A (3:43)

Today on the show, we are going to use that framing to make sense of a lot of different data markets, oil, consumer prices, and get a little context about the future from the wisdom of crowds. I'm Lizzie o' Leary and you're listening to what next? Tbd, a show about technology, power, and how the future will be determined. Stick around. How would you describe the initial reaction in the markets so far?

B (4:21)

So, first of all, the President has this habit that now has become such a statistical regularity. I think there's something to it of doing things when markets are closed. Liberation Day was the last big thing he did when markets were open and markets beat him up and forced him to undo it within a week. So markets were closed. So actually we couldn't tell. So then we had to wait until futures opened. On Sunday night, they opened down 1%. Now, let me say three things about the number 1%. One, it's small. One is not a lot of percents. It's 1. 100%.

A (4:56)

No. But traditionally, a market move of 1% or more is considered a big move.

B (5:02)

Great. That gets to my second point. Two, it's big 1% on the S and P. The S and P, the market cap. Let's do some arithmetic. I know people love doing arithmetic, and it's actually the hardest kind of arithmetic, which is counting the zeros. So The S&P 500 has a market cap of 60 trillion. 1% of 60 trillion is 600 billion. There are roughly 300 million Americans. 600 billion divided by 300 million is $2,000. The typical listener on average lost $2,000. Hmm, $2,000 sounds like a lot. And the truth is it Is right. If someone walked on up to your front door and said, could I have $2,000 now, you'd feel pretty bad about it. Some people say, well, it doesn't affect most Americans. All stocks are owned by the rich. But remember, one day you're going to retire. And my guess is you have a retirement account. And so your retirement account may be worth some amount less if you earn above average, maybe more. If you're below average, maybe less. The other thing is, wow, really something happened that made me $2,000 less wealthy. The thing to understand is the stock market is forward looking. So it's saying the net present value of future profits of American companies is $2,000 lower. That could be. They expect it to be $100 lower for 20 years. There's some discounting stuff. But again, it could be a modestly small effect for a long time or a big effect for a short time. Now it starts to feel a little plausible, like, did we open a door into a future that could make each of us a hundred dollars worse off for 20 years? I don't think it would be implausible to believe Iraq did that. And then the third point, remember the first point was it's small. The second point is it's big. The third point is it's surely bigger than that, which is to some extent the expression people use is markets had priced it in.

A (7:01)

Right.

B (7:01)

If people had already thought it was a 50% chance, then what happened over the weekend was we didn't get a whole war with Iran, we got 0.5 of a war. Which means if half a war causes stocks to fall by 1%, a whole war would cause them to fall by 2%. To give you some scale on that, it may actually be far worse. I was a young economist during actually the Iraq war, and I wrote a paper with a dear colleague by the name of Eric Zitzewicz which looked at the ups and downs of the American stock market as we debated should we or shouldn't we go to war with Iraq? And if you remember the very, very different history, which is the administration actually tried to convince the American people.

A (7:39)

Yeah, there was a big public debate. Colin Powell went to the UN Security Council. I mean, I was in journalism school at this time. I remember it all very well.

B (7:47)

Yeah, and so what that narrative gave you is ups and downs and the probability we ever invade. And it turns out in the week where it became more likely we were 10% more likely we would invade, the US stock market would typically fall 1.5% in a week. In which we became 10% less likely to invade. The US stock market rose 1.5%. And so that same logic then says, well, if one tenth of a war subtracts 1.5% from stocks, then all of a war subtracts 15%, which sounds remarkably big. But the point I want to make here then is when I'm telling you that the Iran war may cost you or your family thousands of dollars, it's not crazy in that financial markets responded as IF was worth 15% of the S and P when last time we played this game.

A (8:37)

Let me ask you about an index that I think most people who are not economists or financial professionals maybe don't pay as close attention to. And that is the vix, the volatility index. The day that we are talking, which is Thursday, it appears to be up 11%. I wonder if you could put into normal people words what that means.

