Trump's devil-may-care economic stance spells trouble

Trump's devil-may-care economic stance spells trouble
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Judging by the singularly poor timing of the Trump administration’s two major economic policy initiatives, namely the Trump tax cut and its "America First" trade policy, one can be excused for thinking that it has an economic recession wish.

Last year, defying the most basic principles of sound budget management, the administration opted for a highly expansionary budget policy stance at a time that the economy was at or beyond full employment.

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Today, ignoring gathering economic storm clouds abroad, the administration has chosen to double down on its protectionist trade policy. That is bound to invite retaliation from our trade partners and thereby risk a trade war.

 

The principles of sound budget management dictate that while budget deficits might be helpful during times of economic weakness, they should not be tolerated at times of economic strength. If not, the government’s debt would be on an ever-increasing path.

In addition, as the budget deficit widens in the good times, we would not have the room for fiscal policy stimulus to support the economy in the bad times when such support might really be needed.

Seemingly oblivious to these basic principles, at a time when U.S. unemployment had reached its lowest level in the past 10 years, the Trump administration opted for an unfunded tax cut that is estimated to increase the public debt by around $1.5 trillion over the next decade.

As if this were not bad enough, the administration also went along with a $300 billion congressional increase in public spending.

Pursuing undisciplined fiscal policy is not a good idea at the best of times. However, these are not the best of times in the sense that years of very easy monetary policy by the world’s major central banks has led to overvaluation in global equity and housing markets.

At the same time, ample global liquidity has caused credit risk to be seriously mispriced around the world.

Pursuing expansionary fiscal policy at this juncture risks causing long-term interest rates to rise sharply. With the Fed now in the process of reducing the size of its bloated balance sheet, an increase in the budget deficit is bound to push long-term interest rates markedly higher.

That in turn risks bursting asset price bubbles and causing a painful repricing of credit around the world. In particular, it risks causing a sudden stop in capital flows to the emerging market economies. That could be particularly painful for Argentina, Brazil, Indonesia, South Africa and Turkey. 

Seemingly not satisfied with the risks that a reckless budget policy poses to the U.S. and global economic recoveries, the Trump administration is intensifying its protectionist stance toward trade policy.

This goes well beyond taking punitive trade measures against China, where such measures might well be justified. Rather, it includes the imposition of steel and aluminum import tariffs on our allies both in the Americas and in Europe.

It also includes the adoption of a much tougher stance in the North American Free Trade Agreement (NAFTA) negotiations, an antipathy toward trade agreements in general and the threat of much higher tariffs on German automobile imports.

The ostensible reason for the administration choosing to increase import tariffs is that it wishes to eliminate the country’s trade deficit. However, this objective is in direct conflict with the administration’s expansionary budget policy.

If there is one point on which virtually all economists can agree, it is that a country’s trade balance is arithmetically the difference between its savings and its investment rates.

By following policies that will increase the budget deficit and reduce the country’s savings rate, the administration is heightening the chances that the country will return to the twin deficit problem of the 1980s. That in turn increases the chances that the administration will intensify its protectionist stance toward trade policy when the country’s trade deficit widens.

If there is another point on which virtually all economists can agree, it is that a trade war can be destructive to U.S. and global economic prosperity. This makes it all the more difficult to understand why the administration now chooses to risk taking us back to the beggar-thy-neighbor policies of the 1930s.

The timing of the administration’s hard-line trade policies would seem to be particularly unfortunate for Europe. At a time when Italian political developments threaten the return of the European sovereign debt crisis, the last thing that Europe needs is the prospect of a trade war with the United States that might further undermine investor confidence in its economy.

Hopefully, should the administration’s budget and trade policies trigger a global economic recession, it will find a way to cooperate with our main trade partners to promote a speedy global economic recovery.

However, judging by the major macroeconomic mistakes that the administration has been making and the high-handed way it has treated our allies, I would not hold my breath for that to happen. 

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.