Guest Article: Why Keynesians got inflation and growth wrong.

We are delighted to share, with permission, the following article from highly esteemed economist Daniel Lacalle, PhD.1

Inflation is not soaring, and economic growth is solid.

The Tariff Tantrum has proven that consensus was wrong about soaring inflation and an economic slump. Why? The exaggerated perception of tariffs’ economic impact stemmed from the belief that American consumers would bear the full burden of tariffs. Why were they wrong?

The first reason was that most analyses relied on a simplistic calculation of tariffs, treating supply chains as if they only involved buyers and sellers. Supply chains are very complex, and most exporters must deal with overcapacity challenges and working capital problems. Thus, the impact of tariffs is likely to be absorbed by numerous links in the supply chain, including transport, storage, distribution, manufacturing, retailers and purchasing chains.

Furthermore, most exporting companies face a significant problem of overcapacity and working capital; if they don’t sell their products fast and effectively, their debt soars, and the losses at warehouses can lead to a chain of bankruptcies.

Ignoring that the world of exporter businesses, particularly in China, has a structural overcapacity problem and mounting financial challenges due to working capital build was one of the mistakes made by excessively pessimistic analysts. Therefore, there is no sign of inflation soaring anywhere. The Export Price Index rose only 0.1% in April and 2.0% year on year, while the Import Price Index rose a modest 0.1% in the month and 0.1% year on year. Prices dropped by 0.5% in the final demand PPI (producer price index) for April. On a year-over-year basis, headline and core April PPI declined versus previous readings.

United States retail sales rose by 0.1% in April, up 5.2 % from April 2024, and following a large 1.7% increase in March 2025. Inflation hit a four-year low in April, a month that should have reflected a massive increase due to tariffs, according to consensus estimates, while wage growth rose to a four-year high.

Inflation in April slowed to the slowest pace since 2021. Egg prices fell by 12%, and prices for bakery items, meat, and poultry also decreased. Americans are not suffering the apocalyptic inflation that interventionists predicted. The consumer price index (CPI) rose by 0.2% compared to the expected 0.3%—an annualised rate of 2.3%—and the lowest in four years. Furthermore, core CPI rose only 2.8%, showing no sign of inflationary pressures.

The first quarter’s gross domestic product was positive. Despite a 0.3% decline, the private sector increased by 1.6% annually. Government spending declined 5.1%. In the past week, JP Morgan has removed its call for a recession and the Atlanta Fed Nowcast shows a healthy 2.4% GDP growth for the second quarter, an estimate shared by Goldman Sachs and Capital Economics.

The key to understanding the lack of inflation is to look at monetary aggregates. Tariffs do not cause inflation. There are other reasons we can use to criticise tariffs, but not inflation causation. Market participants have realised that tariffs are a tool for negotiating better trade deals and facilitating the opening of markets rather than being used solely as a protectionist measure. The same reason why you need nuclear weapons to avoid a nuclear war: tariffs are required to force better trade deals.

The cause of inflation is the soaring government spending, which leads to an increase in both the money supply and money velocity. Deficit spending is down 35% between February and April 2025 compared to the same period last year. While money supply is rising, albeit at a modest pace, velocity of money is gradually declining. The public sector is slowly shrinking and the private sector is strengthening; hence, there is no real inflation risk.

The only thing that can make aggregate prices rise, consolidate, and continue is the debasement of the purchasing power of the currency due to uncontrolled government spending. Thankfully, government spending is starting to moderate.

The United States economy is stronger than it appears, and the negotiating power of importers is larger than estimated due to two factors: the previously mentioned overcapacity challenge of most exporters and the global relevance of the U.S. market. Exporters cannot substitute their U.S. sales with other markets. Even the European Union is relatively weak as a market.

In the following months, we will likely see more trade deals, and most concerns from market participants will probably vanish or at least be significantly reduced. Ultimately, the Tariff Tantrum has proven that Keynesian analysis is wrong and that successful trade deals were the goal of the administration.

1Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

Guest Article: China’s Keynesian Model Is Crumbling. It Needs a Trade Deal, Fast.

