. As an economic analyst who researches and writes about trade, who wrote a book about trade, is this a good way to determine the degree to which each country is cheating the U.S. no.
- [12:50]
Matthew Klein
So very clearly, no. There are a couple things here to break down. The first one, I think it's worth pointing out, is this only looks at the trade balance in goods and that' services. And sometimes people can overstate the significance of this. But it is nevertheless important that, for example, the United States does have a lot of services exports with countries. So you're already only looking at one side of the ledger. The other thing, which I think is actually more important than that is that we shouldn't expect every single bilateral trade relationship, so between any two countries to be balanced or even reflect anything fundamental about how those trade relationships those countries are. You know, what their trading partnership is like, what the kind of trade restrictions they have. So what's interesting, there's been reporting on this that came out the end of last week about how this decision was made in the White House. And the, the reporting says that actually starting before the inauguration, that there were teams of, of experts and, and, you know, civil servants in the, in the government, on several groups of them, and like within the U.S. trade Representative's office and the Council of Economic Advisors and so forth, the Commerce Department actually trying to come up with a rigorous methodology for how you could look at tariff barriers and non Tariff barriers. So everything else that someone might have to prevent US Exports, they did things like interview American businesses that were operating in foreign countries and ask them what their challenges were. But then they didn't take any of that research. For example, it may have been related to this. The US Trade representative every year publishes this very long detailed report on every single country and what their tariff and non tariff barriers are. It happens. The most recent one was published last Monday, so two days before they announced these tariffs. And you can read through for the countries and sometimes you get some interesting discrepancies. So for Brazil, for example, they actually have a note of saying Brazil's tariffs are relatively high. On top of which the uncertainty around Brazil's tariffs mean that it's actually more of a burden for trade than otherwise would be. And then you look at the formula and the formula says Brazil gets the lowest tariff rate. Okay, well that's kind of weird, right? Lesotho is not going to be a big importer of American goods. And that's okay. You know, it's what the question is, how does everything add up together collectively? So if you look at where actually the US Is the biggest trade surpluses in goods, according to US Data, those countries are the Netherlands, uae, Hong Kong, Singapore, which. There are two things interesting here about this. One, these countries are all very small. Sorry, three things. They're all very small. They have really big ports. So Port of Rotterdam is like one of the biggest ports in the world. And they actually all have very large trade surpluses with the rest of the world as a whole. So you can look at the US Netherlands relationship and say, oh, well, we're doing really well in our trade in the Netherlands. If you look at the Netherlands relationship, just what is their overall trade perspective? You would not think that in fact that they are normal measure of country. That's not importing enough relative to what they export. Netherlands would be very high, as is true for the UAE and Singapore and all these others. So clearly this is not telling you anything useful in Mexico. It's basically the inverse situation. We have a huge trade deficit in Mexico, but that's because Mexico is effectively like it's not a port. Right. But a lot of companies, including American ones, put factories in Mexico to sell US things. Those companies might be Japanese companies, might be European companies, but we're importing them from Mexico, even though in a sense they're importing other things from other places. And in fact Mexico, like the United States, has a trade deficit with the rest of the world. And so in other words, they are importing more from the rest of the world than they are selling to the rest of the world. So they are actually much more similar in our situation than we are than the Netherlands. And yet this formula, by looking only at the country to country relationship, kind of misses that.
- [16:28]
Derek Thompson
I want to slow down here for listeners just to make sure that they're picking up what you're putting down. And I think we might want to do a quick econ 101 here too on why trade deficits matter in the first place. So the Trump tariff plan, as you said, is based on country to country trade deficits. And that's a problem, you're saying, because these so called bilateral trade deficits between individual countries can be goofy for all sorts of reasons, right? The fact that the US Exports so much stuff to the Netherlands isn't a sign that like we're getting one over the Dutch. It's just that Rotterdam acts as the doorway to Europe. So of course the US Is going to send a lot of its European exports first to Rotterdam before they move on to Germany or France. It doesn't tell us that much about our actual relationship to or the ideal tariff rate for the Netherlands. And by comparison, the fact that the US Buys so much from Mexico, buys more than we sell to Mexico, is partly a function of the fact that so many multinational companies that want to sell into the US have factories in Mexico. Is that a problem of Mexico's tariff or is it just a function of global supply chains? Clearly it seems more like the latter. But we are circling here this very big question, Matt, which is why would the Trump White House or anyone for that matter, care so much about America's longstanding trade deficit, meaning the fact that we import more than we export over the last few decades? And the way I want to get at this question is through winners and losers. What is a sophisticated way to think about the winners and losers of the large and sustained trade deficit of the.
