A boosted economy helped bolster Republican successes in the mid-terms. By 2020, the tide will have turnedby John Rapley / November 19, 2018 / Leave a comment
“It was a big day yesterday, incredible day,” said Donald Trump at a chaotic press conference the day after the mid-term elections. “I thought it was very close to a complete victory.” True or not, though, it’s probably as good as it’s going to get for the President. Mr. Trump’s economic policies gave Republicans a strong tailwind going into this election. But the wind he sowed will come back as a whirlwind—quite possibly in time for the next election cycle.
While the Electoral College and Senate are biased towards small and rural states, which is where Mr. Trump’s strength lies, his electoral strategy has narrowed his course to victory. His explicit appeal to his base has withdrawn the Republican Party into a defensive laager that will, given current demographic trends, further contract. He held small towns and rural areas, but lost the suburbs, weakening the fragile coalitionhe built between blue-collar populists and suburban conservatives.
But more worryingly for Trump, that economic wind which filled Republican sails this year will have likely reversed direction by 2020. Few economists thought it clever to cut taxes at the peak of the business cycle. Adding fuel to a fire would only stoke inflation, jeopardising the boom.
But the President and his advisors insisted the flood of money released by tax reform would be invested, driving up labour productivity and thereby keeping a lid on inflation. In reality, corporations used most of the cash to pad profits and buy back shares.
That produced the surging stock market the President so keenly trumpeted during the campaign. But beyond that, there’s been scant new investment—at least not beyond what one would expectat this point in the business cycle. In fact, in the most recent quarter, investment actually slowed back down.
Inflation, meanwhile, is rising. Flush with cash, consumers are bidding up the prices of goods and services. Moreover, the administration’s policies may lock this inflation into the economy. Firms are reportinghigher input costs as a result of Trump’s tariffs and trade skirmishes.
To make matters worse, his aggressive crackdown on immigration amid historically low unemployment has aggravated labour shortages,nudging labour costs upwards. Although consumer inflation still remains low by historical standards, it has been moving relentlessly upwards for the last two years.
As always happens, inflation has pulled interest rates in its wake. But so too have the government’s policies. Someone had to pay for the tax cuts, and in the first instance, it has been the government itself. With revenues eroded, the deficit has soared. The Congressional Budget Office now forecaststrillion-dollar shortfalls for the foreseeable future.
To fund them, the government has had to issue ever more bonds. In recent years, foreigners have been keen buyers of US debt. However, like someone fed by an Italian mother, there can come a point where you can’t just eat more. Foreigners are no longer soaking upadded bond issuance the way they once did. And given the way bond markets work, falling (relative) demand means rising interest rates.
As prices and interest rates go up, consumers will have less money to spend. The resulting drop in demand could well produce a recession. Indeed, recent stock-market declines appear to suggest investors are preparing for this eventuality. Of course wages could keep rising, offsetting the impact of tightened pocketbooks. But that may be a bit much to hope for.
Proponents of the Trump tax-cuts celebrated the bonuses which companies gave their workers out of their new cash piles. But in fact, less than three percent of the tax money went to pay rises; most of that, in turn, took the form of one-time bonuses. Firms have thus left themselves the flexibility to cut pay and lay off workers when demand drops. That will worsen the downturn, as it unfolds.
When that happens, the government will find its own purse-strings tight, making it harder to jolt the economy back to life. Having given away billions of dollars this year, the government won’t have pots of cash left overto pump into the economy.
The truth is, as former Fed Chairman Ben Bernankeput it, Trump’s tax cuts came at the worst possible moment for the economy. Because fiscal stimulus is generally considered most effective at the opposite end of the business cycle, amid recession, the tax cuts may not do muchto boost long term-economic economic growth. Instead, their principal effect may have been simply to redistribute some future growthto the present—supercharging the economy today, worsening tomorrow’s recession. So, what was good for Republicans in the 2018 mid-terms, may well be bad for them next time around.
Or, as Bernanke put it, sometime about 2020, just as President Trump is campaigning for re-election, “Wile E. Coyote is going to go off the cliff and look down.”