Regime Uncertainty
The harms of reduced business investment
(source Reuters https://www.reuters.com/markets/us/investors-flee-equities-trump-driven-uncertainty-sparks-economic-worry-2025-03-10/ )
Investing in the stock market is not for the faint of heart. When it comes to money, I am fairly faint hearted, so mostly I’ve learned to just not look. But it’s hard not to pay attention when the news services are screaming headlines like the one above. I want to encourage caution when reading such headlines in general, because the movements of the market are complex and impossible to know the reason. More on that in a moment. But I also think the uncertainty the Trump administration is inserting into… well, just about everything - is likely to be causal, and in a bad way. The Biden administration did a bunch of bad stuff, too1, but that’s now history. I want to talk about the near future.
Here is a chart of the S&P 500 over the last year. The S&P 500 is an index that is generally used to measure the performance of the overall stock market, although it is based on the performance of the 500 largest US stocks (hence the “500” in the name - here’s an article about the S&P 500 if you are not familiar). Most professional investors measure their performance against the S&P 500 - if you do better than the S&P 500, you consider yourself as “beating the market”. What you can see from the chart is that the S&P has been doing quite well over the last year, until about a month ago when it began a precipitous slide.
The S&P hit 6,144 on February 19th, and closed this past Friday (March 14th) at 5,639, for a loss of about 9% in less than a month. The stock market, as represented by the S&P, fluctuates by 1-2% pretty much every day, so a couple of percent change is no big deal. A 9% change starts to be a big deal. But it's also important to note that even though we are down 9%, we are still better than we were a year ago this time. And in fact, if you take a longer view, which you should when trading stocks, you can see the overall trend is quite good. Here’s the S&P 500 over the last 10 years:
(source: https://fred.stlouisfed.org/graph/?g=1ECAZ )
If you bought an S&P 500 index fund on March 19th, 2015 and held it till today, through the recent downturn, you would have earned a 170% overall return, or about 10.4% per year. That’s actually pretty good for a 10-year return, especially given our overall low inflation for that period.
How do stock prices get determined? You can think of the stock market as a continuous auction for used shares of stock. If you were to set up a brokerage account and buy a share of, say, Amazon, you would most likely be buying it from another investor who wanted to sell her shares. You are most likely not buying it directly from Amazon. On average, 43.5 million shares of Amazon change hands every day. People sell their stock for a variety of reasons. They may be cold, calculating investors who have determined that their shares are overpriced and therefore they want to sell, or they may be parents whose kids are getting ready to go to college, and the shares of Amazon are part of the kids’ college savings account and it has little to do with the price and selling is based on their financial needs. The point is, it’s impossible to know exactly why those 43.5M shares are trading hands, because the decisions are made individually (sometimes by individuals, sometimes by investment firms, but regardless, acting individually for their own purposes). This past Friday (Mar 14th), 7.4 billion shares of US stocks (not just Amazon, but all US stocks) changed hands according to the CBOE Global Markets. If it’s impossible to know why 43.5M shares of Amazon traded, it’s even less possible to say why 7.4B shares of all stocks traded. But one thing we can say is this: the prices have been trending downward for over a month, and not by a little bit.
Although we can’t say why individual trades are made in the short run, we can make guesses about longer term trends. Stocks trend upward when people believe they are becoming more valuable and they trend downward when people believe they are becoming less valuable. Stocks become more valuable when people believe they will be more profitable in the long run, and vice versa. Stock value in the long run is determined by profits. Firms that don’t just bring in a lot of money, but turn that money into profit, are valuable.
(A quick aside - revenue and profit are not the same thing. Revenue is the money you bring in from selling things or services. Profit is what is left over after the business pays its expenses. Grocery stores bring in a lot of revenue from selling food, but the cost of the food they sell is almost the same as the revenue they bring in, so they tend to have very low profits. Pharmaceutical companies bring in a lot of revenue, but their expenses are quite a bit less than their revenue, so they tend to have big profits. Revenue - Expenses = Profit)
The Trump Administration has been very busy since Trump’s inauguration. They have made a lot of changes and implemented a lot of policies. I disagree with a lot of them, but not all of them. I’ve written at length about tariffs, so I won’t go into that again here. Tariffs are bad. Trump keeps threatening to impose them. But he also quickly rescinds them for the most part. Despite the tariffs not actually being imposed in many cases, he creates a great deal of uncertainty. He and his team are also creating uncertainty in foreign policy (and therefore global trade). Are we really going to reward the Russians for mass murder and give them Ukraine? What does that mean for our relationship with Europe, and by extension security and trade? What about the Pacific and China? The bluster and maybe I will, maybe I won’t approach might be good for one-off negotiations in New York real estate, but that approach creates massive uncertainty on the global stage. Businesses do not like uncertainty.
