Over the past 24 hours, a remarkable confrontation has unfolded on X (formerly Twitter) that perfectly encapsulates the inherent contradictions in Elon Musk’s political positioning and the broader tensions within American tech politics.
The drama began when Musk, the owner of X and Tesla CEO, launched into an expletive-laden defence of the H1B visa programme, declaring “The reason I’m in America along with so many critical people who built SpaceX, Tesla and hundreds of other companies that made America strong is because of H1B.”
When challenged by MAGA supporters, Musk’s response escalated dramatically: “Take a big step back and FUCK YOURSELF in the face. I will go to war on this issue the likes of which you cannot possibly comprehend.”
The reaction from MAGA figures was swift and severe. Laura Loomer, a prominent voice in the movement, immediately countered: “We have an incoming President and his name is Donald Trump… We won’t allow Big Tech to create their fantasy monarchy in America and make MAGA their indentured servants slaves.”
The confrontation intensified when Musk attempted to use his platform control to mark critics’ posts as “spam” – a move Loomer immediately characterised as “totalitarian conduct by an incoming admin official.”
This exchange lays bare not only the fundamental contradictions in Musk’s position but also serves as a perfect case study for understanding the evolution of rent-seeking behaviour in the modern technological age.
Modern Rent-Seeking Through Tullock’s Lens
What we’re witnessing with Elon Musk’s business empire represents precisely the kind of rent-seeking behaviour Gordon Tullock warned about in his seminal 1967 work on the welfare costs of tariffs, monopolies, and theft.
Tullock’s central insight was that the social costs of rent-seeking vastly exceed the nominal value of the rents themselves, as resources are expended not just in securing preferential treatment but in creating and maintaining the institutional frameworks that make such treatment possible.
The proposed Strategic Bitcoin Reserve perfectly illustrates Tullock’s principle.
When Tesla entered the Bitcoin market in late 2020, triggering a price surge to $63,000 in 2021, it wasn’t merely engaging in financial speculation. Rather, it was positioning itself for what would become a sophisticated form of rent extraction through potential government policy.
The correlation between Tesla’s stock price and Bitcoin since then shows remarkable synchronisation, suggesting that the market understands this connection between private gain and public policy.
Stigler’s Regulatory Capture in the Digital Age
George Stigler’s theory of economic regulation provides the perfect framework for understanding Musk’s approach to government interaction. Stigler argued that regulatory capture occurs when regulatory agencies, created to act in the public interest, instead advance the commercial or special interests of the entities they are meant to regulate.
In Musk’s case, this manifests through a complex web of subsidies, regulatory credits, and government contracts.
The implications for taxpayers worldwide are staggering. American taxpayers fund SpaceX contracts and EV subsidies. European taxpayers, particularly German citizens, fund factory subsidies and EV incentives.
Now US taxpayers might effectively fund Bitcoin price support through the proposed Strategic Bitcoin Reserve.
What makes Musk’s case particularly interesting is how he has managed to secure these benefits while simultaneously maintaining a public image as a free-market innovator.
This is precisely the kind of sophisticated regulatory capture that Stigler warned about – where the line between regulator and regulated becomes so blurred that the public can no longer distinguish between market success and political favoritism.
The Collision of Rent-Seeking and Populism
The sophistication of Musk’s rent-seeking strategy is now colliding spectacularly with political reality.
The confrontation on X over immigration reveals how the careful balance of maintaining political influence while extracting government benefits can suddenly unravel.
As Tullock observed, the resources invested in securing and maintaining regulatory capture can quickly become stranded when political winds shift.
The China dimension adds another layer to this complexity. Musk’s recent statement that Taiwan is a natural part of China exposes not just his dependence on the Chinese Communist Party’s goodwill for Tesla’s Chinese production, but also the inherent instability of global rent-seeking arrangements.
As Loomer pointedly noted in today’s barrage of posts: “A lot of compromising news involving China dropped today… Tumultuous times are definitely upon us as it relates to China.”
This international dimension would have fascinated Tullock. His analysis of rent-seeking primarily focused on domestic arrangements, but Musk’s empire shows how modern corporations can extract rents across multiple jurisdictions simultaneously. The risk, as we’re now seeing, is that these arrangements become increasingly difficult to maintain as nationalist politics resurges.
The Social Costs Mount
The social costs of this rent-seeking behaviour, so central to Tullock’s analysis, are becoming increasingly apparent. Resources that could be directed toward genuine innovation are instead channeled into maintaining political relationships and regulatory advantages.
Tesla’s regulatory credits alone represent a massive transfer of wealth from traditional automakers (and ultimately their customers) to Tesla’s shareholders.
Stigler’s insights about regulatory capture help explain why these arrangements persist despite their obvious costs. The benefits are concentrated among a few well-organized interests, while the costs are diffused across the broader population. However, as today’s Twitter confrontation shows, even this dynamic can shift when populist movements mobilize against perceived elite privilege.
Markets at Risk
The current surge in tech stocks following Trump’s electoral success may prove to be built on dangerously naive assumptions.
Just as MAGA’s fundamental opposition to immigration and free trade has caught tech leaders like Musk off guard, the movement’s latent hostility to technological advancement – particularly AI and automation – presents a serious threat to market valuations.
Trump’s recent meeting with the International Longshoremen’s Association, where he strongly criticised port automation, provides a troubling preview of what might come.
