Further Thoughts on the Tariffs

 

While I fully expected Trump to look for some face-saving out to back down on the 145% tariffs on China, I did not expect it to happen so soon.   (The day after my latest post, actually!).  I expected him to cave only when we started feeling some real pain on Main Street.  He didn't wait that long.

I will add that I fully expect the 90 day "pause" to be the face-saving out Trump was looking for, and any return to either the 145% rate on China or "reciprocal" tariffs on the rest of the world to be quietly forgotten when 90 days roll around.  I expect any noises Trump is making now about resuming tariffs to be so much empty talk.  Of course, I though that when he put a 30 day "pause" on tariffs against Canada and Mexico as well.

So, what if I am right?  Well, for starters, I expect Trump's popularity to recover at least somewhat with the decision not to drive us into a ditch.  Then again, 10% tariffs on everyone and 30% on China will cause some price increases and economic slowing, particularly in our international trade sectors.  It will not be obviously catastrophic, but there will be a pinch.  People may not recognize the tariffs are causing the pinch, but it will be there and I expect it to eventually erode any recovery in Trump's popularity.  But it will take time.

I also suspect that Trump will take away some lessons from this little episode.  One will be that if one of his policies proves disastrous it is, after all, better to abandon the policy than to stick with it.  Fair enough.  One only wishes any number of other Presidents had learned the same thing.  Of course, it is better not to adopt a disastrous policy in the first place, but that is a different story.

Another lesson I expect Trump to take away that may -- alas -- prove true is that if you start with a disastrous policy, retreating to one that is merely bad makes the bad policy look pretty good by comparison.  (Incidentally, it is past hoping that any future President will not adopt any bad policies.  that amounts to saying one hopes future President will never make mistakes -- not compatible with ordinary, fallible human nature).  

One he seems highly resistant to learning is that, while it is better to retreat from a disastrous policy to a merely bad policy than stick with the disastrous policy, it is better to pick one bad policy and stick with it than to jump erratically from one bad policy to another.

And, of course, I could be wrong.  Trump might raise tariffs again after all.  Then all bets would be off. 

Reflections on the Tariffs

 When I read that China could potentially bring our economy and our military to its knees by cutting off our supply of rare earths, a part of me thinks that Trump is really doing us a favor by starting a trade war with China.  After all, if China can bring us to our knees in a trade war by cutting off our rare earths, that has some rather alarming implications about what they might do in an actual shooting war.  

What if China invades Taiwan, something that could happen as soon as 2027?  How will we be able to come to Taiwan's defense if mainland China can bring our military to its knees by cutting off our rare earths?  Any why haven't previous administrations -- Trump 1.0 included -- been working on developing our independence from Chinese rare earths? Decoupling ourselves from China now seems rather late in the game but, as the saying goes, better late than never.

That being said, I am not prepared to give Trump credit for any sort of strategic thinking here.  The US economy is about a quarter of the world economy.  Only China comes close to the total size of our economy -- nearly $18 trillion for China versus $27.72 trillion for the US.  Germany, the third in line, clocks in at $4.5 trillion -- less than a sixth the size of the US.  Clearly, then, we are big enough to crush any economy except China.  China is big enough to engage the US in a trade war, although both countries will be much the worse off for it.

What the orange idiot in the White House hasn't figured out is that, while we can crush any economy except China and inflict serious pain on China, we are not big enough to prevail in a trade war against the entire rest of the world at the same time. And our best chances of emerging triumphant in a trade war with China alone is to have as many allies as possible. 

Presumably Trump and company assume that we have the advantage in a trade war with the rest of the world because we are big enough to stand alone, while the rest of the world consists of many different countries that can be split.  Except the Trump has done his best to make it impossible for anyone to strike a deal with us by (1) making clear that he cannot be counted on to keep his word, and (2) not even making clear what he wants (perhaps because he doesn't know himself).  

Or, as this article comments:

Instead of spending years, or even months, investing in American industry, Trump is angling to get rid of the major investments in semiconductor and clean-energy manufacturing implemented under the Biden administration. Instead of engaging in a gradual tariff rollout, the administration jacked up tariffs to 145 percent over the course of a few weeks. Instead of providing businesses and investors with clear guidance, the administration has changed its story by the day, if not the hour. And instead of building a coalition of allies, Trump has spent the past few months threatening, feuding with, and tariffing them. Even if the U.S. were to suddenly change course and try to build an anti-China coalition, a prospect recently floated by Bessent, it is likely too late. What country would sign up for economic hardship for the sake of an “ally” that has not only treated it poorly but has also repeatedly demonstrated that it can’t be trusted to honor any bargain?

Vance's Vision as an Exercise in 1950's Nostalgia

 

Make America Great Again presupposes some good old days when America was great that we have declined from.  The slogan works better when you leave it somewhat unclear when America was great.  After all, different people are apt to have different ideas of exactly how far we want to turn back the clock.  And no matter when you want to return to, closer inspection will reveal the time has problems.

Donald Trump has now revealed when he thinks our golden age was -- during the Gilded Age.  William McKinley is his ideal President, mostly because he charged high protective tariffs.*  That makes sense from an economic royalist perspective, but Vance is no economic royalist.  Vance is a champion of the working class, and the Gilded Age was most definitely not a golden age for the industrial working class.

The Gilded Age was the time of The Jungle, of brutal work hours and frequent industrial accidents with no workers' compensation.  It was also a time of a chaotic business cycle, with alternating bouts of inflation and deflation, and of widespread, violent industrial strife, particularly during economic down turns, and the National Guard being called out to suppress strikes.  It should also be noted that at the time the industrial working class, far from being seen as the most quintessentially American of all Americans, were regarded as suspect -- immigrants whose first language was not English, associated with radical anarchists and socialists or, at best, corrupt political machines.  Identity politics were rampant at the time, with each ethnic group of immigrants sticking together in its own separate neighborhood, voting for its own candidates, and not trusting outsiders.

The Progressive Era brought in some workplace safety laws, limitations on hours, and Workers Compensation laws.  But it was the Great Depression, the New Deal, and mass diversion of manufacturing to military use during WWII that brought about national recognition of unions and the right to strike, the National Labor Relations Board, and good-paying manufacturing jobs.  In short, the golden age of good-paying manufacturing jobs was the 1950's.  

Many  people have pointed out that people in the 1950's were less wealthy in absolute terms than today.  One of the reasons people could afford to buy a house right out of high school was that houses were smaller then, even though families were larger.  Many appliances were bough separately instead of coming with the house.  A single car was the general rule, at least at the outset -- a two-car garage was a clear status marker.  But I don't think the MAGA working class crowd would find that concerning.  If absolute wealth has gone up, they may say, why can't we afford a larger house now on a blue collar wage.

But there were serpents in the garden even in the 1950's.  For one thing most men in the 1950's did not actually work in manufacturing.  The number runs to about 30-32% of the workforce.  Similarly, only about a third of the workforce belonged to a union even at their height.  Nor were women quite so uniformly full-time housewives as nostalgia would have it.  About a third worked outside the home, albeit at lower wages than men.  Though factory jobs paid well, they were not appealing in most other regards -- extremely regimented and prone to repetitive-stress injuries.  And then there was the matter of race.  Immigration was mostly restricted to northern and western Europe, so the ethnic strife of the past largely faded.  But there were plenty of Black people who were long-term residents of the United States and were largely excluded from the general prosperity -- not only in the segregated South, but in the North the good-paying jobs were generally White-only.  And let us not forget that the GI bill led to an ever-growing expansion in the college-educated population, turning college from the preserve of a small elite to something available to the broader public.  Presumably Vance and his cohorts would see this a a bad thing.

It should also be noted that the 1950's were the beginning of the liberal international order that Vance so despises.  The Cold War drove our foreign policy, and the US founded the NATO alliance, and well as other anti-Communist alliances.  We also worked to reduce trade barriers, believing that protectionism greatly contributed to the Great Depression and the rise of fascism.  Even much of our domestic policy -- encouraging unions and good blue collar jobs, and support for Civil Rights -- was driven by the Cold War and the perceived need to maintain our moral authority against the Communists.

