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While time got away from me, more, albeit seemingly disconnected, news has come in that only adds to my concern. So… some thoughts. And just to lead with the punchline: I’m worried about and hence constantly watching for signs that the US government is running into serious financial trouble. These are all some signs that it is. Whether it’s really bad today or these are just road bumps on a longer road, I don’t know. But the more I see these signs, the more I worry.

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Government-Driven Economic Crises and US Intervention

Normally we do not want the US government intervening in foreign exchange markets to influence the US dollar’s value. The price of US dollars (“the” exchange rate) is a price like any other, and its movement is important.

Price movements signal underlying information about the state of the world that millions of individuals - who are scattered around the world - see, but no one, centralized authority sees. Price movements also provide incentives that influence people’s behavior. When the price of, say, gasoline rises, it (a) sends information that there’s some issue in the gas market and (b) encourages everyone to be more conservative with their use of gas (i.e., “dampens demand”) and encourages others to find either cheaper supplies or alternatives (i.e., “encourages supply”). If the price of gas stays high for long enough we see smaller cars develop, hybrids, and EVs (all dampening demand for gas) and new oil/gas drilling or alternatives like EV charging stations.

We want prices to play those roles. In currency markets, the prices of currencies play the same roles but the actors involved are a little different, since the supplier of a nation’s currency is the nation’s government. A weakening currency in world markets usually signals weakness in the issuing nation’s government. Either they are nearing bankruptcy or they overprinted money and everyone sees a wave of inflation coming. Both those are actually the same phenomenon. They are “haircuts” in the value of the government’s liabilities: bonds (which they usually partially default on during crises) and national currency (which inflation erodes the value of).

When a crisis truly hits a country, there is little option other than being bailed out by another, larger country, and then engaging in massive reform. We can think of the economic crises in Latin America in the 1980s, the Mexican crisis of 1994, the Asian crises of 1998, the Russian debt crisis of 1998, the Argentinian crisis of 2001 and, more recently, the Sri Lankan crisis of 2019. In all those cases, the governments essentially ran into bankruptcy and the US and other major economies had to intervene to bail them out.

By chance, in all those cases (I think…at least I can’t think of an exception), the countries had fixed exchange rates, so we didn’t see the crisis coming in advance via movements in their national currencies’ value in world markets. Rather we saw the interest rates they had to pay to finance their debts and deficits start to skyrocket and major declines in the international reserves their central banks held.

A Quick Aside on International Reserves

Hopefully, the rising interest rate piece is obvious and understandable (footnote if it’s not clear1). What might not be is why are international reserves are important.

Countries use their holdings of foreign currencies to intervene in world markets to affect the value of their currency. To see why, imagine you are an American. Suppose you want a bottle of water that sells for a dollar in the store. What do you use to buy it with? Answer: 1 US dollar (obviously ;-).

Great. Now, suppose you want to buy 1 US dollar. What do you use to buy it with? Okay, if you are in the US and have friends willing to trade, you could trade 1 bottle of water for the dollar; true. But what if you need 1 million US dollars in the next 5 minutes?

Well, it turns out, the easiest way to buy $1 million is to pay with another currency. At today’s market rate (8/17/2026) you would need 863,600 Euros to buy 1 million US dollars.

The lesson: You need a foreign currency in order to buy your own nation’s currency. Want to buy a USD, you need something other than USD. Think about it.

Now, if you are in the kind of business - like banking - where you need these sorts of currencies all the time, you’ll need to keep a stock pile of foreign currencies around to use to buy your nation’s own currency. But if you just hold large piles of, say, Euros around, it’s better to earn some interest on them instead of hold them in pure cash.

Central banks are such institutions and they have to hold large piles of foreign currency called “international reserves” in order to be able to buy their own currency in world markets. Let’s look at two super simple but illustrative examples. And, remember, a currency’s value is determined by demand for and supply of it, just like anything else’s value.

1. Example 1 - Overvalued Currency: Suppose you are Japan and your Yen is looking too valuable (“overvalued”). [Footnote on why you might think that’s a problem2.] What can you do to make it less valuable? Easy: increase the supply of Yen. Print Yen and sell them in the international markets. This increases the supply of Yen and lowers their value.

2. Example 2 - Undervalued Currency: Suppose you are Japan and your Yen is looking too weak (“undervalued”). [Footnote3.] What can you do to make it more valuable? Easy: increase demand for Yen. This requires you to go into world markets and buy Yen. But that requires you to have lots and lots of foreign currency (called “international reserves”). But, if you have that foreign currency, you go out and buy Yen, increasing demand for it and raising its value again.

Japan and the USA

And that, my friends, is the situation Japan has found itself in. A few weeks ago, near the end of July, beginning of August. The Yen was getting very weak.

The unsurprising thing was that Japan spent an estimated $60-85 billion USD to buy Yen in an effort to increase demand for Yen and, hence, raise its value again in world markets. The surprising thing was that the US Treasury also stepped in and spent $5-10 billion USD to buy Yen, further increasing demand for Yen to help prop up its value.

Now, why would the USA do that? As I mentioned before, there are major crisis examples when the US - and probably Japan in many of those examples - stepped in to help a country in serious crisis. In those cases (Mexico, Asia, Russia, etc.) they lent money to the government and also likely supplied them with US dollars to help them manage their currencies which usually lost lots of value due to the crisis.

Japan has over 200% debt to GDP, which is INSANE and unsustainable, and its government is still running large deficits. It is, in technical jargon, spending like a drunken sailor on leave. But the economy doesn’t seem to be falling into economic collapse like those other cases; at least not yet.

The other reason the US sometimes enters like this just to help a country with its currency’s value or USD liquidity in the country’s banking system is when there’s a real shock to the market, banks suddenly run out of dollars or something similar. During the Great Financial Crisis of 2008-2009, central banks shared their own currencies with foreign central banks and banks to help provide liquidity and calm markets. In 2025, Argentina was having a serious and sudden financial crisis and the US gave them $20 billion or so to help stabilize their currency and Argentina then paid the money back.

But, to the best of my knowledge there was no sudden financial crisis in the Japanese banking system. There was no imminent threat of major economic collapse. So, why?

I think there are two big reasons. The first is relatively okay, but likely futile. The second is my guess and the bigger problem.

First, there is some legitimate concern about Japan’s economy. It’s not going into crisis today, but it is a giant elephant of government debt dancing on very thin economic ice. The Trump administration doesn’t need a major partner like Japan slipping into economic trouble and pulling the world economy down. The Trump administration has enough trouble with its war in Iran (and resultant energy prices) and domestic affordability crisis, combined, of course, with a very unhappy world of countries the administration has managed to irritate with tariffs, threats, and the like. So, maybe, it intervened just to avoid one more crisis that could easily lead to a global economic slump, and, Trump often tries to help allies and sees Japan as an ally as he sees Argentina.

This has been futile, however, because if the economy really is sliding into recession, no exchange rate intervention will offset it. And, sure enough, the Yen later lost value again undoing the temporary boost to its value. You can’t prevent the inevitable.

Second, and the reason this caught my eye, is that Japan is the largest holder of US debt. And the US is rapidly doing everything it can to catch up with Japan’s amazing 249% debt to GDP ratio. To do that, the US needs countries to (a) buy our debt and (b) do it at affordable interest rates.

If our largest foreign holder of US debt were to sell large quantities of our debt in order to buy Yen, this would make our ability to sell our debt even harder and drive interest rates higher. By stepping in and financing part of the demand for Yen, the US kept another $10 billion of our debt from going on sale (the $10 billion the Japanese would have needed to sell).

To put it all in perspective, the US has about $39 TRILLION in debt (see the debt clock for the latest) and GDP is around $32 Trillion or so. We’re at around 122% debt to GDP and we are climbing that higher with both hands and both political parties and doing it as fast as we can!

Debt is borrowed money. We pay interest on that. The US pays about $3 billion dollars a day … A DAY … on that debt which is about $1 Trillion dollars per year, just on interest.

We are also doing everything possible to finance that with the shortest term debt possible. Just imagining financing your house with 1 year loans instead of, say, a 20 year mortgage! That means we need to constantly refinance our national debt, all the time, every month some part of it is coming due and needs refinancing. And, of course, we need even more than that because we are still running deficits - currently spending more than the government takes in - at levels usually only seen in war or crisis, generating the need to sell even more debt.

Supply and Demand for US Debt, Interest Rates and Other News

When the value of debt falls - because you, say, worry the issuer can’t repay you - then to issue more debt (i.e., borrow more) everyone in the market (the lenders) require you to pay higher interest on the debt, just like any lender would require from a person or a business with every worsening financials.

I’ve been watching for signs that interest rates on US debt are rising. See my comments about the other economic collapses: rapidly rising interest rates as they near bankruptcy and collapsing currency values as everyone loses faith in their economies.

I’m watching for those two signs. The US dollar’s movement hasn’t been too concerning to me as a sign of US economic problems. Yeah, it’s been weaker against the Euro but stronger against other currencies, and overall not a major concern in and of itself. And, yes, there’s some recent news of a weaker dollar, but it’s the weakest it’s been “since June”. June this year. I’m looking at longer, deeper trends and the dollar’s value in world markets isn’t showing it.

But, when I hear things like this from Bloomberg “US Bond Selloff Drives 30-Year Yields to Highest Since 2007” (Aug, 17, 2026) it makes me worried. You sell off bonds when you don’t want to hold them. To convince people to hold them anyway, the US raises the interest rate - it’s the exactly the borrower-lender story I told above - and that’s happening. We now have the highest interest rates on 30-year bonds in the last 20 years (since 2007, just before the financial crisis).

Part of that is because most other major countries in the world are also suddenly trying to borrow more in world markets. That includes European countries, Canada, the UK, and Japan as a few examples. If everyone in a market is trying to borrow, then who’s lending? The global bond market is getting tight for everyone and that’s going to be a problem. The Japanese selling only adds to this and it’s specifically a problem for the USA if Japan sells US bonds. All those interest rate effects will kick in faster the more countries are in the market competing. Why lend to a questionable country when you have every other country also needing to borrow your money too? Lend where it’s safer. And that also means that problematic countries have to offer higher interest rate and sooner than in a world where markets are slack.

This Bloomberg piece says just that “Bonds Face Bigger Threat Than the Fed as Global Rates Climb” (August 16, 2026). Global markets are tight and global rates are rising.

I’m sorry, by the way, about Bloomberg references, since they have a pay wall. Sorry, I don’t know how to legally get around it for you.

Normally, only governments are big enough in world markets to have this sort of effect (soaking up supply and pushing up interest rates). Things would truly have to be getting tight for business borrowing to start moving that needle.

And that brings me to the final link in the chain. Sorry, again from Bloomberg, “AI Is Driving Up Treasury Yields: ‘It Just Touches Everything’” (August 17, 2026). The title almost says it all. I first thought it was another article about AI in an industry and causing something. I thought “good grief guys, AI affecting treasury yields is either a stupid topic or traders used AI and it glitched or moved everyone at the same time and causes a glitch”.

Then I read the article. It explains that investment in AI is of such a large scale that AI data centers and AI developers have to borrow so much that it’s actually moving the interest rate in bond markets for US Treasuries. That’s insane. It turns out that investment-grade companies sold nearly $1.5 trillion in bonds this year alone! And that “the biggest tech companies' borrowing is equivalent to roughly 25% of the US Treasury's net issuance of notes and bonds to private investors.” That shocked me.

Conclusion

I’m worried. I’m really, genuinely worried about the size of the US government and the financial instability that it’s bringing. We’re running another 6% or so deficit again this year and already have over 100% debt to GDP. Every proposal I see and every news item includes more spending in every dimension of our lives and, as I mentioned before, both parties are doing it as fast as they can, and we, the American voters, are cheering them on, pushing them for more.

This is not financially sustainable. The signs of the cracks in the foundation will come with rapidly rising interest rates on US debt and a currency that rapidly loses its value. That loss in value of the currency comes in two forms. Usually, it first manifests in domestic inflation and then domestic inflation combined with declining global value (i.e., rising exchange rates). Sometimes the domestic government can suppress one form of inflation (domestic or global) for a bit, but they both show up eventually.

The most likely first steps will be difficulty financing debt and increasing interest rates. Then it’ll show up in the currency’s value. This will happen ever so slowly and in fits and starts leaving us all wondering if it’s going to hit the fan today or we can kick the can down the road. Then it hits suddenly and is not stoppable.

I’ll reference the old banker’s adage, usually referenced in the sudden stop literature in global macroeconomics (retold apparently by Prof. Rudiger Dornbusch): “It’s not the speed that kills, it’s the sudden stop”.

Let’s hope and pray that time is still way off. We need major reform in the United States and most other countries around the world, as far as I can tell.

I believe there’s still time, but financial news like the kind we’re seeing lately makes me worried that it’s all speeding up.

Thank you for reading.

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Data link.

The US released its latest data on the Consumer Price Index (CPI). The main punchline is that inflation fell in June largely due to the pause in the Iran-US conflict and the resulting decline in oil prices. While that’s good news, there are two obvious caveats. First, annual inflation is still around 3.5% in the USA. We really haven’t been able to get inflation down to our 2.5% target and keep it there. We’re close, just not quite there, and that means any economic challenge can easily derail things… leading to the second caveat. Second, the CPI has been rising and high due in large part to the Iran-US conflict, fell due to the pause, and, therefore, will likely rise again now that the conflict has resumed.

You can see in the above graph that pre-2020 inflation fluctuated pretty wildly sometimes (peaking near 4% and bottoming at a little less than 0%) but still around 2% or so. Post-2020, even ignoring the inflation mountain, you can see where are settling at a higher average level. Just imagine a line at the average pre and another one post inflation mountain. The pre line would be at 1.8% inflation and the post at 3% inflation.

This slowly but surely becomes a challenge for the Federal Reserve’s credibility with regard to controlling US inflation. Normally, I’d worry a little more about that, meaning the Fed might really hike interest rates to squash inflation - likely driving a mild recession - and publicly regain credibility. But… the other graphs suggest why that’s not likely the case.

Data link.

Once again, I think the culprit driving inflation is pretty clear: Energy at +15.7%. If you follow the link and click on Energy, you’ll find Fuel oil is at +42.9% and Gasoline +26.7%. Those are clearly related to the US-Iran conflict. So, once again, the key to getting inflation back down in the very short-run is an end to that conflict. That’s a political question, and your guess as to when it will end is as good as mine.

Interestingly, Electricity is also at +4%. That’s not due to Iran. Here is the average price of electricity in levels.

And, as a percentage change…

Data link.

Notice, again, that the pre- and post-Covid trends are different.

Higher electricity prices are not an inflation issue. They are the result of structural issues in the USA. That can only happen if demand for electricity is growing faster than supply. I know that sounds obvious - and it is - but I point it out, because the underlying drivers are not improving. We will only continue to demand more electricity for our homes, our EVs, our devices, our data centers and so on.

We need more supply. What can the government do to help? Ideally, help remove regulatory entanglements that slow down developments. But, we the people, need to step up, too. As far as I know, a lot of the supply is also being held up by a Not-In-My-Back-Yard (NIMBY) mentality. Sooner or later, we the people need to confront the fact that we demand ever more electricity but don’t want to pay the price for it in terms of higher electricity or more electricity in some of our back yards.

I see the same challenge with housing in the United States today. That and electricity - especially in connection with the AI revolution going on - are issues I am watching but topics for another day. They aren’t driving inflation.

Quick Prediction and Conclusion

My quick prediction is that the FOMC will again leave interest rates unchanged in their July meeting. They will argue that current inflation fluctuations are clearly being driven by external factors, namely the US-Iran conflict. If the conflict ends and inflation falls down to the 2-2.5% range and stays, it will have looked like a wise decision. If non-conflict inflation doesn’t fall below 3% this year, however, I think it will be a real problem for the US Fed.

In any case, the Fed meeting will be in part about inflation and interest rates but also a lot of attention will go to Fed reform. That’s important but will also serve to distract the media a bit. All in all, new Chair Warsh has another month maybe, but then he’ll really need to address inflation issues more seriously, in my estimation.

Thanks for reading.

Image drawn for me by ChatGPT.

I moved to Hungary in 1994 and got my first lesson in what it means to be in a place where government and politics dominate society. Between the time I was invited to Hungary (in March/April) and the time I arrived (in August), the government changed and the people who had invited me lost their connections in the government, so the one-year internship, housing and monthly living stipend I was promised no longer existed. I was on my own. It made for a bumpy start, to say the least.

Coming from America and being relatively young, it had never occurred to me that this could happen. At the time, I thought it was just a feature of Hungary being a post-communist country. Unfortunately, it turned out to be a more enduring feature than I realized at the time.

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Politics, Government Dominance, and the Hungarian Seesaw

After the collapse of the Soviet Union, the first democratically elected government in Hungary was the Hungarian Democratic Forum (MDF), and it was in power from 1990-1994. The 1980s-communists/socialists were then re-elected to power in Hungary as the Hungarian Socialist Party (MSzP) in 1994 and remained until 1998, the same year I also returned to the USA.

While it’s easy to imagine that those two governments had different policies, what I underappreciated was the degree to which changing governments meant changing institutions and people in all of society. In Hungary, the state is a large player in not only the economy but in the society overall. This is generally more the case in Europe than in the US anyway, and was amplified even more in post-communist countries given their history of near total state dominance.

