Three Puts To Rescue The Global Economy?

Don't bet on Trump, the Fed or Xi Jinping to pull the world out of the tariff disaster

Photo by Jametlene Reskp on Unsplash

A warm welcome to the many new subscribers over the past week and apologies to long-standing subscribers for the lack of a regular Sunday newsletter this week. What follows is a few thoughts on the current state of play in the tariff wars. If you find it helpful and you can afford it, please do consider becoming a paying subscriber. And even if you can’t, then you can still support my work by sharing this post with anyone you think might be interested. As ever, I look forward to your comments!

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This week has certainly got off to a much calmer start in the markets after the wild gyrations of the last two weeks. US stocks, for example, have now risen for two day trading days in a row for the first time since “Liberation Day” on April 2. The S&P 500 has now recovered to just under 5 percent beneath its level at the tariff announcement, albeit 12 percent beneath its mid-February peak. Bond markets have also stabilised. And the US Treasury 10-year bond yield, which rose by 0.49 percentage point last week, the biggest weekly rise since 2001, has now fallen back by around 0.14 percentage points.

So crisis over? Not necessarily. First, one exception to this pattern remains the dollar, with the dollar index falling to a 3-year low yesterday. That suggests that investors are still nervous about the outlook for US assets. Second, one only has to look at the notes being published by investment banks to see that no one in the financial markets has any idea what is going on. Indeed, Wall Street and the City have consistently misjudged the Trump administration, unwilling to believe that the president would really follow through on his crackpot theories.

A good way to think about where the markets and the global economy might go from here was suggested by Nouriel Roubini, the emeritus professor of economics at New York University’s Stern School of Business, in the discussion that I moderated with him at the Delphi Economic Forum last week. He talked of the “three puts” that investors are counting on to draw a line under the market volatility and limit the economic damage, a “put” being financial speak a trade that caps your losses in falling markets. There is the Trump Put, the Fed put, and the Xi Jinping put. It is worth taking a look at each of these in turn.

1. The Trump Put

The Trump put is based on the idea that there is a limit to how much damage the president can cause before he runs into various guardrails - pressure from the markets, from businesses, from Republicans, from donors - that force him to reverse course. We got a first instalment of the Trump put on Wednesday last week when, in response to the extreme meltdown in the US Treasury market that threatened to tip the global financial system into a crisis, he announced a pause on his “reciprocal tariffs” on everyone except China.

We got a second instalment on Friday when under pressure from Apple and other tech companies he announced an exemption from the 145 percent tariffs on imports of electronics from China. Then yesterday we got the news that he was considering a special deal for automakers. That has raised hope that we are past “peak tariff” - hopes fuelled by claims that the administration is making progress on negotiating trade deals with some of the countries clobbered on April 2.

Nonetheless, this may be more wishful thinking. Even after the pause, the average US tariff rate is still an eye-watering 27.5 percent, reckons Goldman Sachs. That falls to around 16 percent when you adjust for a collapse in trade with China, but that is still around five times what it was before the inauguration and not far off 1930s Smoot-Hawley levels. And there is always the possibility that some tariffs will be reinstated. The EU, for example, says that trade talks are going nowhere.

Meanwhile US policymaking remains patently chaotic. It is astonishing that it did not occur to anyone in the administration before it slapped a 145 percent tariff on Chinese imports that the US electronics industry remains entirely reliant on imports from China and that the consequences of these tariffs for companies such as Apple would be disastrous. Yet even this reprieve for the electronics sector has created a fresh anomaly, as Paul Krugman has noted:

For electronics, at least, we’re now putting much higher tariffs on intermediate goods used in manufacturing than on final goods. This actually discourages manufacturing in the United States.

What’s more, the reprieve for electronics turns out to be temporary. Smartphones and computers are to be caught by another package of tariffs on semi-conductors that may come this week. “NOBODY is getting “off the hook” for the unfair Trade Balances,” Trump posted on Truth Social, “especially not China which, by far, treats us the worst!” Similarly, a reprieve for automakers is likely to be time-limited. “I don’t change my mind, but I’m flexible,” Trump said.

Indeed, Trump hasn’t changed his mind on anything since the 1980s, when he first developed his obsession with trade deficits and the notion that other countries are ripping America off by providing it with goods that it wants at cheaper prices than Americans can make them for themselves. That should worry those betting that the Trump put will cap their losses.

