Peter Thiel: What Do We Not Want to Talk About?

Peter Thiel’s talk at the National Conservatism Conference is chock full of hard questions, well-reasoned thoughts and dry humor. Absolutely worth watching, though probably easier to stomach if you lean libertarian.

Investment takeaway: Avoid Wall Street banks if you think the US trade deficit will shrink. Peter brought up an interesting point: balancing trade will be bad for Wall Street banks. Specifically because a current account deficit means the US will have a capital account surplus, and that means cash will be flowing through the Wall Street money-center banks and supporting their profits. A decreasing current account deficit means less cash will be flowing through money-center banks.

What I like about Peter Thiel’s talk is he asks tough questions, ones that make us feel uncomfortable and tears away some of the obfuscation that permeates our discourse and thinking. He throws hard questions at Google, the higher education-complex, “Harvard Stanford Yale Studio-54 night clubs,” the Obama’s, George W, international “entanglements,” the Left, identity politics, the Right and American Exceptionalism. Something for everyone to feel offended. (Ha!) You can find some gems (excerpts) below, but the whole talk is well worth it. Enjoy!

Peter Thiel at National Conservatism Conference

On Big Tech:

“Let’s take [Google] at its word. It is building a Star Trek computer. It is building this artificial general intelligence in the form of the deep mind effort that they have at Google. Is this a military weapon? A.I. is presumably, at least a dual-use weapon.

We’ve been a lot more dishonest about that in Silicon Valley than the Nuclear Physicists were in the 1940s. There was a real debate between Teller and Openheimer. We’ve not had any debate about this, whatsoever.

I think there are some questions we should be asking. From a national US perspective, let me suggest the following three questions that should be asked of Google:

  1. How many foreign intelligence agencies have infiltrated your Manhattan Project for A.I.?
  2. Does Google senior management consider itself to have been fully infiltrated by Chinese intelligence?
  3. Is it because they consider themselves to be so infiltrated that they’ve engaged in the seemingly treasonous decision to work with the Chinese military and not with the US military? Because they are making the bad short-term rationalization that if the technology isn’t going out the front door it will go out the back door.

These questions need to be asked on a federal level, they need to be asked by the FBI, by the CIA. And I’m not sure how to put this, they need to be asked in a not-so-gentle way.”

“My read on Silicon Valley is it has much more the feel of a One-Party state where everything is regimented and everybody has to follow a particular party line. The problem is unanimity is not a sign that you’ve just converged on the truth. In a democracy, we believe 51% is generally right, 70-80% is even more right, but when you’re at 99.95%, no, you’re in North Korea. And the problem is there’s some sort of soft totalitarianism that is creating an incredible conformity. People have short bullet point answers on things, but they have actually not thought about them. I’d say that is the problem.”

On Trade:

“We tend to use technology and globalization synonymously, except when we differentiate them very sharply, when we end up turning technology into the scapegoat for the globalization problems we do not want to talk about.

“The fact that money is flowing uphill [to low-yielding US Treasuries rather than faster growth elsewhere] tells you something is insanely wrong with the entire trade picture. It’s probably massively over determined. It’s not just that you have weird restrictions on business and import restrictions in China and unfair double standards in taxation. You probably also have intellectual property theft, all sorts of cyber warfare directed against US corporations.”

“Maybe we should reframe the 25% tariffs as a carbon tax … and maybe the 25% is a floor and not a ceiling.”

“You don’t want people negotiating trade treaties who dogmatically believe in free trade because the worse they are at negotiating, the better job they think they do. It doesn’t matter how bad the other side rips us off, the more we get ripped off, the better job we’re doing.”

“The way to articulate this is as a very straight forward accounting identity. That if you have a current account deficit you need to sterilize the current account deficit with capital inflows into the US, the bigger the capital inflows, the capital inflows go through the money-center banking system, the bigger the flows the more profits the banks make.”

“Every time the current account deficit comes down in the US we had a banking crisis. We had one from ’87 to ’91 when the deficit came down from minus-three-and-half to zero and you had 2000 S&Ls go broke and Michael Milken went to jail, and we it again from ’06 to ’09 when it went from minus-six to minus-three and it’s stayed at minus-three for the last decade.”

