Trump blames the Fed for market meltdown but could blame himself

Trump blames the Fed for market meltdown but could blame himself
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It is said that success has many fathers, but failure is an orphan. That proved to be the case for the 2008-09 Great Recession. In the aftermath, nobody in the policymaking, financial or academic communities stepped forward to accept responsibility for the worst global economic setback in the past 70 years.

Judging by President TrumpDonald John TrumpTrump conversation with foreign leader part of complaint that led to standoff between intel chief, Congress: report Pelosi: Lewandowski should have been held in contempt 'right then and there' Trump to withdraw FEMA chief nominee: report MORE’s haste in blaming Federal Reserve Chairman Jerome Powell’s interest rate policy for the most recent episode of world financial market turbulence, the same is likely to be true of the next global economic recession.

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This is unfortunate since it increases the chances that policymakers will keep making similar mistakes in the future that will set us up for the next painful economic boom-bust cycle.

The truth of the matter is that there is plenty of blame to go around for the next global economic recession. A good place to start might be with those policymakers in the major industrialized countries who were too timid in their fiscal policy response to the last economic downturn. This placed too much of the burden for securing a global economic recovery on the world’s central banks.

Receiving inadequate fiscal policy support, and with interest rates soon having reached their zero lower bound, the world’s main central banks felt that they had little alternative but to engage in highly unorthodox monetary policies to promote an economic recovery and to avoid deflation.

They did so by mainly buying long-dated government bonds on a massive scale that in the end saw the combined balance sheet of the Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England increase by a staggering $10 trillion.

The unorthodox monetary policies pursued did in the end secure a prolonged global economic recovery. However, they did so at the cost of creating bubbles in the world equity market and in many housing markets.

They also did so at the cost of substantially distorting the world’s credit markets and of allowing non-creditworthy borrowers to borrow on very favorable terms.

The world’s main central banks too should accept their share of responsibility. While they might be able to rationalize the initial phase of their quantitative easing policies, it is all too likely that they further inflated asset and credit market bubbles by keeping monetary policy too loose for too long.

In particular, one has to question the wisdom of Janet YellenJanet Louise YellenWhat economic recession? Think of this economy as an elderly friend: Old age means coming death On The Money: Rising recession fears pose risk for Trump | Stocks suffer worst losses of 2019 | Trump blames 'clueless' Fed for economic worries MORE’s Federal Reserve being so slow to raise interest rates in 2017 at a time that a strongly recovering U.S. economy was being boosted by a 25-percent increase in U.S. equity prices, a 10-percent dollar depreciation and a Trump fiscal boost.

While President Trump must be expected to be the last person to accept responsibility for any economic setback, he too should bear a major part of the blame for the next world economic recession. He should do so because of two egregious macroeconomic policy mistakes made under his watch.

The first mistake was to have the world’s largest economy engage in a major budget policy stimulus at this late stage in the economic cycle.

By choosing to boost the U.S. economy by a large unfunded tax cut and by significant public spending increases, he left the Federal Reserve with little option but to raise interest rates in order to prevent the U.S. economy from overheating.

This risked deflating the world’s asset and credit market bubbles at a faster pace than might otherwise have been desirable.

The second was to engage in a trade war with China, the world’s second-largest economy. Not only has this contributed to heightening global investor uncertainty at a time of rising world interest rates, but it has also risked derailing the economic recovery in a country that has been the world’s primary engine of economic growth and the world’s major consumer of internationally traded commodities, which are the lifeblood of all too many emerging market economies.

Fingers might also be pointed at policymakers in emerging market countries like Argentina, South Africa and Turkey, which all allowed large economic imbalances to develop during the period of easy global liquidity conditions.

It has also not helped matters to have had a populist government in Rome that has now put Italy on a collision course with its European partners over the question of budget discipline.

This is now raising serious questions in the markets about whether Italy, which has the world’s third-largest sovereign debt market, might in the end default on its debt and provoke a European banking crisis.

One has to hope that rather than engage in finger pointing, the world’s economic policy makers will carefully consider what policy mistakes were made following the 2008-2009 Great Economic Recession. Maybe then we will be spared from yet another destructive global economic boom-bust cycle.

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.