- [18:14]
Matthew Klein
US That's a very good question. And again, so I think the first thing is that one winner is going to be the financial sector. Because that trade deficit, when you know what is a trade deficit, right? A trade deficit is you're buying more than you're earning, you're spending more on stuff than you are earning from selling things. And so if you spend more than you earn, you have to make that up somehow. Maybe you have financial assets you're selling because you're rich or you're borrowing, taking out a home equity loan or something, you're running up credit Card, debt, whatever. And so the people who are providing that service of giving you purchasing power that you don't have, that's what finance is. It is a miraculous technology, existed for a long time, but is always improving, which is to allow people to buy things with money they don't have. And so they're going to do relatively well, which is, in fact, what we've seen over this period. So that's, I think, one clear winner. Otherwise it gets a little trickier because again, you have to look at sort of what are the roots of a trade deficit. There are sort of four basic elements here that affect it. One is, how much are we producing? Then it's how much are we buying, how much is the rest of the world producing, and how much are they buying? And so those can all be adjusted in different ways to lead to a result of a trade deficit or trade surplus. If you have a trade deficit, because we are producing as much as we can, but we want to buy even more stuff, I mean, America's fine in that case, unless we're taking on a lot of debts that are really hard to repay. So then that's kind of a question. And the rest of the world is also probably okay, unless, again, you have people who are buying less than they would like and are financing us, lending us money to buy stuff, and then are not going to get their money back. So that's a world where it wouldn't be good, but otherwise it's not necessarily bad.
- [20:01]
Derek Thompson
Right. So we think about trade deficits as inherently bad sometimes, and they can be bad. But. But can you think of an example of a country that ran a large trade deficit for a long time, and it was good for them, maybe even good for the world.
- [20:16]
Matthew Klein
Look at Norway. Like, before they discovered oil and gas in Norway, Norway was one of the poorest countries in Western Europe. And then they did discover oil and gas, but again, it's a very poor country. So how are you going to develop it? You need a lot of external financing, a lot of money from other countries, other people going into Norway to help them. And so while that happened, unsurprisingly, they had massive trade deficits while they were building out their oil fields. But this was good for the world, aside from the carbon emissions of it. But it was good for the world because suddenly you have a lot more stuff that people actually like to have. So at the end of the day, there's a lot more oil and gas available, which is good for heating our homes and electricity and all that other stuff. And Norway ends up way richer than they were before. So that's a positive sum world. That's not a case where trade deficit is telling you about bad things.
- [21:00]
Derek Thompson
Okay, then there's the US which has been running a huge trade deficit for the last few decades, buying much more from the world than we sell into world, notably due to the fact that we buy so much stuff from China and we don't sell much stuff to Chinese consumers. How does the American experience differ from Norway?
- [21:19]
Matthew Klein
So there you had a situation where Americans were not spending more than they normally would have. If you look at things like how much are after adjusting for inflation, how much is the average person buying in goods and services. And it was basically growing around the same rate as it was the long term average before 2000. So not like there was some great big spending boom that did not happen. What did happen was that income growth was relatively weak. And that was coinciding with the fact that the manufacturing sector stagnated after almost 100 years of long term growth in real manufacturing output. The Federal Reserve has been tracking this since 1913. They publish it once a month and basically since 2000 kind of flatline and that. And then there's a big rise in unemployment, there was a shift in employment from higher paying jobs to lower paying jobs. And you had a big increase in household borrowing offset this. So there's a difference between if someone says I'm going to spend a lot more money for whatever reason and I borrow to do that, versus I lost my job and I'm going to borrow to make sure I don't starve to death. And you know, we were closer to that second one in the 2000s than the first one. And so that, you know, that was the situation with the trade deficit was clearly a problem. But you know, you have to be looking at the different components, see how they add up. And that's I think an important thing to be doing this kind of analysis.
