The games Donald plays

 

By now, anybody who is anybody – and plenty who aren’t – has had their say on the Trump tariffs and their possible implications. Much ink has been spilled documenting the twists and turns of the Trump Administration’s actions and the subsequent market movements. If there is one lesson to be learned from recent weeks, it is not to overreact to latest events because likely as not, there will be a rollback which renders the previous position invalid. That is not to say markets are wrong to sell off/rally as Trump’s whims dictate – after all, investors have to take a position based on available information because each signal from the White House alters the landscape of risks, costs and growth expectations. But it is no way to run an economy.

More than a game

One way to think of Trump’s strategy is through the prism of game theory, and there are some elements which echo the main findings of Thomas Schelling’s classic 1960 book, The Strategy of Conflict – a seminal work in game theory and strategic decision-making, particularly in the context of conflict, negotiation, and deterrence. One of the key takeaways of Schelling’s work is that conflicts are not merely power plays that pit one side against another, but are instead contests that highlight strategic interdependence – in other words, the actions of one player have an effect on the strategy of the opponent.

Schelling also highlighted the role of brinkmanship in which pushing one party further outside their comfort zone forces them to change their own strategy. This is very clearly the case in the context of the US-China trade row which threatens to inflict significant economic damage unless cooler heads soon prevail. China responded to the 145% levy on exports to the US with a tariff of 125% on US imports, highlighting the impact of brinkmanship. But the strategic interdependence element also came into play when the US exempted Chinese-made smartphones from higher import levies – the number one Chinese export to America by value – when the inflationary impact of smartphone tariffs became clear. It was a small de-escalation in a much bigger dispute but it highlights that there are some people in the US Administration who appear to understand the risks of escalation.

Another game theory concept highlights what can happen if actors in the dispute focus purely on the pursuit of their goals – Martin Shubik’s dollar auction problem which I originally used as a demonstration of the irrationality of Brexit negotiations. In brief, the dollar auction problem is a two-person thought experiment in which a dollar is initially auctioned off at a substantial discount to its face value. In subsequent rounds the price is bid up, with the highest bidder winning. But the twist is that the loser must also pay their bid. Consequently, both bidders have an incentive to continue bidding beyond the value of the prize in order to minimise losses, which results in a lose-lose outcome.

In the trade context, neither China nor the US wants to look weak in the eyes of the world leading to a cycle of escalating tariffs, even when both countries incur economic losses. The rational solution to this problem is to back down early or find a co-operative solution which minimises losses for both sides. Unless this approach is adopted, the key lesson highlighted by the dollar auction paradox is that once the bidding process becomes entrenched, the competing parties lose sight of their original goals and produces an outcome where the costs of winning outweigh the cost of defeat.

Credibility and how to lose it

One aspect of Schelling’s work that has not been adhered to is the principle of credibility. Schelling made the point that in strategic interactions, the ability to credibly commit to a course of action conveys a decisive advantage and that threats and promises must be credible to be effective. In the case of trade, however, Trump has not acted credibly. He has backtracked on his tariff policies on a number of occasions, leading many to wonder whether he is bluffing. While Trump sets great store by the art of the deal, the art of the bluff can take you a long way in life, love and poker. But bluffing only works if opponents believe the bluffer will follow through. While Trump has the power to impose tariffs, the question is whether doing so is politically or economically wise. According to a recent poll, 56% of respondents disapprove of his handling of the economy while 75% believe tariffs will push prices higher in the short-term. If Trump were attempting a further run for the White House, it would be politically dangerous to go further with the tariff policy. But because he is not bound by this constraint, further trade escalation cannot be ruled out, especially since 34% of poll respondents believe Trump's economic policies will pay off in the long run (admittedly down from 41% at end-March).

In game theoretic terms, a key weakness of Trump’s approach is that he takes a zero-sum approach to strategy – in other words, winner takes all and the loser gets nothing. This might work in the casino business – although Trump’s record as a casino owner is terrible, having twice filed for Chapter 11 bankruptcy – but it does not work in politics. One reason for this is that politics is not a one-shot game in which strategy is formulated without any concern for future consequences (as the dollar auction problem illustrates). Geopolitical decision making is a multi-shot game in which today’s actions have an impact on future decisions. For example, the US may ultimately need Europe onside if it is to successfully pursue its economic policy with regard to China. But by damaging relations with Europe today through its approach to both trade and security, it becomes less likely that Europe will side with the US in future.