Since the state is involved in churches, education, media, cultural programs, etc., it means the heads of any related institution likely changes when the government changes. And, while one might retort that the head of a church isn’t likely to be appointed by the government, you can bet your life that their funding and related support is tied to political connections, and hence they are still heavily influenced with each political change.

The heads of media companies, national media organizations, heads of theaters, music schools and heads of other cultural centers generally change as does the minister of culture who funds them and gives them their national agendas. The heads of nearly every university and most research institutes change along with their minister, funds and national agendas as well.

From a practical point of view, that means, if you run a business of any size, you need new connections in different ministries to connect to various media organizations where you might want to run ads, for example. Other ministries will be doling out contracts for projects and related funds, so you’ll need connections to those as well.

The MSzP, from 1994-1998, sold several domestic companies to international companies where they could get top dollar. That meant having political connections mattered a lot. With connections, you could take part in the sales and make money, sell your own company (assuming you were managing a large enough company) and so on.

Let’s put aside, for a moment, whether any of these particular policies or agendas are a good or bad idea. My goal here isn’t to criticize any particular government or policy.

I do, however, want to highlight how much things changed in every aspect of someone’s life whenever the government changed in Hungary. When I landed in 1994, everyone I met was changing jobs, was unemployed and looking for jobs, or something similar, because all their old connections were doing the same. It was a mess.

In 1998 the Alliance of Young Democrats (Fidesz) was elected to office for a four-year term, ending in 2002. They immediately set about undoing what the MSzP had done.

Fidesz changed many agency leaders back, changed the agencies themselves or put new people in charge and changing their agendas. They reversed some of the agreements of the previous government that had allowed foreigners to buy Hungarian businesses, essentially re-nationalizing some industries that they saw as vital for the Hungarian state. They changed which companies got the key contracts in the country, who ran universities, and so on. Once again, everyone changed, many organizations changed, they changed the ministers, they changed whole ministries and what ministries did and so on.

When you spoke with people in businesses of nearly any kind they’d explain that they had contracts with companies that had connections to the previous government and no longer existed, changed owners or were simply irrelevant. They had to find new suppliers, new customers, and new partners. And, as always happens with government, your personal political connections matter most.

In 2002, Fidesz lost to the MSzP who then ruled for the next 4 years. Every organization, every leader, many business contracts and so on all, once again, had to change. Yesterday’s business successes were quickly forgotten and state money poured into new national champions. Some businesses were sold off, others re-nationalized, and the pattern continued.

For my American audience, imagine that every time our government changed from democrat to republican or vice versa, things happened like the IRS was merged with the FCC, then the SEC and the Federal Reserve were merged, and, maybe, the Education Department and Labor Merged. Then the next government comes in and the IRS separates, but the FCC and SEC get merged into a new agency, the Federal Reserve gets something else, Education and Labor separate but they combine Education with Innovation, which oversees funding structures for startups and so on. Even in our relatively market-based system, this would be a mess.

Up, Down, Up, Down, See-Saw, See-Saw.

The MSzP was the first post-communist Hungarian government to be re-elected in 2006, but their world soon came crashing down. Following their re-election, Prime Minister Ferenc Gyurcsany gave a speech to the party leaders that was leaked to the media (link). In that speech he cursed like a drunken sailor, often in reference to the Hungarian people, and, more importantly, said directly “We lied in the morning, we lied in the evening and we lied at night”. Not really a recipe on how to win friends and influence people, if I do say so myself.

Following that speech, things unraveled quickly. Corruption started coming to light, especially (based on my memory) around construction and other projects being financed with EU money.

In 2004, Hungary had joined the European Union, which gave them full access to tons of EU funds for development, innovation, legal reform, and so on. Of course, EU funds are fantastic if you are in the recipient’s government. EU funds come in billions of euros, which means, in a small country like Hungary, getting EU funds for projects is like drinking water from a fire hose. And, it also means that your political friends, your connections and all their related businesses suddenly get tons of money for all sorts of projects.

The opportunity for corruption is tremendous. This is, however, very much a European thing. Europeans generally believe in industrial policy, using the state to pick winner and loser businesses, fund innovation, and so on. It’s one of the key reasons, in my opinion, that Europe has so little innovation and so few globally successful businesses these days. But I digress.

All this meant that Hungary was in chaos when the 2008/09 Global Financial Crisis hit. Despite all the EU funds flowing in, Hungary had been running large government deficits and was accumulating unsustainable levels of debt. By 2006, when the Prime Minister made his speech, the MSzP government was running deficits around 9% of GDP and had accumulated a 64% debt to GDP ratio.

The general rule is that debt to GDP over about 70% becomes a real financial burden on a country and puts it in danger of a financial crisis. So, when, in the middle of this chaos, the 2008/09 Great Financial Crisis hit, Hungary went financially belly up. They were on the front page of every financial paper along with Ireland, Iceland and others at the time, all potentially facing total collapse.

Debt to GDP continued to climb, peaking at around 80% of GDP in 2010 when Fidesz was re-elected with an absolute majority and a strong mandate to “fix the country”. After eight years of the MSzP, personal/political relations, networks and corruption had become well entrenched. Thus Fidesz, once again, started with cancelling old contracts, leaders were replaced, new ministries established, some businesses were sold and others re-nationalized and so on. See-saw, see-saw….

Lamenting the Seesaw

For years I lamented the seesaw. I blamed it on Hungary being a small, post-communist country with a large government. It has 9-10 million people and is very Budapest-centric.

But the point of my column today is not to criticize Hungary. It is to criticize and warn the United States, because I see us turning into the same. I didn’t think it was possible or at least did not think it could happen this fast. We are getting there via a different route, but I see it happening.

This is top of mind for me at the moment because Hungary just had elections, removing Fidesz after 16 years in office and voting in the new Tisza Party (link). The new government is canceling contracts, undoing the corruption of the Fidesz government, restructuring ministries, and so on.

I was there, May 17-24, with leaders of my university to sign an agreement with a Hungarian university. We have worked on this for well over a year, agreeing to launch a dual degree, joint research programs, develop joint programs with companies in the US and Hungary and so on. On Monday (May 18) we signed the deal. On Wednesday (May 20th) the new government announced they are modifying the constitution - which they did the following week - and re-nationalizing the Hungarian universities that had been pseudo-privatized via a foundation system set up under Fidesz in 2019. I’m not yet sure what this will mean for our joint programs, but I can imagine leaders will change… etc.

As a side note, today is July 1st and currently it looks like the government will, thankfully, move cautiously with higher-education reform and I’m optimistic our programs will survive, but we’ll see. Ministers changed, the ministries changed, they changed the constitution already, and I’m sure a lot of other stuff will still change, but I’m optimistic for now.

I am not opining on the wisdom of the changes, just that, once again they are happening. Actually, I agree with many changes the new government is proposing. Chief among them in terms of importance is that they are introducing term limits and potentially modifying election laws to limit any one party’s ability to get two-third majority too easily.

Fidesz had two-third majority for 16 years, now Tisza has two-third majority. That’s a lot of power. Two-thirds means you can change the constitution with each change of government!

Please understand that I actually wish the new Hungarian government all the possible success in the world if they aim to place guardrails on the government and cement them into law. I hope they can achieve that, and fast, because once they are in power a few years, they won’t have the incentive to do it.

I’d love to see corruption decline, more limited government and more free markets. I sincerely wish them all the possible luck and success in the world. I deeply want to see the Hungarian people thrive.

I watched and lamented the Hungarian seesaw for years. I’ve been thinking about why you see it in some places and not others. I’ve been thinking about why I am seeing it more and more prominently in my own country.

Signs of the Seesaw in the USA

The seesaw, I’ve realized, comes with and is inherent to a large government. It’s inevitable as long as the government plays a large role in the economy and you have elections where the government can change. If you have a large government and no political change, you’ll just get malaise and corruption over time. If you have a small government and no political change, you’ll eventually get a large government.

The far better option, I think, is small government and regular political change. I think that keeps the political-economic power bases limited in their ability to grow roots and in their influence on the average person’s life.

I’ve seen the seesaw affecting us firsthand at my university. Now, universities are especially sensitive to political swings, but that just means I’m seeing it before others in other industries.

At some point during the Obama administration we suddenly had to shift everything to accommodate new education policy. Within a year we had to cut budgets, lay people off, cancel projects, build new female athletic facilities, and add gender-neutral bathrooms. Then Trump entered office and his education department cancelled or reversed all of that. Then Biden entered office and we went back, now with a DEI spin added to it. Then Trump returned to office and reversed it again, banning DEI and adding a MAGA spin to it… and so on.

Regardless of which side of this cultural war you fall on, what I want to emphasize is that the seesaw or pendulum began swinging one way, then back, then back further, and then the other way even further. The big culture war swings across US administrations affect universities, companies - especially their HR departments - what people choose to study and what professions they pursue.

Add to that major swings supporting different industries. We moved, for example, toward hybrid cars under Obama, then back to gas under Trump, then to EVs, wind turbines and heavy subsidies for clean energy under Biden. Now, under Trump II, we erased all that, and are pushing oil (“drill baby, drill”). Again, regardless of your position on any one policy, it’s the swings and how broad they are that worries me.

I now hear local businesses talking about it. That didn’t used to be the case. They were largely immune. Today, policies and political changes affect their customers, their hiring practices, their plans for the future, their investment decision, and more. I hear it from my students. I hear and see it everywhere. Push crypto. Oppose crypto. Push green. Oppose green. Push DEI. Oppose DEI… Or just look at immigration policy from Obama to Trump I to Biden to Trump II. That swing was bigger each time and affects more businesses and more and more of us with each change of regime.

The US government today is huge. It’s involved in everything from our educational choices and health decisions to our industrial decisions, environmental policies and immigration. It’s everywhere.

Over the last 20 years, it’s also become increasingly common that big changes are made by presidential executive decree. That means the next president of a different political stripe will just reverse everything and issue new decrees.

The Trump II administration has added one further complication to this as well. It is having the government invest in data centers, AI, crypto and other industries in exchange for governmental shares in those companies. That just ensures that those companies will have to reconsider their plans, strategies and investments with each change of administration to ensure their goals align. Overtime that flip-flop, or seesaw, will lead to a decrease in investment, especially long-term investment. It’ll be wiser to invest less and in reversible areas in order to maintain the flexibility required to accommodate each government’s priorities.

Slowly the number of industries affected grows until none of us are immune.

Closing Concerns

I don’t want to live in an America where my university president, local business leaders and others change with every US election. It’s destabilizing for every person, business and organization in our society. We aren’t quite there yet, but we are moving in that direction.

The seesaw is a natural result of a large and engaged government combined with political change. With each change, the priorities change and a large government means those priorities influence a wider and wider sphere of our lives. We ban these books and promote these other books. Then we ban those other books and promote these books. We tax these industries and subsidize those industries. Then we tax those industries and tax these. Flip. Flop. See. Saw. Over and over.

People can’t build and plan. A successful business today is gone tomorrow. In the seesaw world, the incentive to invest in capital or in human skills is diminished. The key becomes having the right political connections. If your connections are too tied to the current administration, then your incentive is to take as much from the pie as you can today since the plate will be removed tomorrow by the next regime.

I really hope for the best from the new Hungarian government. They at least claim they want to limit government and keep it constrained to prevent the abuses of the past. I hope they do. It would be great for every Hungarian.

Let’s push for the same in the United States. Our government’s budget deficit is larger this year than last and last year’s was bigger than the year before. Our debt is over 100% of GDP. Our government wants to have a say in every aspect of our lives.

Back it up. Slow it down. Limit its scope. Let’s push in that direction and get off the seesaw before motion sickness gets us all.

Thanks for reading.

I just updated this article (Monday, June 15) briefly. The Fed is meeting this week and new chair Warsh should hold his press conference Wednesday. I say “should” because there’s speculation about what he’ll do since he has long argued for less Fed communication. We’ll see, but I’m assuming he keeps the press conferences.

The US had two high inflation reports in recent weeks and last week Europeans raised interest rates to fight inflation. Where are we headed?

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Inflation Pressures

At the start of the year, inflation was falling and everyone was expecting the ECB, the US Fed and other central banks to cut interest rates this year. But, inflation has moved the other way since then. The question is whether this is a trend or just transitory. As I see it, there are three things pushing inflation at the moment.

The first one is the war with Iran (see my other column - link - that this is definitely the driver of immediate inflation). This is clearly driving up oil prices and hence gas prices. Those prices factor into nearly everything since transportation is part of our daily lives. As individuals, we see high prices at the gas pump. Businesses find transportation rates rising, pushing up the costs of obtaining inputs and selling/shipping outputs, which pushes them to raise prices over time too.

The war was supposed to be quick and over. Over the weekend, again, President Trump announced an agreement with Iran that they will sign on Friday (June 19). I hope that’s the case, but since he’s announced a deal coming in 2-3 days every 2-3 days for the last month or so, you can forgive me for being a little skeptical. I sincerely hope it’s true this time.

In any case, gas prices will remain high as long as this continues and then for some time afterwards. So, assuming there is a deal Friday, it’ll still take 2-3 months for global trading prices to normalize, it’ll depend on how fragile the deal is, etc. But, this means higher prices will remain through the summer at least, although perhaps easing each month.

The second driver is still tariffs, or perhaps more accurately, the ever-elusive tariff threats and their impact. The Trump administration is still wiggling and squirming every way possible in order to keep a higher tariff regime. Many efforts have been defeated in the courts, but they keep at it.

As far as I understand, the average tariff is around 10% today which is not really too high. It’s high compared to the two or so percent average pre-Trump, but 10% is bearable. The Trump administration seems to want them higher, our trade deficits (unsurprisingly) have not gotten any smaller; actually, they returned to their pre-Covid trend as far as I can tell.

All that just tells me we aren’t truly finished with tariffs, but let’s see. Tariffs are a tax, and as such raise prices some, which, on this aggregate level, means some inflation during the period while prices adjust.

The third, and final, driver comes from government spending. The US government is again running deficits near 6% of GDP this year.

Deficits are very inflationary for two reasons. First, they overstimulates aggregate demand in the economy in the short run. That has the immediate effect of pushing demand to grow faster than supply, burning the economy hot, leading to inflation. Second, deficits require further borrowing or money printing. Persistent borrowing is not automatically inflationary, but over time large and growing debt burdens create pressure for monetary accommodation and can undermine confidence in the currency. Both activities erode the value of US dollar over time, which is inflation, i.e., the erosion of the value of our currency.

Of these three, I see driver one (oil and war) as the major immediate driver of inflation but short-lived to the extent the war is short-lived. I see driver two (tariffs) as mild background pressure but not a major determinant. And, finally, I see government debt and deficits as the primary long-run driver of inflation with a constant but growing probability of blowing up in our faces at any time. Either it keeps ever higher pressure on inflation over time, or we resolve it, or investors one day quit buying our debt and we have a real financial crisis. In that last scenario, inflation will be the least of our problems.

We Are Not Alone - The European Situation and Response

The Europeans are facing very similar problems. High energy prices, larger deficits, and rising defense expenditures are all complicating the inflation outlook. Actually, most countries in the world are facing temporary inflationary pressure coming from high oil and gas prices. Most countries are also running larger government deficits and hence accumulating more debt than they did pre-Covid. Essentially we never returned to “normal”.

The European monetary response, on June 11th, was to raise their policy rates to fight inflation. Their national governments, however, don’t seem to be addressing debts and deficits in part because they are raising military spending in light of the war in Ukraine and an American administration determined to push more of the burden of NATO and European defense generally onto the Europeans themselves.

The ECB follows a medium-term inflation targeting regime and therefore must fight the slow rise of inflation its been seeing over recent months. Inflation in the Eurozone was at or below their 2.5% target since 2024. In January this year Euro inflation was only 1.6% and everyone anticipated further rate cuts. Since then however, it crept up every month: 1.9% in February, 2.5% in March, and now 3% in April. They had little choice if they want to remain a credible inflation targeting regime. So they raised rates.

The American Situation and Potential Response

This brings us back to the USA. President Trump finally appointed a new Fed Chair. Having only recently taken over the position, Warsh now faces his first major inflation test. His pick, Kevin Warsh, is a solid choice by all measures. He wants to reform the Fed’s monetary policy framework - moving us away from the giant balance sheets we developed post 2010 - and was originally in the cut-interest-rates camp. President Trump has been pushing hard for rate cuts and many expected Warsh would help deliver some rate cuts, likely combined with further reforms.

The US Fed has a dual mandate. It must maintain reasonable unemployment, which is usually considered to be 4-4.5%, and stable prices, which is interpreted to mean 2.5% inflation.

Unemployment today is 4.3% but inflation is now 4.2%.

My prediction is that the Fed will raise rates at their June 17 meeting. If the war in Iran is truly ending or appearing to end (which we won’t really know until Friday, I guess), maybe they will hold rates constant and argue that oil and gas prices will fall back to normal, eliminating the inflation pressure on their own. There’s no scenario where I expect a rate cut any time soon.

If all that really progresses in a positive direction, then at most we could imagine a possible rate cut in mid- to late-fall.

All that is just to explain what I expect will happen. But how should we think about all this? And what do I think the Fed should do?

