Month: December 2024

In classes about personal finance, once of the best-known lessons is that investing in US stocks can have considerable short-term risk, but that over an extended period of time, a patient investor has been rewarded for that short-term risk with higher long-run returns. David Chambers, Elroy Dimson, Antti Ilmanen, and Paul Rintamäki discuss this pattern and others in “Long-Run Asset Returns” (Annual Review of Financial Economics, 2024, volume 16). A particular advantage of their study is that, for them, the “long-run” doesn’t mean going back the 1980s or the 1950s, but back to the 19th century and sometimes earlier.

On the issue of stocks having higher returns than bonds in the long-run, they write:

An abundance of evidence has shown that the total returns of equities have exceeded those of (government) bonds over various long-run periods since the beginning of the twentieth century—both in the United States (Ibbotson & Sinquefield 1976; Siegel 1994, 2022) and in the rest of the world (Jorion & Goetzmann 1999; Dimson, Marsh & Staunton 2002). First, we address one of the central questions in empirical asset pricing, namely, whether stocks consistently beat bonds over the long run. As we noted above, this evidence relies primarily on data series starting in 1900 or, in the case of the United States, 1926, when the University of Chicago’s CRSP data starts. In this section, we first discuss the history of stock and bond returns before 1900/1926 … The main message is that the US equity premium over (government) bonds at and above 5% in the 1900s was considerably higher than estimates for the 1800s ranging between +1.6% and –0.6%. … The 224-year estimate of the annualized UK equity-bond premium is in the range of 2–3%, which is again well below the twentieth-century premium of 4–5%.

In short, it’s been a good century for stock returns, especially in the US economy. But some centuries have not been as good.

For bonds, a key question is that they seem to be historically low rates in recent decades.

[B]efore the twentieth century, inflation was very low and there was little difference between nominal and real yields, which both fell to 3–4% around 1900. The twentieth century saw more persistent price rises, particularly the Great Inflation of the 1970s, which pushed nominal rates up to double digits—a level last seen in the 1500s. The post-1982 Great Moderation witnessed global convergence in inflation rates toward 2%—back to the low levels that characterized the pre-1900 economy.

Even after inflation expectations stabilized at low levels in the 2000s, real yields and policy rates kept falling to negative territory. Eventually, even nominal yields in many European countries and Japan turned negative, or reached record low levels in places where they didn’t (the United States and the United Kingdom). The global rise in inflation in 2021–2022 finally turned bond yields higher after a 40-year downtrend. The yield evidence … stretching back over centuries provides confirmation that the recent low (even negative) bond yields were truly exceptional.

What about corporate credit risk, measured by how much the rate of return on corporate bonds exceeds the rate of return on government bonds? They discuss the weakness of the evidence on this point, but argue that it seems as if corporate credit risk doesn’t actually appear in the data until 1973.

What about investments in housing? “When reviewing the evidence on the investment performance of real estate, we discuss the challenges presented by the heterogeneity and immovability of this asset class. The evidence has largely focused on housing and suggests that total returns are below those from equities.”

What about returns to investing in commodities? “We then turn to commodities and critically examine the claims of the recent studies pointing to surprisingly high long-run returns. Here, we conclude that the long-run historical returns on a diversified portfolio of futures have come close to approximating those on equities.”

Generalizing wildly from my own personal experience, I sometimes tend to think about “long-run” returns as the returns happening over the decades in which I am saving for retirement. But of course, the “long-run” does not care about my birthday. A longer view on the long-run opens up new ways of thinking about how possible outcomes, and how and why financial markets distribute their rewards.

Most actions of the US government require a process. A law is passed through Congress and signed by the president. An administrative agency follows a process for a rule, which is then open for a period of public comment, before being finalized. So it seems reasonable to ask: Does President Trump have the legal authority on Day 1 of his presidency, without passage of a new law by Congress or an administrative regulatory process, to impose imports on tariffs from places like Mexico and China–or even the entire world?

When it comes to tariffs, Article 1 of the US Constitution–the part which lays out the structure and powers of the legislative branch–states in Section 8: “The Congress shall have Power To lay and collect taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States …” On its face, this certainly seems to suggest that new tariffs need to start in Congress and be signed into law.

(For those of you wondering about terms like “Duties” and “Imposts,” a “duty” is a tax on imports or exports, and an “impost” is a nearly archaic term for “import duties.” It has been argued that when drafting this part of the Constitution, several different terms were included to reduce the chance of someone arguing that Congress did not actually have these powers.)

But what if Congress decides to delegate its Constitutional powers in this area to the President and the Executive Branch? Clark Packard and Scott Lincicome make the case that this has already happened in “Presidential Tariff Powers and the Need for Reform” (Cato Institute, October 9, 2024, Briefing Paper No. 179). Just to be clear, these authors do not support tariff increases and would prefer that presidents not have the power to impose them with the stroke of a pen. But their review of existing legislation leads them to state, in the subtitle to the article: “Congress has broadly delegated its constitutional tariff powers to the president, and there is a real risk that the legislative and judicial branches would be unwilling or unable to check a future president’s abuse of US trade law as currently written.”

