Ninety days into a new world order, we mere people are increasingly apoplectic about the rate of return in the stock market. If this 15% drop in the stock market is extrapolated over an entire year, our 401Ks will become 201Ks or maybe even 101Ks. At the same time, the wave of automation that caused entire manufacturing sectors in the U.S. rust belt to evaporate into thin air are now coming for those with college degrees. Global automation can probably do little additional harm to those without college educations, but now A.I. has the college educated in its sights. These various factor got me to thinking about rates of return. Today’s graph demonstrates how the value of a college education has evolved over time. I’m particularly interested in the return to a public university education, which remains the predominant model in Canada and the U.S. alike, and especially in the skills we instill in business schools within which I teach. In the 1960s and 1970s, good manufacturing jobs in the U.S. and Canada were plentiful. However, they were the first casualties of the automation first pioneered in Japan (using American intellectual property) and, in the 2000s migrated also to China. Until automation and lower wages found a home in those two nations, many a high school graduate aspired to a job at the company factory, as had their fathers and grandfathers. But, by the 1980s, we saw a significant shift of demand for such lesser-skilled labor and a greater demand for the skills a college degree could guarantee. As a result, salaries rose for college educated graduates, including those who graduated from business schools, while wages were depressed for manufacturing jobs. By the mid-1990s, the U.S. had essentially relinquished low skill jobs to Japan and then China while the American economies converted to service industries - medicine, law, the FIRE services (finance, insurance, real estate), the creative industries, research and development, and education. North America became the bastion of higher education and attracted millions of students from the world over to learn its techniques and perhaps immigrate here upon graduation, or take these skills home with them to ensure higher standards of living elsewhere too and hence also a greater appreciation for and reliance on the western model. The net result was a movement of exports from manufacturing and into services, a great growth in domestic Gross Domestic Product, and a premium paid for jobs taht required a college degree relative to those that did not. An economist would then ask the question - what is the return on investment from a college education? Now, I have worked at Harvard in my post-doc days, and certainly appreciate what it has to offer the world, but that model is rarified. I’m more interested in the return on investment to those who pursue a public university education as that is the most common type of post-high school training most of us receive. The College Board publishes a Trends in College Pricing and Student Aid that provides good data on how much it costs to earn a public university education. In addition, groups such as Coursera (Business Degree Salary: 2025 Guide | Coursera) document how a business degree offers a premium above the typical earnings of a college graduate. When I run the numbers, I can make some interesting observations. First, as we would expect, the value of a college education, especially from a business school, increased dramatically as our economy converted from manufacturing to services in the 1990s. The more surprising observation is what happened after that, though. I model a college education as an investment. This investment certainly includes tuition and fees but does not include room and board because one must shelter themselves whether we attend college or work a local job. But the larger cost of investing in higher education, especially for those who attend lower tuition public schools, is the sacrificed income from those jobs one must sacrifice right out of high school if we are college-bound. Using the data described above and from additional data provided by National Center for Education Statistics Digest and an article by two Federal Reserve economists named Jaison R. Abel and Richard Deitz entitled “Is College Still Worth It?”, I could compare the investment in education to its return. I then calculate the return on investment as would any financial investment. What is the Internal Rate of Return for a typical career to social security retirement based on the premium one enjoys from a college business degree relative to the investment. Formalities aside, we see a great flattening of returns. These returns are strong for those who can complete their course of study, but they peaked at almost a 25% return in the mid-1990s, levelled off but held their own through the 2000s, but started to taper off in the 2010s. The decline even accelerated in the 2020s, even before the influence of Artificial Intelligence. Now, a rate of return above 20% is still great, but the trend is trickling downward. In addition, it is this sector of somewhat analytic skills that are also most easily replaced by artificial intelligence. As AI replaces some accounting, auditing, financial analyst, social media, supply chain, and management skills, it may be difficult to attain the premium we have long enjoyed in the analytic fields. Other creative fields may suffer too as machines write our reports or our screenplays, AI performs our legal research, and computers author our books and articles. If so, we may see an eroding of wages in these sectors as demand falls, and hence a decline in the rate of return of good paying jobs relative to the cost of education. Also worsening this trend is the steady increase in higher education costs since the late 1990s. Of course, these displacements will most quickly and likely affect entry level positions. As one garners experience and if one keeps up with leading edge techniques, we will always need our most skilled to oversee our artificial intelligence machines. And, with the rate of return for higher education still well over 20%, there is not another investment that earns such a return but without the risk that has roiled financial markets three times since 2008 - over the Great Recession of 2008, the Great COVID pandemic of 2020, and the Great Shooting Oneself in the Foot of 2025. It will be interesting to see the extent to which we reup our great education investment. After all, rates of return, while flagging a bit, still remain strong. Education also provides other non-monetary quality of life benefits that enrich our civic life. Now is the time to up our game in the quality of education. We must also develop industrial policies that encourage and reward even greater degrees of workforce expertise and sophistication so we can remain one step ahead of the AI machines bent on replacing we humans. And, we must make it easier to attract the best and the brightest to our institutes of higher education, including foreign students we wish to remain here upon graduation or we wish to trade with as they return home and simultaneously increase prosperity elsewhere. You see, the wealth elsewhere induces greater imports, so if our economic and education system can endear us to those who return home after a fine education here, that allows us to maintain the global relevancy that has maintained our standard of living in the post-WWII era. The United States and Canada can not only accept but also excel in that challenge. That does not imply we will. To also recognize to exceed in a more competitive world requires us to innovate and have a plan for excellence, not take the counterproductive path of tripping others up instead. And, if we are to avoid the discontents by leaving an entire generation behind when we converted from industry to innovation, we must also have a plan for those who fall through the cracks. If we are to transition to a 21st Century economy in a cohesive way, nobody can be left behind - lest we wish to endure the fits and starts of disillusionment that seems to plague some of the world’s most laissez-faire economies.

