Trump and the Trade Deficit

When Trump or his supporters mention the trade deficit as a problem, they are treated as ignoramuses. It is assumed that they don’t understand that there are gains from trade and that the idea that countries producing goods or service in which they have a comparative advantage making everyone better off is too complicated for them to understand.

But people complaining about the trade deficit have obviously heard this argument many times before. To harp on this basic point as if they don’t understand it is extremely counterproductive. Some of their favored policies to fix the problems may have too many unintended consequences but they are right to point at our trade deficit as a symptom of significant problems.

In 2015, the current account balance, which includes the balance of trade, net income and cash transfers, was -2.7% of GDP. We are not very close to potential crisis levels. So why are people who understand gains from trade still so worried about trade deficits?

For one, comparative advantages are not stable ratios in the long run. When those who worry about trade deficits look at manufacturing going overseas, they don’t just see a company taking advantage of low priced labor. They see technical knowhow being given to future competitors. The Chinese factory next week is going to lower prices for US consumers and expand profit margins of a US company at the expense of a few workers in the US. A few years later, the foreman leaves and sets up a competitor and starts undercutting the US company’s prices when they sell to the rest of the world. What used to be a comparative advantage for the US vis-à-vis the rest of the world is now one for China.

From a global perspective, everyone is still better off. Chinese workers are rising from poverty and European consumers get even cheaper goods than when they were buying them from the United States. But from a nationalist perspective, America loses. Reducing certain types of technology transfer is not a crazy goal, it’s what needs to be done at some level to keep the United States richer than the rest of the world. There are good and bad ways to reduce the transfer of technology. The best policies to police technology transfer are very complicated as companies have global supply chains and many types of technological expertise are not going to be easy to attain or reattain. And perhaps more difficult for politicians to navigate, there are always rent seeking corporations who would like to charge domestic consumers higher prices in the name of protecting American competitiveness.  

Even many of those in the anti-Trump camp understand the need to prevent technology transfer intuitively when it is framed differently. Many are still lobbying for ways to remove immigration barriers for talented students trained by our world class colleges. Sending those college graduates back to their country of origin transfers technology the same way that moving production overseas does. What’s obvious is that protecting our technological edge is a policy that can make Americans better off when applied properly.

Another aspect of the trade deficit is that it indicates that America is not as efficient as we would like. If companies were less restrained by regulatory hurdles, it’s very possible that the United States would be the low-cost leader in far more categories and exporting far more goods and services than it does now. If the EPA was less stringent it’s obvious that we would be importing fewer commodities because we’d be producing more. And if it happens that whole industries are being threatened in the United States, looking to streamline the regulatory and compliance costs could solve the issue more effectively than implementing tariffs against the new low cost competitors. There are real political tradeoffs when it comes to policies that create our trade deficit, the policy disagreements aren’t about whether there are gains from trade.

Trade deficits aren’t just about production; they are also about consumption. Increasing debt levels, both personal and governmental, allow for consumption in excess of production. US citizens are living better now, but it’s at the expense of a run up in debt and potentially their future quality of life. If economic growth is healthy then kicking the can down the road makes sense, let those richer people of the future deal with the problem. But that’s a big if for many people living in communities who are not finding the same opportunities as their parents in the global market thanks to consistent technology transfers abroad and the increasing cost of doing business in the United States.

Many economists will point out that the United States is a safe haven where people around the world park their money, and that’s a good thing that helps create our trade deficit and current account deficit. But just look at Switzerland, also a widely acknowledged safe haven. They have a trade surplus and current account surplus of around 10% of GDP. It’s nice that everyone wants to invest in the United States, but it would be better if US citizens had even more wealth to invest in the rest of the world.

The trade deficit is a symptom of many underlying problems. There is basically no way that a blanket policy of tariffs to brute force the deficit into a surplus will make things better. But if many of the inefficiencies and problems of the United States economy were fixed the deficit would go away. The trade deficit is representative of real problems and there are things that politicians should be doing to address them. 

I Voted

For most of my life, I've been pretty skeptical of democracy. My basic perspective was if three wolf and a sheep are voting on dinner, should the sheep legitimize their decision to eat him by voting for grass? In this analogy, the sheep would be the productive part of society while the wolves are the rent seekers, big and small. 