This is patently an administration that is making it up as it goes along. Tariffs are announced and then withdrawn, seemingly on a whim, without explanation. But one thing remains constant: Trump’s determination to eliminate trade deficits, reshore manufacturing jobs and raise “trillions” of dollars of revenues in the process. All that will require tariffs to remain very high on a permanent basis.

In other words, the Trump Put may provide some protection against the sort of extreme financial market volatility that we saw last week, but it provides limited protection against severe economic pain - or what Trump calls “medicine”.

2. The Fed Put

If the jury is still out on the Trump put, what about the Fed put? This rests on the idea that the US central bank will always ride to the rescue of the markets and the US economy. This has been a reliable one-way bet since at least the 1980s, when it was known as the Greenspan put, after former Fed chairman Alan Greenspan, now best-remembered for inflating the giant bubble that burst in 2007.

Today, there are three types of Fed put that investors are counting on:

Interest rate cuts: This is the classic version of the Fed put. If and when the economy starts to slow as a result of Trump’s monumental act of self-harm, then other things being equal, investors would expect the central bank to cut interest rates which would be good for stocks and bonds. But other things are not equal because Trump’s tariffs are bound to be inflationary, at least in the short-term. Also, there is a complete lack of clarity over the endgame for US tariff policy.

Goldman Sachs, for example, says that as a result of last week’s pause, it now reckons there is a 45 percent chance of a recession, and that US interest rates could be flat for the remainder of the year or be cut by 2 percentage points. In other words, it doesn’t have a clue how things will play out.

What seems certain is that the Fed will want to wait to be guided by evidence of how Trump’s tariffs are affecting the real economy. That rules out emergency rate cuts. Indeed, some economists are even starting to wonder if the next move in US rates will need to be up. The reality is that this time may be different.

Market intervention: Another form of Fed put would be direct intervention if there is another market meltdown. It is confirmation of just how close we came to this last week that Susan Collins, the head of the Boston Fed, felt the need to reassure the readers of the Financial Times on Friday that the central bank “does have tools to address concerns about market functioning or liquidity should they arise”. That statement would have been more reassuring if it had come from the New York Fed which has actual responsibility for maintaining financial stability.

Such an intervention would be akin to what the Bank of England had to do during the Liz Truss debacle. That operation was a success, but as Sir Paul Tucker, the former deputy governor of the Bank of England, noted in this forensic analysis of the episode, that success was not guaranteed. It hinged on the BOE limiting its gilt-buying operation to one month to allow time for pension schemes to unwind highly leveraged Liability Driven Investment funds. Had the BOE been unable to end the intervention on time, its credibility would have been badly damaged:

Only the governor can know whether he called it right or got lucky, but the effect was salutary. Confidence in the monetary authorities was boosted, which, even if only a gift from the gods, helped turn the tide.

If the Fed had to intervene in the Treasury market, would it be so lucky? The danger is that any intervention would need to be larger and longer, and thus indistinguishable from restarting QE at a time of rising inflation. That in turn would further erode confidence in US policymaking. So while this version of the Fed put may exist, the Fed will be extremely reluctant to exercise it.

Bank regulation: There is a third version of the Fed put that seems much more likely: a reform bank regulations that would allow banks to buy unlimited quantities of Treasuries and thus provide liquidity to the market by holding more bonds on their balance sheets. This can be done by excluding government bonds from calculations of the so-called supplementary leverage ratio (SLR), a post-global financial crisis rule change that was designed to cap overall bank leverage.

There is a precedent for this: the SLR was suspended for a year at the start of the Covid pandemic so that banks could help absorb the vast amount of extra government borrowing. The banks were only too happy to oblige since it offers them effectively free money. They can use deposits on which they pay little or no interest to buy high yielding bonds without having to hold expensive capital against them. Not surprisingly, banks have been lobbying for this rule change to be reinstated, as Jamie Dimon, the JP Morgan boss, did again last week.

Scott Bessent, the Treasury secretary, is keen on this rule change too because it would hep him solve another problem. As Tan Kai Xian at Gavekal notes:

He needs to sell somewhere in the region of US$2trn in new US treasury debt this year, as well as roll over some US$8trn in maturing treasury notes and bonds and pay a further US$500bn in interest on outstanding notes and bonds.

With each 100bp increase in yields equating to an additional US$100bn in interest costs, Bessent badly needs to restore investors’ confidence in the market or find some new buyers for his treasuries in order to bring down yields.

