Money Stuff: Tariffs Are For Emergencies

The stock market continued to crash this morning because of President Donald Trump’s “Liberation Day” tariffs announced last week. Despite widespread criticism of the tariffs, Trump is unmoved. He gets to decide, and he has decided that the tariffs are good.

But does he get to decide? In some ways the simplest solution to the tariff problem is the one that I wrote about last Thursday. The US Constitution says that “the Congress shall have Power to lay and collect Taxes, Duties, Imposts and Excises.” The power of taxation is the most fundamentally legislative function, so much so that the Constitution also says that “all Bills for raising Revenue shall originate in the House of Representatives.” This was at the very center of constitutional design, and in fact of the founding of America. As a history of the House puts it:

Congress—and in particular, the House of Representatives—is invested with the “power of the purse,” the ability to tax and spend public money for the national government. Massachusetts’ Elbridge Gerry said at the Federal Constitutional Convention that the House “was more immediately the representatives of the people, and it was a maxim that the people ought to hold the purse-strings.”

English history heavily influenced the Constitutional framers. The British House of Commons has the exclusive right to create taxes and spend that revenue, which is considered the ultimate check on royal authority. Indeed, the American colonists’ cry of “No taxation without representation!” referred to the injustice of London imposing taxes on them without the benefit of a voice in Parliament.

Tariffs are uncontroversially taxes — “duties, imposts and excises” are listed in the constitutional text, and they are designed to raise revenue — so only the House of Representatives can originate them. It is simply an error for President Trump to impose tariffs. He can’t, that’s not his job, this is all a misunderstanding, and the tariffs will go away as soon as anyone notices.

Of course it is not that simple. Congress has in fact delegated tariff powers to the president for over 100 years, and courts have generally said that that’s fine.

But there are some differences between those precedents and the current situation. For one thing, Trump’s tariffs were imposed under a law called the International Emergency Economic Powers Act of 1977, which allows the president to regulate imports if he declares a national emergency. [1]  The IEEPA had never been used to impose tariffs before Trump used it in February to impose tariffs on Canada, China and Mexico; he also used it on “Liberation Day” last week to impose much broader tariffs. Here is what the IEEPA says:

Any authority granted to the President by section 1702 of this title may be exercised to deal with any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy, or economy of the United States, if the President declares a national emergency with respect to such threat.

The authorities granted to the President by section 1702 of this title may only be exercised to deal with an unusual and extraordinary threat with respect to which a national emergency has been declared for purposes of this chapter and may not be exercised for any other purpose. Any exercise of such authorities to deal with any new threat shall be based on a new declaration of national emergency which must be with respect to such threat.

What is the “unusual and extraordinary threat” that requires these tariffs? The declaration of the tariffs says that there is a “national emergency posed by the large and persistent trade deficit that is driven by the absence of reciprocity in our trade relationships and other harmful policies like currency manipulation and exorbitant value-added taxes (VAT) perpetuated by other countries.”

The idea seems to be that every trade policy of every country in the world, over the past several decades, constitutes an “unusual and extraordinary threat.” This is a strange way to use words! How can every instance of trade with every country be unusual? How, after decades of trade deficits, is a trade deficit extraordinary?

It is also a strange way to use law. The US is in a perpetual state of emergency with respect to every country forever, allowing the president to use emergency powers to bypass the Constitution to impose tariffs.

The other thing that has changed, as we have discussed a few times, is that US federal courts, and particularly the Supreme Court, have recently become more interested in “nondelegation” challenges to executive action. The idea is that Congress often gives executive agencies the power to make rules, and there is a longstanding, largely conservative legal tradition objecting to this: The Constitution gives Congress “all legislative powers” of the federal government, so only Congress, not executive agencies, should be writing substantive rules.

