Ceasefire Sort-Of Holding?

The world economy remains hostage to the war in the Middle East. Although the news flow remains extremely erratic, direct combat between Iran and the United States has been muted (although fighting was happening in Lebanon with Iranian proxies).

As I believe I noted before, one of my “hobbies” in university was reading up on international relations theory and diplomatic history. The current situation appears somewhat bizarre from the perspective of that theory. The usual story from the Realist perspective was that diplomacy since the Peace of Westphalia was determined by national interests. Since nations’ interests are determined by material facts, we do not need to enquire too deeply into the inner workings of countries to understand their international behaviour. We have reverted to an earlier mode of affairs, as many key governments are acting as neo-Royalist entities, where the interests of the ruling clique determine national policy. (Neo-Royalism has been the term recently floated by a few academics to explain the dynamics of the Trump administration.)

No War Plan Still

The main reason to be pessimistic about the war between Iran versus the United States and Israel is the lack of path towards peace. The United States does not have a plan that is remotely viable, since there is little sign that the Iranian regime will collapse. On the Iranian side, the plan appears straightforward: strangle traffic through the Strait of Hormuz until the damage forces third countries to move in directions favourable to Iran (e.g., expel American bases).

Victory Declared — Did Not Go Home

I am about to write another article for publication tomorrow (I hope), but just wanted to express my dismay about the situation in the Gulf.

We appear to be on a worst case trajectory — American and Israeli leaders unable to find a meaningful way to end the conflict, and Iran closing the gulf to shipping traffic for an extended period. There is no sign of the American leadership having any plans for containing the economic fallout, and they are scrambling for ways of posting their way to victory.

Declare Victory And Go Home

The last 24 hours were chaotic in the oil futures and equity markets. From the perspective of an East Coast North American time zone, oil futures (both West Texas Intermediate and Brent) had record intraday upward movements, and equity indices tanked Sunday night. The carnage slowed down until a press release on 3:30 PM Monday that suggested the war was over, which caused a reversal in North American equities and oil futures markets to around Friday’s levels. President Trump gave an erratic press conference after the North American market close which both had claims of victory and statements that the war would be continued.

Oil Price Spike Underway...

In the absence of traffic flowing through the Strait of Hormuz quickly, oil prices will rise a lot. Forecasts of $200/barrel are coming from some analysts, and something like that would be needed to smash down demand to meet sharply lower supply. Although there are buffer stocks, there is not going to widespread willingness to sell inventory out of them below replacement price. A release from the American Strategic Petroleum Reserve appears likely in the absence of immediate good news, but that just delays the reckoning.

Iran War Risks

The main global economic risk associated with the renewed war against Iran is an energy price spike. (Regional problems are very easy to see.) I discussed energy price spikes in Section 5.4 of Interest Rate Cycles: An Introduction. A very short-term spike would not matter that much, rather the risks are of an extended period of a reduction in energy exports from the region. Once again, political risks emanating from an erratic American executive overwhelms traditional econometric business cycle analysis.

It is possible to see a way to a relatively rapid end to this this phase of the conflict — Israel and the United States and other allies have total control of the air in terms of conventional air weapons. There are indications that Iran remains willing to make peace.

However, the statements of the American leadership are shambolic, and there is no clear war aim that is achievable. Without committing boots on the ground to occupy Iran, discussions of regime change are fantasy. Meanwhile, it is entirely possible that Iran has far more unconventional drones than the U.S./Israel have interceptors that they are willing to commit. The striking power of groups aligned with Iran is unclear to me, but it appears that they have been weakened ahead of this (although future recruitment will be easier). 

"Sell The Dollar": Think Price, Not Flows

The “sell the dollar” trade is coming up in the chatter I see. I think that economists love making international trade and finance more complicated than it should be, but that is partly a side effect of needing to publish new articles on a continuous basis. My simplistic input on this topic is that people need to stop thinking about “global rebalancing” in terms of flows, price changes can do the job.

My guess is that the focus on flows draws from the experience of developing markets, with countries with less developed financial sectors. If a handful of rich people directly control most of the assets in a country, it is a lot easier to generate catastrophic herding behaviour. When financial assets are in the hands of professional investors, there is a more diffuse response, as many professional investors are liability matchers that have the capacity to go against the herd.

Liberation Day 2.0

The latest crisis of the weekend was the announced tariffs on selected European countries for their decision to base a tripwire force in Greenland. Since Canada was not initially in the tripwire force, we were spared.

The most likely scenario appears to be that Trump is distracted by something else, and this trade war largely fizzles out — although last year’s trade deals may be victims. This appears to be a “I’m taking my ball and going home!” act by someone who is mad at an unexpected loss. However, everybody in Europe cottoned on to what the Canadian Liberals figured out last year (and the Conservatives most emphatically did not) — running against Trump on a nationalistic platform is an easy “I win” button for popularity. European retaliation could goad Trump, but given how he treated the U.K. since last year, rolling over is not a good strategy.

Coup In Venezuela

The White House sponsored a coup in Venezuela, with some loss of life. They captured President Maduro, leaving Vice President Delcy Rodriguez as the interim leader.