And, just for what it is worth, popular culture of the day did not valorize manufacturing work the way so many people do today.  Leave it to Beaver, Ozzie and Harriet, and Father Knows Best all featured white collar families.  Art imitated life in I Love Lucy -- Ricky was a night club performer.  The Honeymooners was an exception, a show about a blue collar family, but a bus driver, not a factory worker.  Blue collar characters became more prevalent in the 1960's and 70's, but still one has Fred Flintstone (crane operator), Archie Bunker (retired dock worker and taxi driver) and a whole spate of movies with truck drivers for heroes.  The same may be said for the 1980's and 90's, featuring Dan Conner (drywall contractor) and Al Bundy (shoe salesman).  

Manufacturing jobs began taking on a certain political glamour when they started being automated away or going overseas.  But they never employed more than a minority of the workforce even at their height, and were never all that appealing, except in retrospect.

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*During Trump's first term his favorite President was Andrew Jackson.  Jackson is a controversial figure, seen by admirers as the first true People's President and the transition of the US from aristocratic republic to true democracy and associated by detractors with the Trail of Tears, the spoils system, and a depression caused by his veto of the national bank.  But no on  disputes that Jackson was a highly consequential figure.  McKinley is a strict mediocrity, noted mostly for being assassinated and making way for Teddy Roosevelt.

Trying to Understand JD Vance's Social Vision

 

I will not waste any brain cells trying to discern the method to Trump's tariff madness.  There is none.  By contrast, I do think that some of Trump's advisor's have a semi-coherent vision that they are trying to execute.

The one that interests me most is JD Vance because he appears to be the closest to the working class populist MAGA appeal.  JD Vance has come out strongly against the post-WWII international order, saying that it does not serve the working class well, and proposing that we put something else in its place.  What he appears to have in mind is a much more nationalist vision, with a focus on each country as a self-contained unit having as little as possible to do with the outside world.

Two things are notable about Vance's vision.  Once is that it is a departure from the Republican Party's old ideology of economic royalism.  Vance does not think that either the free market or capitalists are infallible, and he is willing to allow government intervention on behalf of the working class.  The other is that it is a conservative vision in the sense of favoring depth over breadth in social commitment.  In fact, he appears to believe that the working class is best served by strong social cohesion, and that he sees breadth as a threat to depth and therefore to be excluded.

But how far does this go?

Hershel Walker often sounded like a sort of caricature of this viewpoint -- proposing a sort of hermetic seal around the United States that would stop China from breathing our clean air and keep China's pollution out of the US.  Vance, I have no doubt, is more sophisticated than that.  But his vision sounds like a milder version of the same.  But a lot is unclear.

One thing that is clear is that his vision is one of zero immigration. No family migration, no refugees admitted, no asylum claims.  Afghans who put their lives on the line assisting the US who face torture and execution by the Taliban will just have to find somewhere else to go.  And, so far as I can tell, no naturalization law, no permanent legal residents, no green cards, no work visa, no student visas, no admission of anyone except (presumably) foreign diplomats and tourists.  All  non-citizens should be expelled.  Any work that citizens are unwilling to do can be automated.  

He extends this view to Europe, urging Europeans to refuse admission to any non-Europeans and to expel "the enemy within."  Certainly Elon Musk has maintained the importance of each country keeping its own distinctive character.  Vance appears to agree.

This raises a number of questions.  Nationalists love to mock the liberal vision of all different ethnic groups living side by side in harmony and equality as impractical.  But the nationalist vision of neat lines across the map with only one ethnic group one each side of the line and no moving across is not all that practical either.  In any event, it is out of the question in the US.  At  most, we can halt all future immigration and push heavy measures for assimilation.  How far does Vance (or Musk) propose to take this in Europe?  Clearly he/they want to halt and reverse all non-European immigration.  Are there prepared to tolerate immigration within Europe, or should European countries harden their borders against each other as well?  Both men are notably hostile to the European Union, but is that just because it is friendly toward non-European immigration and other forms of "wokeness," or do they consider maintaining sharp border within Europe to be important?  And have they thought it through at all?

I don't think Vance's vision goes so far as to say no trade.  Even Trump has not formally committed to a policy of autarchy, although he appears to think we should never have a trade deficit with any country anywhere.  I assume Vance is more sophisticated than that.  But he clearly wants much less international trade.  In particular, he emphasizes the importance of everyone having their own manufacturing with good paying jobs.  Again, Vance is thinking mostly about the US which is, after all, a very large country.  One wonders if he would approve of much smaller European countries having more internal trade that would at least allow each country to specialize in a different kind of manufacturing, rather than require each country to go it alone.  (Maybe even some kind of common market).

But clearly he wants a lot of heavy industry and manufacturing with good-paying jobs in the US.  One gathers he is open to manufacturing jobs being union jobs and offering good health insurance and defined benefit pensions.  All this is a clear break with traditional economic royalism.  (More on that later).

This economic vision is closely tied to a social vision, mostly of increased social cohesion.  Central to this vision is that raising male wages will raise the marriage rate.  It assumes that women will be more inclined to marry and less inclined to divorce if men have good paying jobs -- especially if women don't have good paying jobs.  It is also hard not to see this as a way of discouraging college attendance, since it seems clear that the MAGA crowd sees college as something that makes people more liberal and therefore an evil to be prevented. It assumes that men will be less inclined to go to college if they can get a good paying manufacturing job with benefits right out of high school.  (How to keep women out of college is less clear.  The offer of jobs in the garment industry is unlikely to be much of an inducement).

And, in fairness to Vance, one can see other advantages in social cohesion here.  A manufacturing job that offers employment for men's full work life can promote social cohesion in many ways.  It offers enduring friendships with coworkers that may encourage association outside of work, either doing things together as individuals or in an organized fashion.  This is especially true if coworkers also belong to a union together.  And offering a long-term job encourages the workforce to stay in the same place and build strong neighborhoods, and stronger commitments to a long-term church, school, etc.

There is an obvious flaw in Vance's criticism of the liberal post-war international order in favor of a more cohesive, more nationalistic view of each country as a self-contained unit, preserving its unique character, admitting no immigrants, and building its own industrial base.  Such a system can flourish only if it follows another key precept of the liberal international order -- no redrawing of borders.  If countries make a habit of invading each other and annexing each others' territory, it is hard to see how each country can maintain its unique, stable, cohesive character.  People in border areas will either see their nationality change quite regularly, or else will be regularly ethnically cleansed to make way for some other ethnically cohesive, but geographically larger, country.  Either way, it is hard to see how the interests of either social cohesion or the working class would be served by countries invading each other and annexing territory.

I suppose Vance might say he agrees that countries should not invade their neighbors or annex territory.  But if that is the case, why is he so dead set against assisting Ukraine when it is being invaded by Russia, and why does he appear to support the US invading Greenland?  Here I suppose he might say that he likes the no invading part and is just opposed to alliances, which undermine a country's sovereignty by forcing it to other countries' interests into account.  

Or he might say that he likes the no-invading rule but doesn't see it as our place to enforce it.*  By this standard, the no-invading rule would stand, but each country would be on its own if actually invaded.  The result of that would be predictable.  Each country would have little choice but to build up its military to defend against invasion.  That would tend to promote domestic manufacturing, but at some cost to the standard of living.

Or, he might be honest and say that he favors invasions, but only by countries like Russia that uphold illiberal values.

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*Or he might say that if I am so committed to countries not invading each other, what about the US invading Iraq and didn't that violate that rule.  And I agree, our invasion of Iraq did violate the no-invading rule.  I opposed it for that very reason.  

Hope, Fear, and Paranoia

It is very egocentric to look at the Ukrainian crisis solely from its effects on me when vast humanitarian and geopolitical issues are at stake. But I am not qualified to comment on those issues and have nothing really to contribute, so let me go with one powerless person's perspective.

Hope and fear are strangely linked.  For days I have been following the Ukrainian crisis, wavering between hope that war can be averted and fear that it has begun. But by now it is obvious based on many factors -- extension of military exercises that were supposed to end today, reports that the final order had been given, Russian forces moving into attack position, Russian propaganda treating war as inevitable, and Putin's arrogant dismissal of all attempts at diplomacy -- that war is at hand.

And for a time seeing war as inevitable made it seem just a little less terrifying.  Fatalism is a common way to overcome fear -- it means saying that what will happen will happen, so there is no point fearing it.  Fatalism also necessarily  means giving up hope.  Apparently I have not become completely fatalistic about the war, because I still keep fearfully peeking at News Today to see if it has happened yet.