- [22:42]
Derek Thompson
So there are several defenses of this policy that are coming from within the Republican world. And one story that's being told quite frequently is that these tariffs are fundamentally about re industrialization, bringing back America's manufacturing base which we've allowed to escape to other countries and in particular to escape to China. And obviously there are some things that are just straightforwardly true about this. Like what's the most successful electric vehicle company in the world? It's no longer Tesla, it is byd, a Chinese company. China absolutely has the manufacturing frontier for a bunch of military and advanced tech technologies. Let's say this is all about bringing back manufacturing, building back the Rust Belt to rearm the American industrial machine for the next century. Under that theory, what are we doing wrong here? Why isn't this the right policy to bring back manufacturing?
- [23:43]
Matthew Klein
Yeah, that's a great question. I actually think that that goal is entirely reasonable. And you know who else thought it was a reasonable goal? The Biden administration. And in fact, not only did they think it was a reasonable goal, but I think their approach was much more thoughtful and successful with it. So the bipartisan Chips and Science act, which was passed by the Biden administration, I think actually is a really good example of how to do this correctly, which was you had Congress pass a law to allocate tens of billions of dollars to the Commerce Department that could give out grants or incentives to basically any semiconductor manufacturer in the world. You then hired some very smart people from industry to actually administer this program. And the net result, I guess four years later, at this point, most of the money was sent out the door. Now you have both the Trump administration, some Republicans in Congress saying they want to get rid of chips and science, but in the in between period, actually basically every advanced top line semiconductor manufacturer in the world has established, whereas in the midst of building new fabs, top line fabs in the United States and on budget from the US fiscal perspective. So that seems to have worked. And part of it was about long term commitments and it's about providing the right set of incentives that work for industries, tailoring it to what was needed for specific places and specific companies. And you paired that with other things that were going on at the same time. So the Inflation Reduction act, which is a strange name for what was in there, but a big part of it was what can we do to encourage the development of high end manufacturing in the United States with a particular focus on sort of climate and green related products. And again, the premise was if we give confidence to companies that there's going to be demand for this product for a very long period of time and we subsidize that demand, they'll want to invest. And again, they did. We've seen that. I mean you can see it in the like the again the government, the Census Bureau publishes data on construction spending by different categories of industry monthly. And there was this massive unprecedented spike in construction of factories over the past few years, largely in semis semiconductor and to a lesser extent things like what they call electrical equipment, which includes things like grid transmission, batteries, whatever. So that hit the target. But what they were providing in both cases, what you're Talking about is providing confidence and certainty to companies that it's worth making a risky investment. What we're doing with the tariffs could have been that way. I mean, I'm not saying it's the best approach, but if you just said, look, we are going to pass a law, for example, that says we're now charging this kind of tariff on imports from, on these products from these places or on this product from every place, however you want to do it, that would potentially give companies a confidence, say, okay, that changes the economics of where we build the next factory. So maybe they don't move a factory that's already in Vietnam or India or China, but they say the next one we'll put in the United States.
- [26:51]
Derek Thompson
And it's not just that we're dismantling existing policies that would clearly help us build a high tech manufacturing base. It's also that these policies introduce a level of uncertainty that will actually add a barrier to bringing back manufacturing. Right. How does that work?
- [27:09]
Matthew Klein
First of all, they're using a law that is supposed to be about dealing with economic emergencies. So the reason they keep talking about how this is a crisis, an emergency, is because that's the only legal justification they have for doing what they're doing, which is again, it's kind of tricky and people are suing about this already. So first of all, it very well might get overturned legally. So again, if you're following this as a business owner operator, why would you have confidence these tariffs are going to stay here? Whatever economics you might see now in terms of the benefits of a 50% tariff on Lesotho is not necessarily going to stay. And then also the administration might take it off. So it's not even like you put a 25% tariff on once, but then it goes on, it goes off. It's for these products, it's not for these products. And so again, if you don't have that level of basic confidence in what the system is going to be, why would you invest? And it's not surprising that the surveys that are run by either various parts of the Federal Reserve or by things like Duke University or others that they show the CEOs, CFOs and other managers are much less confident about the overall outlook and much less willing to make long term investments in the United States. That's also consistent with the stock market going down. So again, re industrialization is a totally reasonable goal. But the way they're going about it by saying we're just going to put on huge tariffs using, by the way, as we said a formula that makes no sense for setting rates on different countries. It doesn't seem like it's going to be very successful and the markets are reflecting that.