His economic thinking increasingly resembles that of a 1970s New York union leader more than a free-market Republican.
This philosophy, fundamentally opposed to the forces that drive productivity growth – whether they come in the form of immigration, trade, or technological advancement – poses a direct threat to the tech sector’s growth narrative.
The End Game
The world Tullock and Stigler described – where corporations invest resources to capture government benefits – has evolved into something far more complex but no less wasteful.
The confrontation on X between Musk and MAGA supporters isn’t just another social media spat – it’s a preview of how quickly carefully constructed rent-seeking arrangements can unravel when confronted with populist politics.
For tech companies like Tesla, which have benefited from both government subsidies and market optimism about technological disruption, this presents a perfect storm.
The same populist forces that are now turning against Musk over immigration could easily pivot to attack AI and automation.
The tech elite’s fundamental miscalculation extends beyond immediate political dynamics. Their naive belief that they could harness MAGA populism while avoiding its anti-modernisation impulses may prove to be an extremely costly miscalculation.
The profound irony is that while Trump claims to put “AMERICA FIRST”, his opposition to automation and technological advancement could ultimately leave American tech companies – and by extension, the broader American economy – at a competitive disadvantage in the global marketplace.
This outcome would represent exactly the kind of deadweight loss that Tullock warned about – where rent-seeking behaviour ultimately damages both the rent-seekers and the broader economy.
As we watch this situation unfold, the prescience of both Tullock and Stigler becomes increasingly apparent. Their fundamental insights about the nature of rent-seeking and regulatory capture remain as relevant as ever. The only difference is that modern rent-seeking has become more sophisticated, more global, and more technologically complex – but its essential nature, and its fundamental instability, remains unchanged.
I have increasingly become frustrated by the focus on “overheating” of the Russian economy championed by many Western military and geopolitical analysts.
The narrative more or less goes something like this: fiscal policy is very easy in Russia, so demand is high, and therefore there are now massive demand pressures, which cause ‘overheating’ and will lead to a collapse of the Russian economy soon. This is essentially a ‘boom-bust’ story.
The problem is that such a story aligns very badly with economic theory—or, for that matter, economic history. Economies don’t ‘collapse’ because of overheating.
Sudden economic collapses typically happen as a result of a major negative demand shock—typically monetary tightening, either caused by active monetary tightening by the central bank or caused by passive monetary tightening due to a financial crisis.
Russia might, of course, be hit by that, but that is not really the story being told by the military analysts who so very clearly have no economic education at all.
Furthermore, the focus on ‘overheating’ fails to address two much more important issues for the Russian economy: the structural decline in economic growth caused by Putin’s war on Ukraine, and the fact that the large Russian government budget deficit is clearly unsustainable and is de facto causing a major monetary expansion that is set to get even worse going forward.
To understand these issues, I have created a simple model for the Russian economy inspired by the seminal work of Sargent and Wallace on “Unpleasant Monetarist Arithmetic.” The model illustrates how fiscal and monetary factors have shaped Russia’s economic development since Putin started his war on Ukraine in February 2022, revealing that the apparent resilience of the economy is largely an illusion created by monetary manipulation.
Additionally, we will examine the evolving role of the Central Bank of Russia (CBR), which has transitioned from a conservative institution to one effectively subordinated to the Kremlin’s fiscal agenda. Contrary to the common conception, the Russian central bank is not an inflation fighter. It is effectively Putin’s lapdog.
The Model
Below are the equations in this simple model for the Russian economy. First, we focus on the supply side of the economy with a traditional Cobb-Douglas production function.
(1) yt* = at + αkt + (1 − α)lt
Where yt* is the growth rate of potential GDP in Russia, at is total factor productivity growth, kt is the growth rate of capital and lt is the growth rate of the labour supply.
Equation (2) determines the growth rate of the money supply mt:
(2) mt = m̄ + dt
m̄ is the ‘structural’ growth rate of the money supply. Think of this as being determined by the financial system and the central bank, while dt is the government budget deficit, which we here assume de facto is fully financed by an increase in the money supply.
Equation (3) determines long-term inflation (πtᶫ) as a pure monetary phenomenon:
(3) πtᶫ = mt − yt*
If the money supply growth (mt) persistently outpaces potential gdp growth (yt*) then inflation will eventually increase.
However, in the short-run there are price rigidities and this is what is reflected in equation (4):
(4) πt = πt−1 + γ(πtᶫ − πt−1) + δŷt
Furthermore, we have a ‘Phillips curve’ effect on short-term inflation as a positive output gap (ŷt) also can push up inflation.
The fact that we have price rigidities also means that actual GDP growth can diverge from potential GDP in the short to medium term:
(5) yt = yt* + λ(πtᶫ − πt)
Hence, as long as long-term inflation is above short-term inflation then actual GDP growth will outpace potential GDP growth. Again, this is akin to the Expectations-Augmented Phillips Curve.
Equation (6) is (growth in) the output gap defined as the difference between actual gdp growth and potential gdp growth:
(6) ŷt = yt − yt*
Equation (7) is the natural real interest (rt) which is determined by a ‘structural’ level of the interest rate (for example dependent on global interest rates) and a factor that dependent on the budget deficit so a higher budget deficit as share of GDP increases the natural real interest rate.
(7) rt = r̄ + ηdt
Equation 8 is the nominal interest rate (it):
(8) it = rt + πt
The nominal interest rate is simply determined by the sum of the natural real interest rate and actual inflation.
