On Friday, August 30, Trump confidently tweeted that anyone who thinks that his aggressive trade war with China could lead to a recession is sadly misinformed. He offered his own two-part explanation for a possible economic downturn. First, unnamed but “badly run and weak companies” are being undone by their own incompetence. Second, their present plight has not been caused by the trade war, but rather by the Federal Reserve’s failure to rapidly cut interest rates.
Chairman Jerome Powell has become a frequent target of the President’s ire. To be sure, the Fed did trim rates by a quarter of a point, from 2.25% to 2.00%, in July 2019. But Trump wanted the Fed to cut rates, already low by historical standards, by a full point. Even more, he wanted the Fed to further jolt the economy through another round of bond repurchases. In an attempt to prod Powell into action, Trump accused Powell of having a “horrendous lack of vision.” When Powell did not blink, Trump doubled down. “As usual, the Fed did NOTHING! It is incredible that they can ‘speak’ without knowing or asking what I am doing,” he tweeted . “My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?” So much for the traditional independence of the Fed. Trump then lashed out at the private sector by ordering corporations to find alternatives to China. So much for limited presidential powers.
We have three potential culprits for the anticipated economic slow-down: incompetent companies; a dumb Fed Chairman; or Trump’s interminable trade war with China. How would an economic detective assign blame? Let’s take the three in order.
The dumb company explanation is a convenient scapegoat for the President, but it is not the real culprit. The easy way out is to deny that there are any badly run companies. After all, the model of the rational economic actor supposedly makes that an economic impossibility. But no one can make that assertion with a straight face. To be sure, simple static models show the virtues of competition for economic growth. But those static models misrepresent the realities of any dynamic economy, where new entrants routinely displace established players as a result of technical innovation, product differentiation, or market savvy. But the process is far from inexorable as some new entrants are thwarted when older firms reinvent themselves.
It is therefore virtually impossible to make confident predictions about who will succeed or fail in the economic landscape. Markets are always in flux because of differential levels of competence and foresight. The extent of that fluctuation is, moreover, easily concealed by aggregate data. Suppose that a monthly review reveals a gain of 200,000 jobs in an economy with over 155 million jobs. Statistically, no big deal. But that net figure is misleading. It is far more likely that 1 million jobs were created and 800,000 were lost. The summary statistic underestimates the dynamism by a factor of nine, even before taking into account workers who have shifted positions. Economic rationality helps explain why firms always try to do better. But their improvement is only an aspiration, not a guaranteed fact.
Nuance is not a Trumpian virtue. Nonetheless, Trump’s claim requires a more nuanced view. The key question is why the rate of poorly run firms happens to increase just as tariffs start to bite. Here is one explanation that undercuts Trump’s thesis: today’s unstable environment is part of Trump’s strategy of keeping everyone else off balance—essentially an updated version of "The Art of the Deal.” On the first page of that book, he reveals that he gets his “kicks” from making “big deals.” It’s deal-making by improvisation. “I like to come to work each day and just see what develops,” he writes.
That approach might be a fine way for him to negotiate his individual business transactions. Perhaps Trump, the self-proclaimed great negotiator, thinks he gains some leverage by throwing the Chinese off balance. But the necessary side-effect of his grandstanding is to throw scads of American companies off balance as well. Now well-run firms all have to guess which way Trump’s trade winds will blow. Some firms may respond well to Trump’s confused signals, but others will not. Some firms will be better able to weather the storm because their businesses are not heavily dependent on Chinese trade. But lots of other firms will discover that the next round of tariffs on Chinese goods will leave them with fewer options. Hence, that gratuitous uncertainty harms American firms. No one wins in a trade war with China, except perhaps an American president with an insatiable ego.
Now to potential explanation two: What about the Fed and Jerome Powell, who, for the time being, has ignored the Trumpian onslaught? Is there any reason to think that yet another stimulus program will work when the results of past programs have been spotty at best? There were plenty of efforts at stimulus during the Obama years, but these programs produced only slow growth, especially in wages. It turns out that Obama’s ill-conceived (and protectionist) American Recovery and Reinvestment Act of 2009 could not improve economic productivity by offering boons to labor unions, preferences for American goods and services, and an ad hoc set of employment and welfare benefits to favored constituents. A simple program of deregulation would have done far better. Matters picked up in the early Trump years when he followed a deregulatory course, but now there are signs of a decline. The question is—why would we expect this trend to change as a trade war escalates?
Once again it is important to look at the aggregate effects of a given program, not just its intended effects. The common thinking goes that cheap credit will encourage firms to borrow, and thus, increase jobs and production. But cheap credit has multiple consequences, including lower returns to lenders. People who earn lower incomes will be more inclined to spend and consume less. It is clear that a cheap money program hurts some people while helping others. What is not as clear in any given iteration is whether the positive effects outweigh the negative effects, and if so, by how much. The first time around, some undue optimism about the miracles of monetary policy may spur the economy. But investors quickly begin to see that their long-term economic success depends on higher productivity, not financial sleights of hand. On this matter, Powell has a point. Any uncertainty in monetary policy reduces gains to lenders and borrowers alike. And those losses reverberate throughout the economy. My guess is that a Trumpian reduction in interest rates will unsettle the economy, not stimulate it. The Fed is not the culprit.
Trump’s trade war is the obvious cause of impending economic distress. The effects of a trade war on economic activity have always been negative, for two well-known reasons. First, tariffs are not paid solely by Chinese firms; rather, the tariffs reduce gains from trade for both sides. In the short run, that means fewer sales. In the long run, it means lower investment. The only way we can hurt the Chinese through tariffs is to hurt ourselves, and no one can say with confidence which side will suffer more when established markets are disrupted for political reasons.
Second, economic nationalism is contagious. Few nations will respond to a trade war by taking advantage of the cheap prices at which they can buy foreign goods. As a matter of honor and local politics, retaliation by the Chinese becomes a political necessity. So both sides dig in deeper, waiting for the other side to blink. The casualties of Trump’s stupidity are already bleeding dollars. Trump may offer endless praise of America’s great farmers, but there is nothing that he can do to help them when sales of farm produce to China plummet.
Nor is there any easy way out of this economic conflict. Losses will not be offset by increased sales to different trading partners, and it is far from certain that those sales will return when and if this trade war is resolved. Transfer payments from the public treasury to farmers to offset their losses suffer from two fatal defects. First, the payments are too small to fully compensate the losses, even in the short run. More importantly, they impose a tax which slows down productive activities elsewhere in the economy, increasing the odds of having the recession everyone fears.
Trump never seems to grasp that trade is positive sum in both domestic and foreign markets. His instincts for the deregulation of labor and goods in the domestic markets have produced huge gains. But he undercuts these successes with madcap interventions in foreign markets. If he loses the 2020 election, we will all have to pay a high price for his personal vanity and economic folly.