The sheep analogy is flawed, because there are not just three wolves and one sheep. There are lots of sheep and lots of wolves. Who is a sheep and who is a wolf can change depending on the issue. While in many cases the sheep are vastly outnumbered it can still be close in other cases. If a sheep wants to have a chance of influencing other sheep and sympathetic wolves to oppose the wolves then they would be well served to have their actions and their words in alignment. The message "Don't vote for the wolves, and in fact it's so broken I'm not even going to vote" is not credible.

And if there is a group of wolves, and those wolves are beatable if the other sheep just recognize the wolves for what they are, then it makes even less sense to mix messages. Right now the group of newly exposed wolves is the rent seeking homeowners. People who own homes that vote to keep the supply of new homes restricted drive up prices of their homes at the expense of anyone looking to rent or buy a house. Anti-construction policies have driven real estate prices in the San Francisco Bay Area up to absurd enough heights that many people are starting to notice. And while the times that a couple of votes can swing a national election are few and far between, there are plenty of opportunities for small groups of voters to swing local elections.

So I voted. I looked at which politicians were pro-growth and gave them my support. I looked at which rent seeking organizations supported or opposed propositions and voted directly against their interests (Unfortunately, sometimes there are rent seekers on both sides).

While the act of voting individually might not be economically rational, there are things that make it slightly less costly. Earlier this year I filed some paperwork with the state government. The justice system figured out where I lived and put me on the list for jury duty, so the downside to registering and voting became really marginal.

Most people would end this post telling the reader to vote. I would like to make the more modest suggestion that if you are already being called for jury duty and like discussing politics, there is little downside to registering to vote before the next election.

Feigned Weakness and Politics

The concept of faking a weakness is an age old strategy. Feigned retreats have been utilized by armies since ancient times. I'm partial to Dan Carlin's description the Mongol use of this tactic. For those who have not yet listened to his excellent telling, the mongols would pretend disarray and retreat and run. Most of the killing in ancient warfare occurred during the retreat, so the Mongols would be chased in a less than fully organized fashion. Once the enemy lines were stretched out in pursuit the Mongols would turn on the pursuing army and deal them a devastating blow.

A similar stratagem is used in modern politics. Every candidate in this day and age has strengths and weaknesses. But the public does not have a large enough attention span to cover multiple topics. The best line of attack is to find a flaw in the candidate that is representative of their many problems and push hard when it appears they are weak. 

Sometimes the weakness is not real. In 2008, some people thought that the allegation that Obama was not born in this country could be that type of attack. This attack was never going to work. Obama might have been ruled a natural born citizen of the United States no matter where he was actually born as his mother was from Wichita, Kansas. Furthermore, the long and short form birth certificates proving that he was born on US soil definitely existed. But rather than fully confront this attack when it first appeared to be growing he feigned retreat. The allegations were called racist and insulting and not worthy of response. 

In fact, the allegations being labeled as racist and insulting created a good incentive for him and his team to not respond immediately. Not responding in Obama's birther case served many purposes. First, it was a refusal to give any respect to a group of crazy people attacking him. Second, it made many of his opponents look bad. Demanding the birth certificate of the first non-full caucasian president appeared quite racist. But more importantly, it filtered some of the most enthusiastic attackers of Obama into focusing on an issue that he knew would not get out of control. At a time when his advisors with Wall Street connections might have been vulnerable to attack or the handling of the stimulus might be critiqued the birther movement's existence encouraged many of his critics to instead focus on running directly into a brick wall. 

Over time, the refusal to fully parry the birther movement created its own suspicion and attracted additional curiosity. The White House was forced to release his longform birth certificate to end it. But between 2008 and April 2011, a lot of his critics were charging at windmills rather than challenging him on policy.

Hillary Clinton's Wall Street speeches could be seen as a similar feigned weakness. When she was fending off Bernie Sanders from the left, the transcripts were a real weakness. But once she was past the primaries and moving towards the center for the general the speeches were no longer a large negative. Their release might impact enthusiasm among younger Bernie supporters, but that's about it. But by refusing to release them she created a feigned weakness for Trump and others to attack her. Considering her long history of controversy, any efforts here only served to reduce time spent on issues where she is potentially vulnerable.

In Clinton's case, Wikileaks released these speech notes sooner than she would have liked. It was unfortunate for her team not because the releases exposed anything too nefarious (though supporters on the left might be upset to learn that she is an anti-pot candidate), but because the emails were a feigned weakness that could soak up a significant percentage of attacks.