One could (easily) have argued that we should have used the long-term inflation instead to reflect inflation expectations, but we have assumed for simplicity that expectations are static in the model.
This is obviously not realistic, but by comparing the short-term and long-term impact of shocks to the model, we can analyze these expectational effects indirectly nonetheless.
The Russian Economy Post-2022: A Simulation
I have used the model above to simulate two simultaneous shocks to the Russian economy triggered by Putin’s invasion of Ukraine in February 2022.
First of all, we have assumed a decline in total factor productivity growth, the genuine driver of long-term economic development.
In our model, total factor productivity (TFP) growth drops dramatically from an initial 3% to just 1%, reflecting the profound economic disruption caused by international sanctions, technological isolation, and the massive economic restructuring forced by the conflict.
Simultaneously, the model incorporates a second critical shock: a severe contraction in labour market dynamics. While the initial baseline assumed stable labour supply growth, the simulation shows labour supply growth turning negative, dropping from 0% to -1%.
This shock represents the complex human capital challenges Russia faced: widespread emigration of skilled professionals, military mobilization, and the broader economic dislocation triggered by the invasion.
The fiscal dimension of these shocks is equally dramatic. The model assumes a rapid escalation of budget deficits, rising from 0% to 10% of GDP between 2021 and 2023. This represents the massive state expenditures required to sustain a war economy, fund military operations, and attempt to mitigate the economic consequences of international isolation.
Obviously, one can debate the magnitude of these shocks and their speed, but I have chosen them to more or less reflect the scale of the shocks we have actually seen in Russia since February 2022. The graph below shows our stylised fiscal shock where we assume that the budget deficit increases from zero in 2021 to 10% of GDP in 2023.
One can debate the actual numbers, but the latest data from the Russian Ministry of Finance do in fact show a budget deficit of this magnitude by the end of 2023. I have chosen to implement the shock a bit faster than it really was, but that will, on the other hand, make up for the fact that we have assumed static expectations rather than forward-looking expectations.
In the model, we have full monetary financing of this deficit, and consequently, we see money supply growth increase significantly in response to the sharp increase in the budget deficit, as the graph below shows – basically doubling money supply growth from just below 10% to close to 20%.
Again, one can discuss the actual mechanism by which this happens – whether it is through actual money printing or whether it is a result of the Russian central bank failing to offset the monetary and expectational impact of an increased budget deficit – but the fact remains that this development broadly speaking reflects the growth rate in Russian M2.
In the years leading up to the invasion of Ukraine, Russian M2 grew around 8-10% a year, and since early 2022, M2 growth has been consistently above 20% and often higher.
The sharp increase in money supply growth in the model is clearly inflationary.
First, of all through a direct monetary effect that increases long-term inflation (and in reality inflation expectations) and secondly, through a Phillips curve effect that also push inflation up in the short-term.
We see this in the graph below.
Initially – prior to the invasion – Russian inflation was below 5%.
However, as the shock hit, we see long-term inflation (the dotted line above) increase. However, initially actual inflation will remain below the long-term inflation, as we have assumed price rigidities in our model.
Such rigidities exist, for example, due to fixed prices in certain contracts, but they could also reflect the widespread price controls that have been introduced in Russia since February 2022.
However, eventually prices will adjust to the long-term monetary-induced inflationary pressures and, furthermore, the Phillips curve effects combined with the negative supply shock will also add to inflationary pressures in the medium term.
In the model, inflation hits 15% during 2023 and nearly 17% in 2024.
If we compare these numbers with actual inflation, as shown in the graph below, we see that the development has been somewhat more uneven in real life, where we initially in 2022 saw a very sharp spike in inflation to close to 20%, followed by a rather steep drop mostly reflecting a base effect, and then recently a new increase.
The latest official data shows Russian inflation at close to 9%.
One could clearly question the validity of the inflation data in Russia and I personally find it highly likely that they are manipulated, but even if we assume that the numbers are correct, I would argue that the model simulations get it pretty right.
Hence, if we instead of looking at a single year look at the average inflation from the beginning of 2022 to the end of 2024, then it is fair to say inflation has been around 10-12% as an average over the period and is clearly showing signs of increasing further.
And this is of course exactly what we are seeing in the simulation – inflation from 10-15% in the 2022-24 period and a clear upward trend. Consequently, if we instead had compared the actual and predicted price level in Russia, it would in fact be rather close by the end of 2024.
So not only does it look like the model is more or less correct in explaining the increase in Russian inflation (and in the price level) – it is also pointing towards a relatively steep further increase in Russian inflation over the coming year.
And the reason this might be kicking in with more effect now is that we are likely to begin to see the effect of the negative supply shock and because we are moving closer to the ‘long-run’.
We get an illustration of that by looking at the simulations for the development of potential and actual GDP growth, as the graph below shows.
We see two things here.
First of all, we see actual GDP growth (the solid blue line) increase slightly initially as fiscal and monetary policy is eased, but secondly, we also see a sharp decline in potential GDP growth (the dotted line).
The sharp slowdown in potential GDP growth is the direct impact of capital flight, sanctions and an erosion of the labour force as men are mobilized to go to the front and others – maybe close to 1 million Russians – have escaped from the horrors of Putin’s war.