Packard and Lincicome argue that, in the aftermath of the infamous Smoot-Hawley tariff increases in the heart of the Great Depression, Congress mistrusted its ability to refrain from using tariffs to protect specific domestic industries. Thus, Congress began a process of handing trade negotiations and tariff decisions to the executive branch, with the idea that the president (elected at the national level) would be less likely to cater to pressures from local industries and interests than Congress.

What are the most relevant and applicable laws along these lines?

The International Emergency Economic Powers Act of 1977 (IEEPA) … grants the president wide discretionary authority to address “unusual and extraordinary” peacetime threats to national security, foreign policy, or the economy from a “source in whole or substantial part outside the United States.” Presidents have utilized IEEPA authorities to implement US embargoes and sanctions; past uses have included blocking exports to and imports from Nicaragua, blocking Iranian transactions in response to the 1979 hostage crisis, and blocking transactions and property acquisitions made by individuals deemed to be bad actors (e.g., traffickers of narcotics and illicit diamonds, as well as human rights abusers).

IEEPA is subject to a few important procedural requirements. The president may exercise discretionary authority under the IEEPA only if they have declared a national emergency under the National Emergencies Act (NEA). IEEPA also requires the president to consult with Congress in every possible instance before taking action. Concurrent with the declaration of a national emergency pursuant to the NEA and the exercise of IEEPA authority, the president is also required to report to Congress on the necessary actions taken, the countries targeted by the actions, and other details. Unlike other US trade laws, however, IEEPA does not require the executive branch to conduct an investigation or issue a report prior to taking action.

Notice that last condition in particular: no investigation or report is needed. No president has used IEEPA to impose tariffs, but Trump threatened to use the law to impose tariffs on Mexico in 2019 as part of negotiations over what Mexico was (or was not) doing to limit border crossings. The language of the law gives the president very broad authority. For an overview of the IEEPA law, a useful statring point is “The International Emergency Economic Powers Act: Origins, Evolution, and Use” from the Congressional Research Service (updated January 30, 2024)

A second law that Packard and Lincicome point out is “Section 232”:

Section 232 of the Trade Expansion Act of 1962 was passed during the height of the Cold War and authorizes the Commerce Department’s Bureau of Industry and Security—in consultation with the Department of Defense—to investigate whether the importation of a particular product threatens the national security of the United States. If affirmative, the president has virtually unlimited authority to restrict imports to address the national security threat.

Section 232 was little-used in the decades before President Trump’s first term: the previous time it had led to tariffs was during the Reagan administration, with tariffs on machine tools. Some of the proposed historical uses seemed silly, like the idea that national security would be threatened unless the United States limited imports of garlic or scissors. But the Trump administration used Section 232 and “national security” as the basis for imposing tariffs on imports of steel and aluminum, which I discussed here. My point here is not the wisdom of Trump’s earlier choice; it is just to emphasize that Section 232 is alive and kicking as a justification for presidential power to impose tariffs.

Want more? Packard and Lincicome write:

Section 301 of the Trade Act of 1974 grants the US Trade Representative (USTR) the authority to investigate and attempt to remedy “unfair” foreign trade practices through the use of tariffs and other trade restrictions. … The USTR can self-initiate a Section 301 investigations or can open an investigation because of a petition from an interested party. Unlike Section 232, Section 301 is country-specific and requires an investigation and report by USTR. … The duration of Section 301 trade restrictions is similarly open-ended. As long as any representative from the domestic industry benefiting from the action requests its continuation every four years, the action can be extended following a USTR review. The decision to terminate such actions rests solely with the USTR, who can determine whether the restrictions are no longer appropriate.

The Trump administration used Section 301 to impose tariffs on imports from China as part of a broader dispute over intellectual property protection. The Biden administration continued and extended those tariffs: for example, by imposing a 100 percent tariff on electric vehicles imported from China. (Apparently, a dramatic rise in affordable electric vehicles is needed to save the planet, but if the vehicles are made in China, we don’t need to save the planet.)

There are more laws on the books. “Section 338 of the Tariff Act of 1930 grants the president the authority to impose new or additional tariffs of up to 50 percent ad valorem on imports from countries that have `discriminated’ against US commerce as compared to another foreign nation.” “Section 122 of the Trade Act of 1974 empowers the president to unilaterally address “large and serious” balance-of-payments deficits via import surcharges of up to 15 percent and/​or import quotas.  These measures are limited to 150 days unless they are extended by an affirmative act of Congress, and any action under Section 122 must apply to every country. “

The bottom line for Packard and Lincicome is that Congress has effectively handed off a lot of its power over imposing tariffs. In theory, Congress could choose to reclaim these powers, but I am unaware of any broad movement to do so. Instead, they write:

For more than 80 years, presidents largely avoided abusing the enormous unilateral tariff powers that Congress had delegated to the executive branch under several different laws. This changed as both Trump and Biden implemented broad tariffs on dubious grounds, and as Congress, the courts, and the WTO proved unable or unwilling to limit such measures.