So the next time you see a politician refusing to counter an attack that seems easily parried if they are innocent, consider the tactical implications. Perhaps they want more of their critics charging at windmills. 

Or maybe they really are hiding something. They're politicians, after all.

The Falling Stock Holding Period Myth

One common financial fallacy is for people to divide the stocks outstanding by their volume and call that the average holding time. This makes today's average holding period of a stock seem very small, and the resulting chart can be used by those who want to paint today’s stock market as more short term than ever. 

The below tweet is not an atypical example of this phenomena. 

When I found the source of this chart, a newsletter by Alan Newman, the argument that it was buttressing was not surprising. 

“Thus, we are making the case that every year from 1997 may fairly be presumed manic in nature.”

Except that these charts are absolutely the wrong way to look at things. The rise of high frequency trading and the decrease in trading costs thanks to electronic trading has meant that market makers are trading a lot more than they have in the past. Thanks to the improvement in technology, transaction costs for investors have fallen across the board. Measured stock market volatility has also gone down, though there are likely tail risks associated with this volatility decrease such that the worrywarts are not completely wrong. But either way, the rise of high frequency trading says nothing about the changing time preference of today’s investors.

So how should we measure the time horizon of today’s investors? One way is to look at the median holding period of non-market making investors. It turns out that someone has already done this work, it just doesn’t get as much airtime as the average holding period because the data doesn’t tell a crazy story about investors. Martijn Cremers and Ankur Pareek have saved us a lot of trouble, because in 2014 they published a paper introducing the concept of Stock Duration. 

Stock Duration is a measure of how long institutional investors, who have to report their quarterly holdings to the SEC, have held a stock. The paper focuses more on quantitative investment strategy, but they included a measure of Stock Duration over time at the end.

 Source: Martijn Cremers and Ankur Pareek, Short-Term Trading and Stock Return Anomalies: Momentum, Reversal, and Share Issuance April 17, 2014. Figure 1, Panel A.

Their sample looked at the median duration of the largest 1300 stocks most commonly held by institutional investors. And the median stock duration increased during the period when high frequency traders started drastically increasing trading volume.

In another duration focused paper, they analyzed how duration and other factors drove the returns of US mutual funds with over $10 million AUM. In order to accomplish this, they calculated a Fund Duration metric. Fund Duration measures the average holding period of each stock in a fund and requires that a fund have at least two years of history. The aggregate of this metric again counters the narrative that investors are becoming more short term oriented.

Source: Martijn Cremers and Ankur Pareek, Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently, 2015. Appendix A, Table A3

When we look directly at mutual funds, they are if anything becoming more long term oriented.

Source: Martijn Cremers and Ankur Pareek, Patient Capital Outperformance: The Investment Skill of High Active Share Managers Who Trade Infrequently, 2015. Appendix A, Table A3

It’s possible that mutual funds are now furiously trading in and out of their stocks between SEC quarterly reporting periods, but the relatively stable fund turnover ratio suggests otherwise. So while investors will always do many stupid short sighted things and many still have incentives driving them towards short term oriented thinking, the somewhat widespread idea that more investors than ever are thinking short term is probably not correct. 

When Contrarianism Works

I recently came across a paper by Cremers, Pareek and Sautner on Stock Duration, Analyst Recommendations, and Overvaluation.  In this paper they look at how stock duration, the holding period of institutional investors, interacts with analyst recommendations.

One of many interesting findings was a twist on the classic finding of stock underperformance or outperformance driving the analyst rating, rather than vice versa:

But interestingly enough, when stock analysts are late to the party of a stock with long term holders, the stocks still tend to do well.

However, when fast money is holding the stock then an analyst's extreme buy recommendation has on average marked the peak of the stock’s outperformance. The return of fading these optimistic short term investors were found to be larger if positions are not entered for at least 3 months after the signal.

On the downside, extremely bearish analysts are often too pessimistic, but the effect is larger when there is a lot of fast money involved. 

So while investors have many reasons to value contrarianism, it’s important to note that fighting against long term bulls does not necessarily result in a favorable outcome. It’s better to be bullish in the face of pessimists. But if you must be bearish make sure that the people on the other side of the trade are the types who are trying to make a quick buck.

Jury Nullification and Camera Credibility

I almost had jury duty this week. I called in the day before and I was told my pool wasn't yet needed. I called in again and eleven in the morning and found out that I was excused from jury duty. This was convenient, but also a little disappointing. I've never had jury duty before and I was hoping that I'd either see what it takes to get out of jury duty or get on a jury and be able to apply jury nullification. 