This will soon become the real drag on the Russian economy, as we clearly see in the graph where we should already have seen actual GDP start to converge towards the much lower potential GDP growth.
However, in reality we haven’t seen that effect fully emerge yet, and that is also why actual inflation now is below (around 9%) what our model predicts (15-17%) – at least if we trust the Russian statistics (which we should not).
But what about actual GDP growth? We see that in the graph below.
First of all, we see that before the war, actual GDP growth was in fact somewhat below potential GDP (which we initially assumed to be around 3%).
Furthermore, we also see that actual GDP growth contracted significantly in the early phase of the war.
Our simulations – on purpose – have not taken the initial negative demand shock into account as we are more interested in analysing the longer-term impact of the negative supply shocks and the fiscal-monetary nexus.
However, we do see that over the past 15-18 months, Russian GDP growth has been around 4%, more or less as predicted by the model.
We also see that we seem to have begun a slowdown in Russian GDP – from around 4.5% to just above 3% by the end of 2024.
It is certainly no collapse, but keeping in mind just how expansionary fiscal and monetary policy is, then this is notable and in line with the predictions from the simulation.
It therefore also just seems a matter of time before the real world catches up (or rather down!) to the model predictions.
What will cause actual GDP growth to converge (down) towards the much lower potential GDP growth will be what we could call an inflationary-induced tightening of monetary policy – or what in textbooks is often called a real-balance effect or a Pigou effect.
This effect kicks in once inflation starts to adjust to the higher money supply growth. Remember, we have in the model assumed that there are price rigidities, and this is certainly realistic in an economy like the Russian with widespread price controls.
Effectively, this means that at some point inflation will start to outpace money supply growth, and at that time, we will effectively get monetary TIGHTENING. Not because NOMINAL money supply slows, but because REAL money supply growth slows once inflation picks up for real.
We see this in the graph below where the ‘monetary gap’ is the difference between nominal money supply growth and inflation.
In the model, this effect should have started to kick in a year ago, but in reality, this is likely somewhat delayed even though we are actually at the moment seeing this starting to unfold.
Consequently, this ‘passive’ or ‘automatic’ tightening of monetary conditions is very likely to start to depress demand in the Russian economy relatively soon, and as a consequence, we could see actual GDP growth start to slow rather substantially.
This would undoubtedly lead the ‘overheating’ crowd to yell ‘I told you so’, but the fact is that this is not a bust caused by overheating, but rather the good vertical Phillips curve combined with the Pigou effect kicking in and pushing actual GDP growth down towards potential GDP growth that in the meantime has slowed substantially compared to before the war.
There is, however, also another scenario: a scenario where inflation is ‘contained’ by even more widespread and draconian price and wage controls in Russia, and given the regime’s more and more totalitarian and Soviet-style policies, this should not be a surprise.
However, in this scenario, we get the ‘bust’ in another form. What we should then expect to happen is that we don’t see open inflation, but rather ‘closed’ inflation, which means that goods simply disappear from the shelves in the supermarkets.
In this scenario, GDP growth contracts not because of lower demand, but because producers simply stop producing as it will no longer be profitable due to price controls. But that is not the scenario we simulate in the model. The model nonetheless educates us as to why such a scenario could become reality.
So now we have looked at inflation and real GDP growth, and we have shown that sooner or later, inflation will rise sharply if large budget deficits are funded by printing money. What we have in fact assumed is that the Russian central bank is not really independent and that it is the needs of Putin’s war machine that determine the growth rate of the money supply.
Elvira Nabiullina Is Just Another Servant of Putin
The Russian central bank governor Elvira Nabiullina has for years been seen in the financial markets as a guardian of price stability in Russia, and she is often described as ‘conservative’ or ‘ultra-orthodox’ in her monetary policy views and even as a ‘reformer’.
Frankly speaking, I used to use those terms about her, and the fact that she has hiked the CBR’s key policy rates repeatedly over the past year has led many observers to conclude that she is still a world-class central banker trying hard to secure price stability in Russia.
Even among the biggest critics of the Russian regime, it is hard to find anybody willing to be critical about Nabiullina’s conduct of monetary policy.
But this, in my view, is wrong, and it stems from a well-known fallacy in monetary analysis – the fallacy of concluding that ‘high’ and ‘increasing’ NOMINAL interest rates indicate a tight monetary policy, but as Milton Friedman taught us long ago – interest rates are HIGH when monetary policy has been EASY.
And this is in fact exactly what our simulations show us.
The graph below shows the development in nominal and real interest rates in the simulation.
It is important to notice that in the model, the central bank does not in fact CONTROL interest rates – at least not directly and certainly not in the way that many people (and even economists) believe central banks SET interest rates.
In the model, the natural real interest rate is determined by fiscal policy. If the government runs a large deficit, then the real interest rate will increase. And if we add inflation (or inflation expectations) to the real interest rates…
What we see in the simulation is that this ‘market’ determined nominal interest rate increases from around 7% before the ‘shocks’ to just above 21% in 2023 and further towards more than 25%.
This, however, is not ‘monetary tightening’ – it just reflects a large increase in the budget deficit that first of all increases natural real interest and secondly higher inflation due to higher money supply growth – also caused by the large budget deficit.
But let’s compare this with what Nabiullina has actually done with the key policy rate. The graph below shows this.
What do we see?
We start out around 7% and we are now at 21%. Nabiullina delivered the latest rate hike back in October.