Mostly I have found a coping mechanism.  It is based on the fact that Ukraine is nine hours ahead of where I am, and perhaps being overly influenced by the phrase "Attack at dawn."  So I tend to assume that any ground attack will take place in the early hours of the morning.  (Admittedly bombing and shelling can take place at night).  I get up at 7:00 a.m. and check News Today to see if war has begun.  Since Ukraine is nine hours ahead of us, that is 4:00 p.m. Ukrainian time and the maximum peril for the day has probably passed.  When it is 3:00 p.m. our time, it is midnight in Ukraine and another day has passed without war.  About 9:00 p.m. through 11:00 p.m. my time is 6:00 a.m. through 8:00 a.m. Ukraine time -- the time of maximum peril.  It is also 11:00 p.m. through 1:00 a.m. Eastern time.  Most media outlets have closed for the night, so they probably will not report a war till the next morning.  Besides, if I keep doomscrolling I will never sleep and what good is that?

Another point.  It was a very important insight at the beginning of my career reading an account by a psychiatrist who explained that the difference between paranoia in the colloquial sense and true clinical paranoia is one of degree, not of kind.  Anyone being bombarded with more data than they can process becomes suspicious.  People with hearing loss tend toward low-level suspicion because when they see people talking but can't hear the conversation, they wonder if people are talking about them, or if the see people laughing and can't understand the conversation, they wonder if they are being laughed at.  Much the same happens to people with normal hearing around people speaking an unfamiliar language.  Paranoia, he said, is simply a defect in people's data processing.

It explains a lot.  Particularly, it explains the rise in paranoia with the internet.  The internet means the people are being constantly bombarded with more data then they can process and become suspicious as a result.  Certainly one thing I have learned is that if you value your peace of mind, do not follow a twitter thread too far.  Otherwise you will be bombarded, not only with anger and invective, but with a great cacophony of conflicting opinions, all linked to seemingly credible sources that I am completely unqualified to evaluate.

And, indeed, the more I follow developments from Ukraine, the more anxious and paranoid I become.  The best remedy seems to be to keep my mind occupied with something -- anything -- else.  

Some advice from the novel version The Godfather on coping mechanisms for Mafia wives.  Invariably the women are kept in the dark about what is going on and only learn that there is trouble when their men are killed. Sonny Corleone has gone to rescue his sister from her abusive husband and is killed along the way.  Mama Corleone (we never learn her first name) is preparing for their arrival when her adoptive son gets the call that Sonny is dead.  He does not tell her and

[T]he old woman had not noticed anything amiss. Not that she could not have if she wanted to, but in her life with the Don she had learned it was far wiser not to perceive.  That if it was necessary to know something painful it would be told soon enough.  And if it was a pin that could be spared her, she could do without.

After long hours of doom scrolling, I am starting to think that is wise advice.

Economic WWIII

So, let me focus on Ukraine.  The question by now is not whether there will be a war or even when.  The war has already started, with border clashes, ceasefire violations in the Donbass and the like.  I suppose there might be room to argue about the scale of the war, but I think the Russian buildup on Ukraine's borders answers that one.  The only remaining question is how long the Russians mean to stay, and in how much territory.  I don't think we can have any idea about that.

As I have said before, the good news is that the Russian invasion will not lead to WWIII.  We have ruled out military intervention.  But it will lead to economic WWIII. We may be in a position to hurt Russia, but Russia is in a position to hurt us as well. We all know that gas prices will skyrocket.  Europe receives as much as 40% of its oil from Russia.  There has never been an oil shock on that scale. Furthermore, increase oil prices have a ripple effect into all areas of the economy.  So much for inflation calming down any time soon.

Nor is it just oil.  Read this thread. It is terrifying.  

Our computer chip industry, already stretched past its limit, imports 90% of its Neon from Ukraine and 35% of its palladium from Russia.  Hypothetically, this could halt chip production altogether.  Chip manufacturers say they will get by.  I lack the knowledge to say whether this means they have alternatives, or whether it is just industry happy talk.  The article does have one reassuring comment.  Neon prices increased by 600% during the last Ukraine crisis.  The chip industry carried on.

Russia also has 25% of the world's titanium.  Military planes (for obvious reasons) do not use Russian titanium, but that just steers more commercial aircraft toward it.

Russia produces 2/3 of the world's ammonium nitrate fertilizer and stopped exporting on February 2.  This can only drive rising food prices even higher.

There will almost certainly be cyber attacks as well.  Remember that ransomware attack on Colonial Pipeline?  Not to mention support for Iran in unpredictable ways.  The author concludes:

We could potentially find workarounds against most of these economic responses from Russia but, at a minimum, we should expect further spikes in inflation and pressures on supply chains across numerous critical industries

END

Let us also recall that that sanctions have generally been notable ineffective at toppling hostile governments or even getting them to change their ways.

Still, I suppose there is one bright spot if you want to call it that.  It avoids what I call the rolled-up newspaper problem (or maybe the "if you don't drop dead we'll kill you" problem) that Daniel Drezner writes extensively about.  Namely, how to you remove sanctions?  After all, if you impose sanctions to pressure a hostile country into changing its behavior, you have to be able to remove the sanctions if the behavior changes -- even if the country remains generally hostile otherwise.  

In a country with that much power to retaliate, I do not imagine that will be a problem.

Some Very Unoriginal Comments on the Fed and Conservatives

I don't have anything very original to add on the subject of the Fed, but let me echo others.

Throughout the Obama Presidency, right wingers, Trump included, denounced Federal Reserve for its monetary expansion, which they claimed was solely intended to boost Obama's fortunes, and urged tightening.  Despite a depressed economy, they were certain that the Fed must tighten immediately or there would be out of control inflation.  They held up as their role model Paul Volcker, who tightened in 1981 to break an inflationary spiral (as high as 14%).  The applauded him for inducing a severe recession, bankrupting farmers, and sparking an economic crisis in Latin America.  That was the kind of Federal Reserve we needed!  Or else they applauded the 1920 Fed that slammed on the brakes when prices began to rise after price controls were lifted and induced a steeper decline and worse deflation (though shorter lived) than in any single year 1929-1932.  Why wouldn't the Fed today do that?  They seemed to take an outright prurient delight in the pain the Fed was inflicting and asked why the Fed was too chicken to do it now.

During his campaign for President, Trump argued that if the stock market was rising, it was a bubble, and that we were experiencing a false prosperity, buoyed up by artificially low interest rates and headed for disaster.  His campaign was characterized by near-apocalyptic warnings about the disaster that lay ahead when the whole house of cards came crashing down.

Of course, the minute Trump was elected, things changed altogether.  You know that bubble in the stock market?  It immediately filled in and all future gains became real.  And the false prosperity from artificially low interest rates?  When as soon as he was elected it became real.  He was even cynical enough to comment that he considered official unemployment figures fake so long as Obama was President and real for him.

And I was notably cynical about what to expect from Republicans on the subject of interest rates and tight money:

Once Trump is inaugurated, Republicans will regard tight money as a universal and timeless imperative that must be continued in good times and bad, in all economic circumstances. To propose any deviation from this moral imperative would show a lack of principle. No amount of human suffering can ever justify deviation from this universal and timeless imperative and, indeed, the more pain the Fed inflicts with tight money the better, since it will mean a richer reward down the road. So money must always be kept tight, without exceptions -- unless a Republican is in the White House and tightening might hurt his political fortunes, in which case we must be reasonable.

And sure enough, the economy is showing possible signs of softening, the stock market has fallen, and Republicans in general and Trump in particular are calling on the Fed to lower rates.  And an excellent case can be made that they are right.  It's just hard to have any interpretation but a cynical one in light of what they have said in the past.

Trump, I should add, is understandable.  He has no concept of the public good aside from his personal fortunes anyhow.  And looking at developments in the Russia investigation, he must be wondering if he will be indicted as soon as he leaves the White House.  So re-election has gained an imperative for him that it lacks for other incumbents.  (And what about when his second term expires?  I doubt very much that he thinks that far ahead).

But what excuse do the others have?

Trump in a Not-Even-a-Crisis

One of the biggest reasons I dreaded having Donald Trump as President (and one that liberals and conservatives should dread equally) was the thought of him in a crisis.  It was obvious that the best way to deal with Trump in a crisis would be to handcuff him, stuff something in his mouth, and lock him in the closet until it blew over.

