In this edition of The Interview, Fair Observer talks to the economist and resident fellow of the American Enterprise Institute, Desmond Lachman.
With President Donald Trump having completed his first year in the Oval Office, the discussion on what his administration managed to achieve when it comes to the country’s economy remains heated. From the World Economic Forum in Davos, Trump publicly reiterated that the US economy is more rigorous than ever before thanks to his government’s economic policies, such as the tax reform bill passed at the end of 2017, predicted to add a further $1.5 trillion to the deficit over the next decade. While there is modest evidence to support Trump’s boasting of reinvigorating the economy, the question emerges whether Trumponomics would work in the long term.
Desmond Lachman, of the neoconservative American Enterprise Institute, doesn’t shy away from criticizing Donald Trump and expressing his skepticism about some of the president’s protectionist economic policies and isolationist decisions aligned with “America First.” It remains to be seen whether America’s economic strength a result of Trump’s policies, or if he is riding the wave of favorable economic factors, but the president seems to reluctant to acknowledge the Federal Reserve’s contribution to boosting the economy’s performance. Lachman has raised the issue of the budget deficit that, in 2009, he had highlighted as one of the significant concerning matters of Barack Obama’s economic policy. Nearly a decade later, the US budget deficit continues to be at the epicenter of criticism and scrutiny directed toward Washington’s decision-makers.
In this edition of The Interview, Fair Observer talks to Desmond Lachman about the prospects of the US economy under President Trump and the concerns about sustainable recovery.
Athanasios Dimadis: Just over a year after Trump’s election, is the American economy in a better place now than it was under President Obama?
Desmond Lachman: One needs to distinguish between how the US economy is currently operating and how it might be operating in a year or two. One also needs to think how much credit should be given to the Trump administration for the US economy’s recent strong performance and how much credit should be given to the Federal Reserve’s easy monetary policy, and to a strong global economy. Over the past year, the US economy has been operating well. Economic growth has picked up, unemployment has declined to decade-long lows and inflation has remained quiescent.
However, the US economy has not been alone in performing well, as is indicated by a significant pickup in economic growth in all of the world’s major economies. Like the US, these other economies have also benefited from the extraordinarily easy monetary policies that have been pursued by their central banks. Looking ahead, there are real questions as to how long the US recovery can be sustained and whether the US economy might not be heading for an economic recession.
Dimadis: Are there any reasons for concern with respect to the sustainability of the US economy’s recovery?
Lachman: There are two basic reasons for concern. The first is that the very easy monetary policy by the world’s main central banks has given rise to bubbles in global equity markets, in the global bond and credit markets, and in selected housing markets across the globe. When these bubbles burst we could have serious economic setbacks across the globe. The second is that the US economy is likely to be adversely impacted by the recent large and ill-advised unfunded tax cut, which has been the main policy initiative of the Trump administration.
Dimadis: What might the implications of this tax cut be on the economy?
Lachman: That tax cut is estimated by the non-partisan Congressional Budget Office to increase the budget deficit and to add $1.5 trillion to the US public debt over the next decade. An unfunded tax cut at this stage of the cycle made little sense and is likely to get the US economy into trouble. At a time that the US economy was close to full employment and growing well, the last thing that it needed was a fiscal stimulus. This would particularly seem to be the case considering that the US economy is currently receiving a strong boost from the combination of still-low interest rates, very buoyant stock prices and a slumping dollar. This has to raise the risk that the US economy will soon overheat, and inflation will return. An overheating US economy would either force the Federal Reserve to move to a more aggressive interest rate path or else bring out the bond vigilantes. Both of these possibilities risk bursting today’s global asset price bubbles with possibly untoward consequences for the global economy.
Dimadis: Has Trump made good on any of the economic promises he made before the election?