If we compare this to our simulation – this is more or less the same, or rather we should have been at 25% rather than 21%. Looking at real interest rates, the difference is a bit smaller.
But what is the real story here?
The story is that Russian monetary policy in no way can be described as ‘TIGHT’ and there is nothing ‘prudent’ or ‘ultra-orthodox’ about how Nabiullina has conducted monetary policy, particularly over the past 12-18 months. She is barely keeping up with the increasing natural real interest rate and inflation expectations.
And there is another story here – is she getting ‘soft’? Or has Putin now fully taken over also in terms of monetary policy?
Back in 2022, she did in fact tighten monetary policy as we see in the graph above – the key policy rate was increased sharply and much more so than our simulations indicated it should. This is an indication that at that time Nabiullina actually had some monetary independence.
On the other hand, the rate ‘hikes’ over the past 12-18 months do not really show that – it simply shows that the CBR is ‘shadowing’ the market interest rates.
In fact, it might even be worse. Last week the CBR unexpectedly kept its key policy rate unchanged at 21% (a hike had been expected) and at the press conference following the rate decision the governor said:
“The decision to leave the rate at 21% was motivated by the fact that the data over the past six weeks, which describe both actual lending activity and the intention to grow loan portfolios further, demonstrate quite convincingly that it’s very possible that the required tightness in monetary conditions needed to slow inflation has already been achieved.”
And she might in fact be right – it is the Pigou effect that we mentioned above that might be starting to kick in. However, the monetary “tightening” is NOT a result of direct actions of the central banks as the rate hikes over the past year have simply been a ‘shadowing’ of market interest rates.
Nabiullina continued:
“The labour market – really, its condition – is a very important factor now in assessing the possibilities of expanding production, and companies still continue to cite it as the main constraint… But we do see the first signs of a decline in demand for labour. This process will be uneven across the economy, flowing from one industry to another, from one enterprise to another. This process will have a significant impact on our assessment and decision-making, including monetary policy.”
Again, she might indeed be right – I do also, based on my simulation, expect things to start to cool down quite a bit in the Russian economy, but I also expect inflation to continue to rise further.
In fact, what our simulations are indicating is that the Russian economy is increasingly heading for a stagflationary scenario – likely with inflation above 15% and basically no economic growth.
But I will happily acknowledge that Nabiullina is not to blame for this. It is 100% a result of Putin’s war on Ukraine – the massive budget deficit and major negative supply shocks it has created.
On the other hand, we can no longer consider governor Nabiullina ‘ultra-orthodox’, ‘prudent’ and ‘hawkish’ or any other words used to describe inflation-fighting central banks. This is simply a servant.
Economic Gravity – Not Overheating – Is Putin’s Primary Economic Headache
The fundamental misunderstanding of Russia’s economic trajectory stems from a failure to distinguish between monetary dynamics and structural economic deterioration.
Our model clearly demonstrates that what many Western (military) analysts interpret as “overheating” is actually the early manifestation of a complex monetary-fiscal nexus, one that will inevitably lead to stagflation rather than a simple boom-bust cycle.
Economic gravity sooner or later always sets in, and Russia’s case will be no exception. The laws of economics cannot be indefinitely suspended through monetary manipulation or statistical sleight of hand.
The apparent resilience of the Russian economy is largely illusory, sustained by massive monetary expansion and increasingly compromised institutional independence at the CBR.
What we’re witnessing is not the prelude to a classical overheating scenario (if such a thing ever existed), but rather the erosion of Russia’s productive capacity masked by aggressive monetary accommodation of fiscal deficits.
The simulation results point to an uncomfortable truth: Russia is not heading for a sudden collapse, but rather a grinding deterioration characterised by rising inflation and declining potential output.
This “slow burn” scenario is actually more pernicious than a quick boom-bust cycle, as it represents a structural decline in Russia’s economic capacity that will persist long after the immediate effects of the war have faded.
The transformation of the CBR from an independent inflation-fighting institution to an enabler of war financing represents more than just a policy shift – it signals the complete subordination of monetary policy to Putin’s military ambitions. Hence, Nabiullina’s position has evolved from independent monetary policy maker to facilitator of war financing.
Nabiullina’s recent policy decisions should be viewed not as prudent central banking but as evidence of this fundamental institutional change.
Looking ahead, the choice facing Russia’s economic leadership is increasingly stark: either allow inflation to accelerate while maintaining the fiction of price stability through selective data reporting, or impose increasingly draconian price controls that will inevitably lead to Soviet-style shortages.
Neither path offers a sustainable solution to the fundamental problems our model has identified. The real tragedy is that this outcome was entirely predictable from the moment Putin chose war over economic stability.
Try the RUST Model Simulation yourself
The model simulations above were based on modelling I did with the help of ChatGPT and particularly Claude 3.5 Sonnet.
I call this framework the RUST model — Russia’s Unpleasant Structural and Transitional economic model.
The acronym reflects both the theoretical foundation in “Unpleasant Monetarist Arithmetic” and the slow economic decay (“rusting”) of Russia’s economy under the weight of fiscal irresponsibility, war-induced supply shocks, and institutional degradation.
This also means that you can play with the model and its parameters.
History often rhymes, as Mark Twain is famously quoted as saying.