So sometimes people challenge regulations, saying that they are unconstitutional because only Congress, not regulatory agencies, can legislate. These challenges rarely work. The current state of the law is that Congress must give the executive “an intelligible principle to guide the delegee’s use of discretion,” and for the last 90 years or so courts have usually found that it has. But there seems to be revived interest in nondelegation challenges: The Supreme Court case I quoted in the last sentence, from 2019, was a 5-3 decision in which four justices expressed interest in “reconsider[ing] the approach we have taken for the past 84 years” and limiting the ability of Congress to delegate its powers to the executive. (Also, disclosure-brag, my wife argued it.) With the current personnel on the Supreme Court, there might be five votes for a more robust nondelegation doctrine.

Would it apply to tariffs? I don’t know. The modern revival of nondelegation is often about agency rulemaking: People object to unelected regulators making rules, because (say) the US Securities and Exchange Commission is not as democratically accountable as Congress is. The president is elected, and there is some democratic accountability for the impacts of his tariffs; perhaps Congress should be allowed to give him a blank check to invent tariffs.

But the Constitution really does say that only Congress can impose tariffs. Arguably either the IEEPA does have an “intelligible principle” that limits the president’s ability to impose tariffs — they have to be a necessary response to an “unusual and extraordinary threat,” not just general economic policy — in which case the current blanket tariffs seem suspect, or it doesn’t, in which case it is unconstitutional. So you could imagine two sorts of legal challenges to the current round of IEEPA tariffs:

1. The IEEPA doesn’t actually give the president to impose tariffs on every country just because he doesn’t like free trade. IEEPA powers are only for emergencies, and “international trade exists” can’t really be an unusual and extraordinary threat to the US.
2. If the IEEPA did give the president sweeping powers to impose tariffs, that would be unconstitutional.

I called this argument “frankly pretty speculative” on Thursday, but obviously someone should try it. There are trillions of dollars at stake, and a lot of the conservative legal establishment is probably not thrilled with tariffs. Surely there will be cases.

As it happens, also on Thursday, somebody filed one. Bloomberg News reports:

A powerful legal group backed by conservative funding sued President Donald Trump, setting up an early legal clash over the significant US tariffs his administration announced this week.

The New Civil Liberties Alliance said Thursday the president illegally imposed an emergency tariff on Chinese goods. NCLA is representing a small retail stationery business named Simplified, which claims it will suffer “severe” harm from his “unconstitutional” tariffs on China.

The lawsuit filed in federal court in Florida may be the first legal challenge to the sweeping new US tariffs. The levies, which were announced by Trump on Wednesday, have roiled global markets and caused US stocks to plunge.

Here is the complaint. It is not about last week’s broad tariffs: It’s a challenge to the tariffs imposed in February on China (and Canada and Mexico), also under the IEEPA. In those tariffs, the asserted emergency was “the extraordinary threat posed by illegal aliens and drugs, including deadly fentanyl.” Simplified argues that the IEEPA can’t be used for tariffs at all. From the complaint:

In the IEEPA’s almost 50-year history, no previous president has used it to impose tariffs. Which is not surprising, since the statute does not even mention tariffs, nor does it say anything else suggesting it authorizes presidents to tax American citizens.

IEEPA does authorize asset freezes, trade embargoes, and similar economic sanctions. Presidents have used the IEEPA to target dangerous foreign actors—primarily terrorist organizations and hostile countries such as Iran, Russia, and North Korea. Congress passed the IEEPA to counter external emergencies, not to grant presidents a blank check to write domestic economic policy.

And even if the IEEPA allowed tariffs, this is not a sensible emergency for them:

[Trump’s] China Executive Orders show no connection between the opioid problem and the tariff he ordered—much less that the tariff is “necessary” to resolve that problem. The means of an across-the-board tariff does not fit the end of stopping an influx of opioids, and is in no sense “necessary” to that stated purpose.

And:

In fact, President Trump’s own statements reveal the real reason for the China tariff, which is to reduce American trade deficits while raising federal revenue. While the “emergency” is not challenged here, the “fit” of the tariffs to the declared emergency does not meet the requirements of the IEEPA.