For those who don't know, jury nullification is the simple concept that if you are sitting on a jury and think that someone might be punished by a stupid law that you don't have to find them guilty. It can also mitigate harm to people who broke the law for a good reason. Maybe Jack Bauer shouldn't be guilty of torture if he stopped that nuclear weapon from detonating. Maybe the man who plots the murder of his daughter's killer should be found guilty of a lesser charge than first degree murder. Or perhaps that patent troll isn't entitled to millions of dollars from a popular company because the patent office screwed up and granted someone an obvious patent*.  In these cases the jurors don't have to tell the judge why they are deciding as they do (infact they probably shouldn't if they don't want a mistrial declared), they just have to find the defendant innocent of the relevant charges. 

There are downsides to jury nullification. Jurors can prevent the implementation of just laws through the same mechanism that jurors use to prevent unjust laws. One negative example is how jury nullification can perpetuate institutionalized bigotry. A jury of racist white people might not convict someone obviously guilty of murdering a minority or vice versa. But as long as the jury system is used according to the US Constitution each juror has the option to apply the principles of jury nullification. It's better if it is applied deliberately by principled citizens. Because in the right hands, jury nullification is one of the final vetoes that citizens have on the actions of an out of control or overly rigid government. 

Recent protests against police behavior have added another way for jurors to make a dent in bad governance. Historically, juries have often trusted police testimony more than that of accused criminals. Giving officers of the law the benefit of the doubt has been historically necessary to allow them to do their jobs.

But today's environment has a very important difference. Body cameras are cheap, ubiquitous and are becoming more widely available to police officers. More importantly, police officers have significant control over when their cameras are turned on or off. So body cameras were somehow not turned on when police officers raided the wrong house and shot a dog. When the Baton Rouge police shot and killed a DVD seller, their body cameras supposedly accidentally fell off. If police officers are acting properly, they should want the cameras on. If police officers would be harmed by what is shown on the camera, then they have an incentive to prevent the emergence of any body camera footage. 

Jurors everywhere need to push back against these incentives and create new ones. Jurors should assume that a police officer's testimony of events that occurred while they were in the field is worthless if their body camera footage is not also available. I'll call this "Camera Credibility" for lack of a better term and because alliteration is fun.

If enough people view cop testimony under the lens of camera credibility then there will be no way prosecutors to keep people with these beliefs off of juries. Police officers will be incentivized to make sure their cameras are operational and will be more likely to release footage that shows shades of grey in order to preserve their overall credibility.

While the proposed policy is implemented by jurors not trusting police officer testimony under certain conditions, this isn't an anti-cop idea. Body cameras are a way for cops to maximize their credibility and protect themselves against false accusations. The word of a police officer backed up by body camera footage will be held with the highest respect. The proposed camera credibility juror strategy would only really impact the small percentage of officers who need to be reigned in as other cops will have a good reason to make sure their unadulterated footage makes it to the courtroom.

Jury nullification applies everywhere that citizens serve on juries, though a juror discussing this idea openly in California will result in the judge removing them from the jury pool. Before jurors are selected, they are questioned in a process known as voir dire. Those who want to actively apply jury nullification need to somehow get through this process and onto a jury while those who want to get out jury duty can enthusiastically discuss their beliefs on the benefits of jury nullification. Either way, it's a good thing to remember.



*Commercial law decisions by juries who disagree with the law have a greater chance of being reversed in a process commonly known as Judgement Notwithstanding the Verdict

Third Parties should think about selling out

If this election season has taught those watching US national elections one thing, it's that it would be nice to have another option. But in a country with a voting system where the candidate with a plurality takes all, the equilibrium number of parties is two.

Just because that number is the equilibrium doesn't mean that this is always the case. And 2016 certainly looks like a year where the political institutions are not in equilibrium. With the population becoming more politically polarized, appealing to both centrists* and fringe elements is getting harder than ever. But the incumbent two parties have economies of scale, ballot access laws and established network effects which provide them with a significant advantage against challengers.

Their biggest advantage of Democrat and Republican party officials is that the challenging parties don't understand the game they are playing. Most people interested in third parties believe the lie that their parties are all about their ideology. 