It’s been a wild ten days. I apologize on behalf of all economists. What has occurred of late has little to do with economics, even if it has profound effects on the economy. Let's try to see the signal through all the noise, distractions, politicking, volatility, and name-calling. I’ll leave to others an explanation for power politics based on the theory that might make right. Instead, I’d like to offer an explanation of the intricacies of international finance so you can better understand the economic forces at play. Hopefully it will allow you to cut through a lot of the bull espoused by more zealotrous commentators. They profess to know much more about the art of the deal, while economists look at things from a longer-term perspective in which participants actually long to interact with each other, both now and in the future. Let’s begin with something that sounds very boring, but is actually critically important, as you shall see. When I speak about the bond market, let’s focus primarily on a single instrument, the 10-year treasury bond that generates the single most important bellwether interest rate on the planet. After all, we are all affected by interest rates, in one way or another. This 10-year treasury bond is actually very simple. It is in essence a loan made to the U.S. government that promises to pay a predetermined sum called its face value upon maturity (ten years after it is issued) and a predetermined “coupon” payment every six months. The actual price one pays for such a bond depends on how we’d value the returns of the bond relative to its perceived risk and the risk and returns of other investments. Such Treasury bonds issued by the United States government are the lifeblood of the global bond market. Anybody with some surplus US dollars the world over can park their dollars into Treasuries and earn a fair and very safe return, so long as they wish to hold investments in U.S. dollars. It is this dynamic that caused the U.S. president to back down from tariff threats and declare a badly needed 90-day pause in tariff imposition. After generations of faith in the U.S. dollar and the sanctity of American promises, investors (nations, institutions, and individuals) the world over lost confidence in U.S. bonds and the U.S. dollar. Such U.S. debt is used to finance federal government budget deficits. Foreign investors are willing to fund such borrowing to maintain federal spending for three reasons. One, they believe their investments are safe and the U.S. will always honor its promises. Second, they believe the twice-yearly coupon payments in U.S. dollars are valuable and reasonable. The third reason is that international investors want to hold U.S. dollar assets (that also pay some interest) because they are confident in the U.S. dollar as the primary international currency that is prized and traded the world over. The single largest holder of U.S. government borrowing is Japan. When the U.S. transitioned from a goods-based economy pre-1970s to a service-based economy since then, Japan filled the gap by providing the manufacturing goods (appliances, textiles, cars) that America shed and its consumers prized. Decades before the rise of China’s manufacturing, Japan reinvented itself from a nation regarded for its inferior goods to Sonys and Lexuses (Lexi ?). It was much less affluent in the 1960s and could not really afford to buy as much from America as Americans clamored to buy from them. That meant they received more American dollars than they returned in purchases. The difference they parked in the purchase of U.S. Treasuries. In 1987 Japanese financial institutions became increasingly concerned about America's capacity to repay the mounting U.S. government debt that was then about $2 trillion. They warned the U.S. government to be more prudent financially, but their concerns were ignored, despite the fact that the largest share of lending to the U.S. government was from Japanese purchases of US treasuries. At one weekly bond sale at the Treasury, the Japanese refused to show up. On that Black Monday, October 19, 1987, global markets lost $1.71 trillion and US stocks fell 23%, the largest daily drop in the history of the S&P 500 index. A chastened U.S. government got the point, even if it continued to rack up debt. What would have happened if the U.S. government instead strived for a balanced budget over time? If it no longer ran a budget deficit, it would no longer need to borrow. And, if it didn’t need to borrow, countries like Japan back then, and China today would have little alternative use for their excess U.S. dollars, except perhaps to invest in the U.S. or buy more U.S. stuff. This reduced desire to hold U.S. dollars would result in a weakened U.S. dollar that equates imports and exports and also require a lower U.S. interest rate because government borrowing would not be necessary. In the end, the U.S. would no longer run a trade deficit. A balanced U.S. budget (neither in deficit or surplus) would roughly induce equally balanced international trade. For instance, the US trade deficit in goods and services in January was about $130 billion, or about $1.56 trillion annually. Meanwhile, the US budget deficit is about $1.8 trillion. These numbers are typically quite close, as today's graph shows. There are a couple of periods in which the budget deficit spurted, during the Great Recession of 2008 and the COVID era. Those two eras saw the Federal Reserve funding much of the budget deficit temporarily through their radical monetary policy of massive bond purchases to ward off recessions. If those two periods are discounted, the correlation between the size of the budget deficit and its implications on the trade deficit (and hence the international capital surplus the US enjoys) are profound. In other words, the US needs to borrow to cover a deficit. This desperation forces the US government to increase interest rates sufficient to repatriate those excess trade dollars that flowed offshore for net imports over exports. Without a budget deficit, exchange rates would adjust to essentially assure no trade deficits either. This is what economists refer to as the "twin deficits". P erennial US. trade deficits keep the US dollar unreasonably high and imports more attractive for Americans than exports from America. The White House is loath to discuss the twin deficits. It would force our leaders to point their thumbs at themselves when they are pointing fingers at other nations. The executive branch does not want to focus too much attention to the US budget deficit as it tries to make permanent its tax breaks for the wealthy. So, what happened in the bond market to force the President to blink, first with a tweet to his followers, and then to the rest of the world? Just like in 1987, foreign bond investors were gravely concerned about US policies and decided to not reinvest their surplus dollars into US bond markets at their regular rate. With fewer buyers of bonds, but still desperate Department of the Treasury sellers needing to raise money to pay for government, the price of new and existing bonds fell dramatically. This also forced up bond interest rates, called yields, because those coupon payments every six months can be purchased by buying a devalued bond. Hence, these cheaper bonds offer a higher “yield”. Now, none of this description denies that there are not some issues to be worked out with America’s trading partners. But, trade will never be balanced so long as the exchange rate simultaneously equates both the flow of trade and the flow of financial capital internationally. And so long as the US government must rely on foreigners to fund its budget deficits, the exchange rate will adjust to perpetuate its trade deficits. If trade deficits are induced in good measure because of federal budget deficits, what's a president to do? Ideally, we'd sit down and negotiate good trade deals that ensures trade as tariff-free and non-tariff-barrier-free as possible. Hopefully we'd do that with some humility that our trade deficit is due to an artificially strong US dollar that is kept strong by higher than necessary interest rates to fuel government borrowing. It appears that an agreement with China is most important because these are the two largest economies in the world. But, that does not mean balanced trade with every nation, only balanced trade on average. As we discussed last week, American will likely have a trade deficit with lower per-capita income nations, such as China, even if there are issues with intellectual property rights, access to markets, and other annoyances that should be worked out. Do I expect President Trump and Chairman Xi will sit down together in the Oval Office? That’s highly unlikely given the Zelensky lashing. And, if so, when President Trump proclaims “you don’t hold any cards,” Xi may respond “au contraire.” China holds some pretty significant cards right now. It owns more US bonds than any nation but Japan, and it purchases US bonds at the highest rate. With the current 145% tariff rate the US imposed on China, and China's retaliatory 125% tariff rate, trade between the two nations is in effect nil. That’s why China said it would not raise its tariff anymore. It doesn’t need to if trade has in essence come to a halt. This means China cannot continue to fuel profligate US government spending. Potentially even more destabilizing is if China begins to sell its huge stock of past US debt and encourages other nations to do the same. That would bring US financial markets to its knees and potentially result in a financial meltdown that is of a scale of the 1987 financial shock and the 2008 Global Financial Meltdown combined. That’s scary stuff. China holds far more cards and has prepared its people to endure more pain than President Trump may have anticipated. Many other nations, including Canada, are angry as well, and are willing to endure pain while it reorients its trade and investment. This is a recipe for potential financial calamity. Should our economy be flown into a downward spiral through incompetent economic policy, it may be difficult to pull out. If nations flee the US dollar, the resulting exchange rate depreciation may be good for exports, but a desperate Congress, unable to balance its budget, will induce ever-upward interest rates to maintain its borrowing fix as international cash becomes scarce. I wonder if the administration has factored in such risks. The market is starting to realize the stakes. Even if this reality becomes enough to sober up President Trump’s trade threats, lasting damage well beyond China is likely already done. President Trump’s treatment of his allies makes them suspicious that any agreement forged with his office will be kept. After all, leaders around the world see what he did with his closest ally of Canada by negating a treaty he negotiated with them in his first term, which he then bragged was “the best treaty ever.” And Trump’s willingness to play fast and loose with on-again and off-again tariffs, with braggadocio and bluster, threats and trolling, offends world leaders. Nations are now in two categories, those who are victims of his taunts, and those who realize they may be someday soon. Neither camp has much trust and confidence, the two ingredients the Treasury relies upon to remain the world's safe haven for investment and the American dollar needs to be considered the world’s reserve currency. Already the US dollar has plunged the most since 2022, and we are only a few days into this drama. It's time for steadier hands. We need to acknowledge that nations may choose to invest with more reliable partners and hold another currency like the Euro or the Renminbi as a shared currency. This regime change would be incredibly costly for the US Treasury and the American people. Of course, the American people can simply pay for government so it doesn't need foreign nations to bail it out. Note, though, that the argument of tariffs as a way to pay for government is lunacy, given the distortions a rejection of free trade creates, just to have Americans pay in the end for government through a tax on the goods and services we buy. That is even worse than the middling solution the U.S. currently employs that hamstrings exports and requires the U.S. to depend on the kindness of foreign savers. Stella! These observations are not political, just plain economics. Maybe America can muscle its way through in various political ploys, but it is facing an intensifying international economic headwind as it tries to maneuver its way out of the current predicament. I sure hope for the sake of preservation of a reasonably highly functioning world trade order that President Trump gets some sound economic advice beyond the peddling of political pablum that occurs in various echo chambers. By the way, what is the cost of our trade deficit? About 3% of our GDP, around $1 trillion. The cost of the recent stock market crash? About $10 trillion. The cost of loss of trust from the international financial system? Priceless.