If the President is permitted to use the IEEPA to bypass the statutory scheme for tariffs, the President will have nearly unlimited authority to commandeer Congress’s power over tariffs. He would be empowered to declare a national emergency based on some long-running national problem, then impose tariffs purportedly in the name of that emergency—thus sidestepping the detailed constraints Congress has placed on the tariff authority it has granted.

The complaint was filed after Trump’s “Liberation Day” tariffs were announced, but I suppose it was written earlier. That last paragraph turned out to be a good prediction: Trump really did “declare a national emergency based on some long-running national problem, then impose tariffs purportedly in the name of that emergency.” And it is a live question whether courts will let him.

If you are an institutional investor, and the stock market goes down by 10% in two days, you’ll notice. You can, and do, check the prices of the stocks in your portfolio in real time, or at least every day. But your private equity portfolio is different: You don’t necessarily get daily statements, and the assets don’t really trade, so there is no market price for them. You have to estimate their values. If the stock market is down 10%, what does that mean for the value of your private equity portfolio? Various options:

1. It’s down about 10%: It’s a portfolio of corporate equity, and what’s bad for the economy and corporate stocks is bad for these stocks too, even if they don’t trade. 
2. It’s roughly flat: You are paying private equity firms big fees to pick good companies and run them well. The companies’ business models and cash flows haven’t changed even if public market prices have.
3. It’s down 20%: Private equity companies are levered corporate equities, so what’s bad for corporate stocks is worse for levered corporate stocks.

It turns out that the conventional answer is “it’s roughly flat”: Private equity prices get marked down, if at all, more slowly than public equity prices. You mark your public equity portfolio to market every day; you mark your private equity portfolio whenever the private equity managers tell you its value has changed, and they are in no hurry to do that.

This is a well-known benefit of private equity. It is a hedge, a diversification benefit. If you have $100 of public stocks and the market is down 10%, you lose $10. If you have $50 of public stocks and $50 of private equity and the market is down 10%, you lose only 5%. Next quarter, maybe your private equity portfolio gets marked down — but maybe the stock market is up in the interim, offsetting your losses. The simplest dumbest model of private equity is “public equity, on a delay,” which makes it somewhat uncorrelated with public equity. If you are an institutional investor, this is good for you. You can report steadier results; you can get the same returns (equity returns) with less perceived risk (lower reported volatility). 

On this extremely dumb model there is, however, one even dumber downside. If you have a $100 portfolio allocated 50% to public equity and 50% to private equity, and the market drops by 10%, then you have $45 of public stocks and “$50” (at current marks) of private equity. You are out of balance; you are above your target allocation to private equity. You need to rebalance: Your $95 portfolio should be in $47.50 public stocks (so you have to buy) and $47.50 of private equity (so you have to sell). I suppose there is something nice and volatility-dampening about this, on the public side: You are buying the dip. On the private side, though, it is just a mess. How do you sell $2.50 worth of your private equity portfolio? The whole point of private equity is that it doesn’t trade.

Remember, on this model, this is all fake. Your private equity stake isn’t worth $50: It’s worth $45, just like your public stake; it lost 10% of its value when the market lost 10% of its value. It’s just that you get to delay marking it down. But to delay marking it down, you have to pretend to believe that it’s still worth $50, which means that you have to pretend to believe that you are now overweight private equity and need to sell some.

Again, this model is dumb and wrong, but … I don’t know, it does seem to capture something real? Here’s a Financial Times story:

Large institutional investors are studying options to shed stakes in illiquid private equity funds after the rout in global financial markets pummelled their portfolios, according to top private capital advisers. …

Now, after global stock markets dropped by trillions in value, these institutions face a double hit.

Dealmaking and IPO activity has ground to a halt, minimising cash returns. Moreover, pensions’ exposure to unlisted assets swelled this week as the plunge in public markets has created a “denominator effect”, in which private market holdings that are only marked quarterly rise as a percentage of their overall assets, skewing desired allocations.

