Recently, due to deals President Trump is making, some are saying the United States has embarked on a version of Chinese-style “state capitalism” – directly entangling markets and government.  No one is claiming that the US is as involved as the Communist Party dictatorship in China or authoritarian Russia, but certainly more entangled than a normal US free market approach would permit.

There are plenty of examples to go around, like the Trump Administration putting pressure on Intel to replace its CEO, wanting Goldman Sachs to fire an economist, demanding 15% of revenue from AI chip sales to China, creating a government-owned Golden Share in Nippon Steel’s purchase of US Steel, and pursuing pledges of hundreds of billions of investment from our trading partners to buy-down tariff rates.

On top of all this, the US is developing a system of tariffs that relies on the discretion of the president (and his team), varying from country to country, and in many cases product to product.

On the surface, the argument that the US is moving toward “state-run capitalism” seems to have a lot of evidence in its favor.  What the argument ignores is that this started long ago.

Starting back in the 1930s, the government paid farmers either not to farm, or farm certain crops.  In the 1970s, the US instituted price controls and differentiated between industries and even individual companies within industries.  The US also capped oil prices, restricted branching by Savings and Loans and would not let banks pay interest on checking accounts.

For decades, by backing Government Sponsored Enterprises (GSEs), like Fannie Mae and Freddie Mac, government held mortgage rates artificially low which distorted the housing market.  This bid up the price people were/are willing to pay for the existing stock of homes, while many state and local governments make it difficult to build new housing.  The same thing goes for the takeover of student loans by the federal government and the push to forgive those loans.  Anyone who thinks state capitalism is new doesn’t know history.

There are plenty of other long-standing interferences in the market in addition to these, like ethanol subsidies and gas mileage requirements (which, contrary to the narrative about Trump were recently watered down by the Big Beautiful Bill).  The Biden Administration allocated green energy subsidies to favored firms under the Inflation Reduction Act, the CHIPS Act favored semiconductor production in the US, and the Nippon-US Steel takeover was originally blocked for political reasons.  Environmentalists forced manufacturers to change lightbulbs, stoves, dishwashers, toilets, washing machines, and dryers.

So, forgive us if we yawn at the current gnashing of teeth over this issue in 2025.  Are we supportive of it?  No.  But is it new?  Absolutely not.  We’ll breathe our last breath standing up for free markets against political meddling.  We are dismayed that Republicans, who are historically associated with supporting free markets, are willing to support this, instead.  No wonder younger Americans who don’t know economic history well are often supportive of communism and socialism.

And while we fully understand this interference in markets began long ago, it accelerated in a huge way during the Financial Panic of 2008-09, when President George W. Bush bizarrely announced that he had to violate free market principles in order to save free markets.

Back in 2008, mark-to-market accounting procedures turned a manageable loss of housing value into a once-in-a-century financial panic.  But instead of adjusting those accounting practices, policymakers set up TARP to bailout Big Banks, designed an auto bankruptcy that bailed out Big Labor, and launched multiple rounds of Quantitative Easing.

No wonder many people who might otherwise vote to support free markets became more receptive to the idea that the economic system was “rigged” in favor of certain groups.  And, in turn, if politicians are going to rig the economic system in favor of those groups, why not their preferred special interests, as well?

The bottom line is that it would take a major change in political attitudes to undo the massive harm inflicted by the policy reaction to the 2008-09 crisis.  We are hopeful this change in attitude arrives eventually, but don’t expect it anytime soon.  The current leadership expects a surge in potential long-term economic growth from its policies, but the more the government entangles itself in the market, the less likely that is to happen.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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Implications:  Industrial production took a breather in July, with activity falling for the first time in four months as producers continue to acclimate to shifts in US trade policy. Overall production declined by 0.1% in July with nearly every major category edging lower, though data from prior months were revised upward. Looking at the manufacturing sector, both auto production and non-auto production (which we think of as a “core” version of industrial production) posted declines of 0.4% and 0.1%, respectively. Looking deeper, there were a couple of bright spots in the “core” measure.  Production in high-tech equipment rose 1.4% in July, likely the result of investment in AI as well as the reshoring of semiconductor production.  High-tech manufacturing is up 14.0% in the past year, the fastest pace of any major category.  The manufacturing of business equipment has also accelerated lately, rising 0.5% in July, and up at a 11.1% annualized rate in the past six months.  Looking outside of manufacturing, the mining sector was also a source of weakness in July, with activity declining 0.4%.  A slower pace of oil and gas production as well as the drilling of new wells more than offset an increase in metal and mineral extraction. Look for an upward trend in activity in this sector in 2025 as the Trump Administration takes a more aggressive stance with permitting.  Lastly, utilities output (which is volatile and largely dependent on weather) posted a decline of 0.2% in July. In other manufacturing related news this morning, the Empire State Index – a measure of manufacturing sentiment in the New York region – rose unexpectedly to 11.9 in August from 5.5 in July.