In the last couple of days, almost $7 trillion of investment value has been wiped out. A dubious economic theory designed to raise $2 trillion in tariff revenue over a decade to afford permanent tax breaks for the wealthy pales in comparison to the amount lost in the retirement accounts of everyday citizens. I’m trying to understand why, but, like almost every single economist, it makes no sense. A century ago it would not be a profound statement to argue that cars would universally replace the horse and buggy within the century. Nor is it any more profound that electric vehicles will replace internal combustion vehicles in this century. Perhaps a good share of these new vehicles may even be personal aircraft. Also century ago, the U.S. represented the leading edge of automotive engineering. Certainly few would claim that the Big Three (or Two and a Half) manufacturers of gas-powered cars lead the world in innovation. They had a captive audience and were afforded all sorts of tariff and non-tariff advantages, not the least of which are wide oceans that separate them from their competitors. Ford and GM tried to produce cars elsewhere to serve other markets but they suffered from lack of innovation and from fears they harbored that they’d reveal intellectual property that could be replicated elsewhere. Instead they tried the colonial model - send finished cars or assemble cars elsewhere, but let our domestic industry keep engineering and innovation jobs here. This complacency created such hits as Chrysler K-cars and AMC Gremlins when Americans wanted Hondas and Volkswagens. Following these strategic errors of arrogance, the industry has remained too far behind their skis, with almost all requiring bailouts and a couple disappearing entirely. There was a brief exception when Tesla led the world in technology, before Mr. Musk swapped his slide rule for a chainsaw. Now, Tesla is far from the most innovative automobile and GM and Ford are not even in the innovation ballpark. Apparently, we shall coddle domestic manufacturing even more, something that Musk claimed a couple of years ago is a fool’s folly. (He may say something different now). Now, the most innovative and most affordable cars won’t be made in the U.S. because the Chinese fear Americans will try to steal their processes and intellectual property. My, how things have changed. Meanwhile, neither Americans nor Canadians can purchase the world’s most technologically advanced cars. I say all this because the official US trade policy is to double down on protection so that the US can move the clock back half to the 1950s and 1960s when it led the world in manufacturing. Back then, manufacturing represented about 25% of our economy, and agriculture was a tick under 10%. Now these sectors are a third that size. Agriculture never will constitute such a share of our economy because technology has dramatically reduced farm employment, and has brought down costs significantly. We can impose tariffs all we want but that won’t create more or more productive farms. The hope may then be that firing the furious flurry of shots over the bow and into the hearts of allies and adversaries alike to institute a global trade war not seen since the failed Smoot-Hawley protectionism of the Great Depression will somehow allow the US to attain its former position in global manufacturing. Is that what we really want? Manufacturing declined because America realized it can make more money selling services rather than goods. Think Google, Meta, banking, consulting, leasing of patents, and other incredible value-creators prized, until recently, around the world. In fact, despite all the talk of the world ripping America off, the U.S. enjoys a trade surplus in services while it runs a deficit in goods. Maybe nations around the world should claim the US is ripping them off by not buying an equal amount of services from them as they do from the US. And, are we willing to pay the price to establish a goods balance even as the US enjoys a substantial services surplus? The price is high indeed, especially as nations around the world, and even next door, no longer want to buy American goods. That’s particularly upsetting when the nation of Canada has one of the most open free trade regimes in the world, even more open than the U.S. once had. It’s hard to attain symmetric trade between nations when nations don’t trust the U.S. anymore. If we are willing to pay that price of global trade isolationism, are we willing to truly make steel and more cars, washers and dryers, and cheap electronics and plastic goods here in America again? After all, we essentially decided we did not back in the 1970s and 1980s. Certainly we can’t do any better in these low value/tight margin, high pollution industries. We could of course invest huge sums into muscling through the expansion of U.S. manufacturing. The only way we can add sufficient value to pay the wages our President desires is to rely heavily on automation. Such an investment to make an even modest addition to manufacturing would cost this nation somewhere around $1 trillion to $2 trillion, about the same amount that President Trump hopes to reap by penalizing foreign production over the next decade. The problem is the President needs that tariff revenue to fund permanent tax breaks for the wealthy. Perhaps he argues they will take that wealth and invest in America. Let’s take a moment to unravel President Trump’s claims of tariffs imposed on the U.S. by other countries. Let’s say a poor country makes coffee, but nothing else, and imposes no tariffs at all. Americans buy $1,000,000 of coffee (an import) because we like coffee and we can't produce it here, but the coffee-producing country is so poor it cannot afford to purchase Boeing aircraft, supercomputers, or anything else the U.S. sells. According to the White House math, the US subsidizes this country, and the ratio of the trade deficit ($1,000,000) over imports (also $1,000,000) justifies the imposition of a 100% tariff. So, because President Trump is kind, he will only impose half that ratio as a 50% tariff. Of course, the poor country still can’t afford any Boeings, so they will sell less coffee, and American consumers will pay 50% more for coffee. If you are confused about the math, don’t be. It makes absolutely no sense. These “reciprocal tariffs” are not anything of the sort. President Trump essentially claims that if a country such as our poor coffee producer doesn’t buy US goods in equal amounts, it is due to some sort of nefarious anti-American trade policy, rather than simple economics. To make matters worse, if the U.S. has a trade surplus rather than a deficit with another nation, President Trump sets a tariff of 10% for them anyway. In other words, even if a nation buys more US stuff than the US buys from them, which in President Trump’s mind makes the US the “cheaters”, these countries will still have a tariff levied against them. Even “non-cheaters” are punished as “cheaters” and “cheaters” aren’t really cheaters if they are American. I guess using that incredibly flawed logic, I’m a cheater too. My university purchases teaching services from me but I don’t pay tuition to it. And the university also cheats students, according to this silly logic. Students purchase education services from my college, but my college doesn’t purchase an equal amount from students. Well, all this punishment of every country in the world, regardless of whether they run surpluses or deficits with the U.S., and regardless of whether or not they actually have any tariffs at all (Canada’s average tariff rate is only 1.4%), should raise lots of money to pay for the proposed tax cuts for billionaires. Let’s assume American billionaires are willing to invest their wealth preserved in Making American Manufacturing Great Again. There are no signs to date that they are rushing to pledge trillions of new investment into America. In fact, over the past couple of months, investors have recently backtracked on billions of dollars of pledged investments. Some of these investors may buy elections, but not new production. If some of the world’s wealthiest billionaires won’t revitalize manufacturing, can we expect investors from elsewhere to do so? Ironically enough, past investment in the U.S. economy from foreigners has occurred with the same dollars they earned by selling more to the U.S. than they bought from us. The difference is repatriated back to America in investment. But, without such trade deficits there will be no capital inflows of the same amount. Nor would foreigners want to invest in the U.S. if they now feel their own economies are