What is the Right Call?

Interest rates are already rising on US Treasury bonds, mortgages, and everything else charging interest. That seems to be happening due to the expectation of higher inflation in the medium term and of the higher policy rates that would accompany it.

Let’s start with inflation itself. See the following graph.

The trend for inflation has simply not returned to its pre-Covid level. Pre-Covid inflation fluctuated around 2%. Post-Covid we see the giant inflation wave but a trend around 3% thereafter. That’s a problem for the Fed’s long-term credibility.

Controlling inflation has a lot to do with controlling people’s expectations of inflation. Even during that big wave of inflation, people continued to expect inflation to return to 2.5% over the long run. Inflation expectations were said to be anchored around 2.5%.

That’s important. If that shifts, if people anchor their expectations around higher, say 3% inflation, that itself can kick off a bout of higher inflation as a self-fulfilling prophecy.

This means there is a lot of pressure on the Fed to get inflation back down towards 2.5%. If it continues for several more years around 3%, expectations will drift up to 3%. We—and I mean all of us in the world, not just Americans—don’t want that. “When the US sneezes, the whole world catches a cold”, as they say. We don’t want rising US inflation. It will encourage global inflation.

Short-run and Long-run Issues

It is not clear at all that raising interest rates a little will be sufficient to slow inflation rising due to the war with Iran. If we raise them enough to really fight oil-driven inflation, we might achieve lower inflation but at the cost of a real recession.

If the Iran war starts winding down, then the oil shock will indeed prove transitory and the Fed should “look through it” rather than raise interest rates. Today we are past the time when we could call the oil-price shock transitory enough to look through and so they will likely - in my opinion - raise rates some to signal to everyone that they are serious about inflation and in control.

They will not, however, raise them enough to drive a recession. And that actually means their mild rate hike will be symbolic at best. When prices fall as the war winds down the new chair can claim a quick but actually unwarranted victory. “See, inflation was rising, we raised rates and inflation fell.”

If I were on the FOMC, I would vote for a small rate hike to maintain some credibility and push to move forward on reforming the Fed’s overall structure and approach. That’s actually likely what Chair Warsh will be pushing for as well.

The real concern is the debt and our persistent deficit spending. US government debt is now 123% of GDP. That is a long-run problem and only seems to be getting worse. The only way to lower the debt is to first lower the deficits.

Here’s a graph of our government deficits to GDP, looking backwards to 1950 with a trend line. Not sure I need to add much commentary for this one.

Here are our own government’s projections looking forward (link).

The deficit is expected to continue and worsen in the coming years. And, what’s driving it today and going forward? Spending.
Look at the slope of the spending (top, blue, “Outlays” line). It’s not a revenue problem, it’s a spending problem. And there’s no end in sight.

Each deficit is financed by borrowing or printing money, or both. The result is that this is our own government’s expectation of US debt in the coming THIRTY YEARS.

If that’s what our political leaders expect, one only needs to imagine what they’ll actually be able to achieve! A crisis or two, a few more political promises and I’m sure they could double. Where there’s a will, there’s a way… unfortunately.

At some point, people will worry about the value of US debt. When they do, slowly but surely, they will value each government bond less, along with the little pieces of paper the US prints to pay for the bonds. That is the real danger for world markets, for the US economy and for inflation: the ever worsening US government debt and deficit problem.

While Iran and tariffs are temporary pressures, ever expanding government and the concomitant spending are a growing problem, pushing inflation higher over a long horizon. Raising interest rates won’t alleviate that inflationary pressure. Actually, it can make it worse by worsening the debt burden since we pay interest on all that debt and higher interest rates means higher payments.

The only way out of that problem is to have major reform that includes a major decrease in government spending. You cannot raise revenue to get out of this problem. It’s grown beyond just a minor financial issue. It’s an over-expansive government issue.

If you have a friend who keeps buying expensive cars they can’t afford, promising all their friends and family that they’ll pay for expensive vacations for everyone, paying their Visa with their Mastercard in order to continue borrowing to pay for more and more, your advice isn’t to pick up an extra job. Your advice is, first, for them to get their spending under control. Same is true here for the government at this point.

Conclusion: Sunshine and Bunnies

After painting a lovely picture of things, I’d like to end with sunshine, bunnies and happiness. It’s hard, but I’ll try...

Inflation is on the rise today. It’s not clear to me that the Fed can do much about it. It is clear to me that they will try to fight a little - hence raising interest rates some - and hope that the temporary pressures quickly subside, namely the war with Iran.

After the war with Iran ends - whatever that means - inflation will slow. Interest rates will be able to fall as inflation falls, since interest rates tend to move with inflation over long horizons. If that comes with some legitimate economic growth - i.e., not fake growth from government stimulus - then we can enjoy some good years ahead.

And, if we get some divided US government along with economic growth, we might see gridlock that prevents too much new government spending in the coming year or two and limit deficits for a time.

I’m not sure where the political will comes from to address the spending problem. But, everyone warns about it. It pops up as a topic periodically. It’s a known issue. It’s just not being addressed.

There were signs of such concern with the early DOGE efforts that were sadly more haphazard and erratic than meaningfully helpful. But, if the signs were there, maybe someone will make a more serious effort at governmental spending reform.

Okay, that’s about all I can say for now. I’ll let you decide which of those is the sunshine and which the bunny.

Thank you for reading.

You’re probably missing a deep understanding of econometric analysis.

But, let’s see if you can figure out what drove our recent jump in US inflation.

Here’s a picture from the Bureau of Labor Statistics’ website (link).

This breaks total inflation into it’s three big components: food, energy and other.

It may be hard to see…so look closely…

It seems that, maybe, just maybe, it’s energy prices

Maybe. I’m just sayin’. It kinda looks like it.

Now, let’s dig down deeper. Is that coming from energy commodities - like, say, oil and gas - getting more expensive or from some other source?

Oh… it looks like energy commodity prices rose by about…hmmm…let’s see…about 40 percent. That might be the culprit.

And what exactly might be doing that?

Hmm. Looks like Fuel oil rising nearly 60% and Gasoline of all types rising 40% are pretty important drivers.

My conclusion is that, I think, as a professional economist, mind you… I think maybe higher oil and gas prices are raising energy costs and driving inflation at the moment.

Thanks for reading.

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For My Students

I started with this graph for my students. The Covid “M” double spike in government spending is about as clear a case as you can find of the fiscal side of our government (i.e., Congress and President in the US political system) trying to stimulate the economy via spending. And, it’s bipartisan. The first spike was Trump and the second spike was Biden. So, blame whichever side you like.

After printing this graph, howrever, I had another thought that I couldn’t help pursuing: “this graph goes back to 1960… look at that growth! Hmmm. I wonder if it’s growing faster than GDP that whole time?” If it is – which I assume it is – then that’s a problem for many reasons, and it’s non-partisan.

The Financial Danger

Many people are (rightly) ringing alarm bells today about the financial problem this presents. In essence, the US government is racing toward bankruptcy and aiming to jump off a financial cliff that will mean a global-financial-crisis-magnitude crisis when it happens. And that’s 100% true, but not my focus today.

The Deeper Problem

My focus today is on the size of government overall, what it means for us and why it is a deeper problem.

Imagine we are all alone on an island (a closed economy). In this case it should be very obvious that we cannot collectively spend more than the amount we collectively generate (GDP). In such a world GDP is also equal to our total earnings since one person’s spending is another person’s income. When all is said and done (i.e., “in aggregate”) total spending must equal total earnings.

Next, let’s consider deciding between spending our income privately versus spending it via government. I can spend money privately on, say, clothes or a car, or I can spend that same money via government on something else, like supporting national defense or building local roads.

Total spending doesn’t change. The only thing different is how that money is being spent, privately or via the government.

Now, if our spending via government is growing faster than our GDP over long periods of time, then it must be true that we are constantly shrinking the private sphere of our lives and giving it over to politicians and government bureaucrats to run for us. We are asking government to be more and more involved in more and more areas of our lives.

That has certainly been the case in the United States since the early 20th Century as shown in this graph below. I pulled this data from the Global Macro Database (link).

Those spikes are different crises. First is the Civil War (1861-1865), then WWI (1914-1918), and then the Great Depression (1929-1939). But you can see that the Great Depression (soon followed by WWII, 1939-1945) changed everything permanently.

Pre-WWI we see spikes then government spending as a percent of GDP returning to a trend of around 3% of GPD. After the Great Depression/WWII period we continue on a new trend that might, possibly, be settling on a trend around 40% of GDP.

Interestingly, a lot of that growth has actually been at the state and local level in the USA as shown in the next graph where I decompose spending.

Pre-WWI state and local was nearly zero and, as I understand, largely composed of spending on schooling. Somewhere after 1975 State & Local Government spending passes Central Government spending. That’s more clear in the graph below where I start in 1950 (sorry, I forgot to update the title, “1800-2024” should be “1950-2024”).

What’s the point? The point is that (1) we spend more and more via government, which means we leave less and less for ourselves to spend as we personally see fit, so it’s no surprise we feel government is in every aspect of our lives… it is, and (2) it’s not all being driven by Washington DC and central government spending. Point two also helps us see why we feel it more and more in our daily lives. That’s because a lot of it is local. That’s why states like Connecticut, where I live, are constantly raising taxes, fees and the like but are still always broke.

As a quick note, that this isn’t coming just from DC is not to say our central political actors are innocent. Surely, and I didn’t dig into this, much of that is connected to spending tied to federal spending. The USA has a strange health care system, for example, where states get federal funds to match or exceed local spending on hospitals and such. But that practice started getting worse in the 1990s and then in a really big way after 2010 and this trend started in the 1970s. In any case, I’m sure the two (central vs state) are not totally disconnected.

We Need Some Government

Don’t get me wrong, we need some government. The only thing worse than too much government is no government at all. That is anarchy.

We need government to establish laws, enforce those laws, adjudicate disputes and protect us from those wishing us harm, be they inside or outside our country. Most people also feel we need government to work like social insurance to catch and help members of our society who happen to fall on hard times. That is, most of us agree on some sort of social safety net whether it’s unemployment insurance or welfare or government-run retirement accounts. I certainly think so, and we can debate how much that should be, but …it feels like we’ve gone way past what any of us individually would feel is right.

Realizing It’s Too Much

At some point I think some of the modern political movements around the world are a responses to too much government. And government spending, by the way, only captures one aspect of overbearing government. Regulations, abuses of power, corruption, and all those other things are part of the story too.

Democrats under Trump felt that he and his government had too much power. Republicans felt the same under Biden. Under Trump II, we’re all getting more of the same. With each cycle we feel that those wielding power have bigger and bigger levers and sticks with which to control our lives, and pretty much everyone I know is sick of it. It all feels bigger and more invasive and, sadly, more corrupt every year. Faith in all our American institutions is at an all-time low.

In Hungary this April, the 16-years-long Viktor Orbán government was toppled by opposition that grew partially from his own political ranks. The key insight for us here is that it wasn’t a movement of policy differences, it was mostly that people were sick of the Orbán government bleeding into every aspect of life, of it choking the economy and of the inevitable corruption.

I see reports of the same thing happening in the UK today as well. People are fed up. They don’t quite see the clear way out yet, but they are sick of what they do see. Bond markets are also challenging the government’s size and spending with regular hiccups that worry governments, investors and economists the world over.

Today, by chance, the Wall Street Journal ran a long article entitled “The World’s Most Surprising Capitalist Makeover Is Under Way in Sweden” (link). It’s about how Sweden is returning to its smaller government roots. It explains that Sweden went from being one of the poorest countries to the third-richest in Europe from 1870-1970 without high levels of taxation. “But starting in the 1960s, the center-left Social Democratic Party—which dominated the country’s postwar politics—sharply raised taxes and spending, ultimately taking government spending as high as 70% of GDP by the 1990s.” Sweden’s top income tax rate in the 1980s was nearly 90%.

To get back on track it has lowered spending, lowered taxes, and moved to more market-oriented reforms.

Government Spending and Watering a Desert Garden

One way I think about the government spending is that it is kind of like watering a garden in the desert. Without some water, the plants all die. But once you flood it, adding more water doesn’t help and may very well kill the plants too.

Clearly they overflooded their proverbial gardens in Sweden, the UK, the US today, Hungary, Argentina until Milei, and so on. But this raises the question of how we got here if everyone dislikes it so much. After all, in the countries I’m discussing, the voters supported all this.

The Tragedy of the Commons

We need the right amount of government. Most people feel government is too small in the areas where they receive the benefits and too large everywhere else.

If I ask my fellow professors, they would likely all argue that there should be more government support for higher education and more government grants in the areas where they do research, not because they necessarily think they’ll get the money, but because they honestly think it’s a good use of the money.

At home in Huntsville, AL, home to NASA’s Marshall Space Flight Center, the United States Army Aviation and Missile Command, and the United States Space Command, many otherwise small government types will tell me we need more money for NASA, defense, space flight, etc.

It goes on.

People in industry always think government should protect their industry, offer subsidies to people to buy their products, and so on. In the medical field, people often feel government should help hospitals or with access to hospitals. The list goes on and we haven’t even touched government spending on other social issues: welfare, re-training programs, low-income housing, more college loans, more clean energy, more, more, more…

All those well-intentioned people believe government spending is important in their area because they see their area as good - otherwise they’d likely be doing something else - and more money allows more good in their area to be done. And, let’s even say they are all correct. Today I don’t want to debate the validity of any of those areas of spending. The problem is that collectively is “overwaters” the economic garden.

Part of the problem here is a common resource problem. The classic example is the “Tragedy of the Commons”. Fundamentally the issue can be phrased as “private benefits, social costs”. Overfishing or overhunting are classic examples.

If no identifiable individual or group of individuals owns, say, a lake, but everyone in the community can freely fish there, each fisher gets as many fish as they want but collectively they’ll deplete the lake of the fish, because none of them have the incentive to re-new and manage the total stock of fish.

To make the analogy better here, imagine everyone in the community pays a small tax every year to maintain the total fish stock and then everyone can fish freely. Well, you’ll have the same problem. Fishers will feel they have a right to as many fish as they can catch because they pay the fish tax and they will also have an incentive to catch now and catch fast before the stock runs out for the year. The fish tax may help finance the replenishment of the fish each year, but it won’t stop the overfishing that leads to a shortage every year as well.

Government spending is the same. I pay a few dollars in a tax, which feels like nothing to me. Then (a) I feel entitled to benefits and (b) I think government should spend more on things I truly believe are important. That is, we “overfish” government spending.

Politicians in the US Congress - acting at our behest - also catch now and catch fast before the stock funds runs out for the year. The tax revenue may help finance the replenishment of budgets each year, but it won’t stop the overspending that leads to a budget shortage every year as well. [Note, I copied and pasted my earlier wording with a few changes only.]

Classic solutions to the tragedy of the commons are: 1) regulations that regulate when to fish, how many you can catch, etc., and 2) privatize the lake.

When you regulate, the community must still pay the fish tax and now they must pay someone to manage the regulated lake, monitor and enforce compliance. If you don’t comply (i.e., overfish) you pay extra fines and, in extreme cases, could go to jail.

If you privatize the lake by selling it to an owner who sells the rights to fish, that owner has an incentive to manage the long-run stock of fish in the lake and prevent overfishing.

Some combination of these solutions is what I would advocate for government as well. It would be nice to have spending and other restrictions imposed by law. We do that in the US via our Constitution and checks and balances, but that’s obviously not been a good restraint since the 1930s. There are many proposals out there.

The other solution is to privatize many of the activities of the government today. That is, shrink the government’s activities overall. I like this, but unless it’s combined with some legal restrictions thereafter, we’ll just slowly “overfish” and “overwater” again down the road. But, shrinking government and putting more back into private hands is always a good place to start, in my opinion.

To use the WSJ’s Sweden article once more, “Under pressure from investors, the government instituted sweeping economic reforms over the next two decades. They included cuts to unemployment benefits and housing subsidies and the privatization of public services, as well as tax cuts and a reform of the pension system to make it more affordable. Strict limits were imposed on government debt. (Sweden’s debt to GDP is a meager 36%, compared with 129% for the U.S.) In the mid-2000s, the government eliminated wealth and inheritance taxes.” (WSJ)

The article continues to explain that “As the state retreated, the private sector expanded.” I don’t want to rely too much on this one example, however. It is a common trend. Overwatering plants will kill them and over-governmenting economies does the same.

Conclusion

My appeal today is just that we, the voters, start pushing for smaller government. It won’t be easy but we’ll get there one way or another. Financially we can’t afford it. The US debt exceeds GDP now and our deficits are at record levels. That house of cards will eventually collapse and we’ll be forced to cut programs in a harsh and careless way.

We can avoid collapse and cutting government spending by supporting representatives who are in favor of limiting government generally, including its spending. Voters did it in Sweden, Argentina, Hungary, and may soon do it in the UK. Good for them. Hopefully we’ll do the same in the US. Otherwise we’ll continue drowning ourselves in a garden of our own making.

Thank you for reading.

Photo by Eric Krull on Unsplash

I spent last weekend in New York at the 4th Neumann Series Conference hosted at Columbia University. This year’s theme was “The New Frontier: Human Ingenuity in an AI-Driven World” (here’s a link for anyone interested: link). It’s a wonderful series, is free and open to the public and privately funded by people who care about science and free discussion. I’m very proud to be involved.