The story of Syrian President Bashar al-Assad’s flight to Russia—and the presumed transfer of his family’s substantial wealth to Moscow—offers a stark reminder of one of the most contentious financial episodes of the 20th century: the transfer of Spain’s gold reserves to the Soviet Union during the Spanish Civil War.
Known as the “Moscow Gold,” this episode highlights the precarious trade-offs faced by leaders and nations under siege. Both cases vividly illustrate how those who surrender control of their wealth to a more powerful benefactor often find themselves trapped in a gilded cage.
The Moscow Gold: A Historic Precedent
In 1936, as Spain’s Second Republic teetered on the brink of collapse under the onslaught of Francisco Franco’s Nationalist forces, the Republican government made a desperate decision. Over 510 tonnes of gold—72.6% of the Bank of Spain’s total reserves—were shipped to the Soviet Union.
This transfer, initiated by Finance Minister Juan Negrín and carried out in utmost secrecy, was ostensibly designed to safeguard the nation’s wealth and use it to purchase arms for the Republican war effort.
The logistical operation was both meticulous and clandestine. The gold was moved from Madrid to the naval stronghold of Cartagena, loaded onto Soviet ships, and transported to Odessa before arriving in Moscow. Upon receipt, the gold was carefully catalogued by Soviet officials and stored in the vaults of Goskhran, the Soviet state treasury.
Initially, the agreement seemed mutually beneficial. The Spanish Republicans would gain access to Soviet arms and supplies, while the Soviet Union would strengthen its influence over the Spanish Republic.
However, the reality was far less equitable. Once the gold was in Moscow, control shifted entirely to Stalin’s regime. By 1937, the gold was fully integrated into the Soviet state’s reserves, and the Spanish Republicans were left with little leverage.
The promised arms arrived sporadically, were often outdated, and were supplied at inflated prices that consumed much of the gold’s value. In the same way as Putin’s military support to Assad also suddenly disappeared.
The Fallout for Spain
The consequences for the Spanish Republic were devastating. The depletion of its gold reserves not only failed to turn the tide of the war but also left the Republic financially crippled. After Franco’s victory in 1939, the loss of the gold became a symbol of betrayal and desperation.
Efforts to recover the gold were futile, and its disappearance became a political and historical controversy that lingers to this day. For Stalin, the gold was a windfall that bolstered Soviet coffers at a time of global economic uncertainty.
Assad’s Gilded Cage in Russia
Now, almost 90 years later, we see a strikingly similar scenario playing out with Bashar al-Assad. Reports suggest that Assad’s flight to Russia included the transfer of substantial family wealth, likely accumulated during his decades-long rule over Syria.
This wealth, which was presumably intended to secure the Assad family’s future, now resides under the control of Vladimir Putin’s regime.
Assad’s position in Russia bears strong resemblance to the role played by communist leaders in satellite states like Bulgaria or Czechoslovakia under Soviet influence. Much like those figureheads, Assad’s autonomy appears minimal.
Putin has likely extracted all useful intelligence and strategic value from Assad long ago. Now, Assad and his family find themselves in a gilded cage, their wealth little more than another resource in Putin’s geopolitical arsenal.
Adding an ironic twist to this situation are the persistent rumours of discord within the Assad family. Some reports claim that Asma Assad, Bashar’s British-born wife, wishes to divorce and return to London.
If true, this rumour underscores the fractures in a family now bound by circumstances outside their control. Of course, such a move would be almost impossible. Putin, who effectively holds the Assad family’s fate in his hands, would have no reason to permit it. Moreover, Asma Assad would find no welcome in the UK, where her ties to the Assad regime have made her persona non grata.
The Stage is Set: Familiar Playbook, Different Starting Point
As President-elect Trump prepares for his second term, we are entering a period that bears striking similarities to 2016, but with crucial differences.
Back then, I wrote about how Trump’s fiscal expansion plans, combined with the Federal Reserve’s willingness to tolerate higher inflation, created a unique alignment of fiscal and monetary policy. Markets reflected this dynamic, with rising inflation expectations and strong equity performance. See here and here.
Now, the stage appears set for a repeat performance—or at least a variation on the theme. Trump’s vocal opposition to debt ceiling constraints (see his post on ‘Truth Social’ from yesterday below) suggests that fiscal policy will again tilt towards expansion.
While details remain unclear, tax cuts and a push for deregulation seem likely to feature prominently (and higher tariffs). This aligns with the fiscal playbook of Trump’s first term, though the environment today is much less forgiving.
The Fed’s New Context
Yesterday, the Federal Reserve cut rates by 25 basis points, bringing the federal funds rate to 4.25-4.5%. However, their projections for 2025 signal a more restrained approach, with fewer rate cuts than previously anticipated.
Inflation remains above target, and Powell’s Fed is keenly focused on maintaining its credibility. This stands in stark contrast to the Fed of 2016, which welcomed fiscal stimulus as a way to lift inflation closer to its target.
This is clearly illustrated in the graph below – back in 2016 inflation expectations were well-below the Fed’s 2% inflation target. Today, we are closer to 2.5% inflation – hence slightly above the inflation target.
The Bond Market Speaks
The bond market is already reflecting this tension. The 10-year Treasury yield yesterday rose to 4.5%, but inflation expectations have remained largely flat.
This suggests that markets believe any inflationary impulse from fiscal policy will be neutralised by the Fed’s actions. Rising real yields, rather than nominal ones, are driving this dynamic—a clear sign that monetary policy will act as a counterweight to fiscal expansion.
