Recent Items

Trump’s Shock Doctrine: Uncertainty and the Repudiation of Contracts

Posted on by

Trump is surrounded by ideologues, so they really may believe that their efforts to gut entire Federal operations will somehow magically be beneficial. The same was true of the Chicago Boys, who administered a no-holds-barred neoliberal program in Chile under Pinochet. After an initial boom, a rapid rise in debt and insider looting led to a bust so severe that Pinochet backpedaled hard. Among other things, he nationalized banks, restored a minimum wage and unions, and embarked in large-scale Keynesian stimulus.1

However, the Trump shock is markedly different from and more intense and wide-ranging than neoliberal shock doctrines. And it isn’t simply by virtue of the US being a much bigger actor and Trump disrupting trade agreements with his tariff push. It’s that Trump is using radical uncertainty as part of his approach. And his effort, turbocharged by Musk’s DOGE, is threatening the integrity of contracts and legal provisions on a large-scale basis. Even though practice too often falls short of ideals, the adherence to agreements, and underlying and older notions of good faith and fair dealing, along with equity, are foundational to a market economy. So Trump isn’t merely throwing a wrecking ball at entire institutions on his hit list, even when often only parts of them or certain practices are as rancid as his enthusiasts believe. To change metaphors, his slash and burn approach is so extreme that it represents a hazard to commerce.

One example: the reason the UK (and ones following UK law, like Hong Kong back in the day)and US are preferred jurisdictions for entering into financial and other business agreements is that statutes and precedent are generally well settled. So a wronged party who has clear contractual or other legal rights has a high degree of confidence that he can get some satisfaction if he goes to court. That sense of confidence is bolstered by strong discovery rights.

Trump is already running roughshod over contracts with his payments freezes (temporarily blocked) and his attempt to limit NIH and NSF for indirect costs to 15%. Even though the lawsuits that have successfully enjoined this action go at the question of Trump’s authority to change the formulas going forward, the order imposed a 15% cap effective as of February 10. That meant the Trump effort was trying to unilaterally change terms of existing contracts. 2

The sense that Trump could upend all sorts of established programs on which millions depend, from Medicaid and SNAP to even the still-scared cows of Medicare and Social Security, has many on edge. For those not directly exposed, the downdraft could still hit businesses and professionals on which they depend. Thus the effects have the potential to become disproportionate to the original cuts as cutbacks and closures cascade.

This is before getting to the second prong of Trump’s intended economic revolution, that of the widespread imposition of tariffs. Recall Trump deployed them on only a limited basis in his first term. On his current intended scale, they are certain to increase inflation and create shortages, as industry groups are already predicting for Trump’s tariffs on Chinese pharmaceuticals and drug components.

A short take:

Confirming the clip above, from today’s Financial Times, in ‘Cost and chaos’: Donald Trump’s metal tariffs sweep across corporate America:

The push to shore up supplies of crucial inputs comes after the White House on Monday said the US would impose tariffs of 25 per cent on all steel and aluminium imports from March 12, part of a sweeping programme of protectionist trade policies that have unsettled many American businesses.

The US is a net importer of steel and aluminium, meaning the tariffs are expected to push up prices across the country’s market. The extra amount that plants in the Midwest pay for aluminium, compared with those on offer in London, has surged in recent days.

Futures tracking the Midwest premium — a vital benchmark for prices paid by US companies, which includes transport, tax and other costs — for settlement next month have jumped 25 per cent since the end of January, according to LSEG data.