And just to be clear, the latest stock market slide is NOT a crisis.  September 2008 was a crisis -- Fannie and Freddie nationalized, Lehman Brothers failing, Merrill Lynch surviving only by merger, AIG being nationalized, Morgan Stanley and Goldman Sachs becoming bank holding companies to survive, and Washington Mutual Bank failing all in one month -- now that was a crisis!  And naturally the stock tanked, but falling stocks were a symptom, rather than a cause, of the crisis.

What we are seeing now is nothing like that.  It is, at worst, some softening of the economy, a reminder that the business cycle is still with us.  And, if we are lucky, it might just turn  out to be a needless panic.  A normal President would either keep quiet or  give some vague platitude that so long as all is well on Main Street, Wall Street will calm down.

And yes, I will admit it is unsettling to watch the stock market fall by triple digits day after day after day.  To see the stock market fall by 500 points in one day is familiar enough.  But it is usually followed by 200-300 point rebound the next day.  Even a general slide usually has interruptions.  So to see it fall by triple digits day after day with no relief is genuinely disturbing.

But there is nothing in the overall economy, nothing at all, to justify such a drop.  If our Tweeter-in-Chief would just SHUT UP, I'm sure the market would settle down and figure out that its freakout was unnecessary. 

A crisis is, to a considerable extent, a choice.  Presidents can decide, to a considerably extent, whether to respond to a development, like missiles in Cuba, or not.  Some leaders create foreign crises on purpose to boost their sagging domestic popularity.  But creating an economic crisis is generally not recommended.

And, just for the record, I don't think you can tweet your way into a crisis.  If all is well on Main Street, then I really do expect Wall Street to figure it out sooner or later and calm down.  I expect the slide to stop soon and a recovery to begin.  It will probably take some time to get back to the old high.  Stocks were becoming irrationally exuberant and needed some sobering up.  We may slip into a recession, but there is no reason to believe it will be a bad one.  So I fully expect the slide to stop soon, despite Trump's best efforts.  But it would have stopped a lot sooner without them.

UPDATE:  And right on cue, our President and Secretary of the Treasury shut up for one day and, sure enough, the stock market promptly recovers.

Americans are Unduly Afraid of Stock Market Crashes

At least we got a tax cut

Americans have an inordinate fear of stock market crashes, sort of like Germans' inordinate fear of inflation, and for much the same reason.  Just as the great inflation is a powerful German folk-memory, the 1929 crash leading to the Great Depression is a folk-memory with us.
The Germans need to get over it and so do we.  German inflation aversion played a major part in Europe's persistent economic crisis, as Germans refused to accept a little more inflation, instead pulling everyone else down.  As for our fear of stock market crashes -- well, Trump and Mnuchin are exhibits 1 and 2.

The stock market crash of 1929 was a financial crisis.  All financial crises are the same underneath -- the are the result of excessive leverage, i.e., debt-to-equity ratio.  As prices of collateral become inflated, debt builds up that seems well secured until collateral prices fall back to reasonable rates.  Then suddenly a lot of debt that seemed well secured turns out not to be at all.  Lenders are stuck with a lot of bad debt. Borrowers are stuck with a lot of unpayable debt.  And investors find that their investments are suddenly worth only a fraction of their former value -- with disastrous results for their budgets.  The stock market crash of 1929 was such a financial crisis.  The economy was heading for recession even without the financial crisis, but financial crises make recessions worse, and greatly slow recovery.

But guess what.  We responded to the 1929 stock market crash by instituting the Securities Exchange Commission (SEC), barring commercial banks from issuing securities, insuring deposits, and other measures to prevent a repeat.  And it worked.  Since then we have had recessions and stock market crashes, but never again have we allowed a stock market crash to bring down the economy in the way that it did in 1929.

Our worst single day loss on the stock market in percentage terms (the best measure) was not in 1929 at all, but in 1987. On that day stocks fell by 22.6% -- nearly as much as the combined losses of the worst two days in 1929.  For anyone who has never heard of the 1987 crash, that's OK.  The various buffers put in place since 1929 worked.  The Fed lowered interest rates and the economy never so much as missed a beat.  (The stock market, seeing the real economy chugging along without it, got up, brushed the dust off, and resumed rising).

In 2008 we experienced our worst financial crisis since 1929 and, unsurprisingly, stocks dropped and the economy fell into its worst downturn since the 1930's.  But falling stocks were merely a symptom, not a cause, of the downturn.  The overpriced collateral that led to the crisis was real estate.  And, it should be noted, we instituted reforms following that crash to prevent banks from overextending themselves that appear to be working.

The one time since 1929 that a falling stock market really did damage the real economy was in 2000.  As the neighboring graph shows, the 2000 stock bubble (expressed in terms of price-to-earnings ratio) was immense -- great enough to dwarf the 1929 bubble.  Yet the downturn was mild (if persistent).

So really, folks, our economy has learned to weather stock market crashes.  To the extent that they are a symptom of underlying problems in the real economy, stock market crashes can be worrisome.  But we have insulated ourselves from stock market crashes to the extent that the worst one-day drop ever had no effect at all on the real economy and even a bubble as massive as the one that burst in 2000 caused only modest damage. 

So please, guys, a little worry is reasonable.  A total freakout is completely uncalled for.

A Sign that Twitter is Eating My Brain

Me, when Steve Mnuchin was appointed Secretary of the Treasurer.  "Oh, good.  He worked Goldman Sachs.  He understands how  money works.  (Unlike Goldman Sachs alum Steve Bannon) He won't blow up the world financial system just for thrills and giggles."

Me, when Steve Mnuchin's scandals started coming out.  "OK, so he's a repulsively corrupt cartoon plutocrat.  But at least he won't blow up the world financial system just for thrills and giggles."

Me today.  "Actually, Steve Mnuchin just might blow up the world financial system by pure incompetence."

The Future of The Trump Economy

Let us say this much for Trump.  The economy has prospered under his watch.  I am not convinced it has prospered because of tax cuts or gutting regulations, but simply because an extended recovery has been gathering steam.  So the obvious question is, how long will it continue.  Any time before, the sort of conditions we are seeing today would be a sign that we are nearing the peak of the business cycle and that recession cannot be far away.  Is that still the case?

I will begin by digressing and pointing out that there has not been any significant change in the condition of the economy since the 2016 election.  The general trajectory was one of improvement before the election and it has continued since the election.  The stock market has grown faster since the election, no doubt in part as a result of enthusiasm over lower taxes and less regulation, but the stock market is not the real economy and is subject to "irrational exuberance." 

Pre-election, Trump presented this as a false prosperity headed for certain disaster.  If the stock market was surging, it was because of a bubble which was about to burst.  If the economy seemed prosperous, it was a sham prosperity buoyed up by low interest rates and bound to end when rates were inevitably raised.  And if unemployment was only 4.2%, it was because labor statistics undercounted unemployment, excluding discouraged workers and involuntary part-time workers.  The real number was closer to 10% or 15%.  Trump even said 42%, although this was generally agreed to be just crazy.  Certainly my boss -- a Republican, although Trump was his last choice on the Republican side -- was caught up in the sense of gloom and doom and said (when defeat for the Republicans seemed certain) that it was for the best because then when inevitable disaster struck, everyone would understand the Democrats were to blame.

And then a funny thing happened when Trump won the election.  All those statements about impending disaster -- well, apparently all it took was an election to dispel them.  Overnight the bubble in the stock market filled in and all growth became solid.  After just one day, false prosperity became real.  And all those fake statistics about unemployment became genuine next time they came out.  Apparently unemployment fell from 42% the  month before Trump was elected to 4.2% the month after, a 90% drop in record time!

In all seriousness, what is one to make of all this?  Well, for one thing, the economy continues to add jobs at an incredible clip, with no significant decline in the headline unemployment rate (I think it fell from 4.2% to 4.1%), without significant wage increases, and with no sign of inflationary pressure.  All this is a sign that there really was considerable slack in the economy, that unemployment was much higher than the headline figure because of the large number of discouraged workers.  The discouraged workers are coming back, so there is still significant room for growth by eliminating slack.  Other signs of economic slack have been large business cash reserves going uninvested and persistently low long term interest rates.

How much slack?  Time alone will tell.  But eventually we will run out of slack in the economy and then what?  Time was when it meant we had reached the peak of the business cycle and there would be a recession.  Is that still the case?  At least some theories suggest no.