We cannot continue in our game theory mode without talking about a Nash equilibrium – a situation where no player can improve their outcome by unilaterally changing their strategy, assuming the other players keep their strategies unchanged. Since high US tariffs hurt domestic consumers, the US might improve its welfare by lowering tariffs — even without immediate Chinese reciprocity. This suggests that the current position does not represent a stable Nash equilibrium. But since US tariffs also make China worse off, China has an incentive to reciprocate by reducing its own tariffs. Rolling this forwards, both sides engage in tariff reduction until the point at which we reach a stable welfare position. Such a strategy works because it builds trust gradually and is credible, even in the absence of explicit cooperation.

Trust busting

Looked at from a logical standpoint, Trump’s trade policy appears inconsistent because (a) it will make US consumers worse off and (b) he has not followed through on his calls, undermining their credibility. Against that, his policy could be seen as a form of calculated ambiguity or strategic brinkmanship, with Trump attempting to pressure trading partners into concessions and rallying domestic support by appearing strong on trade. By merely postponing tariff implantation, Trump keeps everyone off balance, thus enhancing his leverage and keeping his threats alive without fully committing.

Perhaps the best definition of the current situation is one of strategic ambiguity, based on the goal of retaining flexibility in order to exert pressure and manipulate expectations. Such a strategy might work if the short-term volatility serves a longer-term purpose, but other than putting maximum pressure on China, it is hard to see what the longer-term plan is. At some point Trump has to commit on tariffs one way or the other but when he does, he will have to accept the consequences. America’s putative allies may be amenable to Trump’s threats but China most certainly is not.

Last word: Common sense is not so common

All of this may sound like obvious common sense – don’t escalate conflicts that hurt both sides, don’t bluff unless you’re willing to follow through, and don’t ignore the long-term consequences of short-term moves. Yet time and again, these lessons are ignored in the heat of political battles. This is where game theory proves its value: not as an abstract academic exercise, but as a practical framework for understanding strategic behaviour and anticipating outcomes. By highlighting the incentives, interdependencies, and likely responses of all players, the theory of games offers a rational lens through which to view even the most irrational-seeming policies.

Trading places

Hiding in plain sight

Since his inauguration as US President, Donald Trump has turned the world upside down, as he indeed promised on the campaign trail. Like many people, I have underestimated his determination to follow through on issues such as trade policy and the nature of his relationship with traditional allies, especially in Europe. Although Trump’s bark proved to be worse than his bite during his first term in office, the restraints have come off this time around given the changed nature of his Administration which is much more ideological in nature. That said, Trump has consistently espoused an “America first” strategy – the clue was always in the name – and the President is only acting in line with the Henry Kissinger doctrine that “America has no permanent friends or enemies, only interests.”

One reason for misreading Trump is that his definition of American interests differs from those who see American leadership as rooted in alliances, democratic values and global stability. In this framework, the US sees itself as a stabilising force in global affairs, willing to bear costs to uphold a rules-based international order which allows it to exert its soft power. By contrast, Trump prioritises transactional relationships and a narrower, more nationalist view of US interests, placing more emphasis on short-term gains, economic advantage and the assertion of US sovereignty over collective global commitments. This explains his scepticism towards NATO; his withdrawal from international agreements like the Paris Climate Accord and the WHO, and his willingness to engage with authoritarian leaders based on perceived strategic or personal benefit rather than ideological alignment. For those accustomed to the traditional American foreign policy playbook, this divergence creates misunderstanding. Critics may interpret his actions as erratic or uninformed when, in reality, they follow a consistent logic – one that prioritizes strength, economic leverage, and a rejection of international obligations that he perceives as constraints rather than assets.

But this does not mean that the strategy is optimal – certainly not for the western allies, nor indeed for the US. Despite what Vice President Vance might think, the US and Europe share many common values and there is a benefit to keeping one’s allies onside. Indeed, the only country to invoke NATO Article 5 – the principle of collective action in the event that a member of the alliance is attacked – is the United States in the wake of the 9/11 attacks. Elon Musk’s closeness to the Trump Administration may be one reason why Tesla sales have slumped in Europe, falling in March by 36.8% and 63.9% year-on-year in France and Sweden, respectively. This in turn suggests that Europe may be less willing to erect trade barriers against Chinese products if it can supply better and cheaper products than the US (ignoring for the time being that the EU has already imposed tariffs on Chinese EVs). The wider point being that there may well be economic blowback on the US if the Trump Administration fails to recognise the longer-term consequences of its actions.