Politics are as much about ideology as corporations are about making customers happy. It can be important, but there are other variables that matter much more. An ideologically consistent third party is not playing to win. They are playing to convince the major parties that they need to change their policies on the margin to convince people not to cast a protest vote for the third party. 

Third parties are pretty serious about maintaining their ideological consistency. The Green Party has repeatedly fractured in an attempt to remain true to its values. The Libertarian Party is famous for its attempt to excommunicate its members for impurity or extremism even though its members generally agree on the direction that politics should be moving.

In order to play to win a third party would need to start thinking like a major party. They will have to make compromises to bring people that they only partially agree with into their tent. They will need to make compromises with some types of interest groups even as they take the fight to others. They will have to acknowledge the political reality that it takes more than a promised pure application of their favored ideology to sustainably win elections.

This year the Libertarian Party took baby steps towards this view when they nominated Bill Weld as the vice presidential candidate against the desires of some libertarian purists.

In order to stand a chance this election or going forward they are going to have to take stances that are more libertarian than the status quo, but more status quo than what libertarians generally prefer. Most parents will not vote for a group who wants the blanket legalization of an 18 year old's ability to purchase of crack, meth or heroin, but replacing prison with treatment isn't as scary. Baby steps in the right direction should be preferable to giant leaps never taken. And this type of stance will have to be sustained over multiple election cycles without splintering the Libertarian Party.

No third party stands a chance at long term relevance as long as they keep thinking and acting like a third party who just wants some attention for their ideology from the major parties. This is why any potential replacement to the GOP or the Democratic Party is more likely to come from splinter groups within the party than from third parties built around ideological purity. And considering the value of the party's institutions, network and brand, major changes are still more likely to come from a new group achieving internal control of the party than from one of the parties being replaced.

Take the above with a grain of salt. In this political season I should know better than to make an predictions at all about politics. I should probably just directly predict egg on my face. But the main takeaway here is that the people who put ideology first aren't playing the game to win and few people are incentivized to tell them this. 



*It would be nice to come up with a term that differentiates those with views that aren't clearly left or right from the business interests who support whoever can ensure the continuation of their favored specific rent seeking policies. Both of these groups are called centrist but I hold on to an irrational hope that they might one day be separate.

Did Kleiner Really Already Raise $1.4 Billion?

A lot of news articles are commenting on how Kleiner raised $1.4 billion dollars in two new funds. This is a very believable event as they are a major VC firm who has had their share of success. However, the evidence the news stories point to make the claim of a completed fundraise seem a little bit premature.

The New York Times story, released on June 29, links to the SEC Form D filings of these two new funds as its main proof after stating the following:

On Wednesday, the venture firm Kleiner Perkins Caufield & Byers disclosed in a filing with the Securities and Exchange Commission that it had raised a total of $1.4 billion across two investment funds over the last couple of months.

But clicking through the links gives a different story. The Form D of the $1 billion dollar fund that was filed on 6/29.



The $400 million dollar fund filed on 6/29:



For reference, this is what the Form D of a fund that has definitely finished the process of raising over a billion dollars looks like:


The amount sold equals the offering amount, and there is nothing left to be sold.

The New York Times wasn't alone in their statement. Bloomberg covered the story the same way, Tech Crunch said "It's Official" and the WSJ called the funds closed. Basically everyone who covers tech has called the funds closed.

A few things could be going on here. One possibility is that some larger firms don't disclose their target size until they have a good idea that their limited partners will be willing to come on board with that amount of capital. While fundraising for a fund without filing Form D with the SEC is likely problematic, there are probably types of almost fundraising behaviors that are technically legal. So when a news organization sees this filing from a major VC firm it knows they have basically raised the capital.

Another possibility is that the news organizations got this story wrong and Kleiner is not able to correct the press during their quiet period. Also, because making LPs think that they are missing out on the fund isn't necessarily a bad thing they have no incentive to risk breaking the law to correct the story. This seems more likely.

Maybe media is right because the person in charge of filling out Kleiner's Form D's never likes to admit that the total amount is sold, even when it is. I looked at a 2014 filing of a fund that definitely closed at some point and could not find an updated Form D to indicate that fact (That's also possibly due to my inability to search through Edgar effectively). Still, when news leaked of the 2014 fund closing after those filings it was at least backed up by leaks from limited partner investors and not by a form in which they admit that $0 of the fund is sold.

If there is a better explanation, please let me know. Because right now it seems like the media has followed each other in a herd like behavior and declared two funds closed which are not really closed.