We are delighted to share, with permission, the following article from highly esteemed economist Daniel Lacalle, PhD.1

China’s Keynesian Model Is Crumbling. It Needs a Trade Deal, Fast.

May 11, 2025

In the past decade, the Chinese economy has expanded its central-planned neo-Keynesian model that simply cannot survive without a trade deal. The Chinese manufacturing sector has followed a running-to-stand-still strategy that simply cannot subsist without the enormous trade surplus with the United States.

The Chinese manufacturing sector overcapacity is not an anecdote. It is the norm. China produces 30% of the world’s manufacturing goods but consumes less than 18%, according to CKGSB. Additionally, China’s industrial capacity utilization rate fell to 74.1% in the first quarter of 2025.

China’s Keynesian central planning model aims to maximise employment and maintain strong economic growth, despite financial constraints and excessive indebtedness. Thus, it needs to sell its excess production to avoid a massive problem of working capital. Even the government has recognised the problem in a roundabout way, noting that “involution”-style competition (wasteful competition) is a major focus for the 2025 economic policy, and steps are being taken to reduce unnecessary investments and control growth in some industries. However, overcapacity in China is not a fatality; it was created by political design, with local and national authorities trying to boost GDP at any cost.

The model is aimed at keeping full employment and economic growth even with economic returns below the cost of capital, and it almost works if the excess capacity can be sold globally, receiving reserve currency and maintaining low costs by passing the working capital cost to global consumers and maintaining low production expenditure with currency controls and exchange rate fixing. However, the combination of rising debt, a constantly weakening currency, and the escalating bankruptcy and working capital issues could potentially bring this model to a collapse, even in the absence of an official recession.

China has learnt that it cannot endure a trade war and cannot substitute the US consumer, the richest and largest market, with European or Latin American consumers. Therefore, it needs a trade deal quickly before the domino of bankruptcies that has plagued the Chinese economy since 2021 erupts into a full-blown financial crisis.

China is officially in deflation for the third consecutive month in April. Business insolvencies are projected to increase by 7% in 2025 and by 10% in 2026, according to Allianz, even as the government implements additional fiscal stimulus.

Small and medium-sized enterprises, particularly exporters, are facing mounting bankruptcies due to declining cash flow and the elimination of US tariff exemptions. Job losses are rising in export-dependent regions, and the urban unemployment rate is expected to average 5.7% in 2025, above the official target, according to CNBC.

The official NBS Manufacturing PMI fell sharply to 49.0 in April 2025, the steepest decline since December 2023, reflecting a drop in output, new orders, and employment, with foreign orders shrinking to their lowest in at least eleven months.

The collapse of the real estate sector, which once accounted for up to 30% of GDP, has weakened banks, reduced household wealth, and led to a negative wealth effect, further depressing consumption and credit demand.

China’s economic strengths are well known, but the weaknesses are too important to ignore. The situation serves as a reminder that central planning never works. Everything that is weak in China comes from previous years of government policies aimed at boosting economic growth by building stuff and hoping it would sell at some point. Furthermore, rising bankruptcies, an imploding property market, and mounting local government debt strain the financial system just as non-performing loans from the Belt and Road Initiative (BRI) soar. Several BRI countries have defaulted on their debts or required IMF bailouts, including Sri Lanka, Zambia, Ghana, and Pakistan, while the BRI generated $385 billion in off-the-books debt.

Keynesian policies always lead to high debt and stagnation. However, when combined with a centralised planning system, a closed financial system, and capital controls, Keynesian policies create a dangerous mix of overcapacity, poverty, and economic slack. China can only begin to address its enormous working capital problem through a quick and successful trade deal with the United States. It will benefit China enormously if the government opens its economy, lifts capital controls, and allows the private sector to breathe. An implosion of the overcapacity problem hidden from the media, offset by even more central planning and stimulus spending, is only going to weaken China in the long run.

1Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

April 2025 Market Chartbook

Sean Gross, CFP®, AIF® | Co-Founder & CEO

Click here to view our April 2025 Market Chartbook.

Guest Article: Container Orders Plummet. Trade Deals Now or Economic Depression Soon.

We are delighted to share, with permission, the following article from highly esteemed economist Daniel Lacalle, PhD.1 

Container Orders Plummet. Trade Deals Now or Economic Depression Soon.