This time may be different … or it may not

One of the least trustworthy phrases in markets is “this time is different” – one which is invoked every time a new paradigm appears likely to upset the status quo. Consequently, we should be wary of drawing too many conclusions from the current shenanigans emanating from the White House. We cannot know, for example, whether the current breach in relationships within the western alliance will extend beyond Trump’s term in office (whether that will include a third term remains to be seen). History may provide some clues.

In the 1930s, for example, the US pursued a policy of isolationism which advocated non-involvement in European and Asian conflicts and non-entanglement in international politics. This was stoked by Republican Senator Gerald P. Nye, who claimed that American bankers and arms manufacturers had pushed for US involvement in World War 1 for their own profit, costing many lives while not serving US interests. This was compounded by the Great Depression, which forced Americans to concentrate on their domestic economic problems. Had it not been for the Japanese attack on Pearl Harbor in 1941, the world’s geopolitical history might have been very different.

Domestically, there are also parallels with the McCarthy era of the early-1950s when paranoia regarding “reds under the bed” resulted in huge political upheaval in Washington. The parallels are not exact, of course, since history does not repeat exactly, but it does rhyme occasionally and there are some elements of McCarthyism which chime with Trump’s modus operandi. Perhaps most obviously, Senator Joseph McCarthy used anti-communist fears to rally support, claiming that the US was riddled with communists (here for his famous “Enemies from Within” speech in 1950). McCarthy’s suggestion that “a moral uprising [that] will end only when the whole sorry mess of twisted warped thinkers are swept from the national scene” has echoes of Trump’s promise to “drain the swamp” and crush the “deep state”.

Like McCarthy, Trump has initiated attacks on the institutional framework of the United States: In McCarthy’s case, he launched a number of unfounded attacks on prominent individuals while Trump has variously railed against the FBI, the DOJ and the mainstream media. Both used the media to spread their message (quite how McCarthy would have adapted to social media is a fascinating what-might-have-been), sowing dissension and polarisation. Both also suffered a fall from grace with McCarthy’s influence fading after the infamous army hearings of 1954 while Trump has twice been impeached, found guilty of criminal offences and lost a presidential election. But while McCarthy quickly faded from the scene once the Republican Party realised he was more of a liability than an asset, Trump’s political career has bounced back.

Where the parallels end is that Trump controls a major political party with a much wider base of popular support whereas McCarthy was just a Senator with a genius for self-promotion. It may yet be the case that the Republicans abandon Trump if his strategy proves to be ruinous for the US but he will not fade into obscurity as did the Senator from Wisconsin. There are many in the GOP who buy into Trump’s views – his is not a one-man crusade. And while public opinion has indeed shifted against Trump – latest polls put his approval ratings at 47.9% versus 50.5% at the start of February – this is far from catastrophic, and is in any event higher than at any time in his first term (see chart below).

It’s the economy, stupid

Donald Trump’s political fortunes will depend heavily on US economic prospects. Goldman Sachs recently raised its subjective assessment of a US recession in the next 12 months from 20% to 35% while JP Morgan puts the prospect of a global recession at 40%. These numbers suggest that the odds are still against a downturn but they are rising. Moreover, given the strength of the economy bequeathed to Trump, voters may not be very forgiving of a self-inflicted economic downturn, especially if tariffs have a material impact on the prices paid by American consumers. What really matters from a political perspective is the depth of any recession. It is possible that the Administration could spin a mild correction as the price for taking back control though that might be a risky strategy. But a more aggressive downturn would unlikely play well, given the impact this will have on jobs and incomes. With the US midterm elections scheduled for November 2026, Republican party strategists will be aware that such an outcome runs the risk that they will lose control of Congress.

Key takeaways

The commentariat has spilled much ink in predicting the implications of a Trump presidency and while history suggests it is wise to ignore some of the more excitable predictions, there is little doubt that we are operating in changed geopolitical circumstances. Europe no longer considers the US a reliable partner, and while that may change post-Trump, governments do not have the luxury of time to wait him out. As The Economist put it: “There was a time when America’s allies could count on it to do right by them, even if they got into arguments. These days, by contrast, America’s allies have to prepare for the worst.” As for Trump’s domestic position, it is too early to tell whether voters are buying into his economic strategy. But polling evidence does suggest that there has been a sharp rise in the share of Republican voters who believe the EU is unfriendly – perhaps hardly surprising in view of Trump’s claim that the EU was “formed in order to screw the United States”. By the same token, European voters clearly have a less positive view of the US.

Whether the “special relationship” between the US and Europe can recover from this remains to be seen. As in a marriage, once one partner demonstrates reduced commitment, it reduces the incentive of the other party to hold it together. At the very least, this will lead to estrangement; at worst, divorce. But even a divorce can be amicable.