The series brings together top scientists from around the world to discuss topics broadly under the theme of things inspired by John von Neumann (1903-1957) who was a true genius and polymath. It’s hard to explain his contributions to science and the modern world because they are so great and so fundamental. Saying “he founded” or “contributed to” a field doesn’t quite capture it. Google him on your own. Suffice it here to say that he was fundamental to the fields of mathematics, physics, game theory, computer science, and AI.

Late in his life he penned an essay entitled “Can We Survive Technology?” As the mathematician behind Los Alamos and the nuclear bomb, one can understand his late-in-life question. The essay, however, is more about technologies - many of which he created - evolving faster than humans and human institutions and the challenges thereof. It was the perfect launching point for discussions about AI and its role in sciences, research, education, and our lives overall.

For those who read my earlier column criticizing “AI Insanity” - which is what I call the hyperventilation around the idea that AI will replace all humans in everything - you won’t be surprised that I’m a bit of a realistic-optimist. I understand and expect serious challenges to the current world order, our jobs, and my job in particular as a researcher and teacher, but I see the net gains as tremendous and the most dire, dystopian predictions as unrealistic.

Much of the concern around AI is actually around AI replacing humans and thus around the implied devaluation of humans. What I didn’t expect from the conference was that I would become deeply convinced of how much AI is moving us in the opposite direction, further raising the value of humans and human interaction. That’s the topic of today’s column.

What follows are some of the relevant comments from the conference and how I pieced together my conclusion.

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Robots Lifting Weights in Physics Class

One of our hosts was Columbia Physics Professor Szabolcs Marka. He began in the morning by explaining that he’s optimistic about using AI in class and that he encourages his students to use it. But, he explained, he tells them to use it to help them learn instead of do work for them: “I tell them that it’s like having a work-out robot to help you get in shape but instead you have it go to the gym and lift weights for you. How you use it is totally up to you, but one way benefits you and the other way does not.”

The point then is that all of us should use AI to do the lower-level tasks we understand and essentially delegate to AI but not for new tasks we don’t understand yet, unless, of course, you are asking it to teach you about that new task so you will understand it. In my principles of macroeconomics course, I tell my students what prompts I used in ChatGPT and what notes I wrote versus what I had Chat write for me.

When asked how AI affects him and his grad students or fellow research partners and what tasks they assign, Prof. Marka commented that AI has been great. “We can spend more time now walking, talking and thinking. Then when we have an idea we think is worthwhile, we can have AI quickly start on some initial tasks and calculations. In the past that might have taken us 6 months to work through. Today we do it 1-2 weeks. It means we can make progress on problems much more quickly and thus spend more time together discussing exciting ideas and new information!”

More One-On-One Time to Play

This idea that AI sort of “flips” the classroom so that time with the professor is spent in discussion rather than lectures where information only flows one way (from professor to student) is not new. We saw this with the advent of online courses, books, testing and teaching materials and so on about 15 years ago. The thinking at the time was that students could learn material online and then come to class ready to discuss. The teacher would be more like a discussion leader, engaging eager minds in an open forum reminiscent of ancient Greece or something.

The panel discussion on Learning Reimagined addressed just this. Imre Kökényesi is an inventor-entrepreneur, mathematician and physicist. He explained that he focuses developing games that teach fundamental mathematics. He believes that mathematical reasoning is based on only a few fundamentals, can be taught in early childhood via games and, once learned, mathematical reasoning will open young minds to unlimited possibilities. So, he has developed games and pedagogical material for early childhood learning that will be tested in a few pilot schools this year already.

He explained that this returns us to learning more one-on-one like we learned from our parents and the way others learned earlier on in history, in his opinion. We learn better when we are engaged with a human. It’s not possible to teach well, in his view, in a class of 30 students, it’s much better to have one teacher and a few students. The teacher-student the time should be spent “playing” and learning rather than lecturing. He discussed how AI is helping this come about.

Myriam Da Silva runs a company providing AI-based educational platforms that allow just that. Again, she discussed how this new technology frees the teacher to spend less time “lecturing” and more time engaging with students. This will, or should, in her opinion, also mean smaller classrooms so one teacher can more meaningfully engage with those students.

AI here is being employed to increase human-to-human time. Notice, the classroom got smaller. That’s more teachers per student, not fewer. That’s the opposite of what we have normally been worrying about: AI replacing teachers.

But, I think we can all see from this discussion that, if we indeed move in that direction - and clearly its the one we all want to move in, whether it’s feasible or not is another question - then we’ll likely also reshape how education is structured. Maybe school only needs to be half as long since learning from AI can take place anywhere. Then, the time we do spend in school should be more intense and impactful. Maybe, as a professor, I only have one meeting a week with my class of students and otherwise meet them one-on-one. I don’t know. But it’s clear that the current structures and institutions were all built for a different kind of learning. AI is freeing us to spend more time together, not less. And because that “human time” is more valuable than “AI time”, we want it to be quality time.

Doctors, Patients and AI

Two sessions included panelists that touched on aspects of AI involving medical or psychological practice. Nóra Árvai, an applied health psychologist at the University of Debrecen, has launched a consulting business that helps doctors work with patients that are coming to them with more developed opinions and questions than in the past due to greater information availability and, today, AI.

Dr. János Réthelyi, a psychiatrist and researcher at the Semmelweis University, discussed how patients are turning first to AI like ChatGPT for basic therapy questions. Whether this is good or bad is an open question, but, regardless, psychiatrists are learning to deal with it.

Two other speakers hitting on the same issues were Lili Gerendás, a PhD student at Cornell Medical School, and integration engineer Rebeka Bojboi Van Batenburg works at Zocdoc where she works on integrations that connect healthcare providers, scheduling systems, and patient access platforms, contributing to more efficient digital healthcare infrastructure.

In all these cases, the panelists explained that AI gives good advice and bad. People need to be careful. And they explained that AI is rapidly changing their jobs and, specifically, interactions with patients. AI is helping patients with basic questions and helping doctors with routing tasks of notetaking, filling out endless forms, conducting basic analysis, and even reviewing imaging data which it now does in some areas far better than humans can. While there are challenges, to be sure, all of them concluded that the direction in which they are moving is toward AI helping with basics and freeing doctors to spend more quality time with patients.

The more things change, the more they are the same.

All this modern AI talk has only allowed us, once again, to ask the fundamental questions thinking people have been asking since the dawn of time. Certainly as least since the days of Socrates and Plato… why are we here, what’s our role in society, what makes society “good” and how do we define that? And so on.

Return to Prof. Marka’s comments. AI can teach his students mathematical techniques to solve high-level physics problems. AI, however, can solve the problems itself - hence his warning about using the robot to actually lift the weights - or teach the material - actually doing his job or, to continue the analogy, lift weights for him. We know this. It raises a very different question: Why do the students need him?

What is his role as “physics professor”? What is he teaching? Techniques? Topics? Answers?

I posed the same question to myself about 15 years ago when textbook companies launched online platforms with their books. Suddenly the textbook, which was written by a famous economist, included homework and exam materials and a platform where students could do the problems, get them graded and get grades. The platform provided a tutor so that students could get help in the form of links to the location in the chapter where material is covered, additional questions to help them learn, videos of the author explaining the topic again and, eventually, a collection of other professors teaching the material in videos, digital platforms and so on.

I was asked to develop an online statistics course at the time, which I did. I started by asking myself: “If my students can get all of that online, what value do I provide?” I can edit the material covered to ensure it fits in a semester and then just sit back and let it run. But why? Why put my name on the course at all? What’s the point?

The answer I came up with is that my value is in helping explain the harder parts, the stuff that is hard to learn from a book. We’ve all had the experience trying to learn some topic you can read about until you are blue in the face but you still don’t fully “get” in a deep sense. Then you see some person explain or demonstrate it and voilà suddenly it all makes sense. My job, I decided at the time, was to know those pain points and help them through it.

I ask the same thing today in my class. What is my role? Why are 30 students physically sitting in seats? And why did they choose to be here? They could easily have taken this same intro economics class online. It would even be an online version of the class developed by our faculty for our students. Nevertheless, these students signed up for my class and physically came in to sit and learn. Why?

Well, my students tell me this: Today, I take online versions of the classes I don’t care about. I know if it’s all online that I don’t have to learn the material and I can get an A+ in the class. So, I focus on taking classes in person for stuff I care about or for material I really need to learn.

That, in my opinion, is the heart of the matter. And it’s true of AI now in exactly the same way it’s true of all the online materials students have available. And, my prediction is that it will be exactly the same. For things I don’t care as much about, I’ll have AI do it. That will then free me up to do things I do care about.

And that’s why it always brings us back to the basics, forcing us to ask: What should I care about? Why am I here… to spend time on unvaluable things or on valuable things?

All the conversations at the Neumann conference drove this point home to me. None of the speakers spoke about it directly. They focused on the role of AI, how it’s changing their research, their field and so on. And, just so my column here is not putting words in their mouths, to be clear, many of them, about a third of the participants, based on a show-of-hands poll, felt AI will be a net negative. But that is not what I heard and distilled from the discussions. I drew the opposite insight, even from the skeptics.

Every single example from the physics professors to the medical innovator to the psychologist to the artist: AI was being used to (a) serve a human and a human end (see my older column) and (b) to free them to focus more on what really mattered and that generally was engaging with other humans.

By delegating routine tasks to AI, including basic analytical tasks that need to be performed, we are all left asking what is the role of the human, what is our role as doctor, psychiatrist, and teacher. These are not new questions.

Certainly we must still know our subject matter, but perhaps we will no longer be expected to be walking encyclopedias with perfect recall. In my classes today I have my students look up, say, the current inflation rate or unemployment rate and we use that in our example on the board. Sometimes I ask them to ask ChatGPT to explain a concept and then we discuss it. It doesn’t diminish my role as their professor. It enhances it. It hones in on where I contribute to their learning.

And… the interesting takeaway that I want to share with you all is that, again, in all these cases, yes, AI is changing things and eliminating certain jobs, but the clear direction is that AI is freeing people up to spend more time together, not less. It’s showing that we might be moving to a world with more teachers per student and more meaningful one-on-one with doctors, not less.

John von Neumann and the Computer

The conference ended with a short documentary on the life of John von Neumann. If can get online access, I’ll share it. It’s very worth watching.

But, for our purposes, I will mention that the documentary drove home one final point for me. John von Neumann was the mathematician behind the atom bomb’s development in WWII. He invented the modern stored-memory computer in part so that he could do more calculations and do them more rapidly given the urgency of the project. His wife became the first programmer for this sort of thing and wrote many of the first modern computer codes.

We need to remember that this was a time before computers, before calculators or even electric typewriters. Businesses and government had “armies” of typists in rooms working on documents and “armies” of people working on basic calculations for all sorts of things.

Von Neumann explained that the computer he invented would, in his words, “easily replace ten thousand people who currently make these calculations”. And he was right. The computer eventually eliminated all those jobs and all the jobs of those typist jobs too. AI is doing the same today.

Today it’s not surprising to hear that someone is studying “computer science” but before the invention of the computer it would have sounded more like science fiction. Could you even explain in an understandable way what facetiming, direct messaging, engaging in social media and all the normalities of modern life are like to someone from von Neumann’s time?

Will we one day have “AI science” that is doing things we can’t even conceive of? The answer is “yes”, whether it’s called AI Science or not. Will there be jobs we can’t even imagine today? Yes.

Conclusion

My students say it all. I take the classes I care about in person and take online classes that I don’t care about (so I can get an A without learning anything). AI is no different.

The valuable piece is the human piece. It’s the class you take in person. The automated piece gets devalued, not the other way around.

Will this change things? Yes. And that is both exciting and scary, I readily admit.

It also puts a higher burden on the in-person, on the human piece. If my students take my class in person, it better be good. I better engage them and teach them. I better know my stuff and know how to help them.

AI is taking over the mundane. That will free us up to do other things. And we repeatedly reveal that we value the personal, the interpersonal, the experience. We all need to think what it really is we do. How do and how should we spend our time on this earth?

I’ll end with wise words from my mother, Sharon Ball, who founded a not-for-profit at-home hospice in the early 1990s. She often reminds me that in all her years tending to people in their final moments, not a single one of them on their death bed wished they spent more time in the office. They always wished they’d spent more time with family, friends, and the people they love.

AI is freeing up our time. It’s up to us what we do with that.

May we take my mother’s words to heart and may AI help free us up to spend our time more valuably.

Thank you for reading.

Using the word “pay” in this ambiguous way allows one side to claim “foreigners ‘pay’ the tariff”, and the other side to say “Americans ‘pay’ the tariff”. So, I thought I might provide some clarification. Then, we can all go back to debating the merits of tariffs.

Original photo by Jon Tyson on Unsplash

Physical Payment: Taxes on Domestic Goods

A tariff is a tax. It is a tax on foreign goods. And to whom are all taxes ultimately paid? The government. Let’s start there.

In the USA when you walk into a store there is a sticker price on an item, say $2.00 for a bottle of Coca Cola. For simplicity, let’s say the tax on soft drinks is 10%. Then, when you get to the cash register, you pay the $2.00 for the Coke and 20 cents for the sales tax and give the cashier $2.20. The store then gathers all the taxes it collected and the store physically pays the government the tax it collected from consumers. So, it is very clear here, the store pays the tax to the government.

We handle it that way, because it’s generally more efficient to have the store track and collect all the taxes on all its sales than it is to have consumers self report every Coke and pack of gum they buy and pay those taxes to the government.

With online shopping, sometimes the consumer has to calculate and report to their local state how much tax they owe on products purchased online. But, even in those cases it’s more and more common for the online seller to be the one collecting and physically paying the tax. There can be exceptions, but they are the absolute minority of the situations.

Physical Payment: Taxes on Foreign Goods

When an American business buys a good from overseas, its more efficient to let the US buyer track purchases and taxes owed, and then physically pay the taxes to the government.

If my local wine shop orders 10 cases of French wine, the French quote a sticker price, the tariff schedule says how much tax must be paid on these goods, the local wine shop (or more likely their domestic importer or distributor) physically pays the tariff tax to the government.

So, it’s 100% sure that the US buyer physically pays the tariff to the US government. Again, I’m sure there are a few exceptions, maybe for really large, negotiated items (think airplanes, nuclear reactors, submarines, and the like). But for 99.9% of all the goods, the US buyer physically pays the tariff tax to the US government. No real debate here1.

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Tax Incidence: Who Bears the Burden of a Tax

Who bears the burden of a tax is an economic question, and it is distinct from who physically pays it, which, as I hopefully showed, is not a question. The short answer is that the party least able to avoid it bears more of the burden of the tax. Let’s see an example.

Imagine a six pack of Coke currently selling for $10.00. Now suppose the government adds a tax of 10% on Coke only.

Coke is more of a luxury good and there are alternatives. If the price rises a little, people might switch to Pepsi or Dr. Pepper or something. Or, they might just buy a few bottles at $2.00 each and not a full six pack.

(Personally, I’m a bit of a Coke purist and when I want a Coke, I only want a Coke and I personally never drink Pepsi….but I digress.)

Because Coke consumers can easily avoid the tax and do so without much pain to themselves, they will bear less of the burden of the tax. The store therefore might not want to leave the sticker price at $10.00 because the final price with the tax will be $11.00 and sales will drop as people switch to other goods.

If the store left the price at $10.00 and consumers did not change their purchases at all, gladly buying the same amount but now paying a total of $11.00, economists would say the consumer bore 100% of the tax. People gave up their income to bear the whole extra dollar in tax cost. The store gave up nothing. It didn’t lose any sales or bear any cost (other than admin costs of filing additional taxes).

If, instead, the store lowered the sticker price to, say, $9.09, the final price (sticker = $9.09 plus 10% tax, 99 cents) is $9.999 or, rounding up, $10.00. In this case, consumers buy the coke at exactly the same price they paid before. They bore none of the cost of the tax. However, the store bore 100% of the tax.

This is what economists mean by who “bears the burden of the tax” and we call it “tax incidence”. Notice that in both cases the store collected and physically paid the tax to the US government. But in the first case the consumer bore all the tax and in the second, the store bore 100% of the tax.

Those are the two extreme cases and reality falls somewhere in between. Some people switch from Coke, some don’t. Overall the store probably cuts the sticker price some, say to $9.50 or something and both consumer and store bear some of the cost.

If we’d looked at taxing cigarettes, the logic would be the same but, because smokers are generally more addicted to cigarettes than Coke-drinkers to Coke, they have fewer quality alternatives in their opinion and we’d expect the consumer to bear more of the cost and the store to bear less. So we might expect the store to leave the sticker price unchanged or maybe just lower it to $9.99 or something, leaving most of the burden on smokers.

These are just looking at prices. Additionally, however, we need to consider quantities sold. The store bears the cost of the tax in terms of both less revenue per sale and less sales overall. In our example of cutting the price to $9.09, they sell the same product for almost $1.00 less which harms their profits. They’ll probably push their suppliers to cut costs and so on as well to help offset the loss. In the end, a lot of people and businesses will bear some of the cost of the tax all along the supply chain. If they don’t cut the price by the whole dollar, then the final price rises a little for consumers (for example, at $9.50 sticker price, the final price with tax is $10.45) and some consumers switch to other goods which means the store sells fewer six packs of Coke in addition to earning less per sale.