April 20, 2025

Global container booking volumes fell by 49% between the last week of March and the first week of April 2025, according to Freight Waves. Imports from China to the United States collapsed by 64%, with imports of apparel and textiles declining by a whopping 59% and 57%, respectively. The figures coming from shipping companies are worse than those seen during the Covid-19 crisis.

These alarming figures suggest that importers are unwilling to accept higher prices in the middle of a tariff war, that exporters cannot simply choose to move their products elsewhere easily, and that the excess capacity in many sectors is much larger than initially expected.

No one wants to accept the cost of tariffs, and this means that the only option for the economies with elevated productive overcapacity is to negotiate a trade deal, and quickly, or face an economic depression.

The mainstream view about tariffs was that United States consumers would pay the entire negative impact. This news suggests otherwise. The purchasing power of importers is higher than expected. The number of order cancellations is so large that ports in China have had to take emergency measures to address the challenges created by piles of unsold containers.

The negative impact is enormous on ports, as fees plummet, but we cannot forget the dramatic effect on producers with excess capacity. Many global exporters are going to face bankruptcy if no trade deal is reached due to insufficient working capital.

In the European Union, leaders are concerned that the trade war between the United States and China will bring a flood of cheap products from China that could endanger local producers and create a significant economic problem.

Many exporters are facing a harsh reality: They cannot sell their products if they don’t export them to the United States, and the importers are not going to accept higher prices due to tariffs.

The reason why exporters cannot pass the cost of tariffs to United States consumers is because most of the products they delivered to America were only attractive because they were exceedingly cheap. When prices rise, demand decreases significantly. The tariff war has shown that demand is not inelastic.

The collapse in container orders proves Menger’s imputation theory. Output prices determine factor prices, not the other way around.

The unsustainable state of global shipping will compel countries to expedite trade agreements with the United States, failing which they risk a cascade of economic collapses within their business structures.

The slump in container orders proves that United States importers are not going to accept any price, that excess capacity in the main retail sectors is enormous, and that there is no straightforward alternative for American consumers.

If you believed that other countries would hesitate to negotiate trade agreements with the United States, you need to reconsider.   The American consumer loves cheap products but does not want the same goods at twice the price.

The United States economy may suffer a contraction due to this sudden slump in imports, but the consequences are much larger for the exporter nations.

The outcome is not positive for any country, so there is only one choice to make: negotiate or lose. If countries fail to establish significant trade agreements with the United States in the near future, their retailers are likely to face a severe working capital crisis.

1Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

The Bigger Picture on U.S. and China Tensions

Sean Gross, CFP®, AIF® | Co-Founder & CEO

Market Environment Indicator (MEI): Readings improved from last week and the indicator remains Positive, suggesting that the U.S. stock market will likely hold above the recent lows. However, a retest of the lows cannot be ruled out. The weight of the evidence still suggests that the current decline is not expected to extend into a significant downtrend. If the MEI reverses to Negative, it would be a signal of more substantial problems ahead.

Trade tensions between the United States and China have escalated in recent weeks, with both countries implementing unprecedented tariff increases. For the moment, the U.S. has raised tariffs on Chinese goods to 145%, while China has countered with 125% tariffs on American products. The situation is evolving quickly and continues to affect financial markets. While global tensions can create uncertainty, history shows that markets have weathered similar challenges in the past. Despite the headlines, understanding the economic relationship between these two countries can help long-term investors to maintain perspective.

U.S.-China trade tensions are now in focus 

Tariffs against all trading partners have dominated market news, and the 90-day pause now puts the focus on the U.S.-China relationship. The underlying issue runs much deeper than trade policy alone. Current tensions are a result of the “multipolar” world in which the U.S. and China are the two largest economies, both with significant global influence. This is a decades-long shift from the “unipolar” world in which the U.S. was the only major superpower after the Cold War. This naturally creates new challenges and opportunities for each country.

While there are no easy answers as to how the trade war might progress over the next few months, maintaining perspective has become even more important for long-term investors. The U.S. and China remain significantly linked through trade, finance, and global supply chains.