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Implications:  Consumers started the second half of the year on a good note, with retail sales rising for the second month in a row.  The 0.5% gain in July slightly lagged the consensus expected +0.6%, but factoring in upward revisions to previous months, retail sales rose a solid 0.9%.  Looking at the big picture, monthly retail sales figures have been whip-sawing since earlier this year as consumers front-loaded purchases to avoid potential tariffs.  Given that the retail sales report largely reflects purchases of goods (which are import-heavy), we expect ongoing trade negotiations to keep volatility high going forward.  Looking at the details of the report, July’s advance was broad-based with nine out of thirteen major sales categories rising.  The largest increase, by far, was in the volatile auto sector, which posted the biggest gain for the category (+1.6%) since March and is now up 4.7% in the past year.  After stripping out autos along with the other typically volatile categories for building materials and gas stations, core retail sales rose 0.3%.  These sales are up 4.9% in the past year – above the 3.9% increase for overall sales.  Keep in mind, however, that a monetary policy tight enough to bring inflation down is also tight enough to bring growth down.  One category we will be watching closely for this is at restaurants & bars – the only glimpse we get at services in the report, which make up the bulk of consumer spending. That category fell 0.4% in July, although still up at 5.5% annual rate so far this year.   While this report appears to differ from some other signs of a slowing economy, we remain cautious given the potential delayed effects of tighter monetary policy.  In other news this morning, import prices increased 0.4% in July while export prices rose 0.1%.  In the past year, import prices are down 0.2% while export prices are up 2.2%.

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In this week’s “Three on Thursday,” we explore the current state of indebtedness and financial health of U.S. households in the second quarter of 2025. Curious about the latest trends? Click the link below to get a clearer picture of where things stood in the second quarter.

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Implications:  One horrible inflation headline doesn’t erase the gradually easing inflation trend.  Producer prices surged 0.9% in July –the largest monthly increase in more than three years.  The typically volatile food and energy categories stayed true to their reputation in July, with energy prices rising 0.9% and food prices up 1.4%, but even outside of these categories, “core” producer prices – which exclude food and energy – rose 0.9% in July and are up 3.7% versus a year ago.  The question on many people’s minds (and certainly the Fed’s) is if this outsized July increase is a reflection of tariffs starting to put upward pressure on inflation after months of showing little impact.   If that is the case, you would expect goods prices – which are most exposed to higher import costs – to be the primary driver, but to-date that hasn’t been the case.  Yes, goods prices rose 0.7% in July, but over the last six months goods prices are up at a very modest 0.7% annualized rate, and they are up 1.9% in the past year.  And more than half of the July increase in goods prices is attributable to the food and energy categories.  Services prices were the key driver of higher costs in July, up 1.1%, with final demand trade services (think margins received by wholesalers) jumping 2.0% and accounting for over half of the July increase.  We wouldn’t put too much emphasis on one single month’s data, it is the trend in prices that provides a better reflection of inflation dynamics, and we expect the modest inflation trend that has been in place over the past six months will continue in the months ahead.  As we noted in yesterday’s CPI report, tariffs can raise prices for tariffed items, but they leave less money left over for other goods and services. They shuffle the deckchairs on the inflation ship, not how high or low the ship sits in the water.  That’s up to the money supply, which is up only 1.2% since April 2022.  We believe monetary tightness will keep inflation relatively subdued and that there is already room for modest rate cuts. In other news, initial jobless claims declined 3,000 to 224,000 last week while continuing claims fell 15,000 to 1.968 million. These figures are consistent with continued job growth in August, but at a slower pace than last year.