“What obviously has to happen is the current account deficit should go from minus-three to zero [percent of GDP]. A byproduct of that happening is we are going to have a banking crisis. At best we can have a sort of controlled crash landing for the banks.”

“My one very specific recommendation is that we know that anybody who works at a Wall Street bank will fight tooth and nail against any sort of sensible trade policy. And we need to keep them away from the negotiating table.”

“I’m not against the banks categorically, but the over-financialized economy that we have in US as well as other Anglo-sphere economies is not doing us any good on this.”

On Education:

“I believe the only two scientific or technical fields that it actually makes sense to study are computer science and petroleum engineering.”

For the Harvards or Stanfords where its business model is a tournament, it’s sort of a Studio-54 night club. You know, it’s probably good for the prestige of the people who get in, it’s probably bad for their morals. But whatever you think of the Studio-54, Harvard or Stanford or Yale night club, it is not deserving of a non-profit tax-exempt status. We should get rid of that.”

“Warren and Sanders have talked about the runaway debt problem, they want to socialize it, I want to stick the colleges with the bill.”

On War:

“Just asking the question, in all foreign entanglements: Does it make sense for the US? Does it help the US? I suspect we would be less entangled. I suspect we’d be entangled in a different way, we wouldn’t be engaged in Utopian nation building and things of that sort. 

One reductionist thing to do is say ‘Does this make sense? Do we come out ahead?’

There was this crazy left-wing conspiracy theory on the Iraq war that we were just doing it to get the oil… I think it is sort of an indication of how crazy things are in this country that that was not even remotely true. Shouldn’t the American companies have gotten the oil fields or at least have gotten the automatic contracts for rebuilding them? And perhaps, if we had done that calculation, you’d conclude well it’s actually not worth that much and maybe you’d have a reassessment of the whole thing altogether.”

“One of the signature achievements of the Trump Presidency has been to not get us into all these insane foreign entanglements and to dial this back.”

On American Politics / Identity Politics / American Exceptionalism:

“The thing that’s odd and I want to conclude with is, Why haven’t these questions been asked? What is it about our society about the United States that has been so deranged that these obvious questions cannot be asked or that these obvious answers cannot be given? It’s taken 47 years, since ’72 to have this conference, or to come back to asking some of these questions. 

It is striking how the US is incredibly out of kilter on this. I’m going to give one left-wing answer and one right-wing one. 

On the left, I think the kind of psycho-social hypnotic magic trick that has been played on the population to distract us from these questions is identity politics. Identity politics started in the 1970s, the sort of cultural Marxism identity politics started at the same time as all of these questions have become more urgent and it’s been this phenomenal way to distract from asking these questions. I think that’s the main thing identity politics does. 

You can sort of debate the merits and demerits, the mural in San Francisco with the Communist artists that they are trying to erase or whatever. And maybe they should do it and maybe they shouldn’t. There’s always a merit and demerit debate, the main thing is identity politics is an insane distraction. The word identity means that which makes you identical and that which makes you unique. If you start with A and Not A, you can prove anything. It’s an endless distraction factory. 

I always have this hope that it’s about to end in some sort of paroxysm of insanity. And that the identity politics monster is going to get a heart attack from flopping its tail about wildly as it is, but I have to confess that there’s no empirical evidence that this is about to happen. 

For this reason, I think a left-wing or progressive discussion of what’s good for the United States, what’s good for America, is still not going to happen. And this is a conversation that can only happen on the right, it would be nice if the left could participate, but they’d have to get over that issue and I don’t see that happening any time soon.

I do think there’s also been something on the right that’s distracted us from having these  kinds of conversations in the US.

The single thing I would zero in on that’s distracted [the right] over the last few decades is the doctrine of American exceptionalism. This doctrine that the United States is exceptionally different, not commensurate any other countries, can’t be compared. It’s one that’s sort of incarnated in the insanities of the millenarian Bush 43 second inaugural. The exceptionalism obscured everything. 