The economist Robert Higgs has an excellent paper called Regime Uncertainty in which he examines why the Great Depression lasted as long as it did. Higgs’ argument is that FDR created a great deal of uncertainty through all of his New Deal policies. Like Trump, FDR came out with a fire hose of policy changes and new agencies that were meant to fix the depression. The standard story told in history textbooks is that the stimulus of WWII was what finally broke the Great Depression. Higgs argues that the uncertainty FDR created for businesses leading up to WWII was what created a retreat of investment.
In the period of 1931 to 1935, net investment totaled minus $18.3 billion. After reviving to positive levels in 1936 and 1937, net investment again fell into the negative range in 1938 ($0.8 billion) before resuming its recovery. For the eleven-year period of 1930 to 1940, net private investment totaled minus $3.1 billion. Only in 1941 did net private investment ($9.7 billion) exceed the 1929 amount.
Investment is important because we are talking about real things like factories, farms, businesses, and inventory. In other words, investment drives employment. No investment, no jobs.
According to Higgs, FDR realized he needed businessmen on his side to fight WWII, so he fired most of the New Dealers in government and started taking the concerns of businessmen seriously. FDR died during WWII and was replaced by Truman who did not pursue the anti-business New Deal policies that FDR had espoused. The result was rising investment post-WWII as seen in this graph:
(source: https://fred.stlouisfed.org/graph/?g=1ECBo )
This is a graph of real gross private domestic investment - that is, the amount of money businesses invested in purchasing equipment, buildings, inventory, and so forth, adjusted for inflation. The gray bars on the graph represent recessions - periods of economic uncertainty. You can see a big drop during the global financial crisis of 2008-2010, and another big drop during COVID - both times of great uncertainty. If you follow the link to the graph, you can zoom in and see investment drops during all the gray bars, but if we just stick with just recent history, think of what things were like during the financial crisis and COVID. No one knew what was going to happen. This wasn’t necessarily the fault of the government (lots of ink has been spilled on this statement, but let’s just set that aside for now). A global financial crisis wiped out trillions of dollars in value. People couldn’t get loans. It was a crazy time. COVID is a recent memory for all of us. Who was going to start a new restaurant or store during COVID? When things go crazy, people don’t want to make big investments. They tend to retreat to the sidelines and wait for things to settle down.
Higgs’ Regime Uncertainty story blames the government for creating uncertainty beyond natural disasters (like COVID), or broad global problems (like the financial crisis). Regime uncertainty is the result of the government creating policy turmoil - implementing policies, canceling policies, creating contradictory policies. Even if some of them are good, it’s the uncertainty that causes business people to retreat and close their wallets. No new investment, no new jobs, and maybe even a decrease in jobs.
I will offer this one example based on the current Trump activities around tariffs. Let’s assume you are Ford Motors. You have contracts with plants in Mexico to buy parts. Some of the parts you use in your vehicles actually go back and forth across the border multiple times. If there is a tariff on goods coming from Mexico, it would make sense to build your own factory in the US, despite the higher cost. But if there won’t be a tariff, it makes more sense to buy from your Mexican partner. It takes a lot of money and years to build and staff a factory. If the tariff only lasts a year or two and you build the factory, you will lose a lot of money. If it lasts a long time, you will lose a lot of money if you don’t build the factory. What do you do? Right now Trump's vacillation makes you very uncertain. You probably don’t invest. As a result, cars are just more expensive.
(By the way, if tariffs stay in place, they don’t necessarily create net new jobs. If Ford does build, it pulls workers from other, more valuable work. Furthermore, cars cost more, which makes people poorer.)
It’s too soon to say if we are entering an extended period of Regime Uncertainty as told by Higgs. The conditions are heading in that direction. The Trump Administration is creating a great deal of chaos and uncertainty. Even Trump himself has not ruled out a recession. The Administration’s argument appears to be that the economy needs to take its medicine and we have to go through this period of chaos to get to a better regime. That may be true. Or it may be that we will just have chaos, and businesses will withhold investment because of the uncertainty created by the administration. As I said, it is too soon to say.
Just read about Biden’s FTC Chair Lina Khan’s ridiculous windmill tilting against Silicon Valley. That was a lot of regime uncertainty. If you want to know why the Tech Bros came out in favor of Trump, you don’t have to look much farther.