threatened or if they don’t trust that their goodwill will be met with additional punitive practices in the future. When free trade trust breaks down, they will reserve their investment for home. OK, let’s say this nation can somehow muster a trillion or two to revitalize manufacturing. This sector now represents less than 10% of our economy, so even an almost unfathomable expansion of manufacturing would result in maybe a couple million jobs. That will represent a one-percentage point increase in the employment rate, while the ramifications of tariffs will cause a far greater drop in jobs and growth. On net, we fair far worse in this reshaping of global trade. That’s also on the optimistic side. It assumes there will not be a stagflation, a recession combined with higher inflation and higher interest rates, just as we experienced when the U.S. went to battle with competing nations in the 1970s. It also assumes that the 15% of wealth lopped off from Americans’ stock and pension accounts will somehow bounce back so people don’t reduce consumption accordingly. Such a reduction in wealth induced the Great depression. Dubious claims of revenues that will be generated from tariffs pale in comparison to the $6.6 trillion lost in Americans’ portfolios and pensions over the past couple of days. Let’s double down on the same failed policy and expect different results. Finally, even in the world of magical and deceptive economic thinking, a dramatic increase in new investment in the United States won’t be in industries that create lots of jobs. That is old manufacturing. We now make as many cars as we did in the 1970s but we use a tenth the number of autoworkers. An entire sawmill or paper mill employs a handful of people and lots of automation. There are huge investments in AI, where the smart money is going, but that industry requires a few highly skilled employees, but its goal is to reduce the need for workers across our economy. So, we can imagine some magical scenario that increases manufacturing 20%, as impossible as that probably is, but we should expect a far smaller increase in manufacturing employment, but employment of a lot more robots, likely bought from China or Japan. Musk was right a few years ago. Coddling and protectionism does not increase productivity and innovation. Competitive forces do so. They force us to build a better mousetrap and reinvent our economy based on our strengths, not on some vision to return us to post-WWII bygone days. We don’t want those jobs back. They can’t pay the wages Americans demand and still be competitive. What we need are jobs for the 21st and 22nd centuries, not the 1800s and 1900s. Can the American people and boardrooms reinvent themselves? I think so. But it must be very different from what worked in the past, even the recent past. If only about one in ten dollars and jobs are generated in goods production (agriculture and manufacturing), our comparative advantage is in services - advanced education and innovation, medical procedures and pharmaceutical inventions, better software, AI, and hardware, and, perhaps much less glamorous, but increasingly pressing, compassion for our elderly and care for our children. Or, perhaps, we can believe the claims that President Trump's heavy trade artillery is designed to solve some problems. What problems? Canada was first in the crosshairs, even though their average tariff rate was about 1.4%. The average US tariff is higher. Maybe 1.4% is too high so we will destroy a centuries old relationship and many wars jointly fought because 1.4% are too high? Now, I know some have heard propaganda claiming Canada imposes a 250% tariff on dairy products. Well, so does the US, but neither tariff is invoked unless either country exceeds certain thresholds that have never been exceeded. In practice, there are no such tariffs, but there is now mistrust that will last for decades. Over 1.4%? Over a goods deficit with Canada when the US runs a substantial services surplus at the same time? Over the fact that Midwest refineries clamor for Alberta oil that Canada probably now wishes it sold elsewhere so as to not turn a US surplus with Canada into a minor deficit that is tiny compared to nine other nations with larger deficits? It’s hard to understand, but then again, I’m an economist. I deal in rationality and am ill-prepared for posturing. Given the incredible costs Americans are already facing in this attempt to remake world trade around a mercantilist theory that died in the 1700s, I sure hope for the sake of the U.S. and Canada that this strategy succeeds. It is discomforting that almost every economist believes it won’t. Economists are often a conservative bunch, so they don’t have some sort of axe to grind. Let’s just hope we are all wrong and a few politicians in the West Wing know something no economist understands.

We are embarking on interesting economic times. I don’t mean that facetiously as a comment on the self-inflicted wounds by our leaders. Instead, I refer to an economic territory uncharted since the recession of 1979-81. We learned a lesson in the 1970s that we perhaps had forgotten in the halcyon days since the Great Depression. As comforting was the notion of a self-healing economic system kept always in equilibrium by the Invisible Hand, we discovered that a macroeconomic equilibrium can occur at whatever level we want it to be. Now, this sounds a bit flaky, so let me explain. The father of macroeconomics did not study much economics at Cambridge. Instead, like his philosopher father, he was interested in how humans can create our own realities. He discerned between the subjective realities of the hard sciences and the more objective realities of humans. The probability that it will rain is not influenced by whether we all decide to carry an umbrella today, but the probability of a recession is very much dependent on whether we think there will be one. In other words, our expectations often dictate human outcomes. And, now, expectations are sinking to very low numbers. They will get worse next week when people see their quarterly 401K statements and realize they lost 5-10% of their retirement wealth since January. Our collective moods are a pretty good indicator of the state of affairs of the economy, and definitely dictate our short to medium term economic future. Already, before the gloom ahead, people have been worried about global trade wars, electricity and potash shortages, and a pretty dramatic downturn of the U-6 unemployment rate that measures not just unemployed but also underemployed and discouraged workers. We now see on today’s graph that the inflation rate is ticking up pretty robustly. In fact, if you look at the quarterly trends that I calculate and publish in this blog series, you see that three month averages have been ticking up since the election and are now well above the level that the Federal Reserve deems tolerable. Worst yet is not the new levels, approaching and exceeding 3%, but the upward trend that seems destined to take inflation higher. In fact, in the most recent University of Michigan Survey of Consumer Sentiment, 66% of people surveyed expect higher unemployment in this year, compared to just 51% a month earlier. That’s the highest level of pessimism since the Great Recession in 2009. Our sentiment has dropped 28 points and our expectations are down 32 points in the last year, mostly in the last couple of months. This increasing gloom has not been seen since the depths of the Great Recession, and only a handful of times since the Michigan survey was first created in the 1940s. The ramping up of inflation, barely a year since some tough Federal Reserve policy seemed to have had it licked, is a big reason for the doom and gloom households feel. People are buying less, especially big ticket items that economists call consumer durables. We are getting nervous about spending as economic uncertainty steps in. Where consumers tread, investors soon follow. If we aren’t buying big ticket items, they will stop making them. That means layoffs, which increases unemployment still further and forces the economy to ration the reduced output to only those willing to pay the most for it. Depressing sentiment combined with the self-fulfilling expectation that prices will rise, and the simultaneous retrenchment of private production is precisely what central bankers fear. You see, they can deal with inflation by slowing down the economy through increases in the interest rate. Or, they can deal with unemployment by stimulating the economy with lower interest rates. Either of these policy prescriptions are made more difficult when our gloom