Thanks to my brother, Jonathan Lonsdale, for initially showing me something weird was going on and talking me through what filing a Form D meant. Any errors are my own.

Uber and Lyft's Missed Austin Opportunity

The taxi-driver lobby has been unsuccessful in their fight against ridesharing companies across the country. People have come to be dependant on low cost, reliable and convenient transportation provided by ride sharing companies.

But when the Austin City Council passed an ordinance requiring fingerprinting for their drivers, Uber and Lyft stumbled. They fought it tooth and nail when they could have tried to show how they could make government work better.

They initiated an $8 million dollar campaign against this ordinance where they tried to replace fingerprinting with background checks. On top of this, their proposition wanted to disregard a requirement for Uber and Lyft cars to be identified by markets and legalize the practice picking up passengers in travel lanes and bus stops.

Citizens of Austin felt like they were being bullied by rich outside companies. People pointed out that Houston required fingerprinting from 2014 and Uber and Lyft still operate there. Others felt that the companies were asking too much of the city. Uber and Lyft's attempt to overturn the city council at the ballot box failed with 56% of the people voting against it.

Since then, Uber and Lyft called the voter's bluff and are no longer operating in the city. Some makeshift websites that operate under the table have popped up to provide drivers with income and passengers with rides, but it is less convenient and less safe. And since hailing a ride has gotten less accessible, more people are making bad decisions about drinking and driving.

So the ridesharing companies have made Austin a warning to other cities: Interfere with our business at your own risk. But this didn't have to be the message. Uber often calls itself a logistics company. Fingerprinting new drivers is a simple logistics problem. If their biggest problem with Austin's ordinance was actually being banned from stopping in travel lanes, then they could have made the proposition about that and campaigned accordingly. If electronic fingerprint readers are more efficient and easier to apply to their drivers, they could have lobbied to let them help modernize Austin's government while giving new drivers a grace period before they had to be officially fingerprinted.

If they had turned the Austin situation into one in which Uber and Lyft took an inefficient government regulation and made it more convenient for everyone, we would be talking about why Uber doesn't replace or supplement the provision of other quasi-government services. More people would be talking about how Uber is going to take over the world. 

Instead they are attempting to maximize profits and status in the short term as they attempt to scare governments into compliance. Maybe the people of Austin will realize their mistake and try to welcome Uber and Lyft back into the city in one of the next few elections. It will be a short term victory, preserving their status quo as the incumbent transportation providers. But with self driving cars around the corner, Uber and Lyft are not necessarily the companies who will own that technology. Disruption will come for current transportation company incumbents sooner than it came for the taxi cartels. Austin could have been an opportunity to show that they will succeed in areas outside of ridesharing, but they made it a problem instead. 

The Implications of a Full English Brexit

Britain's decision to leave the Eurozone has already sent waves through the markets. It taught traders too young to remember the 2004 US presidential election that the first few election night polls are not always accurate. (In 2004, markets relying on faulty exit polls gave Kerry a 70% chance to win at one point.) But traders predicting another vote incorrectly is not the story. The story is about an upcoming massive institutional change that no one is quite sure how to interpret.

In order to leave, the UK has to actually petition to leave the Eurozone. This won't happen until a new prime minister replaces David Cameron in three months time. Intraparty battles will occur over this time period as politicians position themselves in the aftermath of a referendum. If there is an attempt to ignore the referendum and keep the UK in the EU it will occur during this time period. Supporters of Remain recognize that after the European Council is notified by the UK under article 50 there is no way to reverse the process short of jumping through all of the hoops required of countries wishing to join the European Union. 

One way supporters of Remain might go about ignoring the referendum if they get into power is by indefinitely delaying any notification under article 50. This would extend the period of uncertainty indefinitely and would not be helpful to the UK or world economy.

After the UK issues their petition, the rest of the EU will have to come to an agreement with the UK about the terms of their exit within two years.

If during this turmoil the UK voters and EU members decide that they don't want the UK to leave the EU quite yet, there is a way to kick the can down the road for more than two years. They can indefinitely extend exit talks as long as the UK and European Council unanimously agree to extend withdrawal negotiations. However, any pro-Leave UK party or anti-UK EU member from that point onwards could cause even worse disruption as any dissenter would have the power to force an immediate exit. The UK would have either too little or too much leverage for this scenario to be stable. So any news about definite plans to initiate article 50 makes an exit more likely and might cause another mini-panic.