This is the point. Whoever can most easily and with the least pain avoid the tax will bear less of the burden. In the case of Coke, people might switch, so probably the store will bear more of the burden. In the case of cigarettes, probably the opposite.

In 1992, despite his “read my lips, no new taxes” claim, US President George Bush, Sr. raised taxes over concerns about the US deficit. Ha … the good ‘ole days when politicians cared about deficits! Sorry, I digress. In order to minimize the burden on average working families and raise the most money, he tried to soak the rich by taxing luxury yachts and private jets. The result? People didn’t buy them, the industry collapsed, jobs were lost in boat-building and related business, and very little revenue was raised.

It’s a classic example in Economics textbooks when discussing tax incidence. It’s also helps us understand why politicians love “sin taxes” which is a tax on something people think is morally bad, like cigarettes, alcohol, gambling and the like, but that they are believed to be addicted to so they won’t change their consumption patterns. It’s a political win, because the addicts bear the burden for their “sin” and the government raises a lot of money. Over time, of course, people do modify their purchasing patterns away from the more expensive items allowing the politicians to claim subsequent success in reducing bad behavior. President Bush, Sr. clearly got bad economic advice somewhere.

Tariff Incidence

Now, let’s think through the tariff which is a tax on foreign goods. Here, there are sort of two popular political groupings of interest that again tend to get co-mingled in the press: domestic vs. foreign, and typical US consumers - read “voters” - in general (not really versus anyone).

Let’s use the French wine example. I think it’ll be the most clear, and then you can apply the logic to any good you want. We’ll also imagine the wine store physically and directly imports the wine from France even though in reality there will be a whole supply chain with distributors and importers.

And, again, we can imagine that the wine store was buying the French wine for $10.00 a bottle and selling it for, say, $20.00 a bottle before the tariff. Let’s imagine a 10% tariff just to keep numbers simple.

First, we know the US importing store physically pays the tariff to the US government.

Second, we want to know who bears more of the burden, “the US” or “the foreigners”. The domestic vs. foreign portion is generally business to business. Who bears more of the burden will depend, again, on who can avoid it the least/most. If the US is a vital market for French wine, then the French will bear more of the burden, likely cutting the price to maintain sales to the US in light of the tax.

I can also imagine that large, powerful retailers like Wal-Mart, Target and similar businesses that have lots of negotiating power can also push the burden onto their foreign suppliers, requiring them to cut their prices to offset the tariff.

So, the effect will depend on the businesses and the relative importance of each business to the other, how rare and/or vital the product is. You can imagine French wine is a bit of a luxury, especially more expensive bottles than in my example, so the French might take a big hit since luxury consumers can switch easily.

The opposite is likely true of rare earth minerals essential for microchip production that are only available from a few places yet in high demand to feed our AI dreams. The average effect will therefore be a mix of US businesses bearing some and foreign businesses bearing some. In both cases, “bearing the cost” means a loss of revenue, likely jobs and, of course, more administrative complication, so a decline in economic efficiency/productivity as well.

The next question, and the one that really gets the political attention - especially in an election year like 2026 - is how much of the US-borne burden gets passed from the US business to the US consumer. Here, again, the answer will depend on the business, how essential the good is and the degree to which US consumers can switch to alternatives.

The ideal case for the pro-tariff advocates is actually that consumers can easily switch and do so en masse. That would mean they bear nearly no burden and, by definition, they would be switching to US-made versions of the same product. In theory, this switch would happen at the business level so they drop French wine and only stock their shelves with, say, California wine. You can imagine the pictures of the happy workers getting jobs!

The ideal political case for the anti-tariff advocates is that tariffs hit some resource like medicine or food or something that is unobtainable from another source yet vital for middle class American consumers. You can imagine the pictures of mothers unable to buy baby formula or something!

Just to recap: US businesses physically pay the tariff to the US government. Who bears the burden depends on who is more flexible - US business buyer or foreign supplier - and then, secondarily, how much of the US business’s burden can be passed to US consumers depends on who is more flexible between the US businesses and US consumers. Who bears the burden is an open, empirical question and will differ across goods and over time.

Why It’s Back in the News Now

It’s back in the news right now for three reasons, as I see it. First, politics and the affordability critique Democrats are making against the Trump administration. Middle class American consumers are still struggling financially after years of inflation and a messed up post-Covid economy. Tariffs definitely raise the costs of some things, Americans don’t like that, and hence it can be used to peel some voter support away from the Republicans, and this is an election year.

Trump himself is also pushing his tariff policy into political focus since he views it as a winning topic and hopes to peel support from Democrats. On January 30th he even ran this column in the Wall Street Journal touting his tariff successes: “Donald J. Trump: My Tariffs Have Brought America Back. The ‘experts’ predicted market crashes, massive inflation and recession. They were all wrong.” … did I mention it’s an election year?

Second, the Supreme Court will soon rule on whether the justification the Trump administration used as the basis for their tariff regime is legitimate or not. If not, then the Trump administration has other justifications, but it’ll definitely be a political black eye for the administration, and may affect some of the tariffs. The timing of the ruling is sort of “any day now”, so this is front of mind.

Third, news outlets are discussing new research by the New York Federal Reserve that is confusingly titled “Who Is Paying for the 2025 U.S. Tariffs?” Given that these are economists, I find no excuse for this title. They know better yet still start with “Over the course of 2025, the average tariff rate on U.S. imports increased from 2.6 to 13 percent. In this blog post, we ask how much of the tariffs were paid by the U.S.” . That’s just confusing, especially since the very next sentence reads: “We find that nearly 90 percent of the tariffs’ economic burden fell on U.S. firms and consumers.”

It was actually a WSJ article referencing the NY Fed’s piece and the fact that the piece starts with this confusion that inspired me to write this today. I hope it clarifies the issue for people.

Conclusion

This sort of imprecision in always using “pays the tax” allows anti-Trumpers to say Americans pay 100% of the tax, and Trumpers, and Trump himself, to claim that foreigners pay the tax. And, the typical person either has no idea who is right, or they just side with whomever they view as their political team.

In the first case, you can read “pays” as physically pays. And it’s 100% correct.

In the second case, you have to believe that the US market is vital for most foreign businesses selling to the US, therefore the foreign seller is less able to avoid the tax and thus bears most of the cost of it. And, if you also believe that American producers can quickly fill the gap as people drop foreign goods, then you really believe that foreigners bear all the burden and the end result - more US production and jobs - is truly a net positive.

There’s still plenty of room to debate the merits of tariffs. But hopefully readers of this column will at least be aware of the technical distinction between physically paying and bearing the burden of the tariff. I hope it helps you approach the topic more clear-eyed.

Funny… I just now skimmed for the first time the NY Fed’s whole article and they have a section walking through “tariff incidence” and use examples similar to the ones I used above. So there’s really no excuse for their intentionally misleading title other than knowing news outlets would jump all over it. Ugh.

Thanks for reading.

Photo by Keegan Houser on Unsplash

There are normal and interesting discussions around AI: where is it useful, which jobs will it replace, which jobs will it enhance, what policies should we have regarding copyrights in an AI world, and so on.

Then there’s what I consider “AI Insanity”: AI will do everything in an economy and people will have no jobs. A commonly accepted caveat to this is the belief that we will therefore need universal basic income. If no one has a job, the thinking goes, then no one has an income and, therefore, government will have to step in.

This is a popular view generally, especially among technology enthusiasts. The first time I recall hearing it was when Andrew Yang ran for President in 2020. He was a tech entrepreneur, and part of his platform was to start universal basic income sooner rather than later so we’ll be ready for the AI-tech apocalypse to come.

Recently Elon Musk brought it back into the popular press headlines when he suggested that in our AI future there will two possible equilibria:

1. A high income equilibrium where AI takes over everything and generates so much wealth that is then shared through a high universal basic income. Here everyone is happy and rich.

2. A low income equilibrium where AI takes over everything, but, for some reason - he wasn’t clear on this - we all get a low universal basic income. Here everyone is poor and miserable.

Musk, ever the optimist, feels the good equilibrium is very possible though not guaranteed. Both these options, however, include two things that are illogical and render the whole discussion silly, in my opinion: 1) AI takes over “everything” and 2) thereafter it generates “wealth” or “income”. After absurdity point 2, if we want a 3rd point it would be that the generated wealth or income must be redistributed via the government.

I’ve long been thinking about writing a column about this as the topic has grown in popularity, but it’s really after my fellow economists started writing academic articles recently about this same topic that I couldn’t take it any longer. They should know better, in my opinion.

The first research paper that got me was in October 2025 by Yale Professor Pascual Restrepo, “We Won’t be Missed: Work and Growth in the AGI World”. He presents a model where “artificial general intelligence” (AGI) makes it feasible to perform all economically valuable work using computers and AI-robots.

The second, by Stanford Professor Charles I. Jones, “A.I. and Out Economic Future”, which he is preparing for the Journal of Economic Perspectives, a top journal, widely read in the field. His topic (from his abstract) “What if machines — A.I. for cognitive tasks and A.I. plus advanced robots for physical tasks — can perform every task a human can do but more cheaply? What does economics have to say about this possibility, and what might our economic future look like?”

These are the sorts of research that get quoted and work their way into the mainstream. And, after reading Prof. Jones’ piece, I decided to write this today.

ChatGPT’s Proof of Concept: AI Is Here and Works

OpenAI’s ChatGPT showed everyone what AI can do, and it is indeed having a hugely transformative effect on our lives now, in real time. Anyone who has used ChatGPT (or Grok or Perplexity or…) productively has had a moment of awe followed by the realization that this is more dangerous than you first thought. Academic researchers are realizing that they don’t need research assistants anymore. Financial firms are realizing they don’t need junior analysts anymore. Marketers are realizing they don’t need junior marketing staff to make promotional materials. In all these cases, more experienced people can do more with ChatGPT than a junior person can do themselves.

In my world of academia, I see it totally changing how I do research. I literally chat with ChatGPT like I might with a senior research partner or even a mentor. Forget junior research assistant, sometimes I feel like I’m chatting with my Ph.D. advisor, may he rest in peace.

My students use AI to learn the material I’m hired to teach them in class to answer all their homework problems, help them study for an exam, and do their projects from A to Z, including getting data, analyzing it, presenting it, and discussing it.

Of course, after a little reflection and we start to worry that Chat and “AI” can replace us as well. And, I do think it will wildly transform the work and education landscapes more rapidly and in bigger ways than any of us imagine. Yes, that means we all have to change and adapt.

We are, in many ways, looking at a horse-and-buggy economy during the birth of railroads, planes, and cars, if all three were invented at a high quality and affordably mass produced all at once. This will be hugely transformative, many pre-AI jobs will disappear and many post-AI jobs will come into existence that we can’t even imagine today.

So, is this all disruptive? Yes. Can AI damage certain industries and professions? Yes.

These are things that should make for vibrant policy debates, great research, and make for a very exciting world.

We should not, however, lose a moment’s sleep over the possibility of some dystopian future where AI and AI-robots do 100% of everything so that people are essentially rendered useless and therefore irrelevant, at least in my opinion.

There is no world where AI runs everything “in the economy” and humans live off universal government-provided income.

Problem One: Humans Are “the Economy”

There is no “economy” separate from humans. There are only people interacting with each other. People interacting with other people is what we call “an economy” and that is why economics is a social science, not a physical science. There are rocks and atoms without humans, but there is no economy without humans.

All our activity is done in service to a person. I challenge you to name a single activity that does not have as its ultimate end to serve a human’s interest or desires.

Take a minute and think about it. Take my challenge seriously.

ChatGPT should only do things I ask it to do. Very often it gives me more than I want and I have to tell it to stop. And it does. It then learns my preferences and gives me more terse, focused answers.

ChatGPT is serving me and my interests. When it doesn’t, it’s turned off.

And why am I using it? Answer: To help in my job. I’m employed in a job serving students, people.

Why are the students at a university demanding my services? Answer: To serve their own interests and have meaningful lives (as they see it) usually through gainful employment at businesses doing what…? Answer: serving their customer’s interests.

Humans and their needs, interests, and desires are the alpha and omega of all economic activity.

How about this as a challenge? I suggest to you that a non-human cannot be the ultimate end user of any service in any meaningful sense.

No business or other organization exists for any meaningful amount of time unless it is serving some human interest. Think about it…

If you think long and hard, the ultimate end to every organization – a business, a non-profit, a government, or even just a loose association – is serving a human end.

Just to address one thought you might have: intermediate services. “Ah-ha”, you say, “a computer can notice it needs an update then download and update itself!” Okay. And why does it do that? Answer: it does that to function better and/or more safely so that it can… serve a human. My car needs an oil change so it can take me places, serving a human end.

I cannot find any exception to this. None.

One side note. There is a separate concern that AI might be poorly asked to do something and cause damage. There’s a classic example where the head of a paper clip factory tells it to make paper clips and the AI and AI machines use up all the resources making endless mountains of paper clips no one needs. It kills anyone who tries to stop it. It takes all the metal in the world for its sole end of making paper clips and so on.

Surely, there are limited cases of this. Surely, there are dangers if it’s used for medical advice, military strategy, and so on. Those are all legitimate concerns and the reason I think it’s a topic worth discussing and considering policy options to address these concerns.

That is not, however, the problem I’m talking about today. That’s not the world where AI does “everything” and people have nothing to do and hence need universal government support to live.

So… to summarize

• A non-human cannot be the ultimate end user of any service in any meaningful sense.

• No business or other organization exists unless it is serving some human interest.

• The ultimate end to every organization – a business, a non-profit, a government, or even just a loose association – is serving a human end.

And this brings me to economics, the social science.

Problem Two: General Equilibrium

General Equilibrium – Part One

Let’s knock off the most glaring foolishness first. Restating “AI Insanity” from the opening of today’s column:

AI will do everything in an economy and people will have no jobs. A commonly accepted caveat to this is the belief that we will therefore need universal basic income. If no one has a job, the thinking goes, then no one has an income and, therefore, government will have to step in.

Where does the government get the money to pay for universal income in this scenario?

No one has a job so there’s no income to tax.

No one has a job, so there’s no one to buy the goods all this AI is producing, so no goods or services are sold, so there’s no profit and nothing to tax there either.

That is the general equilibrium problem with this “AI Insanity”, dystopian idea. If AI replaces all the people, for whom is it producing anything and in exchange for what?

I’m not really sure if I can add more here. Once you understand this, it’s hard to un-see it. If AI does “everything” and humans have no jobs, who pays the taxes so the government can provide universal income?

It’s just logic. It is quite literally Econ 101. I start every principles of macroeconomics class explaining that person A’s spending is person B’s income, and so on.

Let me also quickly address a simple way around this that might occur to readers: the government can print money.

This is true. It is entirely possible that the government could print little pieces of paper and hand them out to everyone.

It can and does do that today. The logical problem is the idea that the money would make people well off. Why not just have the government print money now and guarantee us all Elon Musk level income, if that’s possible? The answer, as we all know and just experienced during Covid, is that this would only cause massive inflation.

There is no free lunch that gets you out of this trap. A government only has financial value to help to the extent its citizens have incomes generated by meaningful economic exchange, i.e., “in the economy”, which is the thing we are precluding in this discussion.

General Equilibrium – Part Two

Now to the question everyone worries about: “What if machines—A.I. for cognitive tasks and A.I. plus advanced robots for physical tasks—can perform every task a human can do but more cheaply1?”

“AI will do everything in the economy”. Again, that’s meaningless because “the economy” is just a collection of human beings. To be fair, however, what people mean by this is that AI and AI-robots will “produce all the stuff” and “provide all the services”. That’s why this argument appeals to people who approach the problem as engineers looking at a machine: this one part is so great now that we can eliminate these other parts entirely. True for a machine; not true for an economy if the “other parts” are people.

The idea seems to be this. With each advance of AI and AI-robots, human labor is less needed. But what is the AI employed to do? Let’s say, it’s employed to make pizzas. Who’s buying the pizza? If everyone was replaced by AI robots, then people have less and less income to buy pizzas with. But, since the pizzas are produced more and more efficiently and hence more cheaply, we are just saying that the price of pizzas will fall. Maybe the price just goes to zero? Free and infinite pizzas! Yeah! Sounds like Elon’s good outcome!

The fallacy here is that resources are not infinite. How many tomatoes and how much flour is needed for free infinite pizzas? The partial equilibrium and engineering analysis sees just the machine: one factor efficient, the other factor not needed. But in general equilibrium we have to remember that multiple AI “businesses” - in theory, all businesses - will be competing for finite resources. This creates massive competition for the inputs and pushes their cost up, not down.

Nothing has changed just because AI is involved. The production of real things requires real, physical inputs.

And AI itself needs inputs. We are already seeing that AI requires massive data centers which require massive power sources. Proposals for new data centers are paired today with proposals for small nuclear generators to power just a single data center! In areas where data centers are tapping into existing electrical grids, energy costs are skyrocketing for the local people… uh people … living there.

