They took the best growth picture in a decade and put us in danger of recession.
Why are so many key global leaders pursuing so many stupid economic policies?
As recently as January 2018, the International Monetary Fund issued one of its most upbeat economic forecasts in recent years, extolling “broad based” growth, with “notable upside surprises.”
By last month, the fund had sliced its forecast for expansion this year to 3.2 percent — a significant falloff from the 3.9 percent projection reiterated just six months earlier — and had pronounced the economic picture “sluggish.” American investors are more concerned; the bond market is sounding its loudest recessionary alarm since April 2007.
The deterioration in the economic picture is not the consequence of irresponsible behavior by banks or a natural disaster or an unanticipated economic shock; it’s completely self-inflicted by major world leaders who have delivered almost universally poor economic stewardship.
The trade war initiated by President Trump sits firmly atop the list of bad policies. But Brexit has tipped Britain into economic contraction. With European governments unwilling to pursue structural reforms, the continent is barely growing. President Xi Jinping of China has focused on standing up to Mr. Trump and solidifying his own power. After a promising start reforming the economy, India’s prime minister, Narendra Modi, has turned instead to oppressing his country’s Muslim minority.
None of this was necessary. As the January 2018 I.M.F. report indicated, the world economy was firing on all cylinders — “the broadest synchronized global growth upsurge since 2010” — as jobs were being added and inflation remained subdued.
Yes, Mr. Trump’s trade war and Brexit loomed, but amid hope that the former would prove empty and the latter would be softened.
Not so today.
Often against the recommendations of his more sensible advisers, Mr. Trump has implemented the country’s most protectionist actions since the 1930s. As a result, world trade has begun to fall for the first time in a decade, with noticeable economic impact. Last week, Goldman Sachs cut its already modest projections for fourth-quarter growth to 1.8 percent from 2 percent.
That’s a far cry from the “4, 5, 6” percent that Mr. Trump talked about just before his tax cut passed.
Nor has that been Mr. Trump’s only misstep in economic policy. Instead of nurturing growth with important investments like a robust infrastructure program, Mr. Trump deployed his political capital to secure tax cuts that disproportionately favored business and the wealthy.
The “sugar high” they produced quickly wore off. And now, instead of developing better policies, the president has chosen to attack the Federal Reserve, whose independence is cherished by investors, business people and economists.
Boris Johnson, Britain’s new prime minister, abandoned his predecessor’s notion of a “soft Brexit” that would have maintained some ties with the European Union. Instead, he reaffirmed his promise that his country would leave the E.U. on Oct. 31 with or without a deal. The pound quickly fell to its lowest level against the dollar since 1985. (It has since recovered slightly.)
Then there’s China. By virtue of both its remarkably fast industrialization and its protectionist policies, the nation has long been a trade threat. But four years ago, the government issued its “Made in China 2025” economic manifesto, which put in writing China’s plans to attain a leadership position in key new sectors, including robotics, pharmaceuticals and aerospace.
The notion of China using its state power to take on important American and European industries instead of pursuing market reforms set off alarm bells across the political spectrum and provided a concrete underpinning for Mr. Trump’s trade confrontation.
Mr. Xi, rather than acknowledging China’s protectionist practices, has proved unwilling to accept a new trade agreement with effective enforcement provisions. That has raised doubts about whether China is seriously interested in reforming its unfair trade practices — keeping key markets fully or partially closed, using state subsidies to favor its companies, forcing American companies to transfer technology to China and the like.
Of course, at least in the world’s democracies, voters bear substantial responsibility for electing these inadequate leaders. The rise of populism as a reaction to disaffection about economic and social conditions has been well documented as a principal driving force.
Occasionally, good choices have been made, such as the election of President Emmanuel Macron of France. But even that has not led to progress; public support for Mr. Macron turned to opposition when he instituted the much needed policy changes that he promised.
Any chief executive officer who botched his or her job as badly as most of these leaders have would be fired. Let’s hope that voters come to that realization when given the chance.
The bond market is screaming
An old line about war says that amateurs talk about tactics, but professionals study logistics. A similar line about the economy would be that amateurs talk about stocks, but professionals study the bond market. And lately the bond market is telling a tale of profound pessimism.
Why does the bond market reflect economic expectations? If investors expect a boom, they also expect the Fed to try to rein in the boom by raising short-term interest rates (which it more or less directly controls), to head off potential inflation. The prospect of higher short-term rates then leads to higher long-term rates, because nobody wants to lock money in at a low yield if returns are going up. Conversely, if investors expect a slump, they expect the Fed to cut rates, and pile into long-term bonds to lock in returns while they can.
So the slump in long-term yields since last fall, from a peak of 3.2 percent to just 1.63 percent this morning, says that investors have grown drastically less sanguine about the economy. Long-term rates are now notably lower than short-term rates — and this kind of “yield curve inversion” has in the past consistently been the precursor to recession:
Ominous yieldsFederal Reserve of St. Louis
Bond investors could, of course, be wrong — there are some people out there claiming that we’re in a bond bubble. And so far the real economy, as measured by G.D.P., job growth, and all that, is still chugging along. But as I said, there’s clearly a wave of pessimism sweeping the market. What’s it about?
