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How things might turn out
LOOKING back from the vantage point of 2025*, economic historians are starting
to write their analyses of the Trump slump. It seemed to appear from nowhere
with the economy growing at around the trend rate (2.3% in 2017) and the
stockmarket booming. The abrupt change came in March 2018 when President Donald
Trump decided to impose tariffs on steel and aluminium imports. "Trade wars are
good and easy to win" he said. Both China and the European Union (EU)
retaliated in kind without trying to escalate the tensions. It might have ended
there.
But unfortunately, the president's more mainstream advisers like Gary Cohn had
been sidelined by a more aggressive group that saw the trade deficit as the key
measure of economic progress. In this mercantilist view, any American deficit
was proof of cheating. Unfortunately, the president had also enthusiastically
passed a tax-cutting programme which resulted in demand sucking more imports
into the country. The trade deficit widened rather than declined. So in late
2018, just before the mid-term Congressional elections, an enraged President
passed a general tariff along the lines of the Smoot-Hawley tariff of 1930. The
other leading economies had no choice but to respond in kind, in the hope of
dragging America back to the negotiating table. Business confidence and the
stockmarket slumped.
In the early months of 2018, the Federal Reserve had continued to tighten
monetary policy in response to the low unemployment rate and the prospect of
fiscal stimulus. That tightening only had a significant impact in early 2019,
just as the trade war got nasty. While the Fed swiftly cut rates again, its
actions were too little and too late. Meanwhile the Republican Congress,
alarmed at the rising budget deficit, had used the opportunity to attack
entitlement programmes, cutting welfare benefits and spending across the board
to shrink the state. Unemployed Americans started to set up shanty sites,
nicknamed "Trump towns" in memory of the "Hoovervilles" of the 1930s.
Right-wing media claimed all those people living rough were actors paid for by
George Soros.
All this might have led the Democrats to sweep to power in the mid-term
elections. But with his popularity in decline, President Trump, in search of an
easy foreign-policy win, launched a pre-emptive strike on North Korea in the
autumn of 2018. The resulting war cost 2m lives, disrupted Asian trade and
added to the economic downturn. But it allowed the Republicans to paint
themselves as the patriotic party, and they expanded their majority in
Congress.
So the American economy was hit by a triple whammy: the lingering effects of
tighter monetary policy; a fiscal policy that hit demand by transferring money
from the poor to the rich; and a slump in global trade. The trade war also
damaged growth in China. So the world's two biggest economies pulled the rest
of the world into a slump. Global supply chains were disrupted as many of the
efficiency gains of the previous 20 years dissipated.
Economists berated the Trump administration for their actions. But just like
the 1,028 economists who signed a petition against the Smoot-Hawley tariff,
they were ignored. The public have had enough of experts, the President
proclaimed. His philosophy of never retreat prevented him from changing
course; in China, nationalist pressure insisted that President Xi stand up to
the Americans; while the EU was too preoccupied with Brexit to make a
difference. Britain emerged from the EU in 2021 to pursue free trade policies
in the middle of a tariff war.
It might not have happened just as the Great Depression might have been averted
with the right combination of fiscal and monetary policies. That downturn also
came out of a blue sky when the economy was doing well and the stockmarket was
at a high. But the political elite of the world were too preoccupied with
headline-grabbing measures to head off the disaster.