- [28:33]
Derek Thompson
There's two pieces that you touched on that I think are really important. And I want to add a third point. Number one is that there are people defending the Trump policy that point to the necessity of re industrializing. But I think it's difficult to on the one hand insist that re industrializing is necessary, while at the same time we are complicated and in some ways totally dismantling Biden era strategies to subsidize industry like the manufacturing of chips and the construction of fabs to build chips. That's point one that I think is important. Point two is that, and we talked about this in the last show that we did with Jason Furman and Roger Karma, there's two sides to uncertainty. There's the argument that Trump's madman strategy is good for bringing counterparties to the table. They don't know what he's going to do, so they offer him the moon. But also, while uncertainty might be useful for international bargaining, it's not useful for domestic investments. People want to know what the policy is going to be in a year, if they're going to start to expand their factory or build a new factory or bring in new investment. And so uncertainty, which might work abroad, I think is very complicated as an input at home. The final piece here that I want to touch on before we move to another justification is that there's a simple model of imports that's like all imports just replace American business. America has shrimp farmers. If we import too much shrimp, it undercuts the shrimp farmers that exists, and I grant it. But you look at something like, let's say the construction of a typical Boeing airliner and you look at the individual parts. We get the fixed trailing edge of the wing from Japan, we get the movable trailing edge from Australia, we get the wingtips from Korea, we get the rudder from China, we get the landing gear from Gloucester, and we get the wing body fairing landing gear doors from Canada. The cargo access doors, by the way, come from Sweden. So Boeing is an American champion that exports to the world one of the most complex pieces of manufacturing in the history of humankind. And it relies on a global supply chain in order to construct that product. If you just randomly start raising tariffs on every single country, it massively complicates the job of re industrializing because our manufacturers rely on the world for inputs to their products. So maybe talk just A bit about how broad tariffs on all of America's trading partners might in many ways accelerate our deindustrialization, accelerate the difficulties, or exacerbate the difficulties of manufacturing rather than reverse their fortunes.
- [31:26]
Matthew Klein
Yeah, that's a really good point. I mean, if I were to take the other side of it, someone could say, well, why don't we make the doors and rudders in the United States? And for certain things, maybe that makes sense. Now, personally, again, if you're looking at sort of a national security argument, I don't think that importing things from Sweden and Japan and Canada is a problem. But you could imagine someone saying that. But you're right, it's a problem. There's also a macro angle here too, which is, let's say you are successful and you tariff those things and then they don't get the income. That means regardless of whether you've moved where the production comes from, foreigners now have less money to buy things, and some of what they're going to spend less money on is going to be stuff that comes from the United States, whether directly or indirectly. So you're still going to be hurting your exports, even apart from this other thing about the input channel. So I agree. I would also add, I forgot to mention this earlier, but in addition to the Trump administration saying they're going to go after chips and science, they're going to go after ira, they're going to introduce uncertainty with tariffs, we've also seen them go after things that have been very longstanding, bipartisan policies that are pro industrialization, things like going after scientific research funding for universities, going after the nh, going after the cdc. One of the most competitive sectors that the United States has is pharmaceuticals. And some pharmaceuticals have been offshored for corporate tax reasons to place like Ireland. That might, who knows? Incidentally, partly in function of the tax laws passed by the Trump administration in 2017, but nevertheless, you have a ton of innovation and production and value created by pharmaceuticals. If you then systematically dismantle the regulators and the basic science research support for that, that's not going to inherently persist. And so again, there's a lot of things happening simultaneously that are contrary to the goal of re industrial.