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Implications:   Inflation came in as expected in July, with the Consumer Price Index rising 0.2%, and the year-ago comparison standing pat at 2.7%.  “Core” prices, which strip out food and energy, rose a consensus expected 0.3%, while the twelve-month comparison moved up to 3.1%.   Yes, year-ago readings remain elevated because of weak inflation data from twelve months ago, but the focus should be on the current trajectory: in the past six months, since Trump took office in January, which includes higher tariffs, overall inflation has risen at a 1.9% annualized rate, while core inflation is up at a moderate 2.4% pace.  We’ve been saying for some time that tariffs do not cause inflation; they can raise prices for the tariffed items, but they leave less money left over for other goods and services.  They shuffle the deckchairs on the inflation ship, not how high or low the ship sits in the water.  That’s up to the money supply, which is up just over a percentage point since April 2022.  We believe this relative monetary tightness, along with moderately high real rates, is why there is room for modest rate cuts.  Looking at the details of the report, core prices were the main driver of July’s overall increase, but not in categories where tariff effects would typically show up. Goods prices remained subdued, with minimal changes in apparel (+0.1%), new vehicles (0.0%), and medical supplies (+0.1%). Instead, the upward push came from the services sector: airline fares surged 4.0%, the largest jump in more than three years, while dental services climbed 2.6%, marking the biggest monthly rise on record.  Fed Chair Jerome Powell, at one point, highlighted “Supercore” inflation – a subset category of prices that excludes food, energy, other goods, and housing rents. Since, he has stopped talking about it, but maybe he should.  Supercore prices are up at a 1.9% annualized pace in the last six months, which supports a rate cut soon.  Given the lags in monetary policy and slow growth in the M2 measure of the money supply, we believe it’s time for the Fed to begin reducing short-term rates slightly in the months ahead.  We expect the Fed to cut rates at their next meeting in September, but just like they were slow to raise rates during the post-COVID inflation surge, they are late to the ball game.   In other news last week, nonfarm productivity (output per hour) increased at a 2.4% annual rate in the second quarter of 2025 versus a consensus expected +2.0%, as both output and hours rose, but output rose at a faster pace. In the past year, productivity is up 1.3%, a slowdown from the 3.0% rate in the year ending in Q2 2024. On the labor front, initial jobless claims rose 7,000 to 226,000, while continuing claims increased 38,000 to 1.974 million. These figures are consistent with continued job growth in August, but at a slower pace than last year.

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At the last meeting two weeks ago, Chairman Jerome Powell got the Federal Reserve to stand pat on interest rates, but not without a struggle.

Two Fed governors, Christopher Waller and Michelle Bowman, dissented from the decision not to change rates and openly preferred cutting the target for short-term rates instead, the first time we’ve had two governors dissent since 1993.  But, in the current political context, with Powell’s term of chairman running out next year, these dissents may be more than normal dissents. They are clearly a way to campaign to be the new chairman.  In that vein, Bowman is going farther and publicly saying she wants three cuts!

And now, due to the early resignation of Fed Governor Adriana Kugler, a Biden appointee, Trump has a chance to add to the two dissents by nominating the current Chairman of his Council of Economic Advisers, Stephen Miran, to the Fed as well.  It is almost certain that Miran, once confirmed, would vote to cut rates if he joins the Fed by the meeting in mid-September.

Powell has been holding out against rate cuts, claiming that uncertainty surrounding the potentially inflationary effects of tariffs requires caution in cutting rates, which is odd considering that Powell was fully willing to monetize extra government spending during COVID, and we do not recall him ever making an argument that increases in income tax rates or the corporate profits tax would require higher interest rates (or slower rate cuts). 

In turn, the Trump Administration has suggested that the search for a successor to Powell has widened recently, to include not only former Fed Governor Kevin Warsh and Trump advisor Kevin Hassett (“the Kevins”), but also the recent dissenting governors, former Bush aide Marc Sumerlin, and former St. Louis Fed Bank President James Bullard.

Round and round the decision goes, who Trump picks no one knows.

One reason for all the drama is simple: the president loves drama, and if you get elected president and like drama, then you’re allowed to generate drama.  Politics 101.

A second reason is that the president wants to play many candidates against each other so he can get the best deal from the one he picks, the one most likely to be more open to cuts in short-term rates, but who would also maintain the confidence of the markets that inflation would remain contained. 

But we believe there may also be a third reason, which is that the president could be looking for a Fed chief who will reverse the disastrous decision originally made by Ben Bernanke (supported by the votes of Warsh and Bullard) almost two decades ago.  

That decision was to abandon the system of implementing monetary policy by managing the scarcity of reserves in the banking system, which resulted in market shifts in short-term interest rates, and instead launching quantitative easing, leading to (over-) abundant bank reserves, and then directly controlling short-term rates by paying banks interest on reserves, a system that’s led to the Fed itself running massive operating deficits.