To understand why, the first thing to understand is that there are at least two types of recession.  One occurs when central banks tighten monetary policy to stop inflation and a recession results.  Since the recession is induced, recovery is rapid when central banks relax monetary policy.  During the Great Moderation from the 1980's to the latest financial crisis, this sort of recession appeared to end, possibly because central banks had figured out how to fight inflation without causing recessions.

But this did not mean that recessions ceased, merely that they became less frequent.  A second kind of recession continued to occur, the kind that follows a bubble bursting and an overhang of bad debts.  Recovery from this type of recession is slower than than from a recession induced to fight inflation.  So, less frequent recessions and longer expansions were paid for by slower recoveries.  But the first two recessions under the Great Moderation (circa 1991 and 2001) were mild ones.  Then with the 2008 financial crisis a really bad recession occurred, followed by a slow and painful recovery.

So the real question is whether the economic crisis produced some sort of change in the economy that means the business cycle has finally ceased.  There are some theories that suggest it is so, although they differ as to why. 

One suggestion is that a really bad financial crisis has finally scared sense into the banking industry and will keep it from ever creating a bubble again.  Pardon me if I am skeptical.  In the 19th century, serious financial crises happened every 20 years or so, and banks never learned a thing.  And, indeed, banks seem eager to engage in reckless behavior any time they get the change.

The other theory is that stringent financial regulations will prevent any more bubbles from forming.  If that is the case, Trump and the Republicans (with significant assist from Democrats) are working on it.  Nonetheless, I will concede that we aren't seeing signs of a bubble at least so far.  So maybe our economy really will reach capacity and just stay there for years and years until the next bubble strikes.

But I am inclined to believe that business cycles are still with us, and that once our economy reaches capacity, a recession will follow as it always has before.

I just have no idea when that will be.

Now What?

At least we got a tax cut

OK, so apparently the Senate tax bill will have to be worked out in conference with the House bill instead of simply passed unchanged by the House.  The Senate Republicans apparently made a little mistake on corporate taxes. 

When Trump calls the U.S. the highest taxed nation in the world, he is clearly wrong, but he does have one point.  Our corporate tax rate of 35% really is high.  Of course, corporations take advantage of enough deductions that the actual rate they pay is less than that.  In order to prevent corporations from getting out of taxes altogether, our current tax code has a corporate Alternative Minimum Tax (AMT) of 20%, so that if a corporation has enough deductions to pay less than a 20% tax, it pays 20% instead.  A major part of the tax bill was to lower the corporate tax rate to 20%.  The plan was also to eliminate the corporate AMT as well.  However, arcane Senate rules that I still don't understand limit how much revenue the Senate bill can cost and still pass by a simple majority.  In order to slip in under the ceiling, the Senate put the AMT back in the bill.  In their haste, however, they forgot to lower the rate below 20%, so that they accidentally enacted a 20% corporate flat tax.  Oops!

So now the conference committee is trying to come up with something that can pass the House, where the Freedom Caucus is a firm believer in letting the perfect be the enemy of the good (or bad, as your opinion may be), and the Senate where arcane rules limit what can by passed with a simple majority and three defections can sink the bill. 

I am of mixed feelings about the outcome.

On the one hand, there is no doubt to my mind that if this monstrosity passes it can cause serious and untold harm.

On the other hand, the only way in the end that we are going to harm Republicans' political fortunes is to allow them to harm their followers.  If only we could prevent collateral damage.

But in the end, the question is what long-lasting legacy this bill will have.  It looks to me very much like an attempt to starve the beast, i.e., to cause enough damage to the government's finances to ensure that when Democrats are next in power they won't be able to achieve anything. 

Attempts to strip 20 to 30 million people of their health insurance with the repeal of Obamacare will certainly be unpopular and will lead to major Republican electoral losses.  But stripping 20 to 30  million people of their health insurance will also create a big enough mess to have at least three big advantages for Republicans:

1. Wrecking things is much easier than building them.  Because stripping 20 to 30 million people of their health insurance is easier than creating a system to insure them, Republicans can be confident that they will have raised the number of uninsured for a very long time.
2. Democrats' inability to clean up the mess fast enough will be great fodder for a campaign against them and will return Republicans to power.
3. Democrats are now on warning.  If by some miracle they actually do succeed in building a new system for insuring millions, Republicans will just blow it up as soon as they are back in power.  That should act as a significant deterrent.

And that was just Obamacare.  This starve-the-beast tax cut looks like an attempt to do the same hting on a much larger scale.  Which is more than enough to convince me to oppose it.

Give Plutocracy a Chance

So, the big question is obviously going to be, how successful a President will Donald Trump be.  And how well will his brand of populism sell.  Paul Krugman has offered one possible reason why it might not.  He cites an article on Poland where right wing populists under the Law and Justice Party have been in power for one year.  Its strongest hallmark is extreme social conservatism.  The Law and Justice Party has proposed textbooks that downplay evolution and global warming and push an anti-contraceptive view of sex education.  They have also banned abortion, defunded in vitro fertilization and challenged an international convention to ban violence against women as a threat to traditional gender roles.*  It is showing signs of clamping down on dissent.  But it has also lowered the retirement age and given cash bonuses to families with children - the more the better.  The National Front in France wants to raise the minimum wage and lower the retirement age.  Indeed, it has been described as an amalgam of two parties -- one right-wing and one left-wing.

The US is different in a number of ways.  For one, many European countries have a large state-run media presence, which is easily manipulated by new appointments.  In the US, media are independent.  Granted, a large portion of the population simply disbelieve anything reported in any mainstream source, but the mainstream remains and will be a lot harder to subdue.

Another difference is the uniquely binary nature of U.S. politics.  Poland's Law and Justice Party rides high with the support of 36% of the population, more than twice the leading contender.  France's Marine LePen will be running against two rival parties.  Italy's Silvio Berlusconi held power so long because his opposition fragmented.  In US politics, by contrast, even an insurgent candidate has to choose between one of the two established parties.  Trump's brand of xenophobia did not sell among Democrats.  So he chose Republicans.  Republicans are the longstanding plutocratic party.  They believe that if they haven't been able to win full power up till now, it is because they haven't been plutocratic enough.  There is every reason to believe that Trump fully agrees and intends to be just as much of a plutocrat as Republicans in general.  Or rather, his proposals are more like plutocracy-plus- protectionism.

And, in all fairness, I think the American people are at least somewhat aware of this and have voted to give plutocracy a chance.  Our economy as a whole has made a slow but decent recovery from the 2008 crash and is nearing full employment.  But the benefits have accrued overwhelmingly to the top and wages lag far behind where they once were.  Working class Americans have their jobs back, but at lower pay than before.  The Republican argument (not counting Trump) is that the reason the economy took so long to recover and that wages are stagnant is that our job creators are being strangled to death by high taxes and stifling regulations, and that if we would just cut taxes at the top and gut regulations, it would turbocharge the economy and wages would soar.  Certainly that is the account I get from Trump voters that I hear from.  They would no doubt prefer Generic Republican to Trump, but so long as he cuts taxes and guts regulations all will be well.  Trump takes the same basic story and adds unfair competition from immigrants and imports.

There are some things to criticized here.  As mentioned before, the much-beleaguered one percent have nonetheless somehow managed to capture most of the benefits of the recovery.  To say that really, they will share the benefits if you will just give them unfettered power to dictate policy sounds self-serving to say the least.  But I think it fair to say that most Americans, having seen all this talk of recovery while their paychecks stagnate, have decided to give the 1% at least the chance to set policy and see if they do, indeed shower benefits on the rest of us.  After all, what is there to lose?

_________________________________________________
*Could this also be part of the reason right-wing populism has not taken hold in Ireland.  Ireland had deeply pro-religious, sexually conservative policies for a long time, only to find that they had been used to cover widespread sexual abuse and exploitation.   

Generic Republicans in Power: Financial Regulation

I am optimistic that Republican plans to strip 20 million people of their health insurance and undermine the foundations for countless others will be so unpopular as to fail or, if passed, impose immense political costs on the Republicans.

The rest of their agenda is a different matter.  Republicans will pass a major tax cut with most of the benefits accruing to the top.  That is what they always do when they come into power.  This time will not be any exception.  There is no major public clamor for such a policy, but neither is there sufficient opposition that it will cost them anything.  Most people just don't care.