If the UK and EU keep it simple and retain relatively open trade and freedom of movement both sides will benefit. This seems to be Merkel's preferred approach.

"The negotiations must take place in a businesslike, good climate," she said. "Britain will remain a close partner, with which we are linked economically."

She has no separatist movement within Germany to worry about scaring away from EU exit. However, other members of the EU realize that there is a risk that the UK will not be the only one to leave, so signaling that leaving does not come without consequences will be a very tempting idea. And some will be tempted to punish the UK for choosing to leave them, as is the case of the Mayor of Calais. Fortunately for all of those in favor of prosperity, that particular mayor does not hold much sway in international negotiations.

The more EU officials sound like Merkel, the better the economic outcome. If they start sounding like the Mayor of Calais, the short and medium term economic damage will likely be significant.

But there will be economic impacts either way. There will be a hit to business confidence. Jamie Dimon, CEO of JPMorgan, seems to expect that they will have to change the location of some roles to comply with European laws. Other companies expecting to move may be reluctant to increase headcount and investment in the near term and when this happens on a large scale a recession is almost inevitable. 

Then there will be capital flight as the volatility of the British pound and uncertainty of the political situation scares away certain classes of slow moving investors. Foreign direct investment inflows for the United Kingdom have fluctuated between one and two percent of GDP in recent years. It is likely to be much lower over the next couple years. The large fall in the GBP after the results of the referendum occurred was in anticipation of these flows and economic weakness in the UK.

Weak economic growth is widely expected to be countered by central banks to the best of their ability. The Bank of England's base rate is already close to zero at 0.5%.  And sometimes the best thing a central bank can do to stimulate the economy is weaken a country's currency to boost exports. In this case, the GBP has already weakened considerably and further weakness may be interpreted as a further loss of confidence.

Part of the problem is that central banks influence demand more than supply. To the extent that Brexit is a hit to confidence, demand matters and central bank actions are important. But if there are permanent business relocations from regulatory change or economic damage from trade barriers going up, Brexit becomes a supply shock. This means that there is not much that the Bank of England can do even if it was in a position to do something. If a central bank tries to fight a supply shock, stagflation is a likely outcome. In light of this, it is heartening that Mark Carney's statement on Brexit focused on the stability of the financial system and not on what the bank might do to support growth.

For Europe, the uncertainty is not going to be helpful, though the impact will be lighter than in the UK. A larger worry is what might happen as other EU members push for the right to hold their own referendums on leaving the EU. Gary Kasparov makes the interesting argument that Brexit will not only help Putin face a divided Europe, but the absence of the UK will lead to far worse policy being made in Brussels. Long term, this could be worse for Europe than the UK.

In the US, many people see the election of Donald Trump as analogous to a Brexit. Both are decision that were been deemed to be very unlikely well before voting day in part because elites regard Trump or Brexit as very destructive. The referendum resulting in a Brexit doesn't mean Trump's victory is any more likely than it was before the vote, but it does suggest that some forecasters might not be able to accurately forecast populist movements like Trump's.

Gold rose significantly on the day of the Brexit. The general theory is that uncertainty causes people to flee to gold. Gold is also helped by the general hit to economic growth expectations. Central banks who shift towards easing to counter the hit to global confidence should also benefit the irrationally valuable metal while also keeping government benchmark interest rates lower longer than previously expected.

The full implications of Brexit really are too many to cover in a short space. This is even more the case when some of the things people pretend are implications of Brexit are really just one of the many political impacts of long term trends like the stagnation of real income growth for many people in developed countries. A fuller picture would also look at Scotland and other parts of the UK who might favor leaving to try to stay in the EU. What it would take for London to remain a global financial center and whether any European city is likely to emerge as the obvious alternative is another interesting question. 

And there is still more to write about other countries. China's enigma of an economy will take a hit when Europe economic weakness reduces their Chinese imports. The Japanese yen is now just above 100 after the panic over Brexit and this yen strength puts extra pressure on Kuroda and Shinzo Abe.

But the biggest thing to track will be whether the world starts turning protectionist. Nasty exit negotiations would be a bad sign. Many people are tempted to constantly make bad analogies between our economic circumstances and the Great Depression. But the Brexit negotiations have the potential to create the closest thing to a modern Smoot-Hawley Tariff bill. And that's why it has the potential to be very scary.