If you want a theological or epistemological analog, I think it is roughly similar to the problem of what one can know about the God of the Old Testament or the God of the Qu’ran: if God is radically singular or radically different, can you know anything about him? It’s the same as the medieval problem of the attributes of God. 

And if you think about the United States, as so exceptional that we can never talk about it, that is going to obscure and obfuscate a lot of the kinds of questions that I have been discussing today. 

What I think has happened in practice is that exceptionalism, the doctrine of exceptionalism has led to a country that is exceptionally overweight, that is exceptionally addicted to opioids, that has an exceptionally dysfunctional infrastructure where it costs 10 times as much to build a mile of subway as it does in socialist western Europe, that is, in short, exceptionally unself-aware, exceptionally unself-critical.

What I think we should always underscore on the Nationalist side for the United States is that Nationalism has nothing to do with the sort of exceptional unself-awareness. That nationalism is not blind patriotism, it’s not: my country right-or-wrong, without any questions. Nationalism is going to ask hard questions. It’s going to ask how does our country stack up against other countries? How does it compare? And it may find it very wanting. It’s going to be extremely critical. It’s not going to be unreflective. 

I think whatever else the Trump Presidency stands for, it stands for a move beyond exceptionalism, beyond those dogmas. They are not coming back on the Republican side. They are over. It is long past time to grow out of exceptionalism and we should settle for greatness.

On Elizabeth Warren:

“One of the challenges for the left is they are captured by the institutions of our country and the institutions in our country are corrupt and sociopathic. If part of the critique of universities is a critique of corruption of the Studio-54 Harvard night club, that’s one that is existentially tough for Elizabeth Warren to do. I’d welcome her doing it, but I’m not holding my breath.”

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Links of Interest 2019.Jun.29

Links of Interest is a weekly email that covers interesting links from the week and any news I find of interest to investors. You can subscribe to the Links of Interest newsletter here.

Greetings,

Trump and Xi will be meeting over lunch tomorrow in Osaka. Many hope to see a significant x.0 upgrade in the G2 relationship, a G2.0 if you will. The big news (so far): SCMP is reporting a tentatively agreed truce and joint press releases to be out before the meeting. The report also says a delay in additional tariffs was Xi’s price for the meeting.    On to the note. 

First off, my apologies for a relatively long note. I take a look at 4 economists’ comments on global trade tensions around what I believe is an underlying cause. I hope you find it useful or helpful. Feel free to forward.   

A few Economists’ view of Trade Tensions & US-China Relations

Imagine someone asked you, where will future global demand come from? You might think demand should be created from globalization spreading and lifting people out of poverty. 

This week Catherine Mann was on Bloomberg Surveillance (overcast)[2]. Tom Keene asked for her view on inter-dependencies and correlations that lead to a country’s individual policies having little effect. Her response:

The trade relationship we have right now with China is emblematic of 10 years of stagnation in terms of global integration. Earlier in my career we talked about more deeply integrated global supply chains, a greater variety of products crossing borders, lower prices available to both businesses and consumers. And all that stopped about 10 years ago.”  

Demand cannot come from globalization because global integration stopped 10 years ago. What about incremental demand in the form of imports increasing as a country’s GDP increases?

Brad Setser, Council on Foreign Relations, last November wrote a blog post entitled “China should import more.” He included this chart, showing the declining trend in China’s trade in manufactures with the US as a share of GDP.

Setser is still on top of this, he wrote a post this week that argues “China under Xi has deglobalized more than the US under Trump.” And he shows it with his namesake’s indicator, which compares the rate of growth of imports with the rate of growth of GDP. A value below 1 shows imports increase at a slower rate than GDP.

So, incremental demand is not coming from China even though its GDP grew faster than any other nation. You may be wondering why this matters. Let’s turn to Michael Pettis.

Last year as trade tensions were heating up, Michael Pettis discussed the historical significance of the global system we find ourselves in. (A video is on youtube, and I transcribed it.) 

“The problem is that the American role in the global economy is to balance the excess demand or excess supply of savings.”

