Thank you Peter and thanks everyone for being here today. I'm looking forward to a rousing session. This is going to be more on tariffs because it's the topic of the day. But mine's a little bit more about Fed policy, interest rates, the dollar and other aspects that I want to touch on here. So this is definitely Jim's view of what's going on. We'll talk a little bit about initial conditions. I do think it's important to keep in mind that coming in things looked pretty good. So, I'll talk a few slides about that. You've got these tariff threats that George talked about a little bit. I've got a little bit on that. I've got the game theory aspect. I've given this elsewhere and the students love the game theory. So, we'll talk about that. And the Jerry Maguire problem that could be looming here. If you don't recall Jerry Maguire, it was a sports agent movie from the 90s. He either got fired or something and they're splitting up from the firm, but the firm is scrambling to get his athletes and he's scrambling to get the athletes and in the end he gets only one, but as I recall the best athlete. So there is a Jerry Maguire problem here that could develop on the decoupling side. So I'll try to cover that a little bit. There's a last trade war which was 2018-2019. I was on the Open Market Committee at that time. So I lived through that one. A little bit about the dollar, a little bit about interest rates. So these initial conditions are good. So I just wanted to illustrate that coming into this year, after the election, these numbers here in the middle of this page are the ones that were projected for the end of 2025 by the Open Market Committee. So the point of these is that these are very benign numbers. 2.1% growth would be very close to the potential growth rate of the US economy. Inflation at 2.5% would be a little bit high but it's been coming down and unemployment at 4.3% would be very close to what many people think is the natural rate of unemployment. So this is about as steady state as it would get for the US economy. That was the projection as of December of 2024 coming into the year and other real time indicators about the economy including about inflation aren't really showing much of a ripple so far. So I'm going to show you three charts to make this argument that the initial conditions are good and that means that whatever the trade war does, you could be coming in on a rocky path or something and then the trade war is just enough to throw you into recession. I don't think that's where we are. We came in on a really good path. So you've got some room to maneuver. Here's a chart about the unemployment rate from the Daily Shot. This is a way to control for the seasonality. Those brightly colored lines are all the different years. The blue line is this year. So this year basically looks like all the other years that were successful years. The lines that go off the chart were 2020, the pandemic, and 2021 as unemployment came back down. So this is weekly unemployment insurance claims, often considered one of the best real-time indicators of what's going on. You don't see anything here. And this goes through last week. So far so good. This is the GDP number that came in. Some of you may recall the GDP number was negative. That doesn't sound very good. Negative 0.3% growth. That's the dotted line in this picture, that looks like it's tanking. So if you just looked at that all by itself, you'd say, 'Oh my god, the world really is coming to an end.' But no, that's not what's going on. As George was talking about, there's a lot of front running because everyone hears the news. One of the most interesting things about macroeconomics and why it's harder than physics is that your particles have a mind of their own. These particles definitely had a mind of their own. They saw the tariffs coming and said, 'I'm going to front run that and import a lot of stuff before it gets taxed.' So the way that shows up in this data, that should have shown up as inventory buildup in the US, but it doesn't quite work that way. And so that dotted line went negative. But Wall Street wasn't too worried about this. That horizontal dotted line shows 3% growth. This is from MRB Partners via the Daily Shot. The story is that if you just look at consumption growth and investment growth in the US and forget about the inventory part and the trade part, you get 3% growth. So a lot of times that's considered a better measure of what's fundamentally going on in the economy and that's a good number. So again, good initial conditions for the US economy. A lot of people have said that the tariffs are going to raise inflation. But the market doesn't think that. The market thinks this in this picture. This goes back to 2021 and goes across all the way out to the current number. This is daily data, actually it might be weekly averages. This is the TIPS expected inflation rate. So this is actual people on Wall Street betting on what they need to be compensated for the inflation that might be out there in the future. The breakeven is about 2.4% over there on the right hand side. You can see that this has not skyrocketed. Nothing's happened so far. So far so good. Markets are not expecting a lot of inflation. Obviously the incoming administration campaigned on leveling the international playing field with respect to trade. But everyone knew that. Nevertheless, when you got to April 2nd, the announcement surprised everybody. It surprised Wall Street. It alarmed everybody. You could say that's a negotiating