Take a look at this IMF Blog “Inside the AI-Led Resource Race” about the global race for resources for the data centers to run AI. Things like “OpenAI and its partners are planning a 5-gigawatt campus, matching the output of five nuclear reactors and sprawling across 10 square miles”, “Data centers already use about 1.5 percent of global electricity supply, roughly the same as the United Kingdom”, and “By 2030, data centers could be consuming more than half a million metric tons of copper and 75,000 tons of silicon each year” should all catch your eye.

The world is a world of finite resources. No matter who or what you are, resources are finite. There are only 24 hours in each day no matter how rich you are. AI isn’t bending space and time, at least not yet.

So, when analyzing these things, the “engineering mindset” looks at production in isolation and forgets that

1. a person must want the good being produced, and if you fired all the people, no one will have money to buy anything, so those products won’t get produced in the first place, and

2. the argument is that “everything” is done like this, which means all these units are competing with each other for finite resources, driving their costs up.

One implication is that the sales price of goods will drop but the costs of producing them will not fall as much and may eventually rise. Afterall, we still need metal and parts and electricity to run the AI and the AI robots.

If output prices fall toward zero but production costs do not, then these AI “businesses” cease to exist.

Rather than only focus on AI making new employees less productive – in a company’s current workflow – we should also realize that the same AI made experienced employees more productive. That means they will get paid more and have higher incomes, not lower ones. Every company will want more seasoned people and thus bid up their wages.

As the cost of hiring experienced people rises, firms will hire inexperienced people again, likely combining their labor with AI.

And, is it true that AI actually makes new employees less productive? No. That you need only 1 new employee instead of 10 means that those new employees are actually more productive. One person does the work of ten. And, as companies continue down this path, they will realize that seasoned employees retire or switch jobs to get better pay and they need to maintain a pipeline of people in the company who start, learn and grow into seasoned employees who, we agreed, are much more valuable now due to AI.

I predict that the decline in new entry-level jobs we think we are seeing today will be the temporary effect of industries working through all this and learning where new employees can be permanently eliminated, on the one hand, and where they are more needed than ever, on the other.

All this says that labor allocations will change. Workflows will change. But each worker is more valuable, not less. In a flexible and free economy, this will eventually mean more businesses. But nothing suggests a world with no workers. You must at least have one human per business who owns the business. If you don’t, then no one would have income to demand the goods being produced and those businesses won’t ever exist in the first place.

I suspect AI will lead to more and smaller businesses over time in some areas, each more specialized. It may also lead to large, mega businesses in other areas. I’m thinking here of the Googles, Amazons and Metas of the world. I worry about any large, concentrated power. So, again, there are legitimate concerns we can talk about. But, I don’t see a world where there are only AI and AI robots and no people working.

Conclusion: Exciting and Turbulent Times but No Dystopia

An economy is just a collection of individuals. Full stop.

Each person pursues their own interests defined in their own terms. In a free society, I can only pursue my interests by serving other people in exchange for money (or other goods/services) or by convincing them to give me their money as a donation.

I actually do, or have done, both. I serve students who are the customers of universities. They pay our university in exchange for education and a diploma. The university pays me in exchange for economics lectures and mentoring. I’ve also raised money for scholarships and special programs.

In both cases, my actions must benefit a human. The donors get satisfaction knowing their money “did good”. The students get satisfaction either because they liked economics or because it helped them get a degree and a job, or both (hopefully).

The true demand side of the economy is only meeting these human desires. If those people have no income, the supply side won’t come into existence. There is no world where AI does everything in an economy without people because there is no economy without people.

Every time I hear about this AI future where people have nothing to do, AI does everything, and we live on government universal welfare, I roll my eyes. Hopefully today I convinced you to do the same.

Thank you for reading.

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Some Global Econ Numbers

This data was just downloaded (Dec 6, 2025) from Trading Economics (https://tradingeconomics.com/).

All in all, the US is doing alright. Our GDP growth rate for the year is around 2.1%, unemployment is at 4.4% and inflation at 3%. We think 4-4.5% unemployment is our natural rate of unemployment so that’s fine. For those of us living in the US - and those of us watching our students graduate and search for jobs - it feels like a tighter job market than the 4.4% reflects. But still, people are finding jobs. People and companies are just being more cautious today than they were a year ago.

Our target for inflation is 2-2.5%, so 3% isn’t bad, and it’s way down from the 9% we had in 2022, but I had hoped we could get back to target by now. Basically we’ve been in the 3-4% range for the last two years and, honestly, I don’t see that changing any time soon.

From a growth, jobs, and inflation perspective we are doing alright today. Compared to Europe, the US is doing a lot better in terms of GDP growth and unemployment, but worse in terms of inflation, which is in the 2-2.5% in Europe today. Our northern neighbor, Canada, is doing better in GDP growth terms (2.6%) and inflation (2.2%) but worse in unemployment (6.5%). But, Canada generally has higher unemployment than the US does. 10 years ago it was 7% and it’s low since then has only been 4.8%. So, relative to that, Canada seems to be doing fine and better than the US.

The UK is a mess today. I’m sorry to see that. Growth is low (1.3%) but inflation is still high (3.6%) and unemployment has been rising over the last year from 4.4% or so to 5% today. That’s a bad direction and none of the news reports are encouraging. The UK government is struggling to find its economic footing and it shows in the numbers.

If I had to pick one country from the list that has the macro numbers, I’d like to have for the US, it’s Australia. Inflation is 3.8%, which is too high for a country that claims to be committed to targeting 2-2.5% inflation, but all the other numbers are pretty good with solid growth (2.1%) and low unemployment (4.3%). Most importantly, however, is that Australia has a lot of fiscal room to maneuver in.

Fiscal Concerns Abound

The GDP, unemployment, and inflation numbers at any point in time can be misleading. They can be manipulated in the short term by government policy, but too much governmental "management" and they’ll soon swing out of bounds, and not in a good way. What Australia has that few in the world seem to have today is solid fiscal numbers.

Their government is running a small, but positive surplus (0.6%) and their total debt to GDP is only 44%. Those are very enviable numbers in today’s world.

Look at the other countries. The US government is borrowing today like we used to in times of crisis or war! It’s insane.

This is from the Federal Reserve’s FRED database (https://fred.stlouisfed.org/series/FYFSGDA188S#). To see the key concern, look at -5% on the left side, then look across the graph and see when we hit that historically. Basically, we hit it in the depths of the 1980s recession, which, at the time, was the worst US recession since the Great Depression. Next we DOUBLED it during the Great Financial Recession, hitting -10% of GDP. Then, with COVID, we decided to outdo our previous record, hitting -15%. And, today, we seem to think -6% or more is normal.

Japan, on the other hand, tells us, well, something. They’ve been running deficits (generally) in the 5-10% range of GDP since about 1996.

The result has been a massive accumulation of debt to GDP.

That the US, UK and others are on a similar path is very worrying to me. On the other hand, while Japan is not the envy of the world it was in the 1980s, it hasn’t collapsed.

We see Japan’s GDP per person (solid blue line) was growing at the same rate as the US (dashed green/top line) and Australia’s (dashed-dotted red line), just for comparison’s sake, until 1990.

We cannot blame the debt as a cause for slower growth since the 1990s. For starters, growth slowed around 1990 and Japan’s debt/GDP started rising dramatically in the early/mid-1990s. But, I do think we can say that all the government spending and borrowing to finance spending did NOT help GDP.

While there’s a lot of reason to believe a short burst of government spending during a crisis can help bridge GDP briefly, there’s zero evidence that I know of showing that persistently increasing government spending, generally, and financing it with debt, specifically, does anything but drive a country into trouble.

Here is one of the few cases where advice to friends and to governments is the same: running up debt is not the path to fame and fortune.

Conclusion

What’s the point of today’s column? Well, for starters, I was personally wondering where things are in the world today. I thought you might too and wanted to share. While very incomplete, this gives a quick snapshot of the North American, European and Asian region.

I was curious if US growth is stronger or weaker than elsewhere. Answer: mildly stronger.

I was curious if the US’ inflation experience - inflation still not at target - was unique at any level or fairly common today. Answer: common. Europe and Canada seem to be the exceptions. It’d be interesting to dig into what’s been different in those countries. I don’t think they responded any sooner or more aggressively to inflation than we did in the US. I could be wrong, but I don’t think so. Again, it’ll be interesting to investigate a little more in another column.

Finally, I am very concerned with the US government’s massive size and role in our economy. And, additionally, I’m worried about the macroeconomic financial implications of our massive spending. We aren’t on a good path.

It looks like Australia has turned around. It was also on an upward trajectory with debt peaking around 70% of GDP a few years ago.

As far as I can tell, the US and most other large economies are spending with both hands and borrowing to pay for it. That’s not good. If we were the only ones, then it would be bad, but with so many others doing the same, global capital markets will really have to be willing to accept our debt long enough for us to turn things around.

But it’s tough when everyone in the market wants to borrow all the time and in ever larger amounts. Who is buying when everyone’s selling?

So… we have a Fed meeting coming up soon. I expect they will cut interest rates again by a small amount. I think we’ll see inflation pick up a little in 2026, unfortunately, and they’ll have to reconsider their rate cuts. The ECB is expected to hold rates constant in their December meeting.

The prayer for the new year: fiscal reform and sanity in the USA. If we can reduce spending and government largesse generally, keep our economy free and agile, then we’ll grow and prosper, inflation will slowly decline over time along with our debt to GDP.

So, let’s pray and hope for the best as we enter the holiday season. It’s possible. Not necessarily likely, but possible.

Thank you for reading.

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The Fed’s Dual Mandate and Current Economic Challenge

The Fed balances two objectives: (1) stable prices and (2) maximum employment. You can read the first of these as “low and stable inflation”, which the Fed officially interprets as inflation near 2%. And, maximum employment is read as keeping unemployment at the lowest sustainable level for our economy. That level is known as the “natural rate of unemployment”, and it’s generally believed to be somewhere around 4% for the United States.

1. When the inflation rate is above 2% and rising, the Fed raises interest rates in an effort to reign in demand in the economy, cooling upward pressure on prices and hence driving inflation.

2. When the unemployment rate is above the natural rate and rising, the Fed cuts interest rates in an effort to stimulate demand in the economy. The logic is that more demand for goods means the businesses selling more need more workers, putting downward pressure on unemployment.

Notice that these are directly in tension.

Today US inflation is around 2.7%, above the 2% target, and expected to rise to around 3% by year’s end. Unemployment is around 4.3%, likely near the natural rate and, in Chair Powell’s words, “still low”.

Based on this, one would have expected the Fed to raise rates, not cut them. Or, perhaps keep them unchanged. What happened?

In Chair Powell’s own words (link) with my emphasis,

“In the near term, risks to inflation are tilted to the upside and risks to employment to the downside—a challenging situation. When our goals are in tension like this, our framework calls for us to balance both sides of our dual mandate. With downside risks to employment having increased, the balance of risks has shifted.”

In short, the targets and data today indicate that pressure on the dual mandates are balanced: some, but not too much, inflation pressure and some, but not too much, unemployment pressure.

The balance of risks going forward, however, seems to have shifted toward unemployment being more fragile. As the Chair explained: labor demand has softened so that job creation appears to be too slow to keep the unemployment rate steady.

On balance, then, the Fed sees potential unemployment as a bigger threat than potential inflation and hence cut rates a little. The Fed lowered the public rate, the federal funds rate, by 0.25 points, from about 4.25% to 4.00%1.

If I can summarize the Chair’s whole conference… Here’s what I understood from him today: the Fed was already expecting inflation to tick up some, to maybe 3% by the end of 2025 due to tariffs raising the prices of some goods. Therefore, the “inflation pressure” they see in the data isn’t due to Fed policy, it’s due to tariffs, will likely be a one-time thing as the economy adjusts to higher tariffs, and hence won’t affect inflation rates over the long term. Recent revisions in jobs data indicating that the labor market was much, much weaker over the last 12 months than previously known (link) combined with other weakening jobs data suggest that the underlying economy and job market is weaker than previously believed. That’s why they cut.

The Fed’s Precarious Position

Honestly, I’m not convinced. I have the sneaking suspicion that inflation is going to get out of control again. The Fed should have cut interest rates a little earlier this year when unemployment rate went from 4.0% in January 2025 to 4.2% by March (link to Fed Data). The tariff announcements will also harm domestic businesses, not just raise prices.

To my mind, then there was a tangible sign - rising unemployment - and a policy reason - tariffs - to justify a rate cut. Not only that, inflation in January was 2.99%, and fell to 2.4% by March (link to Fed Data).

I really don’t understand why, based on their current logic, the Fed didn’t cut by 0.25 points in Spring this year. An additional benefit would have been avoiding as much criticism from President Trump and team.

Fed Independence

The other problem with their inaction in Spring and action now is that both will be viewed as politically motivated, at least in part. I actually do not believe either action was politically motivated. But that’s just my opinion.

Sure enough, about half the press questions today were about the new Trump appointee, Stephen Miran, on the Fed FOMC (that votes on rate cuts, etc.), the Trump administration’s pressure to cut interest rates further, calls for more Fed review, and so on.

I think the Fed is putting itself, slowly but surely, in a bad position. If they have to cut more and more as unemployment rises, people will think it’s political. If they don’t, it’ll be due to rising inflation and that will be blamed on the Fed, not the politics.

My prediction is that we will see higher inflation over the coming 12 months. I do not think the Fed got inflation under control initially, and now that other economic sands have shifted under the Fed’s feet, it’s going to have some real problems. More on this below.

Fed Independence: An Economist’s Note

There’s a lot of discussion about “Fed independence” right now in the political world. People are shouting on both political sides about this.

In economics, Fed independence means that the Fed should make its regular policy decisions based on data and economic theory, independent of political influence. The problem is that monetary policy is particularly prone to political abuse, because it can have short run effects on employment and GDP, but its effects on inflation will occur with long and varied lags.

In short, you can print money or cut interest rates today and that might juice people up, boosting demand a little, but in about 2 years you’ll just see inflation. Milton Friedman used to liken it to drinking alcohol. It makes you feel good and maybe forget your problems tonight, but tomorrow you wake up still having your problems (the alcohol didn’t solve them) and you have a hangover. Of course, you can take another drink and feel better, but that eventually ends up making things even worse.

A politician running for office, then, will always want to print more money and cut interest rates today so voters in the economy feel good today and forget their deeper economic problems. That may lead to an economic boom today, but will just cause inflation in the future. If you try it again and again, eventually you get constantly declining GDP, persistently rising unemployment and ever higher inflation. See US - and most world - History from 1970 to 1980 or so.

Therefore, economic thinking since about 1980 has been that (1) monetary policy can really only hope to influence inflation over the long run (and actually shouldn’t be used much for short-run employment or GDP goals), (2) that the Fed should be independent of political influence in fighting inflation in order to resist the temptations I mentioned above, and (3) that even the Fed should be restricted to following rules rather than act with discretion. So, we even want policy decisions made independent of the discretion of the FOMC members!

That does not, however, mean that the Fed should be outside of democratic oversight. To the contrary, until the Great Financial Crisis of 2008/09, most monetary economists thought that Congress should set a hard inflation target for the Fed, like 2%, and many economists even proposed that the Fed Chair’s contract be tied to hitting that target and nothing else. If he hits it on average, fine, if not, he’s fired.

Many countries did just that, starting with New Zealand in 1992, then others followed suit: United Kingdom, Australia, Canada, Mexico, the Czech Republic, and many others. Their central banks were held to a hard inflation target, usually 2% plus/minus .25% or .5%. Their central banks had to produce monthly inflation reports, generally presented to parliament, explaining where inflation was and what they were doing to hit their targets. And, if they were constantly missing the target, the central bank chair was reprimanded, then eventually fired.

The US Fed was on the path of adopting an explicit inflation targeting regime, pushed by one of the leading writers on the subject, Prof. Ben Bernanke. Prof. Bernanke’s name might ring a bell because he was the Fed chair - and actively promoting an explicit inflation targeting regime - when the 2008/09 crisis hit, and all such ideas were tossed out the window. Instead, he openly and intentionally, with the support of many academic and policy economists, followed the Japanese model!

That Chair Powell talks about a target at all today is a legacy of Bernanke’s early push, but none of the rest of what we do resembles those old inflation targeting regimes. They were mostly abandoned in other countries during the 2008/09 crisis as well, by the way.

The point here is that economists have a very specific view when we talk about Fed independence. No, most of us do not want the US President deciding or even largely influencing policymaking in real time. The problem is exactly what we are seeing now. That is, when inflation is relatively low, political leaders will always push hard to cut rates and stimulate the economy.

But, most economists also see the Fed’s objectives as being set by Congress. The current dual mandate of stable prices and maximum employment was only set in 1977. And it was set by Congress.

When Argentina managed to end its hyperinflation from the 1980s (over 3,000% a year) it enacted a law in parliament, setting the central bank’s mandate as fixing their peso one-to-one with the US dollar. Inflation dropped like a rock to around 7% by 1993 and then remaining 5% or lower for many years.

Milton Friedman often recommended, half jokingly, that Congress should tell the Fed the long-run inflation rate it wants, instruct the Fed to set long-run money growth accordingly, and then go home. No need for FOMC meetings at all.

Economists have no problem with duly elected political leaders “influencing” the Fed. We just argue that they should set the long-run policy objectives and then stay out. That’s what we mean by Fed, or central bank, independence. Of course, most of us would argue that the politicians should choose objectives like 2% inflation over time. Personally, I would drop the employment goal altogether, but that’s just me.