He then explains how this came about after two world wars, countries were destroyed and they desperately needed savings (investment) to rebuild. So in that period the US ran a current account surplus every year. Then it switched. 

“Since roughly the 1960s when the world was more or less rebuilt, the problem shifted. The world no longer lacked savings, it lacked demand. The way to grow was with additional demand. And [the world] had excess savings. And I think it’s not a coincidence that during that period, countries like the US with very open, deep, flexible financial markets (including Great Britain) were constantly running capital account surpluses. In other words, the excess savings ended up in those countries. And if you run a capital account surplus, you must run a current account deficit. And I’d say that is why the US has run persistent current account deficits since the 1970s.  

Because, given the existing global framework, its been forced to absorb excess savings in the rest of the world. So this has been a problem for a long time. During the Cold War, the US was willing to ignore the problem because, by running large current account deficits, it was able to strengthen its relationships with its allies. But with the end of the Cold War, I think it was inevitable that would become an increasing problem.”  

Note: Pettis wrote an entire book on this subject, The Great Rebalancing, which I highly recommend.   

The world lacks demand. Pettis clearly states: “The problem is people think all we need are good trade deals. No. All we need is someone willing to run large current account deficits.”  

Who is willing to run large capital account surpluses? Let’s turn to Mervyn King, who was interviewed on RealVision, worrying about global imbalances.

“If you actually look at the surpluses deficits around the world today, basically there are four countries or currency blocks that matter. Two surplus and two deficit. The two surplus areas are China and the Euro area. The two deficit countries are the United States and the United Kingdom.”

Mervyn King suggests these four countries get together for private meetings to “explain to each other how we are going to rebalance our own economy” with currency adjustments off the table.

It’s not surprising that Michael Pettis had a similar suggestion, “the best way to do it, is for us all to get together and decide what this new world must look like.”

There’s the economists’ solution: get together and come up with a grand bargain. Why? Because all four of these countries have something to fix.

All four have structural supports for imbalances or structural impediments to rebalancing. Basically, policies in the form of over reliance on consumer credit, capital controls and others [2].

But it’s not just individual domestic policies. Every country is operating inside a global trade “system”. A country’s imbalances are impacted by the policies in other countries.

This means global trade is a complex system. And, in order to understand the system, we must avoid treating the pieces as independent from the system.

We, humans, tend to take an “inside view” on situations, because we rely on our own narrow experiences, emotions and intuitions. It’s easy. It’s more difficult to take an “outside view”, where we (1) see our actions from the view of someone else and (2) seek to understand the other side’s situation. And this is exactly what we need.

It is probably impossible to expect a nation of many voices and views to cultivate an outside view of another nation. Thankfully, there are pockets of people who do such a thing, I include those mentioned above in that category.

This brings us to another problem: if (fingers-crossed) our policy-makers can adopt an outside view and somehow get to a new grand bargain that puts the world on a better path, will our individual nations’ people accept it?

Said another way. Can we look beyond our differences, refrain from placing blame, and, perhaps hardest of all, trust one another?

Thanks for reading. Please feel free to forward to anyone you think may find this interesting. As always, I’m happy to discuss any questions, comments.  

Yours truly,
James Hull

Edits: Added inside / outside view comments.


hullx.com  

[1] Catherine Mann had an interesting take on US foreign policy towards China: “There is this disconnect between the objectives: to enhance IP protections, allow for broader joint ownership, allow for protection from technology transfer. That would more deeply engage the US with China. The Tariffs are to divorce our relationship with China, to break up those supply chains and make them go to some other country. There’s a real disconnect between these two different objectives in the current policy set.”)  

[2] I reject the cultural reasons for trade surpluses/deficits, such as “thriftiness” or “laziness”. I find the analysis shallow and, if not completely wrong, woefully incomplete.