One answer is that last fall many investors were looking at a couple of quarters of high growth, and thinking that this might be the start of an extended boom. Serious economists warned that this growth was a temporary lift — a “sugar high” — driven by the shift from fiscal austerity to what-me-worry deficit finance. But at least some people bought into the Trumpist line that tax cuts were going to produce an enduring rise in the growth rate.
Since then, however, it has become clear that the tax-cut boost was indeed a one-time thing. In particular, there has been no sign of the promised surge in business investment.
At the same time, Trump’s trade war may be starting to take a toll. In particular, the uncertainty may be deterring business spending. Whether new tariffs would hurt or help your business, it now makes sense to hold off on plans to expand, until you see what he actually does.
Finally, economic troubles in the rest of the world — several major European economies are quite possibly in recession — are filtering back to the U.S.
Now, most economists aren’t predicting a recession here, for good reason. The truth is that nobody is very good at calling turning points in the economy, and calling a recession before it’s really obvious in the data is much more likely to get you declared a Chicken Little than hailed as a prophet. (Believe me, I know all about it.) But the bond market, which doesn’t worry about such things, is looking remarkably grim. I leave the possible political implications as an exercise for all of you.
Can America and China Avoid a Currency War?
Although the current poor state of Sino-American relations may make even a very limited currency détente unattainable, such a pact is not outside the realm of possibility. Ultimately, both America and China might see some advantage in taking currency conflict off the table, in the hope of preventing wider damage to themselves and others.
SANTA BARBARA – China’s currency, the renminbi, weakened slightly against the dollar at the start of this week. Around the world, the immediate response was panic. Financial markets tumbled, US President Donald Trump’s administration formally labeled China a currency manipulator, and fears of a new currency war spread like wildfire. To describe all this as an overreaction would be a gross understatement. A currency war has not erupted – at least, not yet.But the danger is real. Although markets now appear to be recovering somewhat, America and China remain locked in a perilous trade war with no end in sight. The United States is still poised to impose a 10% tariff on some $300 billion worth of Chinese imports. It does not seem unreasonable to suppose that China might then retaliate by engineering a substantial devaluation of its currency. After all, a cheaper renminbi would go a long way toward offsetting the impact of Trump’s tariffs on the prices of Chinese goods in the US.But, because devaluation would also carry significant risks for China, the country’s leaders will be hesitant to take this step. Many of China’s biggest enterprises have borrowed heavily in dollars, and a weaker renminbi would greatly increase the cost of servicing this external debt. Worse, the prospect of devaluation could spark massive capital flight from China as anxious companies and individuals seek to protect the value of their assets. That is what happened four years ago when the renminbi was allowed to weaken significantly, and the Chinese authorities subsequently had to spend $1 trillion in foreign-exchange reserves to prevent the currency from crashing.
It seems unlikely, therefore, that China is about to declare all-out currency war. What happened earlier this week was much subtler – in effect, a shot across America’s bow. The renminbi was already close to the symbolic level of CN¥7 per US dollar. By setting their daily benchmark rate for the currency at a smidgen below CN¥7, the Chinese authorities created room for currency traders to push the market rate temporarily above CN¥7 – an effective devaluation. Although the actual size of the devaluation was minuscule, the psychological impact was enormous. China was reminding America that it still has many economic arrows in its quiver.
Unfortunately, the Trump administration responded in typical blunderbuss fashion, mistaking the modest Chinese signal for something more sinister. By immediately declaring China a currency manipulator, the US succeeded only in hardening positions on both sides.
To avoid losing face, Chinese leaders may now feel compelled to respond in kind. They could make good on the threat of devaluation, or pull out some of its other arrows. For example, China could
- embargo exports of the rare earth minerals that are so vital to America’s tech industry, or prolong its
- boycott of US agricultural products. Or it could go beyond the realm of commerce and
- stir up trouble in the South China Sea or the Taiwan Strait. In short, relations between the world’s two largest economies could go from bad to much worse.
Can further escalation be avoided? One way to avoid that outcome might be to look to a neutral arbiter to adjudicate the currency issue. The most obvious candidate is the International Monetary Fund, one of whose main functions is to oversee the “rules of the game” in international monetary affairs. All Fund members have pledged to avoid exchange-rate manipulation, and all are formally subject to “firm” Fund surveillance of their currency policies. In principle, if America and China truly want to avoid a monetary conflict, they could ask the IMF to step in to settle matters.
In practice, however, the Fund’s authority is sadly limited. The IMF has no powers to enforce rulings. At best, all it can do is “name and shame” currency manipulators. And in the end, it is hard to imagine either America or China kowtowing to a toothless multilateral organization. Can anyone really picture Trump submitting to the judgment of a bunch of unaccountable international civil servants?
A slightly more realistic option might be a direct bargain between the US and Chinese governments – perhaps also including the European Central Bank and one or two other monetary powers – to achieve some form of currency détente.