Bessent reckons that allowing banks to buy more Treasuries could knock up to 0.7 percentage points off long-term yields. Whether banks would really want to buy Treasuries in such quantities in volatile markers is an open question. But Trump has abrogated the power to direct all regulatory agencies including the Fed in areas other than monetary policy, so in theory the administration could demand it. Besides, Jay Powell, the Fed chairman, has also backed such a move.

Yet rolling back a key plank of post global financial crisis reform in the midst of market turmoil risks reinforcing fears about the capriciousness of US policymaking, which is what has been driving the flight from US assets in the first place. That Bessent was babbling about such a move last week at the height of the meltdown only raises fresh questions about his judgment and fuels the perception that America is starting to resemble a troubled emerging market.

Even if a rule change is justified, how it is executed matters. The last time the US watered down its banking regulations to allow them to hold more government bonds, it was hit by a string of bank failures in 2023, including Silicon Valley Bank. A unilateral move would also increase pressure on other jurisdictions to follow suit, thereby adding to global financial risks. If anything Bessent’s ill-judged intervention should lead the Fed to resist any rule change until the markets have stabilised, thus avoiding the perception of political interference.

3. The Xi Put

What then of the Xi Put? This rests on the hope that the Chinese president will offer an olive branch to Trump to enable him to back down on the trade war that he accidentally triggered when he assumed the Xi would not retaliate to be hit with a 50 percent tariff. The problem here is that the Trump administration can’t make up its mind what it actually wants from China. Does it want a complete decoupling? Or does Trump want to do a deal with Beijing?

Meanwhile Bessent is peddling a “grand encirclement strategy” whereby the US would strike deals with allies to isolate China - although threatening your allies with vast reciprocal tariffs is a mighty odd way to go about it. In reality, America’s actions are driving allies in Europe and Asia closer to China as they seek ways to preserve what they can of the global rules-based trading system and prevent trade diversion arising from China’s vast exporting surplus triggering the raising of protectionist trade barriers everywhere. That way lies complete system collapse.

Besides, as Adam Posen noted in this persuasive piece for Foreign Affairs, contrary to what Trump and Bessent think, it is China that has the stronger hand:

China, the surplus country, is giving up sales, which is solely money; the United States, the deficit country, is giving up goods and services it does not produce competitively or at all at home. Money is fungible: if you lose income, you can cut back spending, find sales elsewhere, spread the burden across the country, or draw down savings (say, by doing fiscal stimulus). China, like most countries with overall trade surpluses, saves more than it invests—meaning that it, in a sense, has too much savings. The adjustment would be relatively easy. There would be no critical shortages, and it could replace much of what it normally sold to the United States with sales domestically or to others.

An analysis by Goldman Sachs points the same conclusion:

Our findings reveal that US reliance on Chinese imports is far greater than China’s reliance on US imports. For 36% of US imports from China (around $158 billion), the US depends on China for over 70% of its supply, indicating limited short-term flexibility for American importers to find alternative sources, even under substantial tariff pressures. In contrast, China's reliance on US imports above the 70% threshold totals just $14 billion, while more than half of China’s imports from the US fall into categories where the US supplies less than 30% of China’s total demand.

All this suggests that Xi Jinping has little incentive to deescalate. Instead, Beijing has urged the US to “take a big stride in completely abolishing the wrongful action, and return to the correct path of resolving differences through equal dialog based on mutual respect.” At the same time, it has suspended exports of a wide range of critical minerals and magnets, reports the New York Times:

Shipments of the magnets, essential for assembling everything from cars and drones to robots and missiles, have been halted at many Chinese ports while the Chinese government drafts a new regulatory system. Once in place, the new system could permanently prevent supplies from reaching certain companies, including American military contractors.

Besides, even if China did not want to reach out to the US, it is not clear how it could. Howard Lutnick, US Commerce Secretary, says that he and Bessent are refusing to engage with Beijing because Trump wants to negotiate directly with President Xi. But there is no chance of that happening, as Ryan Haas, a China expert from the Brookings Institute, has noted. Xi is not going to talk to Trump without extensive preparatory work to avoid the risk of humiliation on the world stage. Everyone has seen what happened to Volodmyr Zelensky.

In the absence of any alternative off-ramp, the Xi put, like the Trump put and Fed put, may not be as solid as the market thinks.