Why 2024-25 Is Not 2016
In 2016, fiscal and monetary policies worked in tandem to boost below-target inflation and support nominal growth. Today, however, we begin from a situation with elevated inflation and higher rates. This changes the entire framework for how fiscal and monetary policies interact.
As Trump’s fiscal plans become clearer, the interplay between fiscal ambitions and the Fed’s inflation mandate will define the economic landscape. The market reaction so far underscores the limits of fiscal policy in a world where monetary vigilance remains paramount.
The Fed’s Balancing Act
The Federal Reserve’s rate cut yesterday, bringing the federal funds rate to 4.25-4.5%, underscores the central bank’s cautious approach to managing a challenging environment.
Unlike in 2016, when fiscal expansion and monetary accommodation worked in harmony, the Fed now faces a very different scenario. Inflation remains above target, and Powell’s primary focus is to ensure price stability while carefully navigating the pressures of fiscal expansion.
What’s particularly striking is the Fed’s revised outlook for 2025. By reducing projected rate cuts from four to two, the Fed has sent a clear signal that its easing cycle will be far more constrained than markets might have anticipated.
This adjustment reflects hard-learned lessons about inflation dynamics and suggests a central bank unwilling to repeat the mistakes of the 1970s, when monetary policy succumbed to fiscal pressures.
The Shadow of Fiscal Expansion
The potential for further fiscal expansion under President-elect Trump (or at least lack of fiscal consolidation) adds another layer of complexity. Trump’s remarks about the debt ceiling and his administration’s likely push for tax cuts signal a return to fiscal looseness. However, the Fed’s stance indicates it will not allow these policies to undermine its inflation-fighting credibility.
This reflects the essence of the so-called Sumner Critique: fiscal policy cannot sustainably drive aggregate demand if the central bank is committed to its nominal target. Powell’s Fed, by maintaining its focus on inflation stability, is ensuring that fiscal expansion under Trump will be met with monetary discipline.
Unlike in Trump’s first term, the Fed’s monetary stance is now operating from a position of relative high and maybe even rsing real rates. This means then Fed must walk a fine line, easing just enough to support the economy while ensuring that fiscal-driven inflation pressures remain firmly under control.
Markets Anticipate Monetary Restraint
The bond market’s reaction confirms this interpretation. While 10-year yields surged yesterday, inflation expectations have remained flat. This stability signals that investors trust Powell to counteract any inflationary impulses from fiscal policy. Instead, the rise in real yields is driving tighter financial conditions, adding downward pressure on equity markets.
The Fed’s Independence on Trial
The current environment places Jerome Powell’s leadership in sharp relief. The Fed’s independence has long been tested by political pressures, from Nixon’s influence on Arthur Burns in the 1970s to Trump’s public critiques during his first term. Powell’s cautious stance suggests he is determined to avoid the mistakes of the past, prioritising the Fed’s credibility even as fiscal ambitions grow.
As fiscal plans take shape, the Fed’s ability to manage this delicate balance will be crucial. Markets are already pricing in a central bank that is prepared to stand firm—a dynamic that will shape the interplay between monetary and fiscal policy in the months ahead.
Equity Markets Adjust to Real Yields
The rise in real yields has also filtered through to equity markets, contributing to the broad sell-off. Higher real yields increase the discount rate applied to future corporate earnings, reducing valuations and driving stocks lower.
Following the revised Federal Reserve outlook, the Dow Jones Industrial Average plummeted 1,123.03 points, or 2.58%, to close at 42,326.87. This marked the index’s 10th consecutive day of decline, its longest losing streak since 1974, and set it on course for its worst weekly performance since March 2023.
Meanwhile, the S&P 500 dropped 2.95% to 5,872.16, and the Nasdaq Composite sank 3.56% to 19,392.69, with losses in the tech-heavy index accelerating toward the end of the trading session.
Both the Dow and the S&P 500 recorded their largest single-day declines since August, a period marked by market turbulence triggered by the unwinding of the yen carry trade.
The Fed’s Path Forward
Markets are now pricing in a scenario where fiscal expansion will face firm limits imposed by monetary policy.
Over the past month, there has been a significant shift in market expectations for interest rate movements in 2025, as reflected in the CME FedWatch Tool (see below).
While the market previously anticipated deeper rate cuts below the 375-400 basis point range, expectations have now become more restrained. The dominant probability now centers around the 400-425 basis point range, signaling a forecast of gradual and moderate easing rather than aggressive rate cuts.
This shift aligns with FOMC statement, which highlighted solid economic growth and continued, albeit slow, progress toward the 2% inflation target.
Although inflationary pressures are easing and the labor market is showing some signs of cooling, the Fed emphasized ongoing economic uncertainty, limiting the likelihood of swift and substantial easing. As a result, the market has adjusted its outlook, anticipating a more cautious approach from the Fed, driven by data and balanced risk assessments.
Bessent’s “3-3-3” Framework Faces Reality
The nomination of Scott Bessent as Treasury Secretary adds a twist to this equation.
His “3-3-3” framework—targeting 3% growth, a 3% deficit, and increased oil production—presents a vision of fiscal responsibility that conflicts with Trump’s clear preference for aggressive fiscal measures.
Markets are already questioning the credibility of Bessent’s framework, particularly in light of Trump’s dismissive comments about debt ceilings.
