Economics Is Not Trump's Strong Suit

Economics does not seem to be President Trump's long suit. First, he promotes import tariffs as if they were the cure-all for the country's trade deficit. And he does so without regard to either inflation or to how our trade partners might retaliate. Then, he engenders the greatest degree of economic policy uncertainty without regard to the damage that this might do to the stock market and to consumer and investment confidence. As if that were not sufficient reason for concern, now he is leaning heavily on the Federal Reserve to lower interest rates. He is doing so without regard to what this might do to inflationary expectations and to the long-term interest rates, like the 10-year Treasury bond rate and the 15 and 30-year mortgage rates, that really matter to the economy.

All of this does not bode well for the US and the world economy in the remainder of this year. It also hardly bodes well for the stock market especially given the stock market's still unusually high valuation.

A lesson that Trump should have learned from his first term in office is that a policy mix of higher tariffs and massive tax cuts is not the way to reduce the country's trade deficit. Indeed, in his first term, such a policy mix resulted in a 40 percent increase in the trade deficit in goods and services from $480 billion in 2016 to $680 billion in 2019.

While tariffs on $350 billion worth of Chinese imports and those on steel and aluminum on their own might have helped curb the trade deficit, they were swamped by a massive tax cut in the form of the 2017 Tax Cut and Jobs Act. That tax cut, which the Congressional Budget Office estimated would add around $1.5 trillion to the budget deficit over the next decade, had the effect of worsening the country's savings and investment imbalance. Savings were reduced by a ballooning budget deficit while investment was incentivized by lower corporate tax rates. Little surprise then that the trade deficit widened under Trump's watch.

Having learnt little about trade deficits in his first term, Trump now is proposing the same policy mix of tariff hikes and tax cuts. However, this time around he is doing so on steroids. Tariffs of between 20 and 25 percent are now being proposed for more than $1 trillion worth of imports. At the same time, according to Committee for a Responsible Budget, over the next decade Trump's tax cut proposals would add anywhere between $5 trillion and $11 trillion to the budget deficit. In much the same way as the last massive tax cut caused the trade deficit to widen in Trump 1.0, so too must we expect something similar to happen to the trade deficit in Trump 2.0 with even larger tax cuts than before.

Trump also seems blind to the idea that markets and economic agents abhor uncertainty. Otherwise, he would not be changing import tariff policy from day to day or allowing Elon Musk to reduce government spending in as chaotic a way as he is doing. The uncertainty that this has engendered has already resulted in around $5 trillion of stock market wealth having evaporated. It has also resulted in an unusually rapid loss in both household and investor confidence in the economy.

Something else that Trump seems not to understand is that leaning heavily on the Federal Reserve tends to heighten inflationary expectations, especially when combined with a price bump from higher import tariffs. As if to underline this point, the latest Michigan survey indicates that households are now expecting 4.9 percent inflation over the next year. Higher inflation expectations in turn puts pressure on the all-important 10-year Treasury bond yield which is the key determinant of mortgage rates.

If there is any reason for optimism, it is that markets will soon force Trump to make a policy U-turn and come up with a more coherent economic policy program than he now has. Trump would do well to heed the strong signal that the recent stock market swoon has been sending and spare our 401(k)s from another big leg down in the stock market.

Learn more: So Much for a Trump Economic Boom | The Trump Stock Market Slump | A Specter of Uncertainty Haunts the US Economy | Will Trump Trigger a Eurozone Debt Crisis?

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