[3] For more on inside / outside view, see Thinking, Fast and Slow

Links of Interest 2019.Jun.29

US-China
China to Insist US Lift Huawei Ban as Part of Trade Deal WSJ
President Xi, Still the Deglobalizer in Chief CFR
Michael Pettis: The US-China Relationship Hx
Surveillance: Too Little Globalization, Mann Says B
Essay on US-China relations by Ryan Hass SupChina

Trade Restrictions & Frictions
Amazon’s Merchants are Feeling the Pain of US-China Trade War CX
FedEx Sues Commerce Department Over Restrictions on Huawei WSJ

China Markets
China Seeks to Bolster Short Selling After Opening Tech Board CX
Why China feel out of love with New York property FT
Where’s the Cash – China’s Private Sector worries about payments MP

Central Banks
Jay Powell says Fed ready to act if trade wars hit economy FT
Reach for Yield by US Public Pension Funds (PDF) Fed

Industries/Companies
Tech Inventory Buildup Worsens on Huawei, Demand Slowdown B
Bernard Arnault: I always liked being number one FT
Facebook’s Cryptocurrency: Stop it before it starts Lawfare

Investors
Stanley Druckenmiller at the Economic Club of New York Youtube
Why This Value Investor Thinks Value Stocks Are About to Make a Comeback II

Misc
Cult of the Dead Cow Review by Cory Doctorow BoingBoing

Michael Pettis: The US-China Relationship

This is my transcription of Michael Pettis’s interview with SuperReturnTV.

Interviewer: How has Donald Trump affected US CHINA relationship?

MP: China has a current account surplus, of course. And it needs that current account surplus because China has a big problem with demand. It has insufficient domestic demand so it has to balance that with huge amounts of investment and with the current account surplus. But because investment is, much of it is non-productive, all of that investment is causing debt to go up. So the current account surplus can be thought about as a mechanism that reduces the need to grow debt. My very rough calculations are that every forced contraction of China’s current account surplus by 1% of GDP causes the required amount of debt, required to meet the GDP growth target to go up by roughly one-third. So it’s a huge number. And if the US takes steps that forces a rapid contraction in the Chinese current account surplus, the only way China can balance that is with an increase in already too rapidly growing debt.

Interviewer: What do you mean by “if the US takes steps”? Are there concerns for some sort of trade war?

MP: Yes, basically, I think one of easier predictions to make after the Global Financial Crisis was that we were going to see significant pressure on trade. Because we are in a world in which the most valuable resource is demand. And the way that demand is proportioned around the world is that demand is created domestically by all these different countries. And it’s apportioned through the current account. 
So countries with current account surpluses are absorbing more of global demand than they are producing. Countries with current account deficits are the opposite. 
As long as debt levels were able to grow very very quickly, then countries with current account deficits were able to counter the impact of their deficits with and increase in debt. But the global crisis was really sort of the end of the ability to increase debt very very rapidly. So now that means that current account deficits have an employment impact. And once that happens, I think it was a pretty safe bet to say that we would see significant pressures on international trade, which as you know has contracted for the first time in a long long time. 

Interviewer: With that in place, how tricky is it to have a man like Donald Trump running the US as well?

MP: I think people pay too much attention to Donald Trump. Remember Bernie Sanders said exactly the same thing about trade. And this has been an issue that really became important political issue in the 1980s and it hasn’t really gone away. 

The problem is that it is true that the American role in the global economy is to balance the excess demand or excess supply of savings. 

You could say there’s been roughly 100 years of dollar hegemony. And the first 50 years, that really characterized by the two great World Wars, which cause a destruction in the income and therefore the savings of the rich countries of the world and a huge need for rebuilding. 

So in that period what people needed was savings, so I don’t think it was a coincidence that during that period every single year the US ran a current account surplus. The current account surplus is the flip side of a capital account deficit. The US was exporting a huge amount of savings into the rest of the world.

Since roughly the 1960s when the world was more or less rebuilt. The problem shifted. The world no longer lacked savings, it lacked demand. The way to grow was with additional demand. And [the world] had excess savings. And I think it’s not a coincidence that during that period, countries like the US with very open, deep, flexible financial markets (including Great Britain) were constantly running capital account surpluses. In other words, the excess savings ended up in those countries. And if you run a capital account surplus, you must run a current account deficit. And I’d say that is why the US has run persistent current account deficits since the 1970s.