train has already left the station. But formulating an optimal policy becomes nearly impossible when we have both unemployment and inflation at the same time. This stagflation problem is vexing indeed. This is really a job for a central banker as our leader. Fortunately, for Canada, it appears that Mark Carney, who ran both the central bank in Canada and the counterpart in the United Kingdom, seems destined to take the helm of Canada’s economy. Unfortunately, the leading economy of the world does not have that insightful leadership, and indeed may now subscribe to mercantilist economic theories that were buried with the creation of economics two and a half centuries ago. There are, of course, things we can do to reverse this malaise. We discuss many such ideas in these pages. I’ll prompt your memory, though. They aren’t what we are doing now. Trade wars and alienating economic allies are not paths to mutual success. Nor is mandating the return to these shores of manufacturing of cheap goods. When nations produce things of low value, our wages drop accordingly because a wage has two components - how much we produce using labor, and how valuable is the stuff we produce. Manufacturing left our shores, for the most part, because we’d prefer to buy the cheap things low wage countries can afford to make rather than earn the low wages and face the higher prices by producing them ourselves. No, we are better off as a beacon of innovation in high tech, rocketry, aeronautics, sustainable energy, medicine, education, AI, and chip manufacturing. In each of these enterprises, only some of which are manufacturing, and all of which are high tech, we need to cultivate a culture of the best and the brightest, and invite people from around the world to be part of our innovation economy or, at least, buy the products and concepts we produce. This is what makes America and Canada great, not trade wars, artificially expensive and depressingly uninnovative automobile manufacturing, or a reliance on a fossil fuel economy that would make us all better off if it just sailed into the sunset, replaced by cheap and plentiful sustainable energy. As I noted from the start, we live in interesting times. But, while my concerns for the economy may make me lose some hours of sleep, the situation is far more dire for Jerome Powell and the Federal Reserve as they try to figure out what to do with stagflation when there is really no good policy possibility. Don’t worry, though, Jerome. You will probably be joining the growing unemployment line as well by about this time next year.

In 1944 a brilliant polymath named John von Neumann collaborated with Oskar Morgenstern to produce a book called The Theory of Games and Economic Behavior. At the time, Neumann was engrossed in developing the first large digital computer and the prototype to programming languages that run computers ever since, participating as perhaps the smartest person among the Manhattan Project physicists, revolutionizing modern meteorology and atmospheric science and even predicting global warming, formulating the modern theory of nuclear deterrence, and his brief foray into game theory. His brilliance astounded his colleagues at Princeton’s Institute of Advanced Studies, including Albert Einstein, and his contribution to economics has tried and proven true to my discipline. The Theory of Games is perhaps the most understated title of all times. After all, when we think of games, we imagine such innocuous activities as checkers or chess. They are non-cooperative in that one person wins only if another loses. They are what Neumann would also call zero-sum since one person’s loss is the other’s gain. Neumann recognized that games may also be cooperative and positive-sum in that we can work together to enhance value for both or even a large number of sides. Nor did he restrict his analysis to idle games of chance that last a few minutes or a few hours before we flit off to another idle activity. In fact, Neumann was deadly serious. He anticipated that the rational analysis of competitive endeavors could apply equally well to Cold War strategies. Such games that superpowers play are certainly inherently adversarial, but are also played out over generations, and with dire consequences if we get them wrong or peace dividends and the potential for cooperation if we instead redirect our military efforts into higher aspirations such as enhanced global awareness, sharing of cures for poverty and disease, sustainability, liberty, and self-determination. Such activities is not a game, but the Theory of Games offers insights. If we first acknowledge that perhaps only idle activities have no important stakes or long term implications, then we can discard the miniscule subset of his theory that applies only to zero-sum games. Even market transactions are not zero-sum. Yes, with every transaction, currency and property are swapped, but value is created. If both sides of a transaction did not benefit from the transaction, there is no transaction. This is where economics differs from politics. In economics, our interactions are always mutually beneficial, but in politics and many other interactions, the parties view each other adversarially, with “winners” of elections, and “opponents” in the other party. The second important aspect of game theory is that, in the real world, our interactions are not “one-shot” but are instead often repeated over and over with the same partners. How we interact in one round will affect how we are regarded in subsequent rounds. Finally, games have rules that define how the game ought to proceed. Figure skating is a highly structured Olympic game designed to tease the best out of its participants. That is why we were aghast when people associated with Tonya Harding harmed Nancy Kerrigan’s knees to prevent her from competing. They used tools from outside of the game to win. We call such transgressions cheating. These understandings of how to follow the rules to meet our needs in games of life or when lives are at stake create the sober rationality not because the stakes are so low but because they are high. This notion of repeated games in which trust becomes paramount, positive sums so that we all gain from our interactions, and a need to play by the rules and not use threats or extortion to tip the playing field one’s way is the very nature of our agreements, in our community or our international interactions. The sport of pugilism may be violent, but one prevails only by following the rules. This sport differs from no-holds-barred wrestling in which people bash others over the head with chairs and much of the ridiculous spectacle is outside the ring. It is silly, unrealistic, and perhaps even troubling in its folly, and few argue it is the serious activity of serious people. Likewise, we could view the world as a series of completely isolated real estate transactions. Sure, you can hit the other side upside the head with a chair in a real estate transaction. You might even knock their opponent out by using tactics of threats, violence, or even extortion, but that opponent will never want to deal with you again. It might appear rational, if perhaps unethical or immoral, to view the world in such a zero-sum game way if you never plan to deal with this person again and there are plenty of other deals to be had. But the world is not one big real estate play. We aspire for mutual benefit, we must build trust if we hope players will participate with us in the future, and, if we don’t follow the rules, we are taking the equivalent of baseball bats to the knees of those we suddenly view as opponents instead of allies. Life is not a game but Neumann’s Theory of Games gives homo economicus (economic man) all the tools necessary to enhance the value for all concerned by fully embracing the rules of the game and our need to build trust so that the game can continue into the future. Eighty years after Neumann’s theory, economists still hold dear the principle of rational negotiations that follow a set of rules upon which we all agree and which provide a sound and desirable blueprint for all of our future interactions. In this approach that is now well-understood by economists, we can enjoy mutually beneficial relationships and transactions. But, alas, that does not seem to be the world of politics. Now, I know we can look at the spectacle of human folly and the games that are played, and chuckle to avoid a tear. Unfortunately, life is not a game. We will prosper better together if we don't aspire to a worldview that is vengeful and negative-sum. Let us not view the world as the World Wrestling Federation.