Lachman: Trump’s major economic policy initiative to date has been his large tax cut. This fell far short of his many promises to simplify the US tax system, to have a tax reform program that mainly benefited the middle class, and not to increase the budget deficit. Following his tax reform, the US tax system remains extraordinarily complex, while most of the benefits of the tax cut are to be received by the wealthy. It is striking that a main focus of the tax initiative was a permanent reduction in the corporate tax rate from 35% to 20%. By contrast, the individual tax cuts are skewed to the high-income earners and are to be phased out over time. The Trump administration has also not yet delivered on its many “America First” promises to tear up trade agreements like NAFTA and to impose large tariffs on countries that take advantage of the US. That he has not delivered on these promises is a good thing and might have spared us from a global trade war. However, I am not holding my breath that he will continue to be restrained in this area.
Dimadis: Despite all this, the stock market has hit an all-time high under Trump. Can this be a counterargument to those who predicted that his election would be disastrous for the US economy?
Lachman: The Trump administration is certainly placing a lot of emphasis on the 25% increase in equity prices as a vindication of how good its economic policies have been. In so doing, it glosses over the inconvenient fact that equity prices in the first year of the Obama administration increased by 35%. It is also turning a blind eye to the fact that over the past year, global equity prices have matched or more than matched the US stock market performance. One should also add that equity-market performance is a very unreliable predictor as to how the economy might perform in the year ahead, particularly if it’s in a big bubble.
Dimadis: Trump receives criticism that he overcomes the limits of his power by attacking, for example, the Federal Reserve. How can such behavior impact confidence in the US economy?
Lachman: There would seem to be two main areas where investors should be concerned about the Trump administration’s interference in the operation of institutions. The first would be his attempt to undermine the independence of the Federal Reserve and to interfere with the Federal Open Market Committee’s interest-making decisions. That runs the very real risk of undermining market confidence in how committed the administration is to keeping inflation in check. If markets lose confidence on that score, one could see real turmoil in financial markets that would certainly have a negative impact on the economy.
A second potential area of concern is the administration’s seeming intention to skirt Congress in the area of trade policy. A move by the administration to a more restrictive trade policy runs the risk of bringing on a global trade and currency war that would certainly put global prosperity at risk.
Dimadis: Wall Street economists warn of the idea that the Federal Reserve could introduce at least three interest rates hikes in 2018. What would that mean if the economy does not continue to show a pickup in growth?
Lachman: It is difficult to see how the US economy is not going to need at least three interest rate increases in 2018. The economy is already at close to full employment and is growing faster than its potential. Meanwhile, it is getting a big boost from the tax cut as well as from the 25% increase in equity prices and the 13% drop in the dollar over the past year. If there is a reason to be concerned it is that the Fed is already behind the interest rate increasing curve and that it will need to raise interest rates by more than three times in 2018 to keep inflation in check.
Dimadis: Economists agree that the Federal Reserve succeeded in meeting the employment goal of its dual mandate, but inflation in the US is still a problem. Do you see the inflation to remain a wild card? What is your projection for 2018?
Lachman: I very much see inflation as being a wild card. It seems to me that both the Fed and the markets are underestimating the likely impact on inflation of an overheated US economy, a big slump in the US dollar and now strongly rising oil prices. We will soon see inflation at levels above the Fed’s 2% target. Two considerations make it difficult to forecast inflation for the year. The first is that one would have to know how a Trump dominated Fed would react to a pick up in inflation. The second is that one would have to know whether the global asset bubble bursts in 2018 and exerts strong deflationary pressure, as it did in the 2008-2009 episode.
Dimadis: How much are Trump’s attitude and strategy toward Europe a real concern for US-EU relations?
Lachman: President Trump’s remarks on Europe over the past year have not been encouraging. He seems to want to encourage other countries to follow the United Kingdom’s Brexit example and leave the European Union. He also has made noises about the costs of the euro to individual countries. This attitude is concerning as it would seem to be in the US interest to have a strong, united and economically prosperous Europe.
Dimadis: President Trump stated in Davos that “America first does not mean America alone.” Do you interpret this statement as a step away from his isolationist stance?
Lachman: Yes. I was encouraged by that statement as it seemed that he is dialing back on his more protectionist rhetoric of the past. However, the proof of the pudding is not so much what he says but by what his administration does in the trade field. In that respect, the recent imposition of tariffs on Chinese goods and [Secretary of the Treasury] Steven Mnuchin’s efforts to talk down the dollar were not encouraging.
The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.