- [33:21]
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- [33:52]
Derek Thompson
Through a couple other justifications for the Trump plan before we close on China, because I do think that a rational, concerted, long term strategy for dealing with our bilateral trade deficit with China is in fact quite important. This is something you've written about a lot, and I want to make sure that I give it space. There is a second story that's being told about the tariffs. This comes from Peter Navarro, a top trade advisor to the White House, which is that these are designed to replace income taxes. Trump has said this before himself, and at this point I think maybe we should start believing the President when he says things. In fact, before the early 20th century, the US government was mostly financed not with income taxes, but with tariffs. Give me your macro model of what would happen if we shifted from a progressive income tax to a global tariff as a revenue generating mechanism over the next few years.
- [34:54]
Matthew Klein
So first of all, you couldn't fully do that income tax right now, and I'm assuming they're ambiguous and they talk about it, but if we're going to be honest, probably they're also including payroll taxes. That's like 15% of GDP, give or take imports of goods. Total is 11% GDP. So you would have to essentially have Americans pay more almost one and a half times on top of what they already do in tariffs. So I don't think 150% tariff on all imported goods would be both feasible. I mean, the simple answer is I don't think people would import as much. Right. That's the sort of standard argument people have drawn Laffer curve type things of what's the optimal tax rate to get the how can you squeeze the lemon the most? Or whatever. And you're not gonna. 150% is not it. So that's, I think, the basic issue. Back when we had tariffs as the most important source of revenue. There are two things to remember. One is it's a lot easier to collect taxes from tariffs because especially when this country was founded, we didn't have what you call state capacity. Right. Mostly people were farmers. It wasn't that hard. If you were going to money, you put some. There were only a few ports where we imported anything from. So you'd have a couple of custom officials go to the handful of ports and they check what comes in. They write, that's not that. That's the solution to that problem of being A relatively technologically and sophisticated place. That's not the world we live in. So why would that be the optimal solution? And the other thing is that before you had the introduction of the income tax, the federal government didn't do very much. So that's why you could get away with tariffs being most of federal revenue, because the federal spending was so much lower. You didn't have Social Security, you didn't have Medicare, you didn't have Medicaid and you didn't have a military. So obviously you're not going to need as much money. Those three things together, plus debt, interest are like 90% of all federal spending. Most of the other 10% also wasn't done. So you could do that as a long term solution. Replacing income tax is not realistic. By the way, if their strategy is to use tariffs for revenue long term, then they're not going to be negotiated away, right? You can't negotiate away to think that's going to be your revenue source and they're not going to go down from. I mean, you might redistribute who's paying which tariff, but the aggregate has to be high or it's not going to be revenue. So that's an interesting thing for people thinking about. If they're like, oh, this is just negotiating tactics like, well, if that's the case, then why are they saying we're going to base our budget off of it?
- [37:22]
Derek Thompson
A final story for the tariffs that I want to bring to your attention is that this is part of a deliberate plan to crash the stock market, bring us into a recession, use that recession to pull down the 10 year treasury, reduce interest rates and thus allow the US to refinance its next bucket of debt much more cheaply. What's interesting about this plan to me, and this will remind you maybe of 2007, 2008 debates. If the US goes into a recession, the deficit will explode. The deficit is the difference between revenues and spending. And in a recession, revenues decline alongside economic activity and spending goes up. So as I hear this plan, and this is popular among the all in podcast, a lot of the tech guys are really excited about Trump's tariffs being funneled toward the goal of reducing interest rates. What I have trouble balancing is, yes, on the one hand, I can see how a recession brings down interest rates, maybe, but also a recession is going to increase our need for debt. So we might have a lower interest rate to pay for even more debt that we need to bring on in order to keep the economy afloat. How do you make sense of square the circle of this plan of tariffs as a strategy to help the US refinance its debt with a cheaper interest rate.
- [38:46]
Matthew Klein
I think the first thing to note is that it's not working. Interest rates are not actually down. So I think we can start with that. And that is of course very interesting too. You wouldn't naively think that's the normal reaction, and that's not what happened earlier. You'd asked about analogies to other countries, and I forgot to mention this one. But there is another analogy we can look at, which is actually the UK briefly. In the fall of 2022, you had prime Minister Liz Truss and her chancellor Kwasi Kwarteng. That came out with something, and I don't know why they use this word, but a mini budget. And because of what was in it and because of the way they presented it, in many ways actually kind of resembling some of the features of the tariff rollout we saw last week. There was a tremendously negative market reaction with stocks going down, bond yields going up, and the currency going down. And people are like, this is an emerging market crisis hitting the UK Now. The difference there, of course, is that it's a parliamentary system. And so basically they just removed her and then undid everything, which is not something we've seen here.