The same goes for most other regulations Republicans want to gut.  They have generally taken a root-and-branch view towards extirpating anything the Obama Administration has done.  The Obama Administration had two main legislative accomplishments -- Obamacare and the Dodd-Frank financial regulation.  One of the top Republican priorities is to overturn this measure.  And as for Donald Trump himself, there is every reason to believe that he fully shares the generic Republican desire to cut taxes and gut regulations and will eagerly sign anything that Congress passes.  Indeed, he has expressly said so.

What does that mean?  Well, we don't know exactly what form it will take.  Republicans have not come out with a proposal yet.  So, the most useful guidance comes from what they have proposed in the past.  Past proposals to repeal financial regulation differ from past proposals to repeal Obamacare in an important way.  Past proposals to repeal Obamacare could simply repeal and leave replace for later, since they were purely theoretical.  Once Republicans have to face the reality of an actual repeal of Obamacare succeeding, they will be confronted with the specter of 20 million people losing their health insurance.  That will put serious pressure on them to come up with a reasonable alternative.

Financial regulation, by contrast, will cause no immediate and obvious problems if it is repealed.  The most visible change would probably be an increase in credit.  Of course, as the last financial crisis showed, increasing credit is a mixed blessing at best, with the potential to set up the system for a future crisis.  But any such crisis would take place well into the future.  For now, Republicans would pay little prices for a repeal.

So how do they propose to go about it?  The simplest proposal is a one line bill repealing the Dodd Frank Act and replacing it with nothing.  Since there would not be millions of people immediately impacted, why not?  Well, for one thing, banks have adjusted to some degree to the new system and may not want the shock of really radical changes in the regulatory regime, just a general loosening of existing restrictions.

A more serious alternative was proposed last June.  Its proposals appear to be:

1. Eliminate the Volcker Rule, which forbids banks from using their own money in speculative trades with no benefit to clients;
2. Weaken the Consumer Financial Protection Bureau;
3. Prevent regulators from designating certain banks as "too big to fail" and imposing stricter regulations on them;
4.  Allow banks to avoid new regulatory burdens by having higher capital ratios (at least 10%); and,
5. Limiting the Fed's authority to lend to troubled but salvageable banks.

The last two measures are the most significant.  Substituting higher capital ratios for tighter regulations could be defensible.  It says, in effect, that banks can invest and run risks as they please, but they must have high equity cushions and be limited in their borrowing.  This had the advantage of not forcing anyone to rely on either banks' or regulators' wisdom.  Instead, it assumes that if banks are kept from over-extending themselves, the harm they can cause will be limited no matter what mistakes they make.  Certainly, in the end all attempts to shore up the financial system are attempts to keep banks from over-extending.  So depending on terrain and circumstances, this might work.

Limiting the Fed's authority to lend to troubled banks is, in effect, forbidding it from saving the economy.  Former Fed Chair Ben Bernanke compared this to shutting down the fire department to encourage fire safety.  Well, pardon my cynicism, but my guess is that Republicans were mostly outraged by the Fed acting to save the economy because it resounded to the benefit of a Democratic President.  With a Republican in the White House, I am sure they will be much more open to letting the Fed prevent and all-out conflagration. And besides, banks won't like it.  I would not expect to see this provision in any financial legislation passed by the Republicans.

And, indeed, the Republicans' current proposal, to the extent it exists, is to weaken the Consumer Financial Protection Bureau by replacing a single director with a panel of five and putting Congress in charge of its budget (no doubt as a prelude to massive funding cuts), weakening the Financial Stability Oversight Council's ability to impose more stringent rules on "too big to fail" institutions, and subjecting future regulations to approval by Congress.  At least lip service is paid to raising capital requirements as regulations are lifted.  Preventing the Fed from lending is apparently not mentioned.  

Although the basic idea of imposing tough regulations on banks to prevent them from blowing up the economy again is popular, the whole subject is too esoteric for most people to follow, and no immediately catastrophic consequences will follow a large-scale relaxation of financial regulations. For those reasons, I expect Republicans to be successful here.

How it will play out in the longer run will depend on whether Republicans are serious about imposing tougher capital requirement in exchange for looser regulations.  If they actually live up to that, it could work out reasonably well.  If (as seems more likely) they go soft on capital requirements, it could lead to trouble down the line.  Not immediately.  In fact, our banks are currently much stronger  than they were in 2008.  The latest stress test indicates that they could survive a severe global recession with a 5-point increase in unemployment without requiring a bailout.  Still, I could see an influx of foreign capital, or perhaps Trump's proposal to cut taxes on returning profits and resulting mass repatriations, combined with lax financial regulations, as causing a bubble down the road.

But not during a first Trump term.  And (one trusts) not on the scale of the 2008 crisis.

Generic Republicans and the Economy: The Limits

So, let us suppose that Republicans really do manage to revive the economy by financing operations by printing money.  Isn't that supposed to be one of those things that can't keep on forever?  Isn't it supposed to cause out-of-control inflation?  Well, yes and no.  Certainly, it has done just that many times in the past.  On the other hand, funny things start happening when the economy is at the zero lower bound (the place at which cutting short-term interest rates to zero cannot raise the economy to capacity).  Japan, at the zero lower bound, has been financing operations by printing money for two decades now, and hasn't even been able to escape deflation.  Still, that appears to be largely because the leadership has kept losing its nerve and refusing to keep deficits large enough for long enough. The Republican Party inspires no such fears.  So, assuming it keeps financing operations by printing money long enough to get the slack out of the economy and raise inflation to around 4-5%, that approach will not be able to continue forever.  I can see several ways it can come to an end.

Premature tightening.  The Fed might lose its nerve and tighten too soon, sending the economy into recession and we may find ourselves once again at the zero lower bound, with the Fed having great difficulty reviving the economy.  Fortunately, the Republicans will be ready to offer plenty of fiscal support.  Don't lose your nerve next time, guys!

Well-timed tightening.  The Fed may get it just right.  It may wait until inflation starts getting over 5%, then tighten.  This will induce a recession,but as soon as inflation falls, the Fed can ease up and the economy will rebound.  In this case, recession will take longer to materialize and recovery will be easier.  If the Fed is feeling hackish, it may manage to time recovery to coincide with election season and offer maximum benefit to Republican.  Still, they will deserve it for a well-executed maneuver. On the other hand, this scenario calls for a level of technocratic skill that Republicans not only generally lack, but are ideologically opposed to, so I am inclined to consider it unlikely.

A soaring dollar and an asset bubble.  US interest rise while everyone else's remain flat.  Foreign investors flock to the US.  The dollar soars.  This will no doubt be a source of nationalistic pride, but it will also flood the country with cheap imports and price out our exports -- exactly the opposite of what Trump was campaigning to do.  This will probably not upset too many people so long as the US economy appears to be soaring.  On the plus side, the US could help pull the world economy out of its rut.  On the minus side, the world economy could drag the US down.  But the really serious problem is that combining a vast influx of foreign capital with a relaxation of financial regulation (more on that later) is made to order for another bubble and bust.  Then again, this scenario could be avoided if right wing populists in other countries see the US economy surging from reckless spending and monetary expansion and do the same.

Too much inflation.  We all know what normally happens with countries finance deficits by printing money -- inflation.  Japan has avoided that fate because it is at the zero lower bound. We are beginning to move away from it, at least, the Fed has raised short-term rates above zero without tanking the economy.  Once we move away from the zero lower bound, our ability to finance deficits by printing money will start to generate inflation.  To an extent (Krugman estimates until inflation reaches 4-5%) this will be a healthy development.  But what after that?  What if the Republicans find a Fed sufficiently hackish to keep expanding in order to expand Republican fortunes?  Inflation will continue to escalate.  There is another term for continuing such a policy -- macroeconomic populism.  It has long been practices by left-wing populists in Latin American countries, and has invariably led to hyperinflation.  Rates have hit triple, quadruple, and even quintuple digits.  I am not worried about such a thing happening here.  The Fed has proven that it can curb inflation by tightening.  Well short of that point, people will be prepared to tolerate a short-term recession rather than allow any more inflation.

When will that time come?  I have no idea if it will even get to that.  But it seems a safe bet that no one will much mind 4-5% inflation.  I have no idea how high above that it can go before people get upset.  6-7%?  8-9%?  I am reasonable confident that if inflation ever reaches double digits, the pressure will grow to do something about it, and the Fed will.  And anyhow, all this is purely speculative.

But even assuming that we get the macro right and that the economy returns to a macroeconomic normal, that addresses only the short to medium run.  Deficits of the type Republicans are proposing cannot be sustainable in the long run for another reason.