Last week we discussed how the dramatic increase of federal deficits under President Trump’s first term has been crowding out the ability of the private sector to borrow and invest in new capacity. This doubling-down of tax cuts for the wealthy has affected us all not through higher output and efficiency but through higher interest rates and prices instead. Normally, the Federal Reserve would deal with the increasing inflation rate through further increases in interest rates, even though these rates never really came down once the Fed took their foot off the brake last year. The reason is that government borrowing has kept demand high for loanable funds, and the market sees that. The Fed now has a competing problem, though. Unemployment is on the rise, and underemployment is increasing perilously, 7.5% in January to 8.0% since the inauguration. These figures are yet to include the massive layoffs arising from Elon Musk’s DOGE chainsaw approach to discretionary spending. There is one predominant formula for the determination of a recession, although it is not a hard-and-fast rule. Two consecutive quarters of real economic decline usually results in a determination of a recession by the umpires of such things, a group of economists called the National Bureau of Economic Research (NBER). We had a couple such quarters of a fall in the production of goods and services, adjusted for inflation, a couple of years ago that did not result in the declaration of a recession. Then the reason was that the unemployment rate remained low. That candidate for a recession may have been more because of the subtleties of inflation on our adjustment of Gross Domestic Product figures. We won’t likely be so lucky this time around, though. Inflation is picking up in this second Trump administration when viewed on a more relevant and recent quarterly basis rather than stale data embodied in the traditional annual inflation calculation. Nonetheless, inflation is nowhere near what it had been at the end of the previous Trump administration and beginning of the Biden administration. The early indications of a first quarter of economic decline should then catch our attention, especially since the current data still does not yet measure the flood of fired federal workers that are beginning to flood unemployment lines. Economic uncertainty is also accelerating and may well become the hallmark of the second quarter. If so, we may well find ourselves in the first recession in more than a decade. In addition to the troubling effect of increased unemployment, market retrenchment may be an equally contributing factor. The economy critically depends on the confidence of the investment sector. Real and relevant investment is based on the belief that the market will properly value what the private sector offers. Entrepreneurs can take the risk to produce a new product but they are not prepared to hazard guesses about the vagaries of financial markets. Such market volatility is measured by an index called the VIX, also known as the “fear index.” This index is now at the highest point since the Great Recession. This VIX usually hovers around 15. The onset of COVID caused it to spike at over 30, but, before that very unusual point in time in March of 2020, the only other time the index has flirted with 30 was surrounding and immediately following the Great Recession of 2008. This time around, the heightened fear index that is terrifying financial markets is completely self-inflicted. There is a certain school of thought among some politicians that great nations must rattle sabres to get the attention of what they view as lesser nations. This time around, such saber rattling is not in the positioning of aircraft carriers off distant shores but in the imposition, removal, reimposition, doubling, and retaliating to responses to trade tariffs. As economists are aghast, investors run for cover concerned what the heck might happen next. A combination of an acceleration of inflation, a dramatic increase in the number of discouraged and underemployed workers, and rattled financial markets all bear poorly in our hopes of avoiding an imminent recession. Fear of those who are unemployed, underemployed, or facing firings, of financiers fearful of global trade wars, and of economists watching a resurgence of inflation is now impinging on perhaps the most significant measure of them all. Consumer sentiment is falling like a rock. Granted these have been a tough few years for consumer confidence as our economy recovered from the great COVID shock. But, over the last few months, fewer people believe the economy is good and more people feel the economy is bad, as today’s graph shows. It is hard to imagine how our economy can avoid a recession when trade wars are erupting absolutely unnecessarily, investors are running for the hills, unemployment and underemployment is rising fast, inflation is reappearing after many many months of steady decline, and, now, consumers are becoming as surly as voters. Of course, we don’t know for sure we are in a recession until the seventh month after it started, which, by then the recession actually abates. We’ll see this time. I can tell you that the combination of apprehension and unnecessary self-infliction of economic wounds is almost unprecedented. If there is such a thing as an economic purgatory, we seem to have found it - a stagnant or declining economy that suffers simultaneously from inflation that may well worsen as a result of impending tariffs. Now, we haven’t seen that combination of economic pessimism for almost half a century. Now that’s history, but not the good kind.

As an economist, I am worried. As someone who researches and teaches sustainability, I’m shocked. Now, as a proud grandfather, I’m concerned. My concern is the bill we are leaving for our children and grandchildren. The tab is getting bigger, and with no end in sight. I’m not referring today about the inflationary effects of troubling trade wars looming on the horizon and how the first shots have already been taken. Beyond the generational mistrust they will engender, their more immediate effects will be transitory once we come to our senses that nobody gains from weaponizing trade. Instead, I am referring to the inflationary effects of massive government debt. Today’s graph shows how the US federal government has been spending beyond its means for decades. The gap has become much worse since the tax reduction act of 2017 and is soon expected to gobble up a 6.1% share of our Gross Domestic Product. That’s money ultimately taken from investing in our private sector supply chain, and from our children’s pockets. And it will assuredly cause perennial inflation. In the United States, Congress is on the verge of formulating a budget that is expected to add about $2 trillion annually to the national debt for the foreseeable future. In fact, we have been adding such debt by consistently running $2 trillion deficits ever since the deep tax cuts passed in President Trump’s first term. In a handful of years this nation has doubled what it owes and may well double the debt again by around 2040, or worse. Interest on the debt is already the federal government's third biggest program, after social security and Medicare/Medicaid. In a decade or two, interest payment for past spending folly will be our second biggest program, if social security survives. If not, interest will be what government does most. What do we have to show for it? And, why does that matter? After all, by mid-century, many readers will be long gone. It matters because of what such debt does to our current economy, even if some discount how it hampers opportunities for our grandchildren. Two or three trillion only amounts to perhaps 7% to 10% of the US economy. Why would such a relatively small federal government deficit make such a difference? Well, our economy is made up of a few sectors that depend on borrowing. In combination, we call this the loanable funds market. Some save, and others borrow, to buy a home or a car, pay for an education, build a new factory, maybe even repair a road or upgrade a new municipal water system. All of us compete for the savings of some to fund these important activities that benefit all. Private investment, to fund new homes, factories, etc. sums about $2 trillion per year in the U.S. In other words, the total amount of investment made in the private sector each year is about the same size as the total deficit the US federal government now runs each year. Also competing for these funds is borrowing for our homes, student and car loans, increases in our credit card balances, but to a much smaller degree compared to commercial and governmental borrowing. We can quickly see how the increasing share of debt commanded by the government can translate into inflation and recession. Let me explain. Our financial markets have traditionally mobilized savings to match private investment. But, over the last eight years, government borrowing has become the biggest drain on loanable funds. Fortunately, the US has also run a foreign trade deficit totalling $1.2 trillion each year. The greater sums we send abroad, to purchase goods and services from other nations compared to what returns to purchase US goods and services, does not somehow disappear. Nor is it by any definition a subsidy, as some would claim. Instead, that trade deficit returns to the U.S. in what is called foreign direct investment. Repatriated dollars may help build our factories or our homes, but now much is lent to the government to cover part of its deficit. We have now assembled the pieces to show why the massive and unrelenting debt causes inflation. The first effect is through disproportionate spending itself by government. If government spends without the inconvenience of having to take money out of taxpayers’ pockets to do so, then overall spending rises, and this imbalance between spending and income is inflationary. As an example, recall the spending induced