- [39:45]
Derek Thompson
So as I see it, and it sounds like you see it quite the same way, there's a defense that says this is about re industrialization, but in many ways we are kneecapping the comeback story of manufacturing over the last few years. You can say this is about reducing interest rates so that we can refinance the debt cheaply, but in fact, interest rates are going up. If you stop the clock right now, this Trump tariff plan does not seem to be going very well. I weirdly want to reserve some space for the possibility that things go unhorribly. Feel free to open up whatever part of your brain was last accessed by some creative nonfiction class that you took several years ago. If this turns out well, I see lots of people saying every economist is going to have to resign in disgrace. Do you reserve in your analysis one square inch to the possibility that, that this could work, that we could go from here, where we are today, to a world where years from now, we look back at the first week of April and say whatever mayhem happened for the first few days, this plan worked and the US Economy is stronger because of it. What would have to happen for that narrative to be true?
- [41:04]
Matthew Klein
So I can do this exercise. I would actually start slightly early in the first week of April, though I think I would actually start with the end of February, because that was when the Trump administration did the heel turn on European defense and foreign policy, which I think separately is non economics, I think is very bad for US Relationship with the rest of the world and what have you. But the response of Friedrich Mertz in Germany, and in fact, the consensus across Europe was, I think, transformational, which is they went from a long period of time saying we have to not borrow money no matter what, to do anything that's constructive for our country to saying, well, the Americans are not here anymore, so let's throw all that out the door. And the party in government, the Christian Democrats in Germany, which have historically been the most committed to fiscal austerity, you know, not, not borrowing, not spending, letting infrastructure degrade over the past 25 years, they said, you know what, we're going to change our rules. So they had a, they had, you know, 15 years ago, made a constitution, changed the German constitution to say, essentially, you can't borrow money, more or less. And they said, you know what, we're going to make some changes. If you want to borrow for military spending, it's unlimited, like, so that's a big change. And then on top of that, they then went to Brussels and said, you know, all those rules we've been telling you to have on every other European country about what they can do in borrowing, that was a mistake, Sorry. You should tell everyone now it's okay to borrow, especially for defense. And that's huge. Another big part of the world that's like, this is East Asia now, again, Japan and Korea, you can find plenty of people and experts in these countries who acknowledge these issues and say, it's not just Americans making this stuff up. For various reasons, there's not enough spending. And there, it's not so much the government necessarily as companies being very conservative and retaining a lot of earnings. But regardless, it's a known issue. The very positive view is that through a set of policies that looks very destructive and destructive in large part by imposing costs on Americans, that people in the rest of the world, in order to shield themselves from those costs, end up making changes that are good for them and eventually are good for us. That's the positive interpretation.
- [43:18]
Derek Thompson
To be totally honest, I think that's one of the most compelling steel man cases for the Trump tariffs that I've heard yet. Even if you made the case with a gun to your head. Because what I'm hearing you say is that this Trump strategy, as chaotic as it is, as bad as it is for increasing certainty for making domestic investments in manufacturing, which is apparently what this is all about. We can imagine a world where this gambit leads to increases in global spending, which allows the US to spend less on defense and then also maybe creates demand that ultimately redounds to the US Right. If Germany, for example, or Korea spend much more on defense, well, not only maybe does that allow the U.S. to spend less on defense here in the U.S. but it also might make it easier for us to export defense manufacturing products, whether it's weapons or planes, to those countries. It's an interesting Steelman case. Even if I force you to make it, I want to end here with China. You and the economist Michael Pettis wrote a book several years ago called Trade Wars Are Class wars where you talked about how the US has a very dysfunctional relationship with China. This is a bilateral trade arrangement that in the last 20, 25 years has not been good for the US in many ways. China's eaten our lunch in terms of manufacturing. It's led to what economists have called a China shock in parts of the Rust Belt which have suffered declines in employment wage penalties, as those jobs have essentially been siphoned off overseas. And while the US has arguably benefited from cheaper consumer goods that we import from China, there's also ways in which our relationship with China has been dysfunctional, has hurt American workers. What would a rational America China policy look like today? Taking seriously the fact that the manufacturing that we've lost out in the last generation or two really is a problem worth prioritizing.