B (8:59)

I actually want to explain it rather than just ask people to believe it's the fear gauge, which is the bottom line, Right? So if the next 50 seconds bores the crap out of you, just call it the fear gauge. So people don't just bet on stocks, they also bet on, is there a chance stocks will rise a lot? Is there a chance they'll fall a lot? We call those bets options. And if people are willing to pay a lot for a bet, that only pays off if stocks fall a lot, that's a way of saying they're sort of buying insurance as if stocks might fall a lot. And you could sort of figure out from that, people believe there's some probability that stocks would fall a lot or rise a lot. So how volatile are stocks expected to be and expected by the stock market? And that's what the VIX is. It's the implied volatility. So one way of thinking of, did the world become more uncertain? Is to look at the vix. Now, obviously it's not telling you everything about your life. Your girlfriend might dump you, your kids might never talk to you, you might get killed crossing the road. And none of those are traded in the vix. The VIX is about the forms of volatility that would affect people's expectations about the future profitability of American businesses. But when we're thinking about war with Iran, the things that you worry about, will my child get called up if we end up there? That will, along the way, have done a lot of damage to American markets. So it is related to your fears. So should you be more fearful right now? And the answer is yes. Now, the vix, as of right now, is probably at its highest level. You know, in a few months. It's definitely not at record levels. The trade war was. The Liberation Day caused it to be much higher. Not because tariffs are so important, necessarily, but it looked like Trump was going to just totally turn upside down America's role with the world. And no one knows what the hell

A (11:03)

that means, which is uncertainty. Markets don't like uncertainty.

B (11:07)

Well, this is just a measure of uncertainty. And they were just. We're so uncertain. The pandemic was much more uncertain. So this is not as bad as finding a small virus that will kill millions and shut down the global economy in terms of uncertainty. But it's worse than it has been. And if you've got a lightly furrowed brow, that's appropriate.

A (11:28)

We have been talking largely about American markets. I think it's worth looking at what markets in other parts of the world are doing, because that is also extremely instructive.

B (11:39)

I love your cosmopolitan ways and the fact that you care about others outside 300 million in this country. So do I. And it turns out if you look at other markets, you see they've fallen much more dramatically. The market response in Europe is. I'm going to try and use words. All my words are still numbers twice as big, maybe quadruple even, depending where you're looking. So is the response in Asia. So if Wall street is telling you, hold on to your horses, these other markets are saying, look out. We're galloping away. And there's some very simple economics. So one thing is, I'm grateful you asked the question, because it highlights a really important asymmetry to the extent that financial markets are a proxy for stuff that matters. It's telling us the pain in Spain will be mainly on the plane. It is telling us that the pain will be bigger.

A (12:40)

Sorry, yeah, that is like a seriously bad dad joke, but go ahead.

B (12:44)

You called it bad. I mean, I want you to adjust for the fact I'm an economist.

A (12:49)

Okay, fair.

B (12:49)

When was the last economist who told you a joke of any form? But let's get back to it. So to the extent that this is telling us anything, it's basically telling us the forms of pain, economic pain, that we might expect out of this war will be 2, 3, 4, 5 times as big. There is here. That's an amazing asymmetry. Right? And it's a really important asymmetry because President Trump. You know the word taco, right?

A (13:21)

Oh, I do.

B (13:22)

Okay. Taco. Trump always chickens out. This is a view that throughout the Trump Term, he does something outrageous and then he backs off, which is true approximately half the time. I don't want us to get wrapped up in this. Cause it turns out when Trump said he was going to take Greenland, he backed off. But he didn't with Venezuela. And I don't think Iran's feeling very taco friendly right now. But to the extent that that is operable, and it was in the trade war, what happens is financial markets start blinking red. Trump's mates from Wall street, many of whom he's craved respectability from his whole life, call and say, this is crazy. He understands stock indices as being a referendum on his self worth and he backs down. Now, here's the thing. Markets in Europe are flashing bright red, but markets in the US Are ringing the faintest of alarm bells.

A (14:18)

So he doesn't care yet.

B (14:19)

I don't know. I'm not inside the President's head, but I do know as an economist that there's an asymmetry here, that the economic consequences, and I again am an expert to talk about security, humanitarian, other things, but the economic consequences, it may be it's our water control, but it's. And obviously it's Iran's war to feel pain. That's the point of the war, particularly the regime. But it's actually the European, our allies, our traditional allies, whose economies will be hurting the most. Now you might be saying, why? And the economic logic of this is actually very straightforward. Many of us carry around a view in our head because we've seen so many State of the Unions where we've had presidents talk about energy dependence on the Middle east that we think we're dependent. We're not. The US is in fact a net exporter of petroleum products.

A (15:14)

You're going where I want to go next.

B (15:16)

So we basically are energy independent. We might even be slightly on the positive side. Now, energy people will then yell at me and say, it's not that simple, Justin. We make light oil, they send dark oil, or, you know, like heavy oil,

A (15:29)

crude oil versus West Texas Intermediate, et cetera.

B (15:32)

Yeah, I'm just going to tell you, when it comes to oil, it all looks the same to me. Now, that's partly a joking aside, but the other thing is the ways in which we turn oil into other products we can substitute. There are folks and parts of the economy that can substitute one form of energy to the other. So saying all oils are similar except for Spanish olive oil is roughly correct.