“If the public market keeps going down and down, the denominator effect will become an issue again,” said Oren Gertner, a partner specialising in secondaries at law firm Sidley Austin.

Many large investors are speaking to advisers and considering options to sell their stakes in funds at discounts on second-hand markets, top industry bankers told the Financial Times.

“The denominator effect is going to mean a lot of people are over-allocated,” said one adviser, who forecast endowments would be the first to consider new sales of assets on second-hand markets. 

If you have $45 of public equity and $50 of private equity, and the only bid for your private equity stake is at a 10% discount to its stated value, doesn’t that mean that you are not over-allocated to private equity? “Good news, turns out our private equity stake is worth less than we thought, we don’t need to sell after all.”

We talked last year about a quirk of levered exchange-traded funds on MicroStrategy Inc. (now just Strategy). These funds aim to give investors 2 or 3 times the daily returns of MicroStrategy’s stock; there are also inverse funds aiming to give investors negative 2 or 3 times those daily returns. The quirk is that the funds need to rebalance their positions every day to continue providing the right daily returns, which means their longer-term returns are not 2 or 3 (or -2 or -3) times the returns of the stock. In particular, one 3x long MicroStrategy ETF was down 82% for the year as of last September, while MicroStrategy itself was up 100%. Intuitively, you would think the ETF would be up 300%, but that intuition is totally wrong. This problem is called “volatility drag.”

When I wrote about this, I got many emails from readers with the same basic question, which is “how do I get on the other side of that”? The simplest answer is that you can short the ETFs; we talked in January about David Einhorn doing exactly that. That exposes you to directional risk — if you short a 2x long MicroStrategy ETF, and MicroStrategy goes up, you’ll probably lose money — which you can hedge, as Einhorn did, by buying the stock. (So: long MicroStrategy, short 2x long MicroStrategy ETF, you figure out the hedge ratio.) 

There’s arguably a better hedge, certainly a funnier one. Here is the Defiance MSTR Double Short Hedged ETF:

The Fund is an actively managed exchange-traded fund (“ETF”) that seeks to generate returns by simultaneously taking short positions in two different daily 2x leveraged ETFs that track the stock of MicroStrategy Incorporated (“MSTR”): one with a daily 2x long exposure (the “Long 2X MSTR ETF”) and the other with a daily 2x short exposure (the “Short 2X MSTR ETF”). ...

Rather than attempting to profit from changes in the price of MSTR itself (as do the MSTR ETFs), the Fund is designed to benefit from the structural features of Leveraged MSTR ETFs, which are products designed to be held for only one day. As described in each of the Leveraged MSTR ETF prospectuses, holding shares for greater than one day may result in performance experiences that are very different from the daily 2x or -2x objective of these leveraged ETFs. ...

By simultaneously shorting both a Long 2X MSTR ETF and a Short 2X MSTR ETF, the Fund aims to exploit these differences to generate returns. For example, if the Long 2X MSTR ETF fails to deliver 2x returns over a given period greater than one-day, it may experience negative performance for that period, thereby resulting in positive performance for the Fund through its short position. Similarly, if the Short 2X MSTR ETF fails to achieve -2x returns over the same period, this may result in negative performance for the Short 2X MSTR ETF, thereby resulting in positive performance for the Fund through its short position.

You short the 2x long MicroStrategy ETF, and hedge by shorting the 2x short MicroStrategy ETF. And then you put the result in an ETF. It does feel like sort of a pinnacle of finance.

What could possibly go wrong? Well, if MicroStrategy goes steadily up every day, the 2x long ETF will actually return more than 2 times its long-term return (and the 2x short will be down more than -2 times the stock’s long-term return). Byrne Hobart calls it “a form of tail-risk insurance: if one of the positions does well enough for long enough, the other one compounds to zero while the winner can get arbitrarily high.” You are effectively doing a market-making strategy: You profit from volatility, from the stock bouncing around in both directions, but you get blown up by large monotonic moves. Someone is going to provide that market-making service to MicroStrategy levered ETF investors, and I guess the natural providers are other MicroStrategy levered ETF investors.