- [45:28]
Matthew Klein
Ultimately, the thesis of our book as it relates to China is that changes within China domestically, internal changes that were driven by the internal priorities of decision makers in China within the Communist Party, changed the distribution of spending power away and took it away relatively from workers and retirees, basically, you know, ordinary, the mass consuming public of China, and redirected that spending power to either Chinese businesses, particularly, but not exclusively in export sector and indirectly to foreigners. So you basically take money away from poor Chinese people and effectively transfer it through credit to Americans who lost their jobs because they no longer are able to sell goods because their businesses are uncompetitive, because in part Chinese wages are lower than they otherwise would have been. And that's sort of a simplified version, but that's kind of the basic mechanics. So you can see most people in that story are losers. It's not like the Chinese took our jobs and China's doing better as a result of it. And a lot of it is like you could say, oh, they're really competitive, and it's true to a point. But cars you mentioned is a really interesting example. You look at the Chinese data, they publish it once a month. China is not producing more cars now in total than they were in 2018, but their net exports of cars is massive. They went from being reliable importers of cars. It used to be the case that the BMW plant in South Carolina, they loved selling X5s to China. I don't know exactly what the state of that is now, but it's definitely not to the same extent. Right. China used to be importing. I don't exact numbers. They used to be a large net importer of cars, and now they're the largest net exporter in the world by far. Even though total production is not up now, the composition is a little different. They make a lot more EVs, and if you're a European, you see a lot of Chinese EVs, but actually most of the exports that they're selling are combustion engine vehicles. Because in China, the market for new combustion engine vehicles has completely collapsed, but they're still making them. And so it's like, well, we want to keep making these things, so we'll just sell them. So they go all sorts of places. Some of those places like Russia, which have been sanctioned, but lots of other places. And so you look at that model, you say, okay, well, this is not a situation. I mean, you could say it's a sign of industrial prowess that they're able to make 30 million cars a year and sell them all. But it's also the fact that they're exporting isn't a sign of industrial prowess necessarily. It's a sign of the fact, in part, that domestic demand is so weak. That's basically the story of Chinese economy in the aggregate. And so that, I think, is a justification for doing something, whether it's. I don't think it's a justification for doing what we're seeing right now, necessarily, but it is a legitimate cause of concern.
- [48:14]
Derek Thompson
So China has purposely constrained the purchasing power of its own citizens. That's the class war in the title of your book, and that's helped China become an international Goliath that's taking over global manufacturing, not just in the US but arguably around the world. That's the trade war in the title of your book. Thus, trade wars are class wars. What the hell do we do about this? Right, like, no one is going to force Chinese consumers to buy more stuff. And yet China's insistence on running this permanent trade surplus really is a Global and geopolitical risk. So what do you think we should do about it?