A (15:57)

Okay, well, help me understand that a little bit because I am looking, if I look at a You know, generic crude future. Right. Again, we're talking Thursday. It's up almost 7%. That's a pretty big move. And I guess I want to understand why you are not so worried about oil. Because usually when there is tension in the Middle east, everybody freaks out about oil.

B (16:19)

Right? And they are on the news. And that's because they're used to that script. But that's a script we started writing in the 1970s. In the 1970s, the US was heavily depending on oil. We produced far less oil than we used. Now we're basically neutral. Okay, so here's the thing to understand. When world oil prices go up, two things happen. Even if oil prices over there somewhere else are going up, that will cause American made oil to go up one for one. Why is that? American oil drillers can sell their oil anywhere in the world. They can get seven bucks a barrel more sending it to someone else. Then they're not going to send it to Americans though.

A (16:58)

Different places use different kinds of oil and refine oil differently.

B (17:02)

But they're all. There's a substitutability. So the moment the world oil price goes up, American producers have the option of sticking it on a boat and selling it elsewhere. So they're not gonna sell to you and me for seven bucks a barrel less than they can get elsewhere. So the price of oil in America necessarily one for one goes up with the world oil price. Little asterisks here. When shipping routes get screwed up, you can get differences across the world. But still we could just send it to Mexico. We can send it to the Straits of A Moors are not that important. They're somewhat important to us, but they're not that important to us. But it still doesn't matter. The world dictates what the American oil price is, effectively because American oil companies could sell to the world. So even though nothing has changed on the American oil fields, American oil prices are going up. So here's where there's two effects. The first effect is it's going to cost you more to fill your car. That's kind of obvious. A basic rule of thumb is American gas prices rise in percentage terms roughly the same amount as oil prices. The price of gas is 3 bucks a gallon. You said oil prices rose 8%. What's 8% of $3? Lizzie, you said you went to journalism school. Is that so?

A (18:17)

I don't do math on camera.

B (18:18)

You really don't?

A (18:19)

No.

B (18:19)

OK. What's three times eight?

A (18:22)

24.

B (18:23)

Great. So now we just got to figure out where to put the decimal point here, 24 cents. Okay. And then we'll round and we'll call it a quarter. So gas prices are going up a quarter. I looked yesterday, they'd already gone up 10 cents. I have friends around the country telling me some gas stations are selling out because some Americans are freaking out. They're thinking, remembering queues at the gas station from the Carter years, and they're off to do that. But a reasonable guess is gas prices for now at least, are gonna go up a quarter. If they go up two quarters, that's still fine. I'm just trying to get the right number of zeros here. Anyway, that's the first thing. Gas prices are going up, right? So bad news for those of us who live in the suburbs driving sexy blue minivans. The second thing though is that's for the users of gas. Now, remember, we make as much gas as we consume, right? So there's all these folks in Texas and in Alaska who either own company and oil companies or who themselves work in drilling, and they're now being told to work longer because we've got to get the gas out of there while we can get this really high price. And so those guys, their price just went up 8%. So you and I are 8% of our gas bill poorer? Cause we're gonna spend more.

A (19:32)

They're 8% richer, so that stimulates economic activity for them.

B (19:37)

And actually, real, real possibility is look for the Alaskan and Texan economies to do well. And look for the Rust Belt, which we do not refer to the state of Michigan as being the Rust Belt. But Ohio, my goodness, nothing but rustic. Don't start me on the Ohio State University. Notice those two offset. So for the United States as a whole, we neither get richer nor poorer because we have the oil. The oil gets more expensive. Good if you're the producer, bad if you're the consumer. In equal and opposite measure. In the 1970s, what happened was we didn't have the oil. We're having to buy it from overseas. So that meant all the extra money we spent was money we didn't have anymore. No one got. We became poorer. That's what's happening in Europe. So much of Europe, not Norway, but much of Europe is oil dependent because

A (20:30)

Norway produces oil, right?

B (20:32)

And the rest of them don't. The rest of them produce delightful cappuccino, terrific wines, great cheeses, but not much oil. So they're taking a hit. And so that's the thing, which is blue collar workers in Europe are losers, not Americans. I mean, obviously People in Iran.

A (20:55)

Right. I understand we're having an economic discussion.

B (20:57)

Economics involves everyone and everything. We care about those people, too.