tactic, take an extreme position at the beginning and then see what you can get as you negotiate going forward. But these were at levels not seen since the early 20th century. So Wall Street didn't like that. Equity markets sold off, many people in this room probably are very familiar with that. And recession probabilities moved sharply higher. Let's look at those pictures. This is similar to the one George had. This is from Capital Economics via the Daily Shot. This goes back to 1890. This chart made the rounds pretty quickly after April 2nd. As George was saying, tariffs used to be high. 1890 is the McKinley era. President McKinley for those of you not recalling your US presidential history. That peak there around 1930 is Smoot-Hawley. I'm going to talk about Smoot-Hawley here in just a minute. Considered a contributor to the Great Depression. This is an effective tariff rate that looks higher than Smoot-Hawley. Wall Street didn't like that and sold off abruptly. Here's the recession probability on Kalshi as of April 22nd. This number has come down in more recent data, but this shows how much it went up in response to the announced tariffs, a 60% chance of recession in the next year, shockingly high. I will say something though about this chart. Recession probabilities are kind of high on the left hand part of this chart that goes back to August of last year. You might recall there's a bit of a recession scare in August-September of last year based on some weak labor market data. This same measure had the recession probability between 40 and 50%. This is a betting market, a daily betting market. You can bet on it if you want. And this came way down after the election and into the first of the year mostly because the data was way better. Some of the data got revised and people weren't sure what the trade policy was going to be. But as that became clear that we're going to get a lot of announcements on trade, this certainly climbed precipitously. So here's the game theory. Let me just talk through this for a minute. The US is the row player and they can play low tariffs or high tariffs. The rest of the world is the column player and they can play low or high tariffs. The Trump administration thinks that we are in the upper right box where it says 'current state benefits rest of world'. They think the US is playing low tariffs and the rest of the world is playing high tariffs. Especially if you consider non-tariff barriers to trade, I think most economists would probably agree with that assessment. A typical country around the world doesn't like the idea that they're going to compete with big American corporations who are very efficient. They ask for protection from their government and they might get it directly in terms of tariffs, or indirectly in terms of bureaucratic blockage of trade with the US. So that's the current state. Whether it really benefits the rest of the world is a great topic for a lecture. I'm not going to go into that, but it's perceived as benefiting the rest of the world. The low-low box on the upper left is free trade. You could probably never have totally free trade, but freeish trade would benefit everybody. There's nothing wrong with the free trade theorems. You're better off allowing all the trades to occur that people want to occur. The lower right is both sides playing high tariffs, like Smoot-Hawley. Let me refresh you about Smoot-Hawley. In 1930, the Congress started in 1929 after a famous stock market crash. There was a rally after that, now called the fool's rally. In the first half of 1930, the Congress started talking about putting tariffs on at a high level and eventually passed that bill and sent it to President Hoover's desk, and he signed it. That's one of the suspects about what caused the Great Depression. There are others. Milton Friedman said it was the Fed. Of course, I don't like to blame the Fed. So I think Smoot-Hawley is a better thing to worry about. But everyone would say this is a problem. The other countries looked at that and said, 'Okay, we'll raise our tariffs too.' So everyone went up and all the trade basically dwindled down to very low levels or even zero. That's the Smoot-Hawley outcome. What Wall Street was worried about was that you might get that kind of outcome, other countries just say, 'Look, we can't work with the US anymore. We're going to put up high trade barriers and look for our markets elsewhere.' If that was the end of it, you would get trade collapsing, especially with the prohibitive tariffs between China and the US. If you had that, it would be a very bad outcome, damaging the value of equities traded on US markets and you'd have a global recession. This is where the Jerry Maguire problem comes in. A version of this is that China and the US leave their tariffs very high, all the other countries will be scrambling to decide which side they want to associate with and create a deal that way. There's some of that going on. If you read about and think about the Cold War, you had a very similar thing. You had the Soviet Union and the United States. Many of the other countries were very shrewd about trading off the Soviet Union against the United States. They wanted to see what you're going to give me if I join your side. You get that kind of competition. I call that the Jerry Maguire problem. There was a trade war in 2018-2019. It was a war of words between China and the US. It drove higher uncertainty. I've consistently told audiences it's that which can send you into recession. No one wants