Because, given the existing global framework, its been forced to absorb excess savings in the rest of the world. So this has been a problem for a long time. During the Cold War, the US was willing to ignore the problem because, by running large current account deficits, it was able to strengthen its relationships with its allies. But with the end of the Cold War, I think it was inevitable that would become an increasing problem. 

Interviewer: So in your view this is so long term.. someone going to have protectionist attitudes like Donald Trump.

MP: I think this was going to happen one way or the other. Donald Trump is not the first person to complain about the US current account deficit. The problem with the Trump administration, I think is that although they are right to complain, they are focusing on the wrong side. They’re focusing on the trade side, when the real problem is on the capital side. What they really should be focusing on is on the US role in absorbing excess foreign capital because that’s what drives the trade deficit. 

Interviewer: So that’s trade, there’s also events that could have a big impact, such as the US implementing a infrastructure program.

MP: Well, that’s one of the few things in the world that actually is a free lunch. The US has huge infrastructure needs which the private sector for a whole bunch of reasons is unwilling or unable to fund. But if the government were to fund infrastructure, I think we all agree, that the US has infrastructure needs, if you spend a trillion dollars on improving or building US infrastructure, you will increase the wealth of the US by more than a trillion dollars. So you actually reduce your debt burden. If the US were to engage in a major infrastructure building spree, in that case running a current account deficit wouldn’t be a problem. Because now the import of foreign capital would go into increasing investment. If it doesn’t go into an increase of investment, it must force a reduction in savings, it must balance. So the best way for the US to have a deficit would be if that deficit was caused by a massive infrastructure building spree. That would be great for the US and good for the world. But without that we are going to see tremendous pressure on the current account deficit. 

Interviewer: That’s the situation with the economy, what’s the situation with the “power void”? With Donald Trump looking more inwardly in the US there is sort of this space for China to expand its global influence. 

MP: “Well, I think it makes sense for the US to reduce it’s global commitments. After WWII US was about 50% of the world GDP, US is now around 23% of world GDP.Now the burden of that is much heavier given relative size of the US economy and the relative size of the rest of the world.There should be a US withdrawal from some of these commitments.If it doesn’t happen now, it’ll happen in the future.It’s better to happen now, when the US is still in a position where it can manage the process, than if the US were forced out of these positions 30- 40- 50 years from now.

The argument that a withdrawal of the US role means an expansion of the Chinese role, is not true. It doesn’t have to mean that, it could also mean that there is no leadership. That would be quite bad. The whole purpose of Bretton Woods was we had no one playing that role in the 20s and 30s and we all agreed it was a disaster. It could happen and in fact, in my opinion, it’s far more likely to happen.

Because the leadership role the US plays, the reason the Dollar is the reserve currency, etc, etc, Is not because the US will invade you if you don’t buy dollars. It is because the US is willing to absorb all of your excess savings and run the corresponding current account deficit.

If China wants to replace the US in that role, it’s very simple, it should open up its capital markets and should be willing to run large current account deficits. — Which it won’t do, there’s simply no way it will do that.

So it’s not as if a US withdrawal will be matched with a Chinese expansion. A US withdrawal simply means a US withdrawal. I don’t think there will be anybody to replace the US.

In that case, I think the best way to do it–it’s not going to happen– but the best way to do it, is for us all to get together and decide what this new world must look like.

For so long the global trade and capital regime worked fairly well, as long as the US and the UK, the other so-called Anglo-Saxon economies always had these very open capital markets, because all of the savings imbalances in the world get resolved in the US financial markets, and as that becomes increasingly difficult, it’s not a surprise people are more and more concerned about what the implications are. I wish I had answers. All I can do is tell you that, I think it gets worse before it gets better.

Interviewer: Question about UK’s Brexit, will there be a China UK trade deal?