Think about it.  For better or for worse, no president in our lifetimes been more willing to use his political capital to review and change the way Washington works.  USAID, the Department of Education, the Census Bureau, colleges that rely on federal largesse have never seen such rapid-fire changes.  We would not be surprised if the Fed is next.

Brian S. Wesbury – Chief Economist

Robert Stein, CFA – Deputy Chief Economist

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In this week’s “Three on Thursday,” we explore the shifting role of trade and tariffs in U.S. economic policy—focusing on the countries the U.S. imports from most. With global alliances in flux and tensions rising, tariffs are once again front and center. In fact, tariff collections in 2025 have already exceeded all of last year’s total. For further insight, click on the link below.

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Implications:  The US service sector continued treading water in July, but data from the ISM Services report add to a growing list of evidence that indicate a slowing economy.  First, the headline: the ISM Services index declined to 50.1 in July, lagging even the most pessimistic forecast from any economics group surveyed by Bloomberg.  Besides the contractionary readings in December 2022, April 2024, June 2024, and most recently in May 2025, that is the slowest pace since the COVID shutdown months.  The details were not much better. Activity among the major industries was split, with eleven out of eighteen reporting growth for the month, while seven reported contraction. The indexes for new orders and business activity both declined in July, falling to 50.3 and 52.6, respectively.  While both indexes sit in modest expansionary territory, uncertainty from trade policy, a pullback in public funding, and rising costs to existing projects are all said to be delaying new investment and activity.  Service companies – once hamstrung with difficulty finding qualified labor – are responding by reducing their headcounts, with the employment index falling deeper into contraction at 46.4, now the fourth month in the last five below 50.  Finally, the highest reading of any category was once again the prices index, which rose to 69.9 in July.  That is the highest level since late 2022, but still far from the worst we saw during the COVID supply-chain disruptions, when the index reached the low 80s.  Though inflation pressures remain – the M2 measure of the money supply is barely up versus three years ago – which means we are likely to see lower inflation and growth in the year ahead.  As for the economy, it’s important to remember that Purchasing Manager’s surveys like the ISM Services index and its counterpart on the manufacturing sector often capture sentiment mixed in with actual activity.  Uncertainty from trade policy has been weighing on sentiment, and it remains to be seen whether recent trade agreements from key US trade partners will alleviate some of that.  However, monetary policy has been tight enough to reduce inflation toward the Federal Reserve’s 2.0% target and is probably still modestly tight today.  And a monetary policy tight enough to reduce inflation may also be tight enough to slow the ever-resilient US service sector.

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Implications:  President Trump may see today’s June trade report as validation of his hardline approach: the U.S. trade deficit narrowed to $60.2 billion, the smallest since September 2023. That result was driven largely by a sharp drop in imports, which fell $12.8 billion for the month—far outpacing the $1.3 billion decline in exports. And in one sense, that’s exactly what Trump’s trade agenda aimed to achieve: fewer imports, more domestic production. But whether that’s what’s actually happening is less clear. The drop in trade could reflect a meaningful shift in global supply chains—reshoring, decoupling, and growing domestic output. Or it could simply signal weaker demand at home and abroad. Right now, the data doesn’t offer a definitive answer. U.S. employment growth has slowed, particularly in goods-producing sectors. For a decline in imports to translate into a lasting economic win, it needs to be matched by a revival in U.S. manufacturing and investment. So far, that resurgence remains tentative. In the meantime, the impact on GDP has flipped. Imports subtract from GDP, and their surge in Q1 weighed heavily on growth—net exports alone shaved roughly five percentage points off the growth rate, dragging real GDP down at a 0.5% annualized pace. But as front-loaded imports peaked in March and retreated in Q2, trade turned into a tailwind, helping lift growth in the most recent quarter.  Still, erratic trade policy out of Washington makes it harder to translate monthly trade swings into meaningful GDP forecasts.  Meanwhile, the landscape of global trade continues to shift.  China, once the top exporter to the U.S., has fallen to a distant third place behind Mexico and Canada.  Also in today’s report, the dollar value of US petroleum exports exceeded imports once again. This marks the 40th consecutive month of the US being a net exporter of petroleum products. In fact, through the first half of the year, the petroleum surplus has been higher than any other 6-month period on record.  In other recent news, cars and light trucks were sold at a 16.4 million annual rate in July, up 7.1% from June, and up 3.7% from a year ago.

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