There is precedent for such a deal. Back in 1936, following more than a half-decade of uncontrolled competitive devaluations during the Great vDepression, the main financial powers of the day – the US, Britain, and France – agreed to an informal arrangement for mutual exchange-rate stabilization. Jokingly called the “twenty-four-hour gold standard,” the Tripartite Agreement committed each country to give 24 hours’ notice of any change in its currency’s price. Though far from perfect, the pact did manage to restore some semblance of order to monetary affairs.
A similar agreement today would be more difficult to negotiate. In the 1930s, America, Britain, and France were on reasonably good terms. Present-day America and China, by contrast, are strategic adversaries engaged in a trade war, and even a very limited exchange-rate initiative might prove unattainable. Yet it is not outside the realm of possibility. Ultimately, both sides might see some advantage in taking currency conflict off the table, in the hope of preventing wider damage to themselves and others.
Trump Is Losing His Trade Wars
The pain is real, but the coercion isn’t.
Donald Trump’s declaration that “trade wars are good, and easy to win” will surely go down in the history books as a classic utterance — but not in a good way. Instead it will go alongside Dick Cheney’s prediction, on the eve of the Iraq war, that “we will, in fact, be welcomed as liberators.” That is, it will be used to illustrate the arrogance and ignorance that so often drives crucial policy decisions.For the reality is that Trump isn’t winning his trade wars. True, his tariffs have hurt China and other foreign economies. But they’ve hurt America too; economists at the New York Fed estimate that the average household will end up paying more than $1,000 a year in higher prices.
And there’s no hint that the tariffs are achieving Trump’s presumed goal, which is to pressure other countries into making significant policy changes.
What, after all, is a trade war? Neither economists nor historians use the term for situations in which a country imposes tariffs for domestic political reasons, as the United States routinely did until the 1930s. No, it’s only a “trade war” if the goal of the tariffs is coercion — imposing pain on other countries to force them to change their policies in our favor.
All the tariffs Trump imposed on Canada and Mexico in an attempt to force a renegotiation of the North American Free Trade Agreement led to a new agreement so similar to the old one that you need a magnifying glass to see the differences. (And the new one may not even make it through Congress.)
And at the recent G20 summit, Trump agreed to a pause in the China trade war, holding off on new tariffs, in return, as far as we can tell, for some vaguely conciliatory language.
But why are Trump’s trade wars failing? Mexico is a small economy next to a giant, so you might think — Trump almost certainly did think — that it would be easy to browbeat. China is an economic superpower in its own right, but it sells far more to us than it buys in return, which you might imagine makes it vulnerable to U.S. pressure. So why can’t Trump impose his economic will?
There are, I’d argue, three reasons.
First, belief that we can easily win trade wars reflects the same kind of solipsism that has so disastrously warped our Iran policy. Too many Americans in positions of power seem unable to grasp the reality that we’re not the only country with a distinctive culture, history and identity, proud of our independence and extremely unwilling to make concessions that feel like giving in to foreign bullies. “Millions for defense, but not one cent for tribute” isn’t a uniquely American sentiment.
In particular, the idea that China of all nations will agree to a deal that looks like a humiliating capitulation to America is just crazy.
Second, Trump’s “tariff men” are living in the past, out of touch with the realities of the modern economy. They talk nostalgically about the policies of William McKinley. But back then the question, “Where was this thing made?” generally had a simple answer. These days, almost every manufactured good is the product of a global value chain that crosses multiple national borders.
This raises the stakes: U.S. business was hysterical at the prospect of disrupting Nafta, because so much of its production relies on Mexican inputs. It also scrambles the effects of tariffs: when you tax goods assembled in China but with many of the components from Korea or Japan, assembly doesn’t shift to America, it just moves to other Asian countries like Vietnam.
Finally, Trump’s trade war is unpopular — in fact, it polls remarkably poorly — and so is he.
This leaves him politically vulnerable to foreign retaliation. China may not buy as much from America as it sells, but its agricultural market is crucial to farm-state voters Trump desperately needs to hold on to. So Trump’s vision of an easy trade victory is turning into a political war of attrition that he, personally, is probably less able to sustain than China’s leadership, even though China’s economy is feeling the pain.
So how will this end? Trade wars almost never have clear victors, but they often leave long-lasting scars on the world economy. The light-truck tariffs America imposed in 1964 in an unsuccessful effort to force Europe to buy our frozen chickens are still in place, 55 years later.
Trump’s trade wars are vastly bigger than the trade wars of the past, but they’ll probably have the same result. No doubt Trump will try to spin some trivial foreign concessions as a great victory, but the actual result will just be to make everyone poorer. At the same time, Trump’s casual trashing of past trade agreements has badly damaged American credibility, and weakened the international rule of law.
Oh, and did I mention that McKinley’s tariffs were deeply unpopular, even at the time? In fact, in his final speech on the subject, McKinley offered what sounds like a direct response to — and rejection of — Trumpism, declaring that “commercial wars are unprofitable,” and calling for “good will and friendly trade relations.”