This tension between the Treasury’s stated goals and Trump’s fiscal instincts further complicates the policy landscape. The Fed, however, remains the ultimate arbiter of aggregate demand, and Powell’s cautious stance ensures that any fiscal expansion will face meaningful limits.
Lessons from Historical Misalignments
The parallels to historical episodes of fiscal-monetary misalignment are clear. The Bundesbank’s reaction to German reunification in the early 1990s provides a particularly relevant example. Faced with massive fiscal expansion, the Bundesbank tightened monetary policy aggressively to maintain price stability, even at the cost of a sharp economic slowdown. See more on this here.
Today, Powell’s Fed faces a similarly challenging environment, though its tools differ. Instead of raising rates aggressively, Powell may demonstrate monetary restraint through a slower-than-expected pace of rate cuts.
The Political Tensions of Fiscal and Monetary Policy
The dynamics between fiscal and monetary policy are not just economic; they are inherently political.
President-elect Trump’s fiscal ambitions, as evidenced by his dismissive remarks about debt ceilings and focus on tax cuts, could bring renewed political pressure on the Federal Reserve.
This recalls the 1970s, when President Nixon famously pressured Fed Chair Arthur Burns to loosen monetary policy to support his fiscal agenda—a decision that ultimately undermined inflation control and the Fed’s credibility. I have written about the this unfortunate episode in US monetary policy before – see here.
Jerome Powell, however, appears determined to avoid such pitfalls. His leadership of the Fed has consistently emphasised independence and a commitment to price stability.
Powell’s resolve surely will be tested, but his actions so far indicate that he is unlikely to repeat the mistakes of the past, but that might ultimately end in a major confrontation with the Trump administration.
Trump’s populist Keynesianism will test the Fed’s independence, while Powell’s cautious approach will likely frustrate those expecting rapid monetary accommodation.
This emerging dynamic highlights the fundamental constraint on fiscal policy: the central bank’s commitment to price stability. As in the past, monetary policy will dominate fiscal outcomes, ensuring that any fiscal expansion operates within the boundaries set by the Fed.
Trump will only win the battle against Powell’s commitment to price stability is Powell is replaced by a Arthur Burns type central bankers. Lets not hope it comes to that.
The Sumner Critique in Practice
The unfolding situation serves as a real-world demonstration of the Sumner Critique. Fiscal policy, however ambitious, cannot sustainably boost aggregate demand if the central bank is committed to its nominal target. Powell’s cautious approach, coupled with the Fed’s measured pace of rate cuts, ensures that fiscal expansion will not lead to runaway inflation or unanchored expectations.
The Bottom Line
The months ahead will provide a critical test of the balance between fiscal ambitions and monetary discipline. The Fed’s cautious approach, combined with the market’s clear signals, reinforces the limits of fiscal policy in a world of vigilant monetary oversight.
As I have long argued, monetary policy ultimately dominates fiscal policy in determining nominal outcomes. Powell’s Fed seems prepared to uphold this principle, ensuring that monetary credibility remains intact even in the face of aggressive fiscal measures. The market reaction so far tells us the story: fiscal policy will not run unchecked, and the Fed will remain the anchor of nominal stability.
Note: The illustration above was created with fal.ai/FLUX.
PS: I want to acknowledge that my use of the term “Keynesian” here may not align with how serious (New) Keynesians would define their approach. In this context, I use “Keynesian” to describe the type of demand management policies that proved problematic in the 1970s. While these policies were inspired by Keynesian economic thought and can be labeled as such, this does not imply that modern Keynesians would necessarily endorse or agree with these strategies. I might also have used the term vulgar supply side economics.
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If you want to know more about my work on AI and data, then have a look at the website of PAICE — the AI and data consultancy I have co-founded.
Yesterday, Donald Trump shared a rather remarkable post on “Truth Social” about his meeting with the International Longshoremen’s Association, where he strongly criticised automation at American ports.
The message reveals Trump’s economic thinking as fundamentally aligned with that of a 1970s New York union leader: opposing immigration, free trade, and now technological advancement.
This is not a growth agenda – it is basically militant socialist thinking.
Trump’s open stance against automation is entirely consistent with his broader economic philosophy. AI and robots serve the same economic function as free trade and immigration – they enhance productivity and competition.
This is precisely why economists generally champion immigration, free trade, and technological progress. Trump, however, appears to oppose all three.
The logic follows that Trump must oppose AI in general terms. After all, if automation is to be restricted in American ports, where exactly should it be permitted?
This in my view presents a significant risk to US stock markets and should Trump continue down this fundamental anti-growth path, it must eventually have rather negative implications for growth and earnings expectations.
It would be prudent to monitor Trump’s future statements regarding AI carefully. While he may be hanging out with Elon Musk, Trump secured power by appealing to American working-class voters who fear competition from immigrants and imported goods. Given this context, it seems entirely natural that he might eventually launch a fundamental attack on AI.
Indeed, Trump’s economic thinking appears in many ways closer to Bernie Sanders than Ronald Reagan and his latest statement demonstrates a clear preference for protectionist policies over market-driven innovation, further confirming a significant departure from traditional Republican free-market principles.
The profound irony is that while Trump claims to put “AMERICA FIRST”, his opposition to automation and technological advancement could ultimately leave American ports – and by extension, the broader American economy – at a competitive disadvantage in the global marketplace.
Lars Christensen
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lacsen@gmail.com
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