What Next?

I think we largely broke our monetary framework in 2008/09. I’m more and more convinced of that over time. There needs to be a major overhaul of the Fed generally. I encourage interested readers to see John Cochrane’s Substack. I agree with most of his writings on the topic, but it gets detailed and technical. I am also still more of a monetarist than he is, although I’m a huge fan of his Fiscal Theory of the Price Level.

Essentially Cochrane argues that, if we want to address inflation then we need to address the fiscal mess, as well as set policy rates, and money supplies. We are not currently addressing our fiscal mess and that alone is inflationary. He also discusses other structural issues, the Fed’s role in banking regulation, etc.

I’ll add my monetarist concerns as well. Here’s a graph (link) that I worry about:

That black line represents reserves. Those are the funds (actually the growth rate of the funds) poured from the Fed into the banks directly. See the 2020 and 2021 years when we pumped reserves into the banks? That was to get us out of the Covid recession. That eventually shows up in more money - or cheap credit - in the economy. In the short run it juiced things. Inflation (red dashed line) was low. But the hangover came 2 years later in 2022 and 2023 when inflation was high. Notice we cut reserve growth, turning it negative for 2022 and 2023 and, sure enough, 2 years later in 2024 and 2025 we had lower inflation. The timing is always a little slippery, but the point is that there’s a delay.

Reserve growth doesn’t have to stay negative, but it popped positive again in 2024 peaking around 20% (left side scale). Then it drifted negative, but has been increasing again in recent months.

I worry that we never conquered inflation, but we’re already cutting rates and pumping more reserves into the banking system. I’m watching to see if it continues. If it does, then it will add to my likely causes of inflation to come. We’ll have tariffs, massive government deficits, and lower interest rates, combined with growing reserves.

Conclusion

I know this column was very mixed. Are we doing the right thing? Should we raise or lower interest rates? Do we need more or less Fed independence?

I think monetary policy is, again, late doing the right thing. I think the Fed should have raised rates higher and cut money growth more in 2022 and 2023 to fight inflation. Inflation would have fallen faster and we could safely be cutting rates now.

Because we missed that window, the Fed has no good option. Raising rates would push unemployment higher and drive a recession. Cutting rates will push inflation higher, but not today, and probably have no effect on unemployment.

We need Fed independence. But it would be nice to have Congressional oversight - we do have some - that sets firm targets for inflation for the Fed, and otherwise gives it a mandate to unwind some of the expansion that took place in the wake of the 2008/09 crisis. That same Congress, of course, should also dramatically cut spending to reduce government spending and balance the budget too! That same Congress should undo a lot of the Dodd-Frank legislation that also followed the 2008/09 crisis.

I’m not overly hopeful on any of these fronts. I think we’ll have meager growth over the coming year, around 3% or slightly more inflation, and kick the fiscal-responsibility-can down the road. At some point, though, we’ll have to fix all of this.

Thanks for reading.

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Panel image, left to right: Mr. Bálint, Mr. Bánki, me, and Mr. Mátis.

I was asked to focus on three topics: (1) whether current US policy, including weapon sales to the EU and Ukraine, will weaken the EU over time, (2) whether policy helps/hurts the US dollar relative to the Euro as a global currency, and (3) how policies are affecting “credit quality” around the world.

I thought I’d share a few of my thoughts and comments.

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My Main Trump Administration Basics for International Audiences

I’ve been leading off discussions of President Trump and his administration’s policies for an international audience with a broad blanket discussion of what I think they need to understand. It goes something like this:

First, Mr. Trump believes in tariffs. It’s not a negotiation or diversion tactic. He believes 100% that tariffs will be good for the US economy and will lead to re-shoring of industries.

My only recommendation and hope, to be honest, is that the EU and other countries don’t fight too hard, because Mr. Trump will definitely retaliate. For me, the sooner we can get past the current global tariff-trade war, the better. From there, we can see what the new world looks like and hope for a more trade-friendly administration in the future3.

Retaliation by the EU in the next round of “talks” with the US will only get us 50% US tariffs, then 100%, then more until the EU caves. President Trump will not. It’s important to understand this mostly because I’m selfish and really don’t want to live through a serious global trade war. The one we have is bad enough.

Second, those of us who believe in Atlanticism need to develop new arguments for the MAGA crowd. Everyone was surprised that the President went after friends and foes equally in his tariff war. Why friends and traditional allies of the United States?

The MAGA world sees the world from a very different lens than we are used to. In today’s MAGA view, the global world order was constructed in the wake of WWII. The US wanted to help Japan rebuild, Germany and Europe to rebuild, and to help our allies become economically and militarily stronger to offset a powerful Soviet Empire. To facilitate this, the US opened its markets to our friends and allies and were okay foregoing reciprocity in the name of helping these countries develop post-war.

But how long should one help a friend get back on their feet? Is 10 years enough? 20? 30?…even at 30 years, post WWII, you are only at about 1980.

Today, in 2025, it’s essentially 75 years (counting to 1950, to keep numbers easy). In the MAGA view, over that time, the relationship went from helpful to dependency and abuse. We opened up and helped you, but you didn’t open up and help us.

As they see it, today we, Americans, pay for the majority of everything in the world (NATO, UN, World Bank, IMF, and so on) and everyone else benefits at our expense. Whether we agree with this position or not, it’s important to understand. This is how they see our relations with our allies, our “friends and family” so to say.

Why punch our friends and families in the face first with tariffs? Well, the MAGA response is essentially, “exactly because these friends and family are the ones who took advantage of us most over the last 50 years or so. Therefore, we should start by fixing our family issues and set things on more fair footing.”

They see tariffs and current trade negotiations (along with NATO, etc.) as fixing long-standing wrongs. But just like in a family squabble, we can both love our siblings and “fight” with them.

And that’s one piece I think international audiences should understand in dealing with President Trump. He can both like you as a friend and negotiate harshly over trade. He’s a businessman. There are friends and family and then there is business. One, in his mind, may not always lead to the other the way non-business people might expect.

What would be my recommendation out of all this? I don’t know. But, I do know that appealing to long-standing tradition, common history and common values is pointless. His administration may or may not see or even agree on those things but, either way, they won’t affect tariffs, trade and the impetus to re-shore American business.

International audiences don’t like hearing some of that, it makes them angry and leaves them feeling a bit helpless. But I feel its important to say. Many of my international friends and colleagues still think Mr. Trump is posturing or has some other thing in mind like hurting the Chinese. The Chinese are of course important, but the point of MAGA is to make AMERICA great. That’s the number one point and number one interest and the President believes tariffs are the key. We need to understand that and deal with it from there.

The Other Three Topics in Short Order

Now, to address the other three topics as quickly as possible.

First, Europe.

I am worried more today, economically, about Europe than the US. Europe is still (or, again?) suffering from Eurosclerosis, the disease of bureaucrats run amok. It comes with undynamic economies that are over-regulated and under innovative.

The Draghi Report of 2024 highlighted exactly this problem. His Foreword alone says volumes:

“Europe has been worrying about slowing growth since the start of this century. Various strategies to raise growth rates have come and gone, but the trend has remained unchanged.

Across different metrics, a wide gap in GDP has opened up between the EU and the US, driven mainly by a more pronounced slowdown in productivity growth in Europe. Europe’s households have paid the price in foregone living standards. On a per capita basis, real disposable income has grown almost twice as much in the US as in the EU since 2000.”

Much to everyone’s surprise and consternation, the economic engine of Europe, Germany, also seems to have stalled. The Europeans had gotten used, I think, to always falling back on German growth. Whether that’s still possible is now in question.

This is a problem for Europe generally, and for Central Europe specifically (since my talk was in Romania and focused on a Central and East European audience). Central Europe relies on exports to Germany and to playing a serious role in many German supply chains, namely automotive ones. And the global automotive industry is in upheaval with US tariffs, Chinese competition, and a move to EVs.

Add to this the problem that, since Covid especially, every country has been piling on debt like there’s no tomorrow and we have real problems to deal with.

Romania is running deficits near 9% of GDP and just had a mild financial crisis, finally just now announcing an austerity package. That will mean higher taxes and massive spending cuts to balance the budget in Romania along with higher interest rates to stave off inflation. That means a very, very painful coming 12-18 month. That will be brutal. I truly feel for all my friends in Romania.

Hungary has been piling on debt in recent years and we are slowly entering an election season. Poland has been doing the same. And, today, with the additional NATO spending and fight against Russian aggression that also requires a change in energy policy, western European countries are adding debt as well. The latest German plans include increased government spending and more debt.

England is doing the same and already having trouble almost weekly, it seems, with bond market sales.

And…to be fair… the US is running government deficits of 6-7% of GDP, alarmingly high and unheard of outside of times of war. Our debt is over 100% of GDP and we worry daily about being able to sell the next round of Treasuries in world bond markets.

This is unsustainable. Period. It cannot last and I sincerely hope people begin to demand their governments address this. They need to cut spending dramatically while things are still relatively good.

Just look at Romania’s austerity package and coming year of hardship if you want to see what it looks like when you are forced to fix things. Romania has no choice but to dramatically raise taxes while also cutting spending. The rest of our governments can still get away with reducing spending and not killing the golden economic goose with super higher taxes, but time is running out.

So, I worry a lot about Europe. There are also new challenges coming from the Trump administration, but the real problems are long festering problems in Europe. Trump policies are just the icing on top of an already problematic cake.

Sadly, I will add here - although I did not mention this during my talk due to time being short - that all the proposals I hear from Europe to improve growth are to increase government spending to invest in innovation. This was in the Draghi report and it’s in nearly every discussion I hear. This will not save Europe and certainly won’t help in a time when governments are already running out of money.

Second, the US dollar vs the Euro as “global” currency

The question here is fundamentally whether all the current Trump policies will hasten the decline of the US dollar as the global currency4.

In short, I don’t think the US dollar is in permanent decline. As other currencies, like the Euro, have grown in global prominence they have naturally grown in usage and as a percentage of international reserve holdings. But I don’t see anything major that displaces the US dollar from it’s overwhelmingly dominant role.

This, however, is conditioned on the Trump administration and who follows. There is a view in MAGA world that the US dollar as a global currency requires the US to run both government and trade deficits. This is not usually voiced by President Trump himself, but is connected to his advisors who wrote the “Mar a Lago Accord” (Wikipedia link) which lays much of this out. There is therefore a connection between tariffs, ending trade deficits and the role of the US dollar in the world economy.

If some of these policies persist, I can see a slow decline in the role of the dollar. The Euro could rise in prominence, but I suspect there would be an emerging market move toward the Chinese and other BRIC currencies along with the Euro. I don’t see that today. If those policies end with President Trump’s term, then I don’t see this scenario as likely. But if the next administration sees things the same and we indeed have the next 8 or 12 years of intentional anti-trade, anti-US dollar policies, and only destroy but don’t rebuild global financial institutions, then I could see problems on the horizon for the US dollar as the global currency.

Finally, credit quality.

This topic is tied to the US’ sliding credit rating which has been happening slowly for decades due to our bad fiscal policy situation (i.e., high government budget deficits and ever higher debt). I touched on this earlier and therefore only add that, if governments don’t start reducing their spending now and balance budgets over time, we will only continue to see an erosion of global debt quality and eventually be forced into a crisis.

Conclusions

I know what follows will seem like a turn to left field, but I’m sick of writing about problems and complaints. Mr. Bánki discussed a number of topics and how Hungary can be agile in responding to global change. Mr. Bálint discussed the Romanian economic problems and austerity package but then turned to broader topics regarding AI, how we respond to global warming and other fundamental changes underway. Both, rightly mentioned positives, not just negatives.

So, my final comments are these.

First, let’s recognize the gains we’ve had recently. The Covid pandemic is over. Yes, we have fiscal problems, but we also had super high inflation and that has largely been conquered in most countries. And it was done without driving a global recession, which was a serious concern. So, let’s be thankful for getting this far.

Second, while I disagree with the MAGA interpretation of history where the US plays the victim, it is true that most of today’s global institutions were shaped around the World Wars. They are structured around the old world, not the new. They probably need to be rethought and restructured.

The Trump administration is going to challenge all current global arrangements, but it is up to us - and I mean me, other Americans, Europeans, and all the citizens of the world - to decide what the new institutions should look like. If we believe in Atlanticism, then let’s fight for that and find the path forward. If we believe in global trade, then let’s fight for more free trade among willing nations. Europe could open its doors to free trade with any country interested. I’ll bet there’d be a line waiting to sign up. It’d be good for European growth and good for global well being.

In the end, “we the people” elected President Trump. “We the people” elected Prime Minister Orbán in Hungary. “We the people” elected Chancellor Merz in Germany, Prime Minister Starmer in the UK, and so on. We have a voice. Let’s take this time to reassess things honestly. Let’s decide what we want to see and not just complain about what we do see.

Third, AI and decentralized technology movements are revolutions we are all living through now, whether we realize it or not. They will transform the world in ways we can’t even imagine. In terms of their long-term effects on our lives and the lives of the next generation, they will dwarf anything any current government or administration does.

I also pointed out that those are good opportunities for the people of Central and Eastern Europe. That part of the world is full of people talented in math, computer science and the physical sciences. Those new worlds are inherently global in nature. Anyone can participate in the decentralized crypto worlds. Entire decentralized economies are being built right under our feet and anyone can participate.

AI is transforming industries and jobs. Yes, a small open economy, like the ones in Central and Eastern Europe, need to be careful to have diversified economies so they don’t accidentally see a large industrial sector wiped out, but this again plays to their strengths. The more you know about coding, computer science and the like, the better able you are to leverage AI to build businesses.

Yes, the world is in flux today. Okay, fine, it’s chaotic today! But change also represents opportunity and let’s not forget that.

I closed with the following “And in the meantime, I wish you all good luck in the upcoming EU-US trade negotiations! Let’s hope we all survive them well.”

Thank you.

As we all have been learning, it’s a new world out there in almost every way. Economically speaking, everyone expected some sort of US recession in the past year or so as the Fed raised interest rates rapidly and high. But no, no recession.

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Inflation and Tariffs

Likewise, everyone has been watching for US tariffs to raise the price of US goods and for us to start seeing that in the macroeconomic data, namely the Consumer Price Index (link: CPI). The latest CPI report came out today but really doesn’t show much.

I don’t think we can claim to see the tariff effects yet. The latest CPI report shows a month-on-month increase of 0.3%, exactly what market forecasters expected, and annual inflation ticked up from 2.6% to 2.7%. That’s a trivial up-tick and could easily be noise.

Last July, inflation was 2.9%. Then it dropped to 2.6% then 2.4% by September only to rise again to 3% by January this year. Since January it’s fallen to 2.3-2.4% or so where it has stayed the last few months. Could the rise to 2.7% be something meaningful? It could. But it could also just be noise. Since we can’t tell them apart, I prefer to say “we can’t tell them apart, so I can’t say I see anything meaningful yet”.

If you WANT to see Tariffs in the CPI

A lot of political pundits will argue they see tariffs in this report. Even the Wall Street Journal is arguing that, maybe, just maybe… So, if you really want to see them, then here are two pictures (both from BLS website: link).

Here you at least see the breakdown. The 2.7% number is shown in “All items” (red bar). You can see that it would be closer to 3% inflation except that “Energy” fell by -0.8% annually.

I dug into the “All items less food and energy” and don’t find anything exciting there. But in “Food”, you can find a breakdown that might, possibly be tariff related, but (again) I don’t know if that’s the case for sure. Anyway… here it is:

Here’s the breakdown of the “Food at home” category which is up 2.4% overall. The “Meats, poultry, fish and eggs” category is up 5.6% and the “Nonalcoholic beverages and beverage materials” category is also up 4.4%. But, I have no clue if that’s tariff related and, honestly I suspect no.

In fact, when I pull out those prices over time I get this graph (same BLS site):

The volatile, dark blue, line is “eggs”. There were spikes leading up to this June and June 2023. “Chicken” (the bottom, yellow line) has been slowly rising up to the $2.00 mark for about 4 years. Finally, the top, red, line is “Milk” (the only non-alcoholic beverage price they show…although admittedly not likely what they or I had in mind) also seems fairly stable around $4.00 the last few years. So I don’t really see a “tariff spike” here.

My conclusion: We aren’t seeing the effects of tariffs yet. If we are, it’s small and lost in the month-to-month noise.

Why and When

The next two natural questions are: Why don’t we see them? and When should we see them?

Personally, I thought we would start to see some effects by the end of summer. So, I thought we might, possibly see some effects in the July CPI, which is released in August, or the August CPI, released in September.

My reasoning was based on two things. First, businesses imported a lot at the beginning of the year in anticipation of tariffs. Second, I think some of these macroeconomic effects are slower to materialize than we generally believe. Let me elaborate on each of these.

We often underappreciate what economists call “anticipation” effects. Economists consider something a “shock” or “surprise” when it is believed it will happen. That is, if Congress announces a change in taxes that will go into effect in, say, 6 months, then the effect of this policy will start immediately upon the announcement. Or, if we all watch the proverbial sausage being made in Congress and see it more and more likely to pass, then the effects will happen as we believe the tax change will be likely.