to make a billion dollar investment in some country if they don't know what the trade rules are going to be. In corporate boards all across America and across the world, they're all sitting there saying, 'Why don't we hold off on our billion dollar investment until we find out what the rules are going to be?' So you have this pulling back. That's a very clear dynamic going on. In 2018-2019, that eventually slowed down the US economy in the summer of 2019. The Fed responded to that by lowering the policy rate. You could get that dynamic today. I would stress I lived through it. Inflation was below target at the time. We might have welcomed a little bit of inflation to get up closer to the target. We didn't really get that. By our preferred measure, inflation actually declined in the first half of 2019 as this trade war was going on. So I think the inflation part of this story that's dominating in the media has to be reconciled with what's going on here. This time you do have threatened tariffs which are much higher than they were in 2018-2019. A lot of people tell me that the dollar is going to lose its reserve currency status because the dollar has depreciated recently. This has bounced up just a little bit at the end of this chart that goes back to 2022. I think you might interpret that as a squiggly line, the scientific term for that. The point is, you've depreciated a lot in 2025 here, about 8% when this chart was drawn, a trade weighted value of the dollar. But you see movements like that since 2022, so it's not enough yet to say, 'Oh, all of a sudden no one wants to hold the dollar globally.' I don't think so. You've got a ways to go if you want to make that argument. If you go back further, the dollar was actually weaker. You'd have to go quite a bit lower just to get to levels you might have seen pre-pandemic. The last point here is on rates. What are rates going to do? That's the classic question. I wanted to make this point with this chart. This is a yield curve chart. We'll take the 30-year Treasury yield and subtract off the 2-year Treasury yield. The two-year is at the short end of the curve more related to Federal Reserve policy, the 30-year is the long bond yield. If those are inverted, that's usually a recession signal. If we subtract one from the other and get a negative number, that would be a recession signal. We had that here in 2023 according to this chart over on the right hand side which is 2025, excuse me. This has actually been going up. So what's going on? If this is a recession indicator and it's a powerful and very accurate recession indicator, then why are the Kalshi guys buying that probability chart saying there's a 60% probability of recession? This is saying there's not much probability of recession. The other thing about this chart is that in 2023, that period was negative. That's because the Fed raised rates enormously in the second half of 2022. That was the time we did four 75 basis point increases in a row. I was a big advocate of that. Markets thought we were going to have a recession. I said we weren't going to have a recession, but markets thought we were. This was inverted all through that period and only reluctantly went positive in 2024. But why is this going up now when everybody thinks we're at higher recession risk? Maybe something else is going on that's making the longer term rates go up. The something else is Congress debating US fiscal policy. They have to decide between obviously trying to pass the bill here. They're trying to decide what the level of taxation should be, what the level of spending should be, and what the level of borrowing should be. My reading is they don't really want to change the taxes, which means keep the old tax cuts in place, and they don't really want to change the spending either, which sounds like you're going to borrow a lot of money going forward. The Committee for a Responsible Budget says that you're going to send the US debt to GDP ratio to 150%. It's under 100% or 120% today depending on how you measure it. Markets might be reacting to that and saying, 'If that's what you're going to do, then I'm going to demand more of a risk premium for longer term lending to the US government.' That's one interpretation. Let's finish up. I said that just so you don't forget what I said because I don't like that. So don't forget what I said. Initial conditions are good, which gives us some cushion, probably good news that might keep us out of recession. The threatened tariffs were definitely higher than expected and at Smoot-Hawley type levels, so that's pretty high. We've got this game theory going on between the rest of the world and the US and bilaterally between all these countries. It's not clear how that's going to play out. There's this decoupling risk between China and the US. One way to think of that is that you are going to get some decoupling. The Treasury Secretary even said today, for some goods we're not going to be trading with China. So you get some decoupling, but how broad would that be and how much does that set up a Jerry Maguire problem? The trade war in 2018-2019 gives you a road map. You did get deals made. Inflation didn't really take off. Growth was slower. The policy rate moved down. So that might be what happens this time. But this is a bigger trade war than what we had that time. Finally, longer term yields today could be pricing in the US fiscal situation more than in the past. So thanks. You've been a great audience and I look forward to seeing many of you later.
