In 1925, John Maynard Keynes wrote a scathing critique of Winston Churchill’s economic policies in a book entitled The Economic Consequences of Mr. Churchill. He did so in response to Churchill’s disastrous decision as chancellor of the exchequer to return Britain to the gold standard at too high an exchange rate. That decision is now generally accepted to have contributed to the depth of Britain’s economic depression in the 1930s.
Judging by Donald Trump’s highly unorthodox economic policies, a similarly titled book about the US president could be penned now. This is not simply because the probable adverse economic consequences of his singularly ill-timed budget policies are in plain sight. It is also because the conflicts between his trade and budget policies risk leading the world towards the destructive beggar-thy-neighbour policies of the 1930s.
The last thing a US economy close to full employment and with rising inflationary expectations needs is an expansionary budget policy. Yet that is precisely what the Trump administration has chosen to do. According to estimates by the International Monetary Fund, President Trump’s $1.5tn unfunded tax cut over the next decade, together with Congress’s $300bn public spending increase over the next two years, will provide the US with a fiscal stimulus amounting to around 0.75% of GDP in both 2018 and 2019.
President Trump’s expansionary budget policy at this late stage in the economic cycle is bound to add considerable pressure on the Federal Reserve to raise interest rates to prevent the economy from overheating. It is also all too likely to bring out the bond vigilantes of yesteryear, should inflation gather momentum and the Fed be perceived to be behind the interest rate curve. This is especially the case at a time when a US economy close to its potential is receiving a strong boost from the combination of still very low interest rates, buoyant equity and housing prices, and a weak dollar.
In putting the economy on the path to higher interest rates than the Fed is anticipating, the Trump administration seems to have forgotten the searing 2008-09 experience of rising interest rates leading to the bursting of the US housing and credit market bubbles. This is all the more regrettable considering how much more pervasive asset price bubbles and credit risk mispricing are in today’s global economy.
Global financial market institutions have exposed themselves to considerable risk by lending vast amounts of money at very low interest rates to borrowers of dubious credit worthiness who are apt to default when rates keep rising.
Equally troubling for the maintenance of open global markets is the administration’s wilful disregard of the basic economic principle that a country’s trade deficit is arithmetically the difference between its savings and investment rates. This exacerbates the chances of the administration doubling down on its policy of imposing import tariffs to reduce the trade deficit when that deficit widens as a result of an increased budget deficit. That is bound to invite retaliation by trade partners, which could disrupt global supply chains.
When the cartoonist of the London Times was asked what he thought of the election of an angular-faced Edward Heath as British prime minister in 1970, he replied that as a private citizen he mourned but as a cartoonist he rejoiced. Sadly, I feel the same way about the Trump administration’s economic policies. As a private citizen I mourn the unnecessary pain it will inflict on the country. However, as an economist I rejoice that my profession will be vindicated by its general scepticism of those policies.
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.