Voluntary Trade Reset Recession?
2025 04
Torsen Slok of Apollo Investing has a model of a Voluntary Trade Reset Recession (“VTRR”)
The starting point:
“The administration inherited an economy with strong growth, 4% unemployment, positive hiring, and a substantial tailwind from investments. US and international investors are building infrastructure, next-generation factories, and data centers. The Inflation Reduction Act increased capex, and the US was poised for a substantial increase due to energy supply additions, increased defense production, and deregulation.”
This is probably a little too bullish on IRA, but could have included that by December 2024 the Fed had achieved near target inflation.
It’s not a great model in that it basically treats the Trump tariff shocks of 2025 as a scaled up version of the runs off the Trump mini-trade war of 2016, while acknowledging that this underestimate because
a) The static economic damage from tariffs increases as the square f the rate.
b) It ignores the uncertainty generated by the chaotic way tariffs have been imposed.
Even with these caveats Slok gets a 4% fall in GDP. The model is inadequate in that it does not model the Fed response to the tariff shock to arrive at the 4% number, so there is no reason to attach much important to it. More interesting is his way of laying out the way the initial impacts of the tariffs will play.
“But implementing extremely high tariffs overnight hurts many businesses; particularly small businesses because the tariff must be paid by the business when the imported goods arrive in the US. Small businesses that have for decades relied on a stable US system will have to adjust immediately and do not have the working capital to pay tariffs. Expect ships to sit offshore, orders to be canceled, and well-run generational retailers to file for bankruptcy.”
This is a very graphic description of how an ex ante shock to supply and demand plays out when relative prices cannot adjust, the situation that Fed action to create temporary over-target inflation can prevent or mitigate.
And as for uncertainty about business capital expenditure decisions, Slok notes
“To make exceptions for large businesses [e.g. the phoe call from Apple that got electronics exempted from some of the tariffs] that have the flexibility and resources to handle unforeseen expenses, but not small businesses, does not make sense. The challenges for small- and medium-sized enterprises are now a macro problem for the US economy, where small businesses account for more than 80% of US employment and [capital expenditures], see the second and third chart below.”
Slok uses the chart to show the important of small businesses, but I think a more important use is to note the COVID dip in the contest of a very strong Fed response. As a shock, the 2025 tariffs are more comparable to COVID than to than 2016 trade war that is completely invisible in the chart. And the Fed response – paralyzed between fearing criticism for increasing inflation and not wishing to appear to give in to Trump pressure for interest rate cuts (that would produce that inflation -- has so far been zilch.
https://thomaslhutcheson.substack.com/p/the-fed-and-trump
Useful as it is in calling attention to the dangers of a recession [and making obvious recommendations for how to avoid one, basically undoing all the trade policies since January 2025 starting with re-instating USMCA with Mexico and Canada], the model fails to specify what implicitly is being assumed abut Fed reaction. A proper model would derive the recession result from specific Fed actions or inactions that would result in a “Voluntary Trade Reset Recession (VTRR) or a Voluntary Trade Reset Stagflation (VTRS)
HT to Brad DeLong
Image: Slok’s “Headwinds”
[Standard bleg: Although my style is know-it-all-ism, I am aware that I could be mistaken or overstate my points. I would, therefore, welcome comments on these views.]