This is why stock markets might rally on the anticipation of a presidential candidate winning office or the anticipation of a law change or something. It’s one reason stock prices are so hard to make sense of on any given day. They move based on market participants’ expectations about the future, and we, outside observers, don’t know what they are expecting. Could be anything!

Anticipation effects can also move things in the opposite way one would expect. Now, I do not know if this is happening with tariffs, but let me walk you through a plausible scenario that could actually generate lower prices today: (1) Businesses import extra stock in anticipation of future tariffs. (2) Consumers pull some purchases forward to buy before the tariffs raise prices. Action (1) increases the supply of those imports and could easily lower their price in domestic US markets (i.e., more supply, lower prices, all else equal). And, action (2) while possibly raising prices on those imports initially - which could be offset by the extra supply - means lower demand for those imports later. So, if the timing works out, we could see extra supply push prices mildly lower early and lower demand later (as businesses deplete their extra imported inventories) pushing prices down again. That would mean lower prices due to tariffs in the short- and medium-term but a much bigger spike later when those effects wear off.

Again, I have no idea if that happened or is happening. But that’s kind of the point. We don’t know all the details. We just watch monthly CPI numbers and look to see if the effects are showing up. This lower price story is just as likely as any other at the moment.

So…for me, I’m going to continue to watch and see. It’s why originally I expected all those effects to play out over, say, 6 months or so and why I thought maybe by end of summer we’d finally start to see clear effects.

And now, Trump delayed some again, threatened more and … who knows what tomorrow will bring. The delay in implementation in April certainly postponed the big effects and caused another round of anticipation effects that are hard to predict.

For now, I’m still expecting some effects by August or September, but who knows. That may get delayed further.

What we do know is that, if you tax imports (i.e., tariff them) then the price of those imports will rise. By exactly how much is not known for sure. It depends on each market’s unique conditions. But 10% tariffs will should have some effect. 30% tariffs should have more effect.

And, some imports go directly to the shelf and we’d see the price rise more clearly. Others are just inputs to other products and we won’t see those as clearly since the final product’s price might only rise a fraction to account for some inputs being more expensive.

I do expect to see it, but it can be slow in coming.

Currencies and Central Banks: What I’m Watching

There’s one other interesting factor at play and I currently am not sure what to think, to be honest. That is, the US Fed has left interest rates constant. If inflation is rising, they should raise interest rates to fight inflation. If unemployment rises, the Fed might cut interest rates to stimulate the economy. Trump, as we see publicly, is pushing the Fed to lower interest rates because he also wants to stimulate the domestic economy. That would also potentially raise inflation.

From our perspective of watching for the tariffs to show up in CPI numbers this is just more noise. Anticipation effects can play a role here. If everyone believes the Fed will cut interest rates either for their own reasons or due to political pressure, they will start to act on that anticipation as well.

And, we haven’t mentioned the “Big Beautiful Bill” which is a very, very mixed bag of spending increases, cuts, reallocations, tax gimmicks, legitimate changes, and so on. All that will also move prices around.

These are noisy times. I guess that’s the point. So, we keep watching for the tariff effects, but there’s lots happening all at once.

One odd thing happening is that the US dollar has also been weakening all year. This is wholly unexpected and likely reflects political blowback to Trump’s aggressive and erratic behavior toward long-time partners. It wasn’t clear to me that the USD should strengthen or weaken relative to most countries, but this general weakness has been relatively clear and pronounced.

The US Fed, thankfully, doesn't consider USD movements when setting interest rates and targeting domestic inflation. We don’t want the Fed to, just to be clear. They should focus on domestic inflation and domestic unemployment. The exchange rate bounces around as sort of a relief valve, protecting the domestic economy from many global shocks. We should let it.

But, in Europe, this has meant a stronger and stronger Euro relative to the USD. The ECB just said it is considering cutting interest rates because the strong Euro is getting inflation too low in Europe.

I’m worried about Europe. It’s an economic mess, and Germany, Europe’s traditional engine of growth, is suffering from slow exports and a range of domestic problems. So, I watch and wonder about the effects of a strong Euro and weaker Europe and what it’ll mean if the ECB does cut rates due to the strong Euro.

I hope to write more about Europe and the global economy soon. Today I was asked to watch the CPI numbers and send some comments, so I thought I would and share my thoughts.

To close: I don’t see tariffs yet. The data is super noisy and, in some ways, getting noisier by the day. I’m watching the FED, ECB and what happens with our Big Beautiful Bill. And, generally, I expect to see tariff effects in prices materializing by end of summer/early Fall. But it’s so hard to know. Did I mention these are noisy times?

Thanks, as always, for reading.

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I thought I’d take a second and just share, then, what I’m watching and worrying most about today: interest rates.

Photo by Kelli McClintock on Unsplash

There are two reasons that I am watching for rising interest rates. First, is that I worry world markets will lose faith in the US government’s fiscal stability. Second is that we are trying to close the door on international funding to the US by moving toward trade balance or, worse, surplus.

US Government Spending

Debt is more than 100% of GDP and our deficit is at all time, non-war highs around 6% of GDP and likely to stay there or even rise to 7% of GDP.

Here’s our government’s deficit to GDP (link).

The US had a surplus starting in 1929, but then ran a deficit of -5% of GDP during the Great Depression. It then dropped dramatically during WWII to over -25%. Post War, it turned positive and fluctuated around zero until the 1970s.

Starting in the 1980s it clearly moved more negative and stayed there until the 1990s. You can see the glimmer of financial hope in the late 1990s after major US government spending reform. Our government actually ran a surplus for a few years! Amazing.

Back to the ‘80s. That early 1980s period is when the economy hit a major recession and we fought massive inflation and tried to rebalance the macroeconomy. It was also a period of massive defense spending buildup to fight the Cold War with the Soviet Union.

It’s worth noting that a deficit of -5% of GDP was historically associated with THE GREAT DEPRESSION … let that sink in…. and during the early 1980s to fight a major recession and a Cold War. Reagan was heavily criticized in the 1980s for letting the deficit get so bad. George W. Bush was similarly criticized in the early 2000s for letting it hit -3% in the 2003-04 period during the War on Terror, Iraq War and so on. Minus three percent for all that!

A -3% deficit to GDP was considered really, really bad. Then the Great Financial Crisis hit and we seem to have lost our collective minds. The problems got much worse starting around 2008. The Great Financial Recession was followed by an expansion of government services, entitlements and national health care (in its many forms). We have never recovered from this unsustainable expansion of government.

Debt is like putting on weight. It’s easy to pile on and slow to get rid of. In the case of debt, you also accrue interest so it just grows and grows unless you actively pay it off which requires running an actual surplus! The next graph (link) shows the US piling on debt without any concern, it would seem. We are now over 100% of GDP.

We were already at 100% of GDP around 2012 and it continued to grow. That’s pre-Covid. Let that sink in too.

The problem is that we show no signs of slowing down. DOGE or no DOGE, cut some money or not, no one is actually reducing government spending for real these days.

Yes, economic growth will help pay the debt, but it does not solve the underlying spending problem. Debt has been growing by around 5-10% a year since 2010 or so. GDP will need to grow by more than that just to halt the growth of debt to GDP. GDP needs to grow more than that AND we have to run government budget surpluses to actually pay it down. And no one sees that happening anytime soon.

Here’s the US government’s own predictions. And, before you claim it’s politically motivated, this graph has looked more or less the same since before the first Trump administration. I used to share a version of it in my classes back in the 2010s when our commitment to government largesse put us on this path. Again, this graph is from the US government’s own budget office (link).

This is due to spending. Covid here is a bump, not the trend. Also, it’s not a revenue problem. Here’s the other CBO graph to see:

The top line, “Outlays” (spending), is rising and so is the bottom line, “Revenues”. Both are as a percentage of GDP. The side notes are worth reading: Interest outlays rise to 5.4% of GDP and outlays on health programs climb to 8.1% of GDP.

Simply put, this is unsustainable.

Debt and Deficits in Context

To finance that, the US government must either raise taxes, print money or borrow. Currently we borrow. And, when lenders become concerned about the credit worthiness of the borrower, they raise interest rates.

The US government has already been dropping in its credit ratings. Just search for “US credit ratings”. We’ve gone from premium and safe to ehh… a little less so. I worry that we’ll decline more.

So, if lenders worry about our credit worthiness because we vote for politicians to spend like proverbial drunken sailors, then demand for our debt declines, pushing down the price of our debt and that pushes up interest rates.

This is the first reason interest rates could rise. And this is a key reason I watch them.

But, for broader context, the US sells debt into the global debt markets. We have a lot of competitors in that global market because other countries are selling tons of debt too. They too want to debt-finance their overspending. If this trend continues, this should also raise interest rates as we all compete for a limited supply of funds.

Here’s the IMF’s note on global debt to GDP (link).

That “WEO” is their "World Economic Outlook” estimate. They make these calculations every year. This graph shows what they expected in 2019 compared what happened for 2020-2024 and as they see it going forward.

It’s important to note, again, that the expectation pre-Covid was already for growing debt to GDP. The Covid bump might be forgivable, but it doesn’t excuse the increased rate of growth post-Covid or the general trend pre-Covid. This is a long-running problem that just got put into high gear.

Everyone’s selling debt. Europe is struggling economically and also trying to increase defense spending in the face of an aggressive Russia and a less committed America. They need to borrow a lot.

Japan is struggling economically. Already at over 230% debt to GDP, they need to borrow more as well.

A sudden increase in countries peddling their debt in world markets - especially large economies like those in Europe, Japan, and so on - combined with growing US debt sales of less credit-worthy debt and we have trouble brewing!

This is the first reason I’ve been keeping an eye on interest rates. I worry about our fiscal sustainability and world markets one day backing off. For example, something crazy could happen like the US could irritate our major allies and they could decide to buy less of our debt. The Japanese and Chinese governments are the biggest governmental buyers.

Anyway, things can change rapidly and we are skating on ever thinning financial ice.

Trade and Capital Flow Reversals.

As I explained in a previous column, (Net Investment and Trade Deficits) the trade deficit1 and financial investment into the USA are intimately related. If you eliminate trade deficits you will eliminate net inflows of global investment into the USA. Again, I wrote on this previously as well (Did capital outflows from the U.S. already start?). Here I repeat myself but with a slightly different approach.

The more the US economy moves toward smaller trade deficits or even surpluses, the less global money will flow into the USA, net. If the US dramatically increases outbound investment we can still have lots of inbound investment but today we have a lot of inbound investment into America relative to our outbound investment and that would have to stop if trade balances.

One person’s investment funds is someone else’s savings. Here I’m using the economist’s restricted definition of investment as “investment into businesses, capital, equipment2, R&D, etc.”

The key then is people’s willingness to “save” money and provide investment funds for all the businesses around the world. When I have money in my hand, I can either use it to buy something to consume or I can save it3. Whatever I save gets used by a business to invest.

The US savings rate is around 5% today but our investment rate is around 17% of GDP. Now, these two measures don’t line up 100%, but they are easily obtainable and give you a sense of the issue. Here’s a graph (and a link).

The top, dotted, line is private investment as a percent of GDP. You can see that it’s pretty consistently around, say 15-20% of US GDP back to at least 1960. Where does the money for all that investment come from? Someone’s savings.

You can see that the domestic US personal savings rate4, the middle, solid blue line, was around 10% but began falling around 1980 and seems to have settled around 5%. If domestic residents aren’t supplying enough savings to finance all that investment, it must come from global markets.

You can see the global markets funding our investment in the bottom, dashed red line, net exports as a percent of GDP. You can literally see our trade deficit worsening as that savings rate drops from, say, 1980 onward.

The Covid spike was an anomaly. It’s due to that huge spike in money transferred from the government to the population which people mostly saved. That bled into inflation later.

The better measure to show this is actually the current account, but FRED only has data back to 2000 or so. If I add that to this exact same graph (link here), you can see it’s lower than the trade deficit and better accounts for that 15-20% investment vs 5% savings difference.

The current account includes the trade deficit plus “interest-type payments” to the rest of the world (see my footnote 1). In theory the current account equals the total amount of global capital flowing into the USA.

Think of US domestic savings plus global savings as the total amount of funds available for US domestic businesses and government to borrow. Businesses borrow it to invest in capital, equipment and R&D. The government borrows it to finance its deficit.

If you force that international door - net exports (or current account) - closed by requiring a trade balance, then US domestic savings must increase from 5% up to the 15-20% if you want to keep the same level of US investment.

If you add the amount the US government needs to borrow from that same market, then THE ONLY WAY to run those government deficits without either dramatically diverting funds away from US investment or requiring a massive increase in domestic savings to pay now for both US business investment and US government deficits, is to bring the funds in from abroad via that international door.

The Point

I guess you can see the point already. The supply of funds needed to finance both business investment in the USA and government deficits is fragile at the moment for three reasons. The first two are self induced. The third accidental, so to say.

First, the US government is committed to overspending at levels never seen outside of time of war or financial crisis. But the American voter insists our political representatives federally and locally give us as many goodies as they possibly can without us having to pay for it (today). We want foreigners to pay for it today and we’ll pay them back later. Later, however, is getting closer by the day. As it does, the US’s credit worthiness declines.

Decreasing our credit worthiness decreases demand for our debt, lowering its value in the market and requiring us to offer a higher interest rate to get people to buy it (i.e., lend us money).

Second, closing the international door to funds we need will obviously reduce that supply of funds. And, today, closing that door as much as possible seems to be popular across the US political spectrum.

Reducing the trade deficit decreases the supply of international funds to the USA. This means competing demands fight for a shrinking supply requiring everyone to offer higher interest rates to attract the funds to them.

Third, and returning to the IMF graph, other countries are doing the same. They are overspending and trying to borrow more in the same world markets we borrow.

Finally, other countries are additional demand for those same global funds. Raising demand will, again, require everyone to raise interest rates to attract those funds.

Conclusion

I’m watching interest rates. I don’t think we are in crisis today, but I worry more and more every day that we are closer than we think we are. Crises have a way of sneaking up on you then pouncing.

We see interest rates rise and say it’s nervous markets which is likely true. Then we see them go up because the Fed keeps them high to fight inflation which is also true. Then they go up because Germany borrows to finance more military spending which is also true. And so on and so on.

At the same time we watch the government decide to borrow more, raise the debt ceiling and refuse to reform anything fundamental. They are rearranging chairs on the deck of the Titanic.

It worries me every day. So, I watch the interest rates.

Side note: For anyone interested in reading accessible material about ways to fix our government spending problem, I recommend Les Rubin’s book, The Greatest Ponzi Scheme on Earth: How the US Can Avoid Economic Collapse (Amazon link), it’s solid, nonpolitical and contains tons of practical examples from countries that did solve similar government spending problems over the years. If you don’t want to buy the book, check out his site which is free and open. He writes on this all the time: Main Street Economics. To channel Les here, “there are solutions, just learn basic economics and use common sense”.

Thank you so much for reading.

Honestly, I thought someone would have taken a minute and done this by now, but they haven’t so, here it goes.

The table below uses data from the US Federal Reserve Bank of St. Louis’s data base (FRED) to get imports to the United States by country. We matched that with GDP for these same countries from the World Bank data base.

Keep in mind that these are quick, “back-of-the-envelope” calculations. We tried to keep the years the same and ensure we were using similarly measured nominal values for both the import measure and the domestic GDP measure. But, this isn’t a scientific report. I’m not concerned that the numbers are exact, but they are all in the ballpark, so to say, and the relative magnitudes are accurate and relevant.

With that caveat, the idea is to take the total amount the country exports to the USA (i.e., “USA imports from country X” in FRED) and see how important that is for their local economy overall. Hence, we divide exports to the USA by local GDP. The table ranks the country’s by that.

Not surprisingly Mexico and Canada are at the top. (If you want the global list, leave a comment and I can hyper link to the excel file. The globally top country, for example, is actually Guyana, but the list here is focused on more relevant geo-political players…sorry Guyana.)

I highlighted the countries we are currently hearing about in the news. Mexico and Canada are there. Their exports to the USA are about 20% of their GDP. That’s huge! A trade war with the US would cripple their economies. Interestingly, US exports to each country are 17% of Mexico’s GDP and 15% of Canadas, so, also large and relevant, but small as a percent of US GDP (which I didn’t calculate). All the leverage here is on the US’s side, clearly.

Colombia was threatened with tariffs and trade trouble recently, so I highlighted them as well. Colombian exports to the USA are around 5% of their GDP, also significant.

Denmark is under some US pressure these days as well and trade with the USA is important, but only 2-3%. The same is true for Germany and France, somewhere around 2-3%. That’s important, but not life threatening.

A trade war wouldn’t put those to zero, but could lower them. We don’t actually know by how much, so let’s say, by half. That would be about 1% point off of GDP. Currently Germany is in recession with two years of negative growth and France is struggling as well. So, the leverage is there both on these basic economic terms and due to their current precarious situations.

Conclusions

I just wanted to share this so you can look for yourselves. I think it gives some insight into the countries with which the current US administration are most likely to use tariffs for leverage.

China is only 2%, but I do not trust any Chinese data, so take that with a grain of salt. But it’s possible.

Otherwise I think this is a simple and interesting insight into where we might see tariff pressure campaigns and why. Think of it as the US trade/tariff leverage list.

Thanks for reading.