Trump's wild ride has Powell scrambling to keep economy on track

Trump's wild ride has Powell scrambling to keep economy on track
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Jay Powell, chairman of the Federal Reserve, should have a cushy job. How hard could it be to manage an economy that will soon enjoy the longest expansion in history, with unemployment at a 50-year low and inflation low and stable? It’s an economy that few Fed chairs have ever enjoyed.

Turns out, running the Fed in the age of President TrumpDonald John TrumpWatergate prosecutor says that Sondland testimony was 'tipping point' for Trump In private moment with Trump, Justice Kennedy pushed for Kavanaugh Supreme Court nomination: book Obama: 'Everybody needs to chill out' about differences between 2020 candidates MORE is no cakewalk. Since Powell took the helm of the central bank he has been scrambling to keep up with the president.

A year ago, the economy was on a sugar high, juiced-up by Trump’s massive deficit-financed tax cuts. Wealthy individuals and large multinational corporations received a massive $200 billion tax windfall, close to 1 percent of GDP. On cue, the economy made a jump in growth.

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With unemployment falling below 4 percent, and wage and price pressures fast developing, the Fed had no option but to raise interest rates. It had kept rates extraordinarily low since the financial crisis a decade ago, and it reasoned appropriately that rates had to normalize in a fully employed economy or risk undesirably high inflation.

The stock market, rejoicing in the business tax cuts, had also been on a tear, and there were signs of bubbles developing in real estate and bond markets. After the devastating economic fallout from the bursting of the technology-stock and housing bubbles, the Fed wanted no part of pumping-up another bubble.

Then the trade war began. Its first salvo actually had been fired days after President Trump’s inauguration, when he tore up the Trans-Pacific Partnership (TPP) agreement. The TPP was the free-trade deal between the U.S. and other Pacific Rim nations, excluding China. China doesn’t play fair in its economic dealings with other nations, and the TPP was the strategy to compel it to behave.

But President Trump blew up that strategy, and instead became the “tariff man.” So far, the only thing higher tariffs on China and other trading partners has accomplished is a weaker economy. Businesses are increasingly nervous, and their investment has flat-lined.

This is especially disappointing given last year’s corporate tax cuts, which the administration sold as an incentive to businesses to invest more and lift the economy’s long-term growth. That argument was always a stretch, but the trade war made sure it hasn’t worked.

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Investors struggling with the potential fallout from the trade war recognize how bad it is for business, particularly if the president follows through on his threats to jack up tariffs to 25 percent on Chinese, Mexican and vehicle imports.

Companies will be forced to change their business models and shift their global supply chains. Sales and profits will suffer. Investors are rightly worried that the disruption will be significant enough to ignite a recession.

Chairman Powell and his colleagues at the Fed agree and have pivoted on interest rates. Just a few months ago, they were forecasting several interest rate increases this year. But they have taken a hard 180-degree turn and are instead signaling that rate cuts could come soon.

Higher tariffs will prompt higher inflation, since they will be passed along to American consumers, but the Fed will look beyond that, reasoning this will be a one-time pop to inflation.

Moreover, the higher prices will act like a tax increase on consumers — if they have to pay a higher price for what they purchase at Walmart or on Amazon, then they have less to spending on everything else — sapping the economy’s strength.

Indeed, if President Trump follows through on all his tariff threats, it will effectively mean an almost $200 billion per annum tax increase on the U.S. economy. Yes, the same size as last year’s tax cut.

Complicating things further for Chairman Powell is President Trump’s frontal attack on the Fed’s independence. We long ago figured out that to function well, our economy requires the Fed to set interest rates without regard to the political desires of lawmakers.

Trump is of a different mind. He has threatened to fire Powell (he can’t) and attempted to stack the Fed with his political cronies (he failed, at least so far) if the central bank doesn’t lower rates immediately.

It’s not that the Fed’s recent pivot on interest rates has been influenced by the president’s strong-arm tactics. The principal of Fed independence is deeply woven into the DNA of everyone at the Fed, but Chairman Powell surely must be looking over his shoulder, dreading what Trump will tweet or do next.

Being Jay Powell is really hard. He has the yeoman’s work of navigating the economy around President Trump’s bad economic policies and efforts to undermine the Fed. Buckle in, because he will almost surely need to pivot hard again to avoid an economic train wreck, which is becoming increasingly difficult to do.

Mark Zandi is chief economist at Moody's Analytics.