- [48:53]
Matthew Klein
Yeah, I mean, the. The simple answer. Just simple and not super specific. But you want to make sure that if whatever they do, you can still protect the things you care about domestically. So the things that I would say you want to care about domestically are threefold. You want to make sure that you still have full employment in the United States. You want to make sure that you have full employment without it being driven by excessive borrowing by households or businesses. And you want to make sure that you still have a vibrant domestic manufacturing sector and you don't just lose entire industries and levels of expertise because someone else is doing something that's bad for them and inadvertently hurts you. So given those constraints, I think the kind of thing the Biden administration was on the right track of, okay, you want to have a macro policy that's pretty hot, not like high inflation, but be okay with it. You want to be willing to tolerate maybe unusually large federal government budget deficits, because again, if people are not buying as much goods and services that you'd expect, and they want to buy assets, you know, give them to them. Right. But if you're going to give them assets, you want them to be the things that are easiest for you to service in the debt. And it's a lot easier for the United States economy to have people buy Foreigners, buy Treasuries than it is to have them buy mortgages or whatever or corporate bonds or anything like that. I guess you could have them buy stocks, too, but that's a, you know, whatever, as long as it doesn't matter. They get paid back. Right. Or you print the money to pay them back. Right. And then the other thing is you have to have some kind of support and maybe protection for your domestic industries. You can do that through, like, a subsidy approach through procurement. Maybe you've targeted tariffs on specific Chinese goods. We saw that with EVs. That was controversial. I don't have a strong view, but I think it's plausibly justifiable. I think that mix is reasonable. But it's tough because, as you said, this is something that's fundamentally the kinds of changes that are fundamentally good for people in China, which many Chinese economists have publicly endorsed. This is not the kind of thing that is banned within the discourse there. Nevertheless, they aren't happening. And so maybe they would happen. But if it's not going to happen under those circumstances for various reasons, then the options you have are basically, what's the second best thing? And I Think it's basically saying we just have to insulate our economy from that. And by the way, those approaches work well for other places. Until very recently, you could say the same thing about Europe. Obviously the European political economy is very different and some of the net impact on the US was not entirely dissimilar. Again, the approach of you want to make sure you have full employment, not have excessive private sector debt, make sure you have some support in the manufacturing sector. I think it's a reasonable policy mix.
- [51:33]
Derek Thompson
After the tariffs were announced, a lot of stuff happened. The stock market crashed, the ten year treasury ticked up, dollar went down. China announced retaliatory tariffs. Some countries like Vietnam reportedly offered to lower their tariff barriers. The EU is allegedly mulling its response. So much is happening. What are you looking at? What's the most important thing you'd leave us with to look at within U.S. data and international data?
- [52:03]
Matthew Klein
I think actually it's simple, but I'd actually say the stock market is probably, and again, maybe I'm outsourcing the work here, but the stock market should be reflecting the collective weight of everyone who's analyzing all the other variables together into a single thing, including all the sort of unquantifiable political noise. And so I think that is very instructive in terms of the hard data. It's just too slow to update to give you. I mean, eventually it will update, right? But I mean right now the latest information we have is from almost everything is from February. So that's before all this. And even some of the data we have as of now from March is from mid March. So it takes time I think for the full impact to show up in the hard data on things like actual spending or manufacturing orders or construction unemployment. You haven't. So I think we can get a sense of what is sort of businesses and investors actually thinking you can say stock prices. It's not perfect by any means, but it is a reasonable indicator in real time.
- [53:03]
Derek Thompson
Got it. The stock market is not the economy, but it is the best real time indicator of the economy In a world where news is moving quickly and some of the most important data points are only released on a month by month or quarter by quarter basis. I think that's a, that's a fine place to land. Matthew Klein, thank you so much.
- [53:20]
Matthew Klein
Yeah, thank you very much for having me, Derek.
- [53:22]
Derek Thompson
Many thanks to Matthew Klein. The big takeaway that I want people to remember from the show is that the defenses for this tariff plan often do not hold up to the actual plan itself. That is the most important conclusion, I think from this interview with Klein, if America really wants to re industrialize, if we really want to build our manufacturing base, if we really want to create a kind of friend trading zone to take on China by pulling in North America and Europe into a free trading alliance and even some countries in Asia into a free trading alliance from which we can supply enough stuff that we need in order to remain competitive to China, why are we taxing our allies? Why are we antagonizing our allies? Why are we threatening to invade Canada? Why are we pursuing a policy of maximal and purposeful and even proud chaos when we know that the most important thing for regrowing American manufacturing is creating clear terms for allowing manufacturing firms to finance their own expansion? It seems to me like you would want here a strategy that is pro allies, pro friend shoring, that is to say, growing supply chains among our friendly countries and providing maximal security and certainty for folks interested in financing America's manufacturing expansion. We are doing the opposite of all of that. We're antagonizing our friends, we're threatening to invade them at the same time that we increase uncertainty. And so this really is, for now, the most important takeaway for me that judging or judged by our own stated goals of bringing back manufacturing, the plan that exists, the plan on the table, the plan announced by Donald Trump last week, sends us in the opposite direction. We'll talk to you next week.