A (21:02)

But yes, when we come back, what about inflation? Well, I want to ask you about this point of tension that I feel like I have seen over 20 years of economists and regular people around the prices we pay for things. And that has to do with where prices are the most volatile and how people encounter them and how prices are measured and how economists tend to look at those prices. Because as I know, you know, the most volatile things out there are food and energy. The Federal Reserve does not take those into account when it's looking at its preferred inflation measure. And yet that is where people freak out, right? They feel this the most deeply. And so I guess I wonder, is there a place where the average American is going to feel price increases that maybe the markets or professional economist says like, yeah, but those aren't real pricing crisis.

B (22:17)

Economists are real people, too. So what we are is more precise in a very specific way. It's actually something I said to you earlier, which is every number answers a question, and the issue is, which question does it answer? So if I want to know what's going on with the cost of living, then I would look at what's happening to the cost of living. And we use the Consumer Price Index for that. And what's going to happen is the price of gasoline in particular is going to go up. So is the price of plastics, fertilizers and other things. But mostly I don't know how much fertilizer your family ate last week, but mine is cutting back. So mostly it's gasoline. So that's going to have a direct effect on the Consumer Price Index. And for reasons you hinted at, we call that the headline Consumer Price Index. But basically that's the measure of the cost of living. And it is often economists are interested in different question. The question is, what is the momentum driving inflation? Given what I've seen in the data over the past few months, what is the underlying momentum that would lead me to have expectations about inflation being high or low in the future? And that's where it's important to recognize the reality that you pointed out, which is that gas prices and oil prices often go up and down for nothing for reasons unrelated to the underlying economic narratives for the momentum in the economy. They go up and down because of wars in the Middle east, they go up and down because of embargoes, they go up and down, new oil is found, tankers get stopped, blah, blah, blah, right? And food Prices go up and down because there's a drought, because there's a drought in another country. And so they go up and down without telling. They don't have much signal for the question that economists are often interested in, which is, what's the future path of inflation? And so what we want to do is look where the signal is, not the noise. And these things for answering this specific question, what's the momentum of inflation? That's useful for thinking about the future. That's why we would want to signal. We focus more on the signal, less on the noise. So therefore we look at inflation. Less food and energy. There's much more sophisticated ways of doing it. I could bore you with an essay about it, but that's sort of the transparent way. So when the latest inflation numbers come out, because what I care about and what the Fed cares about is the future of inflation, we tend to focus on core inflation. And so core inflation is unlikely to be much affected by that, because core inflation, stuff like your rent, you know, insurance, healthcare bills, a whole ton of stuff unrelated to oil prices. So it's unlikely to move much, which is why Powell is going to. And the Fed is going to be under a lot of pressure to, you know, the cost of living might be rising, but they're going, there's not much here. While folks at home are feeling it now, actually, there's one more complicating step. It turns out that beyond this question of signal versus noise, there are some prices we just see a lot. When was the last time you filled up your gas tank?

A (25:20)

Oh, it was a while ago.

B (25:22)

Really?

A (25:22)

Yeah, we don't. I live in New York City.

B (25:24)

Okay, pretend you're a real American,

A (25:28)

probably twice a week.

B (25:29)

Right. How big is the price tag when you drive past a gas station?

A (25:34)

It's pretty big.

B (25:35)

Six feet. Literally the price is six feet. Right. That price is really salient. You see it a lot, you pay it a lot. You're comparing. Cause you're thinking, should I stop at this gas station? Should I stop at the next one? And so over and above the fact that gas is an important bill, it's extra salient. It turns out those become even more politically important. So economists argue these prices are uninteresting for figuring out the future of inflation. But when people think about the cost of living, they actually maybe overemphasize it.

A (26:09)

This is all taking me back to the taco concept. And we know from data, basically, that President Trump makes decisions, or seems to make decisions based on how US Markets react. We saw this with the Liberation Day tariffs, as you mentioned. And so if we look at the data that we're getting now, oil prices going up, markets, you know, up, but not like they are in the rest of the world. The VIX is up, down.

B (26:44)

Markets are down.

A (26:46)

Markets are down. I'm sorry, down. What does that tell you about the taco phenomenon?

B (26:52)

So some people hoped that the President's obsession with financial market success would create a self correcting loop that every time he does something dumb, markets fall and then he undoes it. I don't know if this is dumb. That's a much harder question. And I'm going to leave that to your audience. And it's far more important issues, far deeper issues than the purely economic. But I do know that Wall street is not gonna be flashing as red as it would if we were the America of the 1970s or if we were the European Union, or if we were just thinking about the broader consequences, economic consequences, on others. So if the President were making this decision from Frankfurt, he would already be under immense pressure because energy is so important over there. And in some sense, look, we've had a dry run for this. Lizzie. Actually two and I just wanna try and help people understand in terms of historic nar, maybe it helps, maybe it doesn't. For people of a certain age, the 1970s oil shocks was when we saw a massive increase in oil prices. And that both caused recessions and inflation and led to that glorious word stagflation.