The growing burden of debt service

Nothing described above is really any more than just the normal business cycle, which won't go away just because Republicans are in charge.  To understand what deficits are or are not sustainable requires going beyond the simple assumption that all deficits are bad to a more complex understanding (invariably derided by people who see complex understandings as mere hypocrisy) that not all deficits are alike.  This requires understanding the distinction between temporary deficits and permanent deficits, cyclical deficits and structural deficits, and primary deficits and fiscal deficits.

Temporary versus permanent deficits:  This one is the simplest.  A deficit caused by a short-term measure like a temporary tax break or a one-time expenditure is temporary and need not affect the long-run sustainability of the budget.  A deficit caused by a permanent tax cut or implementation of a new program does affect the long-term balance of the budget and, if not made sustainable, can lead to serious problems down the road.  For instance, for all the freak-out the Obama stimulus generated, most of it consisted of one-time expenditures which would expire on their own and not blow up the budget over the long run.  Obamacare, by contrast, is a program that is intended to be permanent and must therefore be financed, either by tax increases, or by permanent spending cuts elsewhere. Likewise, Trump's proposed infrastructural program is a temporary measure that will expire on its own.  Proposed tax cuts, on the other hand, are permanent and have ample opportunity to blow up the budget.

Cyclical versus structural deficits:  This distinction is best illustrated by a graph:

A few things are significant here.  One is that outlays and revenues tend to move in opposite directions.  That is the business cycle at work.  During recessions, revenues drop and expenditures on unemployment insurance and the like rise.  But these deficits are not worrisome because they will be erased when the economy recovers.  Another is that the projected expenditures and revenues are a lot smoother than the actual ones.  That is because actual revenues and expenditures reflect these cyclical ups and downs, while projected ones do not.

Another point is what it shows about the Republican supply side argument that tax cuts ultimately raise revenues.  Ronald Reagan's tax cuts took place in 1981, in a severe recession.  That year shows a sharp drop in revenue, partly as a result of the tax cuts, and partly because of the recession.  Although Reagan admirers like to boast that tax revenues increased, as we can see, they remained unchanged as a share of the gross domestic product (GDP).  Bill Clinton's tax increases took place in 1993, a year in which the US was starting to come out of a recession, but recovery was looking very slow.  Republicans screamed bloody murder, but revenues did increase, partly from the tax increases, and partly from general economic recovery.  At the peak of the business cycle, the US budget actually went into surplus.  George W. Bush cut taxes in 2001, also in a recession. Revenue fell, partly from the tax cuts and partly from the recession.  With recovery, revenues recovered, shrinking the gap to well below average at the peak of the business cycle.  The the financial crisis of 2008 broke out, and deficits skyrocketed to unprecedented heights.  The full scope of the deficit led to panic, but spending fell and revenue improved over time.  The graph below is illustrative:

This graph shows deficits as a share of GDP and how they have ebbed and flowed with economic ups and downs.  Clearly the deficit following the financial crisis was larger than anything we have seen since WWII, even higher than our deficits in the 1930's.  It has fallen considerably since then.  But as we approach the peak of the business cycle, the deficit remains 2.5% of GDP, an abnormally large deficit for this stage.  This amount is clearly structural; it will not be erased (at least not much of it) with further economic recovery, and it will rise with the next recession.  So, yes, this is a problem.

Consider, then what the Republicans intend to do about it.  They intend to make immense tax cuts, a major military buildup and (at least per Trump) a large infrastructural building.  Then compare to what we have now.  The Congressional Budget Office (CBO) estimates 2016 expenditures at $3.9 trillion and revenues at $3.3 trillion, for a deficit of approximately $600 billion as we near the peak of the business cycle, or a little over 15% of the budget.  This is worrisome.  Now, what do the Republicans want to do?  Trump's tax cuts are estimated to reduce revenues by $5 trillion over ten years or (grumble, grumble about how I hate that "over ten years" formulation) about $500 billion per year.  That would raise the deficit to $1.1 trillion per year.  Add to that his infrastructural plan for $1 trillion over ten years (grumble, grumble), or $100 billion per year and you raise the deficit to $1.2 trillion, or about 30% of the budget.  Recall just how intense the alarm was in 2009 when Obama took office and ran a deficit of $1.4 trillion -- and that was during the worst recession since the 1930's, with much of it clearly cyclical.  To run such a deficit near the peak of the business cycle is simply unprecedented.

Can the Republicans make up the difference by spending cuts?  We always accuse them of wanting to "balance the budget on the backs of the poor."  Can they actually do it?  See the neighboring pie chart.  Interest on the deficit cannot be touched without setting off a financial crisis.  Republicans intend a major military buildup.  Trump has vowed not to touch Social Security or Medicare (federal health insurance for the elderly).  Medicaid, the federal health insurance for the elderly, makes up 9% of the federal budget and "income security," i.e., unemployment insurance, food stamps, disability payments and other programs for the poor make up 8% of the budget.  Total spending on the poor: 17% of the federal budget.  If one cut this amount to zero and kept everything else the same, it would balance the budget and even leave a small surplus.  But under the Trump plan, which leaves fully 30% of the budget to be paid by borrowing, even zeroing these programs out would still leave a deficit about the size we have now.

Of course, Congressional Republicans may not be as crazy as Trump.  As I understand it, they are currently proposing to ditch the infrastructure and enact a smaller tax cut.  (I have not been able to find any specific estimates).  So we may be spared deficits exceeding $1 trillion near the peak of the business cycle.  But even a more modest increase in the deficit is unlikely to be sustainable because of the third distinction.

Primary versus fiscal deficit:  The first table reveals something more than just the cyclical nature of deficits.  It shows that we have regularly been running a structural deficit around 2.8% of GDP for the last 50 years.  How have we managed to avoid fiscal crisis all this time?  The answer is the distinction between primary and fiscal deficit.  The primary deficit (or surplus) is the total deficit, minus payments on the national debt.

Why is that significant?  It is significant because running deficits adds to the national debt and the amount of interest we have to pay on it.  At the same time, we are constantly reducing the amount by paying on it.  So long as deficits are equal to or less than interest paid on the debt, they can be sustained indefinitely.  But if deficits exceed interest on the national debt, then gradually they add to interest paid on the national debt, and slowly interest payments eat up more and more of the budget and leave less and less for anything else.  This is why  running immense deficits cannot continue forever.  Sooner or later interest payments will eat up more and more of the budget.

This makes interest rates immensely important.  The higher interest rates, the sooner this phenomenon takes hold.  In the 1980's interest rates were extremely high, both because of inflation and attempts to fight it.  The spiking of deficits meant an immediate spiking of interest rate payments eating up the budget.  Our ability to run protracted deficits was much less than we have now.  But even now, with extremely low interest rates, extended deficits will catch up with us sooner or later.  And if (as I suspect) Republican profligacy leads to higher interest rates, then our capacity for profligacy will diminish.

And that is the real reason that deficits on the scale Trump appears to be proposing will ultimately lead to serious problems.

Generic Republican in Power: The Economy

Paul Krugman reacted to Donald Trump's election with a world-class freakout:

It really does now look like President Donald J. Trump, and markets are plunging. When might we expect them to recover? . . . . If the question is when markets will recover, a first-pass answer is never.

. . . . . . 

It’s true that we’ve been adding jobs at a pretty good pace and are quite close to full employment. But we’ve been doing O.K. only thanks to extremely low interest rates. There’s nothing wrong with that per se. But what if something bad happens and the economy needs a boost? The Fed and its counterparts abroad basically have very little room for further rate cuts, and therefore very little ability to respond to adverse events.
Now comes the mother of all adverse effects — and what it brings with it is a regime that will be ignorant of economic policy and hostile to any effort to make it work. Effective fiscal support for the Fed? Not a chance. In fact, you can bet that the Fed will lose its independence, and be bullied by cranks. 

So we are very probably looking at a global recession, with no end in sight. I suppose we could get lucky somehow. But on economics, as on everything else, a terrible thing has just happened.

This is just silly, as Krugman himself later acknowledged.  Employing analysis I learned from my hero, Paul Krugman, I was able to foresee that the Brexit would not, in fact, precipitate a recession in Britain, as did Krugman himself.  Don't do anything ridiculous like confuse what Republicans say when out of power (Deficits are evil!  Hard money is a moral imperative!) with what they will actually do in power.  Of course the Republicans will give effective fiscal support to the Fed; they are doing it already.  And I have no doubt their fondness for tight money will end the minute it threatens their electoral fortunes.  The Republicans taking power will give a boost to the economy. Markets are celebrating.