If you are in the business of building expensive houses, one risk that you run is that you will spend a lot of money building a very expensive house but then, when you are done, no one will want to buy it. One way to avoid this risk is to spend even more money building the very most expensive house, because then, when you are done, Ken Griffin will have no choice but to buy it. Here’s a funny Wall Street Journal story about Ken Griffin’s love for expensive real estate:

Over the past 13 years, the billionaire Citadel founder, 56, has spent billions of dollars assembling an unparalleled portfolio of trophy properties across the country—Palm Beach, Miami, Chicago, New York and beyond. Industry insiders say his purchases, often for historically high prices, have, for better or worse, helped reshape the pricing dynamics of the high-end real-estate market.

“He’s a whale’s whale,” said property appraiser Jonathan Miller of Miller Samuel. “In my career, I’ve really never run into somebody that singularly has dominated a segment of the market in so many different places. He’s a prolific buyer of full retail-price real estate.”

“Full retail-price real estate”! One possible interpretation here is that real estate used to be a normal good where wealthy sophisticated buyers tried to preserve their wealth and signal their sophistication by getting good value, but Griffin turned it into a status good, like fine art or sports teams, where wealthy sophisticated buyers try to signal their wealth and sophistication by paying as much as possible:

[Douglas Elliman agent Gary] Pohrer said Griffin’s purchases have emboldened other moneyed buyers to spend nine figures on luxury homes. “Before, some buyers didn’t want to be seen spending that much money on a house, but now that it’s been done so many times, it’s not that weird. They don’t feel like they’re overpaying.”

In certain circles it would be embarrassing not to spend nine figures on your house, and that might be Griffin’s doing.

You know how there was a wave of companies whose basic business plan was “we will lose money on our services, but we will accumulate a lot of customer data, and probably eventually that will be worth money”? MoviePass was probably my favorite example. Anyway here’s a business model:

Eager to gain access to an exclusive establishment near Harvard University, biotech executives, doctors, lawyers and politicians filled out applications and handed over IDs, work badges and personal references. 

This elite club was a high-end brothel charging up to $600 an hour for sexual encounters in luxury apartments in Cambridge, Mass. 

Now, that unusual trove of personal information is serving as evidence in a series of criminal hearings that have pulled back the curtain on upscale sex work. Dozens of prominent Boston-area men, who lost a legal battle for anonymity, are facing misdemeanor charges that have caused major public fallout. …

The brothel, where young Asian women used names like Tulip and Tiki, also operated just outside Washington, D.C., but Virginia prosecutors said they declined to pursue charges against johns there.

I submit to you that if you run the Washington, D.C., branch of that business, charging $600 an hour for sexual encounters is the least efficient way to monetize that meticulously maintained client database. [2]

Price Hikes Are Already Rolling in From Tariff-Hit Businesses. In Matter of Days, Outlook Shifts From Solid Growth to Recession Risk. Matt Klein on tariffs. Ray Dalio on tariffs. How Investing Will Change if the Dollar No Longer Rules the World. Crypto’s Trump Rally Evaporates as Tariffs Savage Riskier Assets. TikTok Deal Stalled by China’s Objections to Tariffs, Trump Says. Britain to dilute rules for smaller private equity firms and hedge funds. DeepSeek and Tsinghua Developing Self-Improving AI Models. Tether Explores New US Stablecoin Launch Targeting Institutions. Big Office Landlord Made $4 Million in Previously Undisclosed Payouts to Its CEO. Buffett Says Comments Attributed to Him on X Are All False. Tesla Shares Plunge Below Lutnick’s ‘ Never This Cheap’ Level. “Sharoubim, wearing gold Cartier bangles, said that he isn’t worried about the extra costs because his clients are rich.”

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