by Presidents Trump and Biden as they sent check after check to Covid households. Spurring spending without enabling production added fuel to the Covid fire. Economists predicted that inflation would be inevitable. Surprise. Government spending in excess of tax revenue is also far more inflationary than private sector spending. When the private sector produces more stuff, it generates additional income for those who help produce it. That income and production is met with an equal amount of purchasing power and spending. Everything remains in balance. But, if government spends from borrowing, there is no commensurate additional production to match the spending. Prices rise. Inflation takes off. The second effect of government spending in excess of production is through the effect of excessive borrowing on interest rates. We saw above that the huge deficits the government is inducing are funded not out of taxes but out of competition for loanable funds. While the imbalance this creates has been partially ameliorated by the trade deficit and the related repatriation of US dollars through foreign capital inflows that can fund runaway fiscal deficits, foreigners don’t make up the entire difference. Instead, the greater demand for borrowing economy-wide forces up interest rates and deprives the private sector of purchases of new equipment and facilities, households of new homes, students of an education, as loanable funds must be rationed to the highest bidder. Nobody can outbid government which borrows without any regard for the interest rate. Private sector investment designed to ultimately improve production is left out in the cold. As private sector production diminishes with increased government borrowing and spending, our supply chain tightens, and prices rise. In economics we call this the crowding-out effect that arises when government borrowing usurps private investment. We are seeing that happen already. The Federal Reserve had, until recently, declared an end to the great inflation generated by Trump I and Biden. They lowered their interest rates to more typical levels, and yet broader interest rates such as the mortgage rate or commercial loans just did not come down. The reason is that government continues to borrow massively. Unfortunately, the huge tax reduction, mostly for the wealthy, in 2017 set us up for spending beyond our means. The dubious economic theory of free money by simply borrowing and then passing to our children the responsibility of paying for our debt has set us on a path by which inflation will be difficult to control. We thought we learned our lesson when we saw governments of South American countries make the same mistake by spending profligately without a commensurate increase in production. Hyperinflation resulted, naturally enough. We scolded them for their poor economic policies then, but we repeat variations of those same policies now and somehow expect different results. Historians will look back at the bungling of the Great Recession of 2008 and the decade of low interest rates that followed, the ridiculous and patronizing tax cuts of 2017, our response not to Covid but our unnecessary responses even once Covid came under control, and our trade wars and other policies since and will declare this a generation of economic dysfunction. Let's see whether Congress continues this week to perpetuate the mismatch between revenue and expenses that portends to economic hardship in the future. The problem is that economists are already expressing these concerns in real time. But let’s not let the obvious economic dysfunction get in the way of some good ole political fun. After all, it's all just a game, isn’t it? Except for our grandchildren who are left picking up the pieces. I’m currently teaching a couple of sections of macroeconomics. I had a student come up to me at the end of a lecture on Thursday quite troubled. He said he is losing hope and is wondering why people in power are creating such a mess that will be left for his generation to clean up. I had to agree. Meanwhile, let the trade wars erupt between the two best trading partners and strongest allies in the world. As President Trump says, “it will make good TV.” Don't our grandchildren deserve better from us than good TV?

I remember when I was a kid and Leave It To Beaver was on the television. Mr. Cleaver and his family could afford to live in a nice house in the suburbs all with the income of one parent, usually the father in those days. If Mr. Cleaver got transferred, no problem. They knew they could start anew in another community, maybe even another state or province. The move would not be too expensive, and the real estate commission rate was lower than it is today. In 1950, the median home price was $2,990 and the median household income was $7,354. It took about 40% of an annual salary to buy a home. If a family moved, little was lost - about 5% real estate commission of a home worth 40% of one’s income, or a mere one-month’s salary as the major cost to relocate. Those were the days when people could consider opportunities for a better life elsewhere. The American nation was mobile. This is great for entrepreneurship, for economic development, and also for tolerance. When people are willing to move to new regions and experience new neighbors and new ideas, we develop a healthy tolerance for each other. We live less insular lives, and we are exposed to new ideas, many which perhaps we do not agree, but all of which we tolerate. The 1960s saw a great expansion of the labor force as laws prevented the discrimination against women and minorities that kept women in the home and minorities in separate communities. Reproductive freedom also afforded women greater options in life. This dramatic expansion of the labor force created opportunity and economic growth, but much of that growth was capitalized into higher housing costs. By the 1980s, median household incomes had risen dramatically, but housing costs rose far higher. A household with a single income earners did not stand a chance of buying a home. Even most young two-income households consider homeownership out of reach in many metro areas in the US and Canada. A median home in the US has risen from the 40% of household income in the 1950s to 110%. In current dollars, family income in the 1950s was about $40,000 then, and is now upwards of $100,000 now. Household incomes have risen dramatically, but home costs have risen far faster. Too many have given up on the dream of homeownership. This is significant because even those who can save enough to purchase today cannot afford to move. The cost of selling a home and buying elsewhere has risen from about one month’s salary in the 1950s to about four months of salary today. Meanwhile, mortgages must be renegotiated, and typically the monthly payments rise. At one time, most everyone could move to seek a better life. Now, few can. Today’s graph shows that the average person had about a 22.5% chance of moving in a given year back in the 1950s. Now, people move at a third that rate. This 60-70% drop in the rate we move is a symptom of a less dynamic and entrepreneurial economy, with new opportunities that abound. Instead, it is an economy in which people feel stuck, afraid to move, priced out of housing markets, and terrified with the lack of health care should they be forced to change jobs. Last week we saw that unemployment is rising but rising faster yet is the U6 underemployment rate. When people feel stuck and are laid off from, say, a federal job, they could end up driving an Uber, despite their master's degrees. Lack of mobility matters, and it damages the economy. What concerns me more is the sense of being stuck. Certainly someone who lost their job when the local steel plant closed could not relocate to a new location and a new high tech job that replaced the steel sector. Perhaps like no other time since the beginning of the Gilded Age have Americans felt so stuck. Certainly higher income households can afford to be mobile, in jobs and in geography. Many, especially lower income, households are immobile, which is why we move a third as often as when our economy was growing much faster. This breeds some of the social malaise we sense today. People feel threatened, economically and by new ideas. People are resentful that they do not have access to better jobs because they can’t afford to move to a faster growing community with higher housing prices. They can’t afford to pay to convert themselves from a steelworker to a computer technician. And when people are stuck, they feel threatened and disheartened. It is human to blame others, which further depreciates our social capital. We become more entrenched as we converse with smaller and smaller circles of people who are often facing the same economic plight. This results in economic segregation and frustration. It manifests itself as an angry electorate that feels little optimism about the future. When we cannot balance the risk and uncertainty of an evolving and dynamic economy with the comfort and confidence we can share in increased economic bounty, we tend toward conserving what we have as we lose faith in what could be. Retrenchment has replaced the pollination of ideas, cultures, and ways of life. The world has become a zero (or perhaps negative) sum game. Gone by the wayside is tolerance and optimism. Instead we revert to beggar-thy-neighbor, glass-half-empty thinking rather than a confidence that a rising tide lifts all boats. It should then be no surprise to find ourselves in the plight we do, with a declining sense of national cohesiveness and with divided and dysfunctional government. We seem to have forgotten that it is opportunity which paves the way for economic dynamism. The great bounties can and do flow to the wealthiest among us, but as the income gap between the wealthiest and the rest widens, what was once considered an attainable American Dream disappears for many. That should trouble us all.