And Trump and Musk are seeking to make such big spending cuts in such a short timeframe that even putting aside what economist like to call “fiscal multipliers” and potential outsized supply chain damage, that a reduction in GDP growth and worse seems baked in. Recall that Pinochet did generate an initial boom. By contrast, the extent and severity of Trump actions, along with his fondness for whipsaws like on again, off again Mexico and Canada tariffs, are already sapping confidence. And the the Wall Street Journal highlights that the problem is not just the radicalism of many of Trump’s actions, but that that they are too often incoherent. From Trump’s Conflicting Business Policies Sow Economic Uncertainty:

But events since the inauguration have dented that optimism. The S&P 500 rose 5% in the first five days after the election and has since moved sideways. The University of Michigan on Friday said its preliminary index of consumer sentiment, based on surveys conducted since Trump’s inauguration, dropped in February. Preliminary results of a small business survey by Vistage Worldwide for The Wall Street Journal show that a postelection pop in confidence was reversed in February. Wall Street just ended the quietest January in a decade for mergers and acquisitions announcements.

Ethan Karp, chief executive of Magnet, a nonprofit in Cleveland that works with local manufacturers, said, “There is so much turmoil. People don’t know what is going to land. Even though there is potential long term benefit to the tariffs in terms of reshoring, the immediate things that are happening is just turmoil.”…

An index of policy uncertainty based on news articles, co-developed by Nick Bloom, a Stanford University economist, has reached levels last seen during the pandemic and in the wake of the 2008 financial crisis. Uncertainty can hamper long-term investment such as in research and development and infrastructure, Bloom said.

One of many examples comes in the Financial Times in ‘We’ll all have to go vegan’: Wisconsin dairy farmers fret over immigration crackdown:

John Rosenow, a Wisconsin dairy farmer, says that if Donald Trump deports all undocumented aliens, Americans will have to get used to a whole new diet.

“If there’s no immigrant labour, there’s no milk, no cheese, no butter, no ice cream,” the dairy farmer said. “We’ll all have to go vegan.”…

The dairy industry is particularly vulnerable. Produce growers can recruit legal seasonal workers to harvest fruit and vegetables, under the H-2A visa programme for temporary farmhands. But there is no such system for dairy farms, which require workers to milk cows three times a day, all year round…

“Let’s say the people in Washington could wave a magic wand and make all these people disappear — you’d have dead cows piling up outside the dairy farms,” he [Hans Breitenmoser of Lincoln County] said. “The industry would die a horrible death within 48 hours. Because no one would be there to slaughter the cows, let alone milk them.”

There is no sign yet that Trump intends to go after farm workers. Tom Homans at ICE’s targets are immigrants with final deportation orders (about 1.4 million) and “criminals” which is taken to mean both the convicted and those merely charged, which totals 655,000. Homans is also making a big show of targeting sanctuary cities, which as far as I can tell, do not have a lot of dairy farms.

But even if ICE does not plan to deport agriculture workers, it’s not hard to see how a raid or two near dairy farm country could create a panic, and do huge damage via dairy workers going into hiding, as in not showing up to milk cows. How hard would it be to issue plausibly deniable reassurances through Congresscritters or state legislators, which could then be conveyed to farmers and via them, to farm hands? This is an easily preventable train wreck, yet no can be bothered.

The Wall Street Journal also reported on imminent labor shortages due to undocumented immigrant crackdowns:

Still, it’s likely to have economic repercussions, including exacerbating labor shortages. In a recent survey, members of the Associated General Contractors of America listed an insufficient supply of workers as one of their top concerns for 2025. Members in Florida, Georgia, Texas and Oklahoma, among other locations, have reported workers not showing up “because of rumors or fears of potential ICE raids,” said spokesman Brian Turmail.

Another layer of policy inconsistency is on how Trump’s geopolitical schemes collide with his domestic priorities. Trump has said he wants lower oil prices to hurt Russia and bring them to the negotiating table, and has even gone as far as trying to pressure OPEC members. But they have no reason to hurt their incomes to help Trump, particularly when Trump is also threatening to destabilize the region by forcing Egypt and/or Jordan to take Palestinian expellees. And many experts have also pointed out US shale gas producers won’t play ball either because they have no interest in depleting their reservers for inadequate rewards.