What makes this situation different from previous trade tensions is both the magnitude of the tariffs and the broader geopolitical context. As the accompanying chart shows, the U.S. maintains a significant trade deficit with China. Tariff levels above 100% effectively mean that goods crossing either border would more than double in price, all else being equal. This increases the price of goods for consumers, raises costs for businesses, and can slow economic activity. The fear of high inflation and worsening profit margins have caused market volatility in recent weeks, with a notable shift in consumer surveys and corporate earnings guidance.

Markets have also been worried about how far the White House would be willing to go in escalating a trade war with China. Since tariffs at these levels are unlikely to be sustainable in the long run, it’s still likely that they represent a negotiating position for the administration. The 90-day pause on tariffs above 10% (except for China), and the exemption for technology products, are evidence that the White House’s main objective is still to achieve deals.

The tariffs implemented in 2018 and 2019 provide some historical context for how markets and companies might respond as the situation evolves. Many companies demonstrated resilience by adjusting supply chains, finding alternative suppliers, or absorbing portions of the increased costs. While markets stumbled in 2018, they performed well in 2019 and again during the post-pandemic recovery. The broader scope of tariffs makes it more difficult for companies this time around, but the historic market rally after the 90-day pause was announced is evidence that markets can recover once conditions improve.

For investors with long-term time horizons, this challenging market environment can create opportunities. Valuations are much more attractive than they were even just a few months ago, both across the broad market and in sectors like Information Technology and Communication Services that drove the recent bull market. Rising interest rates have led to bond market volatility, but they also mean that investors have more opportunities to generate portfolio income.

China's economy faces many challenges

While much attention has focused on the U.S. response to trade tensions, China faces its own set of economic challenges. These include persistent concerns of a real estate bubble and financial system instability that could impact its ability to withstand trade tensions. China's post-pandemic recovery has been uneven, with GDP growth slowing to 5.4% year-over-year in late 2024, according to official Chinese government statistics. Many economists have already reduced their 2025 growth forecasts below the government's 5% target.

Chinese leaders are reportedly considering more stimulus measures. This would be on top of significant stimulus measures implemented last year, including a 5-year, 10 trillion-yuan stimulus package to support local government debt issues, a commitment to increase the budget deficit, cut interest rates, reduce bank reserve requirements, and measures to support the real estate market.

In recent days, the People's Bank of China has also allowed the yuan to weaken as a potential offset to tariff impacts, including setting its currency peg to the weakest level since September 2023. Currency devaluation can help boost exports by making goods cheaper for foreign buyers. However, it also carries risks including capital outflows, which is especially risky for China since it could destabilize its financial system further. It can also be seen by the White House as an attempt to circumvent tariffs.

The chart above, which shows major currencies indexed to a level of 100 two years ago, highlights how volatile global currencies have been in recent weeks. In addition to the yuan’s moves, the value of the U.S. dollar index has fallen to the low end of the range over the past three years. This is the opposite of what some expected since, in theory, tariffs tend to reduce imports, lowering the need for foreign currency, and thus boosting the value of the dollar.

Most U.S. debt is held domestically

Some investors also worry that China's holdings of U.S. Treasury securities give them undue influence over the U.S. economy. There have been concerns that recent moves in the bond market are the result of countries like China selling their U.S. Treasuries. While this is difficult to verify, what’s clear is that China's Treasury holdings represent about 2.1% of total U.S. government debt according to government data. Importantly, most Treasury securities are still held domestically by U.S. individuals, corporations, and other federal, state, and local government entities.

If China were to significantly reduce its Treasury holdings, it could potentially cause short-term market volatility and temporarily push up U.S. interest rates. However, China and other countries hold U.S. Treasuries, the dollar, and other foreign assets for an important reason: to maintain financial stability. The U.S. dollar and Treasury securities have consistently maintained their "safe haven" status even during periods of uncertainty. This has been true over the past few years despite inflation fears, budget crises, U.S. debt downgrades, and more.

The bottom line? While escalating U.S.-China trade tensions create uncertainty, history shows that financial markets are resilient in the long run. A flexible, diversified portfolio aligned with your long-term financial goals remains the best approach to navigating the changing global landscape.