Every month or so I offer a summary of the current state of the economy and a comment on what may lay ahead. This month the horizon appears unusually cloudy. Economic data is not a cause but is rather a symptom. Let’s look at the symptoms and then try to glean the cause. Our graph of the week shows a return of inflation. Since the middle of last year our inflation rate had been hovering just above the magical sweet spot of 2%. It allowed the Federal Reserve to lower interest rates as they sensed a steadying glide path toward a healthy, resilient, and optimistic economy. Since then inflation has begun to ratchet up and is now in the 3-5% range by some measures. That is not reason to conclude the sky is falling in itself, but it occurs at times of other bad news. Monthly surveys of consumer sentiment have taken a dramatic turn downward. The U-6 unemployment rate, a far better measure of well-being because it includes those who are forced to be underemployed (a former administrator driving for Uber, for instance), has risen precipitously. And the level of inflation for those goods and services most purchased by low income households is far worse than the inflation many readers of this blog sense. Meanwhile, growth has slowed to the second lowest rate in three years, and we appear to be on the verge of global trade wars that can only result in higher prices, higher unemployment, and slower growth most optimistically, and far worse than that pessimistically. A few data points may not be significant, even if the trend is consistently in one direction. However, the strength of our modern global economy is fueled by optimism and destroyed by pessimism. We might then combine economic data with some political trends. Nations are bracing for conflict and are forced to make guns instead of butter as alliances that have shared defense resources and hence deterred hostilities are at their lowest points since the War to End All Wars followed by World War II. The notion of the new world order forged after World War II to prevent hostilities by integrating all nations economically has all but completely broken down. To put the dark economic clouds in perspective, let me offer up a bit of economic history. The period that forged the nation of the United States was one of colonialism that induced foreign powers to search for new lands from which they could strip resources to feed the factories back home. The colonial political model was the result of a theory of economics that predated the formal study of economics itself. Proponents of that theory, called Mercantilism, believed that the power of one’s nation was proportional to the vastness of its trade surpluses. It is not hard to see how they drew that naive conclusion. After all, nations’ leaders are invariably politicians or warriors. They view the world in a way dramatically different from the universal view of economists. To some presidents and generals, the world is a zero sum game. If you are a hammer, all you see is nails. They only win if someone else loses. Their cup is always half empty and they wish to fill it up by plundering, outsmarting, tricking, invading, cajoling, or even killing someone else. Some will do so at almost any cost. We see that playing out today. Some have set their eyes on Ukraine, Moldova, and the former Soviet republic of Georgia, Taiwan, Greenland, the Gaza Strip, the Panama Canal, and even Canada. Elsewhere, but under the radar screen of many of us are conflicts such as the cobalt war in the Democratic Republic of Congo. Some of these conflicts are in search of territory, some for rare earth metals, some for minerals, some for human capital and manufacturing capabilities, and of course, many in the last few decades were over oil. There are battles too over ideology or hatred. When we think of wars, we often focus on these more obvious human motivations, even if the resulting genocide is sometimes a pretext for mere empire-building conquest. In this new mercantilist world where one’s power is proportional to one’s stock of minerals, oil, or trade surpluses, and where might makes right, peaceful resource-rich nations have become easy targets. If even Canada is now threatened by an economic war over resources, there is now no safe haven. This attitude of “I win only if you lose” and the logically false premise that every nation should run a trade surplus did not survive the 18th Century. In 1776, the United States threw off the shackles of an increasingly controlling Britain by first revolting over onerous taxes on tea and then in a war of independence. That same year Adam Smith, considered to be the founder of economics, produced a book called The Wealth of Nations that exposed the logical inconsistency of mercantilism. Smith was no rabid capitalist. In fact, he held a professorship in theology. But, he did believe in the generosity of the human spirit that is rewarded not when each of us does well but when we all succeed. He believed it was intrinsic in human nature to want what was best for us all, and if that were truly the motivation inside of us, the pursuit of self-interest becomes a noble cause. To Smith, self interest was not greed. In fact, it was motivated partially be benevolence and partially with the human desire to invent the better mousetrap or replace human toil and suffering with the efficiency of machines. You can understand why such an optimistic approach would have its detractors among authoritarians. For instance, Smith viewed government not as oppressive but as a provider of some goods or services (public education for example) that free markets could not or would not produce in sufficient quantity. Smith implicitly believed we could be governed with a light hand because we all want the same thing - life, liberty, and the pursuit of happiness, which of course was forged indelibly into the U.S. Declaration of Independence. Smith’s optimistic approach that we trade for mutual advantage and that my success also contributes to yours, and vice versa, is not a universally shared ideal. A real estate developer may be more transactional than synergistic. Such a transactional approach implies the art of the deal is not to find a point where both sides prosper but rather where every bit of economic surplus, and maybe a little bit more, is extracted by the more powerful, cunning, or ruthless side of the transaction. World War One (then simply called the Great War) was fought over nationalism, imperialism, oppression, and resentments that were catalyzed by an assassination. It came to an end with the defeat of Germany followed by a series of oppressive conditions on the loser of the war that would fester for decades more. At the time an economist named John Maynard Keynes warned that economic oppression will not turn out well for either the oppressed or the oppressors. He was right. World War II ensued. As the end of World War II was in sight, Keynes inspired and led the British delegation to bring world leaders together in the small picturesque place named Bretton Woods, New Hampshire, with a spectacular view of Mount Washington. Keynes was no mercantilist. He believed that it would be in the interest of countries that ran surpluses to help nations with deficits develop so that markets could be expanded and prosperity shared. In other words, both sides gain from trade and prosperity by the very nature of what humans realize implicitly but nations now forget. I don’t expect the local supermarket to buy something from me if I benefit from buying something from it. By encouraging trade and not sweating the childish details of who benefits more than another, we produce a mutually beneficial world that recognizes and avoids the folly of aggression. To aid in such economic integration and ward off World War III, institutions such as the World Bank and the International Monetary Fund were formed at the United Nations Monetary and Financial Conference in Bretton Woods to strengthen economies and promote mutually beneficial trade and economic development, while the United Nations was strengthened to promote peace and prevent poverty. Today, concepts such as the United Nations, the virtue of sovereignty and self determination, and even the advantages of established alliances such as the North Atlantic Treaty Organization (NATO) are viewed with disdain by some because they serve their intended purpose to deter war and conflict. After a quarter millennium of experimentation with free markets, some wish to repeal modern economics and roll us back to the days of mercantilism and colonialism. Now, I am not always a huge fan of unbridled capitalism. But, to paraphrase Winston Churchill, the free market system is a terrible one, until you compare it to the alternatives. World superpowers now seem quite willing to throw out the notion of sovereignty and free markets and replace them with economic or military wars. The increasing volatility in global stock markets, the upward trend in prices, the plunge in consumer sentiment, and the dramatic ratcheting up of uncertainty are symptoms of a new world order that is a throwback to one we thought we left in the dustbin of history centuries ago. I guess what’s old is new again. May the spirit above transport us mortals from the dangers of our worst instincts and the folly of our ways. Where is the theologian Adam Smith when we need him the most? Has economics forsaken us? I leave you with two sentences from John F. Kennedy’s inaugural speech on January 20, 1961. You recognize the first, but perhaps we need to reflect on the second: “And so, my fellow Americans: ask not what your country can do for you--ask what you can do for your country. My fellow citizens of the world: ask not what America will do for you, but what together we can do for the freedom of man.”