MP: The problem is people think all we need are good trade deals. No. All we need is someone willing to run large current account deficits. And the UK has a deficit and if it is willing to allow the deficit to grow, and I think the UK has a limited appetite for that. Then trade deals between the UK and China could probably strengthen, we could probably see an awful lot more. Because China needs those surpluses, remember it has very weak domestic demand and much of that demand is non-productive investment, which is why debt is exploding. And their current account surplus is one of the ways in reducing the pressure to increase investment and to increase debt. That’s really what China needs from the world [surpluses]. I’m not sure that is what the UK wants to give it.

Interviewer: you called yourself a history nut, what could we learn from history in trying to understand the next 5 to 10 years?

MP: Well I think we need to look very closely at the 20s and 30s period. That was a period of tremendous imbalances. And, as has often been argued, the UK’s withdrawal as the director of the system, and the refusal of the US to step in. If we see a US withdrawal as the director of the system and no one else is able to step in. And I would insist, the only way for China to step in would to be willing to run the large current account deficits that the world needs it to run. Then that is the period we should look at. And it’s a very bad period. In fact, as I said, the whole purpose of Breton Woods was consensus–the universal consensus, that whatever it was in the 20s and 30s we don’t want that anymore. Unfortunately, I think that is where we’re going to go.

Interviewer: We need global leadership and there is a bit of a void.

MP: We need even global leadership, which was possible when the US was 50% of the world. I think it’s more difficult now that the US is 23% of the world and there’s no body else to replace it. Or we need a coordinated system that works, with no gaming of the system.

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Trade War as Prisoner’s Dilemma

A trade war is like a Prisoner’s Dilemma game gone wrong.

  • (1) Trust between both sides has eroded.
  • (2) They cannot communicate effectively.
  • (3) They decide to forego cooperation and defect.
  • (4) And, by foregoing cooperation both sides are hurt.

In a prisoner’s dilemma game, two players are separated (can’t communicate) and given two choices: cooperate or defect. The only winning outcome is when both players choose to cooperate. 

There is a special kind of prisoner’s dilemma game, where the game is repeated many times over and the players can remember the other player’s actions. This means past rounds matter, reputation matters. In these prisoner’s dilemma games, a winning strategy emerges: Tit-for-Tat.

How Tit-for-Tat wins Prisoner’s Dilemma games

First off, the Tit-for-Tat strategies that win are slightly modified. They have a function that tries to break a negative ‘defection’ cycle by forgiving the other party and making the first move to cooperate. 

Forget injuries, never forget kindness

More specifically the winning strategies tend to be: “nice (never the first to defect), retaliating (willing to defect), forgiving (willing to attempt to regain trust by breaking a defection cycle), and non-envious (not specifically attempt to outscore individual opponents)”[1]. I’m going to focus on forgiving because that is where the cycle gets broken.

In a standard Tit-for-Tat strategy you copy the move of your opponent. If they defect : you defect, if they cooperate : you cooperate. This easily turns into a negative cycle, where both sides keep defecting (and spending a lot of extra time in jail).

The negative cycle is broken first by forgiveness and second by extending a hand (attempting cooperation). One side decides to forgive and tries cooperation for two rounds.

Why two rounds? Because the players don’t know the other player’s action until after the round. The first round forgiveness is the signal. The second round is the real chance for cooperation:

  • If the other side cooperates, the negative cycle is broken. (Hurrah!)
  • If the other side refuses cooperation, in the next round (the third) the forgiving player switches back to escalation. The negative cycle continues.

Here’s some food for thought on forgiveness:

  • “记人之善,忘人之过” – 三国志 forget injuries, never forget kindness.
  • “We must develop and maintain the capacity to forgive. He who is devoid of the power to forgive is devoid of the power to love. There is some good in the worst of us and some evil in the best of us. When we discover this, we are less prone to hate our enemies.” – Martin Luther King, Jr.
  • “To forgive is to set a prisoner free and discover that the prisoner was you.” – Lewis B. Smedes

Forgiveness is the intentional and voluntary process by which a victim undergoes a change in feelings and attitude regarding an offense, lets go of negative emotions such as vengefulness, forswears recompense from or punishment of the offender, however legally or morally justified it might be, and with an increased ability to wish the offender well.

Wikipedia [2]

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