The current state of the economy is so-so.  It could be better and it could be worse.  Unemployment is falling below 5% and wages are starting to rise for the first time since the crash in 2008.  Employers are starting to complain that rising wages are cutting into their profits.  All this may be a sign that we are reaching the peak of the business cycle.  At the same time, inflation and interest rates are extremely, even pathologically low, a sign that there is still slack in the economy.  What are the chances of a recession some time during the next four years?

Here I will defer to my hero, Paul Krugman.  Krugman identifies two kinds of recessions.  One occurs when the central bank tightens to stop an overheating economy and accelerating inflation. Recovery is rapid once it eases off.  In the 1950's and '60's, the Fed made frequent use of these, but the last such example was the 1981-1982 recession, used the break the inflationary spiral from the 1970's. That recession was unusually severe because it had particularly high inflation to fight, but as soon as the Fed eased up, the economy rebounded just in time for the 1984 election.  Since then, inflation has managed to stay low without such interventions, but a new kind of recession has arisen -- the kind that follows bursting bubbles.  We have seen mild ones in 1991-92 and 2000-2001 and a severe one in 2008-2009.  These are less frequent than the earlier recessions, but recovery is slower.

And now, he fears, we may be heading into an age of secular stagnation, i.e., one in which total savings exceed investment opportunities and large amounts of capital will lie unemployed.  The result is permanent slack in the economy, slow growth, low inflation, and pathologically low interest rates. Monetary expansion cannot cure the slack because even if it lowers short-term rates to zero, savings will still exceed investment opportunities.  So, is the plus side of secular stagnation an end to the business cycle?  Clearly there will be no opportunity for economies to overheat and thus no need for central banks to step on the brakes.  Will there be speculative bubbles?  Possibly, although those are usually the product of "irrational exuberance" during good times, which seem notably lacking right now.

And yet . . .  And yet Krugman is calling for higher inflation, in the 4-5% range, so that in case of recession, central banks, by lowering real interest rates to zero, will effectively make it negative 4-5%.   And yet when I look at graphs of the business cycle, we do look as though we are drawing near the peak, extremely low inflation and interest rates notwithstanding.  And yet the last business cycle peaked in 2007, which will make next year ten years later.  It seems a stretch to imagine the peak-to-peak business cycle would be over 13 years.

So, right now we have an improved economy, but one with some slack and no apparent prospects of ever ending the slack.  What do do?  Krugman and others like him recommend a fiscal stimulus, with monetary accommodation, both to end the slack in the economy  and to encourage somewhat higher inflation to make it easier for the Fed to lower interest rates in future recessions.  The main obstacle to such a course so far has been that all parties have been faint-hearted.  Prudence has led all responsible parties to balk at the sort of deficits such a policy would entail, and the whole finance industry wants higher interest rates to increase profits.

Enter Republicans to the rescue.  Every Republican knows that deficits only matter when a Democrat is in the White House.  They also know that deficits that result from tax cuts don't count; only deficits from spending increases count.  Also, military spending doesn't count either, only social spending.  So, Republicans are doing what they always do, proposing massive tax cuts and a military buildup.  Trump is now adding a new measure to the mix -- a trillion dollar infrastructure plan.  I have no idea whether they will reject the infrastructure as an extravagance and stick to the tax cuts and military buildup or whether partisanship will prove stronger than principle and they will reject it.  But one thing I am confident about is that Republicans will never be faint-hearted about deficits brought about by tax cuts, especially at the top.  Remember, it is Republican dogma that no tax increase can ever be justified.  And while they theoretically favor spending cuts to match the tax cuts, in practice they are not prepared to do anything that unpopular, so deficits will surge.  Granted Krugman and company don't think tax cuts at the top deliver much of a multiplier, but I am inclined to think that the form of fiscal stimulus matters less than the central bank's willingness to accommodate it with monetary policy.

So, what are the chances there?  Hard to say.  It is true that central banks have also proven faint-hearted and not been willing to give a really aggressive monetary stimulus to get the economy going, but less to favor inflation over 2%.  And it is also true that so long as Obama has been in power, Republicans have maintained an almost theological commitment to tight money as a universal and timeless moral imperative, some even going so far as to endorse a gold standard.

Well, make no mistake.  Once Trump is inaugurated, Republicans will regard tight money as a universal and timeless imperative that must be continued in good times and bad, in all economic circumstances.  To propose any deviation from this moral imperative would show a lack of principle. No amount of human suffering can ever justify deviation from this universal and timeless imperative and, indeed, the more pain the Fed inflicts with tight money the better, since it will mean a richer reward down the road.  So money must always be kept tight, without exceptions -- unless a Republican is in the White House and tightening might hurt his political fortunes, in which case we must be reasonable.

But Republican politicians will not determine monetary policy; the Fed will determine monetary policy.  Will the Fed accommodate?  That one is harder to answer.  Certainly, with a Republican in the White House, the pressure for politicians to tighten will vanish.  What about the pressure from banks, theorists and (to the extent that it exists), the general public?

Ironically, I think that if the Fed manages to accommodate Republican fiscal expansion enough to get the slack out of the economy, the pressure to tighten might lessen.  Fiscal stimulus is deeply  counterintuitive and has proven impossible for political reasons (in Europe and the US, now and in the 1930's).  Less apparent but  nonetheless there are some similar pressures on central banks.  Since most people think of inflation solely in terms of prices and not of wages, people tend to become extremely inflation averse when their wages are stagnant, even though stagnant wages are in themselves part of very low inflation.  Likewise, the finance industry gets upset about low interest rates and puts pressure on central banks to tighten when rates get low.  But there, too, there is a bit of zen at play.  As Milton Friedman says, high nominal interest rates are a sign that money has been too loose; low nominal rates are a sign that it has been too tight.

How can this be so?  The first half is simple.  Too-easy money leads to inflation.  Inflation leads to high interest rates.  The second half is merely a reflection of the first.  Too-tight money depresses the economy, a depressed economy leads to low interest rates because of the lack of investment opportunities.  Still, automatically linking them to monetary policy makes yet another assumption.  If high interest rates are the result of easy money, it means that inflation is necessarily the result of too-easy monetary policy and can always be cured by monetary tightening.  This is an uncontroversial statement that basically everyone agrees with.

But the second side makes another assumption -- that a depressed economy is always the result of too-tight monetary policy and that, regardless of what shocks it receives, an economy can always be revived by monetary expansion.  That latter is very controversial indeed.  Can central banks always boost the economy by printing more money?  And keep in mind that central banks "print" money by buying up government debt.  That means that they can continue a monetary expansion only if the government obliges by running massive deficits.  Well, all evidence is that the Republicans are going to oblige in that regard!  Once they get the slack out of the economy, interest rates will rise and the finance industry will stop clamoring for tightening.  Once nominal wages start to rise more, people will stop being as upset about rising prices.  Krugman thinks we need 4-5% inflation to ensure that central banks will have maneuvering room to cut rates in case of recession.  We have often had inflation at that rate during good times and no one has minded in the least.

So the question should be, will the Fed have the nerve to keep expanding when inflation rises above its official target?  Or to raise its inflationary target, which was sheer madness in the past, but might be okay now that there is a Republican in the White House?  I am guessing that the current leadership will not be willing to raise its inflation target.  I have no sense at all whether they will allow inflation to overshoot its target once the pressure to tighten recedes.

But then again, it will take time for inflation to start rising above the 2 percent target.  Current chairman Janet Yellen's term expires in February, 2018.  Maybe by the time it expires, the Republicans can find a hack who cares more about Republican political fortunes that responsible monetary policy and will continue to expand until inflation reaches 4-5%.  It doesn't seem so far-fetched.

Krugman loves saying that what we need is for central banks to credibly promise to be "irresponsible," but they are such staid institutions that he is not sure it is possible.  That is one reason why he thinks they need some fiscal support.  Well, if there is one person whose promises to be irresponsible will be absolutely credible, it is Donald Trump.  But other Republicans aren't far behind. Maybe they can find an equally irresponsible person to manage the Fed and actually revive the economy.

Next:  How it can go wrong.