Sunday Thoughts
As we head into a week full of potential announcements on tariffs, it’s important to emphasize that while we are all focused on Trump’s moves, we should also consider what the tariffed countries’ response could be. That’s not easy, but a bit of game theory might help untangle the possible paths things could take.
The Nash equilibrium is a fundamental concept in game theory, describing a situation where no player can unilaterally improve their payoff by changing their strategy, assuming other players' strategies remain constant. It occurs when each player's strategy is optimal given the strategies of others. This equilibrium represents a stable state where players have no incentive to deviate, even if the outcome may not be the best for all players collectively. Named after mathematician John Nash, this concept has applications in economics, politics, and beyond, helping analyze strategic decision-making in competitive or cooperative environments.
A classic example is the "Prisoner's Dilemma," where two individuals must independently decide whether to cooperate or betray each other. If both betray, they each receive moderate punishment. If one betrays and the other cooperates, the betrayer goes free while the cooperator suffers heavily. If both cooperate, they receive lighter punishments. The Nash equilibrium in this scenario is for both to betray, as betraying provides a better individual outcome regardless of the other person's choice, even though mutual cooperation would yield a better collective result. This highlights the tension between individual rationality and group benefit.
The Nash equilibrium can help explain the strategic dynamics behind Trump's tariff policies. Trump imposed tariffs on goods, aiming to protect domestic industries and incentivize better trade deals. In response, other countries could retaliate with tariffs of their own, creating a strategic standoff. Each side's strategy (imposing tariffs) is a Nash equilibrium because unilateral withdrawal would worsen their respective payoffs — Trump feared losing domestic economic protection, while China risked economic vulnerability. The situation illustrates how the Nash equilibrium can lead to suboptimal outcomes (a trade war) because both players act in their self-interest rather than seeking cooperation that might yield better overall benefits.
Now, we are hearing and reading about some sort of cooperation between the US and China, which highlights that both parties aim to soften the blow of a possible trade war that clearly doesn’t benefit anyone. The fact, however, remains that their specific goals have not changed. As such, the more positive news is potentially just masking the real strategic goals both countries are still undoubtedly following. Remember, talk is very cheap and belongs in any negotiation tactic. The end result is what matters.
Let’s now read Macro D’s latest thinking before we briefly scan the week’s upcoming calendar. We then check out the 10 most important charts for the upcoming week before scanning the newest output of our asset allocation model.
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