A (28:03)

Stagflation, stagflation.

B (28:05)

And so lots of people think oil prices stagflation. And so the first thing to realise is we're not the 1970s, we're now oil neutral. So what we're looking for mostly now is inflation. Forget the stag. But I want to put a pin in that. I want you to come back to that.

A (28:20)

Okay?

B (28:22)

Whereas the Europeans are probably looking at stagflation now. Let's Fast forward to 2022. The nice thing about 22 is it's quite recent. The US economy looks a lot like it does today in 2022. There was also an important oil shock. This is about Russian oil, Ukraine and so on. And what happened in 2022 is oil prices went up. The US economy did not slow, but other countries did. And if you spend any time talking to friends around the world during that period, they were talking about the energy situation much, much more than Americans were. And so 2022 looks a lot more like the present day than 2026. So that's probably the right template. And then I did put an asterisk on it. Affecting the real economy that maybe you'll come back to.

A (29:10)

Where does this intersect with the real economy?

B (29:12)

Okay, so just to get the terminology straight for people, inflation's what's going on with prices. The real economy, that's the word we use, is for the amount of stuff we do, how much we make, how many people have jobs, and so on. Everything we've been talking about so far has been through the lens of oil. And so people have sort of been like, oh, there's an Iran war that will affect oil. Let's talk about an oil shock on the economy. But actually, this is a war, not an oil shock, and that's really different. So let me tell you a couple of things that I know. Wars leave a mark, and often a generational mark. Second thing I know is almost always before we go into war, almost every war has been preceded by excessive optimism about how quickly we'll win, how easily we'll win, how quickly folks will roll over. Think about the Gulf War, think about Vietnam, think about World War I. Think about basically all of them. Do you remember the famous Rumsfeld quote? We will be done in six days, maybe six weeks. I doubt six months. And we failed to hit six years, right? So he was wrong by a factor of 365. A factor that means take someone's estimate and multiply it by 365. The president already started at days. He's already out two weeks. So once we open the can of worms and realize it's more likely things are worse than we expect than better, just because that's the historical, empirical fact of war, then we have to start thinking about what are the worst scenarios. And that's where I'm just gonna say, I'm not a military expert, I'm not an international relations guy, any of those things, but just open up your mind to what things could go wrong. This now opens up new possibilities. We failed to bring along many of our allies in this, unlike what Bush did. So maybe this is the next stage in American isolationism. Maybe NATO takes a step away from the United States as we prove to be an uncomfortable partner. And if that's the case, all of the defense that was being collectively provided by industrialized countries. If we still want to be just as tough, we have to provide for ourself, which would mean literally billions, trillions of dollars of spending. Maybe a generation does end up with boots on the ground, and they come back with ptsd, and the VA has to look after them for A generation. None of this is to say it's worth it or not worth it. It's simply to point out that going to war in Iran comes with a set of risks that are far larger than our imaginations are probably capable of and far larger than conversations about oil. I know there was a generation of men who saw their careers destroyed or fundamentally transformed by going to Vietnam. My father in law made completely different choices and found himself sort of at age 50 in the military, never having wanted to be in the military. And that's too late in his life to suddenly adjust. And we all have stories like that in our families. So I think, you know, why do we see the fear index rising? It's rising because there's real reasons to be fearful. The fear. There's probably some reasons to be hopeful. I'm not very good at that right now. So I do think we should think about both sets of risks. But to be perfectly honest, it's much easier to imagine things being worse than we hope than better. And that's all beside oil. And so that's why when I say we're not hurting as bad as the Europeans, that's purely the oil channel. Of course, Americans who at the moment stand to get killed. It's America's reputation that stands to be boosted or in tatters. It's American trade deals that may or may not fall apart. So we actually do have a lot in the line as well.

A (33:17)

Justin Wolfers, thank you so much for coming on.

B (33:20)

A great pleasure.

A (33:23)

Justin Wolfers is a professor of economics and public policy at the Gerald R. Ford School of Public Policy at the University of Michigan. All right, that is it for our show today. What Next? TBD is produced by Patrick Fort. Our show is edited by Evan Campbell. Paige Osborne is the senior supervising producer for what Next and what Next tbd. Mia Lobel is the executive producer here at Slate. TBD is part of the larger what Next family. I'm Lizzie o'. Leary. Thanks so much for listening.