Yanis Varoufakis does think there is some method in Trump’s madness on the currency front. From Unherd:

According to Trump, America imports too much because it is a good global citizen which feels obliged to provide foreigners with the reserve dollar assets they need. In short, US manufacturing has been in decline because America is a good Samaritan: its workers and middle class suffer so that the rest of the world can grow at its expense.

But the dollar’s hegemonic status also underpins American exceptionalism, as Trump knows and appreciates. Foreign central banks’ purchases of US Treasuries enable the US government to run deficits and pay for an oversized military that would bankrupt any other country. And by being the linchpin of international payments, the hegemonic dollar enables the President to exercise the modern-day equivalent of gunboat diplomacy: to sanction at will any person or government.

This is not enough, in Trump’s eyes, to offset the suffering of American producers who are undercut by foreigners whose central bankers exploit a service (dollar reserves) America provides them for free to keep the dollar overvalued….

And that’s not the worst of Trump’s concerns. His nightmare is that this hegemony will be fleeting….

For when US deficits exceed some threshold, foreigners will panic. They will sell their dollar-denominated assets and find some other currency to hoard. Americans will be left amid international chaos with a wrecked manufacturing sector, derelict financial markets and an insolvent government…..

Central to this new global order would be a cheaper dollar that remains the world’s reserve currency — this would lower US long-term borrowing rates even more. Can Trump have his cake (a hegemonic dollar and low-yielding US Treasuries) and eat it (a depreciated dollar)? He knows that the markets will never deliver this of their own accord. Only foreign central banks can do this for him. But to agree to do this, they need to be shocked into action first. And that’s where his tariffs come in….

But tariffs are only the first phase of his masterplan. With high tariffs as the new default, and with foreign money accumulating in the Treasury, Trump can bide his time as friends and foes in Europe and Asia clamour to talk. That’s when the second phase of Trump’s plan kicks in: the grand negotiation….

Acquiesce to what? To appreciating their currency substantially without liquidating their long-term dollar holding. He will not only expect each spoke to cut domestic interest rates, but will demand different things from different interlocutors. From Asian countries that currently hoard the most dollars, he will demand they sell a portion of their short-term dollar assets in exchange for their own (thus appreciating) currency. From a relatively dollar-poor eurozone riddled with internal divisions that increase his negotiating power, Trump may demand three things: that they agree to swap their long-term bonds for ultra-long-term or possibly even perpetual ones; that they allow German manufacturing to migrate to America; and, naturally, that they buy a lot more US-made weapons.

There are many fallacies in the Trump reasoning. A partial list: first, Trump wants the US to be a mercantilist and run trade surpluses. So does everyone else, since they get to import other countries’ demand. The stable alternative is a system where countries run more or less balanced trade, which is what Keynes’ bancor was meant to enforce. But countries have to surrender sovereignity to do that. Think Trump will allow that?

Second, as readers know, it will likely take 10 years, more like 20, to get manufacturing back, even if we had industrial policy, which does not seem to be on Trump’s dance card. Putting aside the wee problem of how ugly the transition period might get, the US is out making itself stoopider with AI and investing there in preference to bricks and mortar.

Third, as today’s inflation release showed, inflation is untamed, so the Fed is not set to cooperate any time soon.

But IMHO Varoufakis overthink Trump. Trump has been so inconsistent on so many topics (starting with Ukraine) that attributing a grand plan to him seem to be a big stretch.

I believe Trump instead epitomizes the Sun Tsu warning:

All tactics and no strategy is the noise before the defeat.

We’ll stop here, since this is a large topic in an overly dynamic environment. But killing the Confidence Fairy does not produce happy market or economic outcomes. Even if there actually is a logic in Trump’s slash and burn campaign, the immediate costs look pretty sure to exceed theoretical benefits.