I have zero expertise in Venezuelan politics, but that might put me in the same boat as the brain trust in the White House that engineered the coup. I just want to comment on why it is unlikely to matter much for the oil market.

De-Liberation Day And Other Topics

Rather than write a few small articles, I am just going to have a single article covering a few threads. My blog writing time has been limited by working on my manuscript.

De-Liberation Day?

Outside observers have argued that the Trump administration’s arguments before the Supreme Court were shambolic at best, and the questioning by judges was viewed as hostile. Although the Supreme Court normally bends to the will of President Trump, the argument that he can impose taxes at will might push the conservatives too far. The recent blowouts of Republicans in state and municipal elections is a reminder that politics has not yet been abolished.

Ambling Towards A Crisis?

After 2008, there was a small community who always predicted repeats of The Financial Crisis. The problem the doom-mongers faced was the back side of “The Minsky Cycle”: actors react to a crisis by reducing risk and taking steps to avoid repeating the exact same crisis. That was done throughout the financial system (including Canadian regulators who changed their housing market policies, which was my worry at the time). However, memories fade — and new ways to spawn a crisis pop up.

Financial crises of varying strength have popped up on a frequency of (roughly) once per decade in the United States since the 1960s (when the lingering fear of the Great Depression finally subsided). The COVID recession hit at about a decade after the Financial Crisis — and so we had another crisis that stood in for a financial crisis. The question one might ask is whether the clock is ticking. Although I am fairly permanently pessimistic, I still lean towards a financial crisis being delayed.

Tariffs And Fiscal Policy

The customs duties data for the United States was recently updated, and we can assess the “success” of Trump 2.0’s tariff policies so far. On an annualised run rate, customs duties were 0.88% of GDP in the second quarter (the latest monthly figure Treasury I saw was around $350 billion annualised versus the $267 billion BEA second quarter figure).

Carney Capitulates?

News today was that Prime Minister Mark Carney withdrew many Canadian retaliatory tariffs on American good, although some remain. (One report indicated that the withdrawal was for goods covered by CUSMA/USMCA.) This news angered many Canadians, as it is an apparent reversal of the “elbows up” message of the election campaign.

Chickening Out Over The Jobs Report

I was slow to the outrage about the floated idea of stopping the publication of the monthly Jobs report (in favour of just the quarterly numbers). It now appears that E.J. Antoni has walked away from that suggestion.

Backing down is hardly unexpected. From the point of view of politics, economics data just seems to be a nuisance when it goes the wrong way, and shutting it off does not matter. But for people who are paid to discuss the economy, in the absence of data, there is nothing useful to do. As a result widespread push back from economists in finance and financial media to data cuts are inevitable.

A Banana Republic Without Bananas

American institutions continue their slide into being a clown car with the firing of the director of the Bureau of Labor Statistics (BLS). Although the stock line appears to be that this is a dangerous step in a bad direction, that’s been true since before the inauguration. Nevertheless I would be more concerned by the continuous slide in data quality due to budget cuts and the secular decline in survey response rates. Data gathering is in a crisis even without this sacking.

Fed Independence And The Rates/Inflation Debate

The drumbeat from the White House to replace Powell as the head of the Fed is increasing, and we are seeing potential candidates for the replacement echoing President Trump’s line that the United States needs low interest rates now. (President Trump argued Monday that the policy rate should be 1% or lower - link to news article.) I have just written an article about the difficulties finding writing opportunities about economic theory debates, and I guess I needed to be more careful about what I wish for.

The TACO Principle And Inflation Risk

At the time of writing, President Trump is waffling about the possibility of joining Israel in its attacks on Iran. This adds yet another possible inflation risk story: crude oil prices could spike in response to snowballing conflicts in the Middle East.

To recap, there are four main inflation risks lurking over the U.S. economy.

1. A large tax cut could help fuel demand.

2. Tariff wars are only in a ceasefire, and high tariff rates (particularly for Chinese goods) might resume after the ceasefires expire.

3. A widening of the war might result in a crude oil spike.

4. Widespread deportations are cutting off some industries from labourers, particularly the agricultural industry.

Trump Folded, Uncertainty Remains

Uncertainty got the upper hand this weak. President Trump removed one certainty from the outlook — the U.S. economy would be wrecked by his de facto embargo of China — but we now are uncertain as to how bad a 30% Chinese tariff will be, and we also do not know what happens when the 90 day grace period is up. Meanwhile, the White House has indicated that he will start unilaterally imposing tariff rates within a week. Since Trump appears to get great satisfaction from changing tariff rates, and there is no sign that any country other than the U.K. is interested in his “deals,” he might as well go back to governing via posting tariff rate changes on social media.

Trump Trade "Deals"

Recent comments by Donald Trump seemed to confirm what he implied in his earlier remarks: the “90 trade deals in 90 days” he promised generally did not refer to formal trade treaties. Instead, they would be more informal negotiations about setting American tariff levels.

No Feedback

I have a primer in the pipeline, but I just want to comment on President’s Trump's statements/posts that hit yesterday. The problem with the current trajectory of the United States is that President Trump has effectively taken control of the economy, and it appears that he is getting no useful feedback on the consequences. We would need to go back to historically disastrous central planning episodes to find parallels.