______

1 Our summary in ECONNED:

The “Chicago boys,” a group of thirty Chileans who had become followers of Friedman as students at the University of Chicago, assumed control of most eco- nomic policy roles. In 1975, the finance minister announced the new program: opening of trade, deregulation, privatization, and deep cuts in public spending.

The economy initially appeared to respond well to these changes as foreign money flowed in and inflation fell.27 But this seeming prosperity was largely a speculative bubble and an export boom. The newly liberalized economy went heavily into debt, with the funds going mainly to real estate, business acquisitions, and consumer spending rather than productive investment.28 Some state assets were sold at huge discounts to insiders. For instance, industrial combines, or grupos, acquired banks at a 40% discount to book value, and then used them to provide loans to the grupos to buy up manufacturers.29

In 1979, when the government set a currency peg too high, it set the stage for what Nobel Prize winner George Akerlof and Stanford’s Paul Romer call “looting” (we discuss this syndrome in chapter 7). Entrepreneurs, rather than taking risk in the normal fashion, by gambling on success, instead engage in bankruptcy fraud. They borrow against their companies and find ways to siphon funds to themselves and affiliates, either by overpaying themselves, extracting too much in dividends, or moving funds to related parties.

The bubble worsened as banks gave low-interest-rate foreign currency loans, knowing full well the borrowers in their own industrial group would default when the peso fell. But it permitted them to use the proceeds to seize more as- sets at preferential prices, thanks to artificially cheap borrowing and the eventual subsidy of default.30

And the export boom, the other engine of growth, was, contrary to stateside propaganda, not the result of “free market” reforms either. The Pinochet regime did not reverse the Allende land reforms and return farms to their former own- ers. Instead, it practiced what amounted to industrial policy and gave the farms to middle-class entrepreneurs, who built fruit and wine businesses that became successful exporters. The other major export was copper, which remained in government hands.31

And even in this growth period, the gains were concentrated among the wealthy. Unemployment rose to 16% and the distribution of income became more regressive. The Catholic Church’s soup kitchens became a vital stopgap.32 The bust came in late 1981. Banks, on the verge of collapse thanks to dodgy loans, cut lending. GDP contracted sharply in 1982 and 1983. Manufacturing output fell by 28% and unemployment rose to 20%.

The neoliberal regime suddenly resorted to Keynesian backpedaling to quell violent protests. The state seized a majority of the banks and implemented tougher banking laws.33 Pinochet restored the minimum wage, the rights of unions to bargain, and launched a program to create 500,000 jobs.34

2 Contracts are not sacred. Parties regularly cure big or expected big breaches via waivers. And the breaching party usually makes a concession, like a payment.

Most take the enforceability of contracts and other consumer law protections, like truth in advertising, as givens. It is actually hard to conduct business with parties you do not know personally and trust when that breaks down. Again from ECONNED:

Consider purchasing a computer in the neoclassical paradigm. The buyer has no way of being certain that the computer lives up to the vendor’s promises. So the consumer will have to bring an expert to test the computer’s functionality at the time of purchase (does it really have the memory and chip speed prom- ised, for instance?). The seller will need to be paid in cash, otherwise the buyer could revoke payment.
And what happens if the computer fails in a few weeks? Assuming the vendor has not fled the jurisdiction, the only remedy is litigation, or an enforcer with brass knuckles.

But even that scenario is too simplistic. It assumes the buyer can evaluate the expert. But in fact, if you aren’t a computer professional, you can’t readily assess the competence of someone who has expertise you lack. And even if the person you hired is competent, he might arrange to get a kickback from the seller for endorsing shoddy goods. The same problem holds true in any area of specialized skills, such as accounting, the law, or finance. Many people judge service quality by bedside manner, which is not necessarily a good proxy for the qual- ity of the substantive advice. And as we will see later, one of the factors that helped create the crisis was the willingness of investors to buy complicated financial products based on the recommendation of a salesman who did not have the buyers’ best interests at heart.

Print Friendly, PDF & Email