LOOKING back from the vantage point of 2025*, economic historians are starting to write their analyses of the Trump slump. It seemed to appear from nowhere with the economy growing at around the trend rate (2.3% in 2017) and the stockmarket booming. The abrupt change came in March 2018 when President Donald Trump decided to impose tariffs on steel and aluminium imports. “Trade wars are good and easy to win” he said. Both China and the European Union (EU) retaliated in kind without trying to escalate the tensions. It might have ended there.
But unfortunately, the president’s more mainstream advisers like Gary Cohn had been sidelined by a more aggressive group that saw the trade deficit as the key measure of economic progress. In this mercantilist view, any American deficit was proof of cheating. Unfortunately, the president had also enthusiastically passed a tax-cutting programme which resulted in demand sucking more imports into the country. The trade deficit widened rather than declined. So in late 2018, just before the mid-term Congressional elections, an enraged President passed a general tariff along the lines of the Smoot-Hawley tariff of 1930. The other leading economies had no choice but to respond in kind, in the hope of dragging America back to the negotiating table. Business confidence—and the stockmarket—slumped.
In the early months of 2018, the Federal Reserve had continued to tighten monetary policy in response to the low unemployment rate and the prospect of fiscal stimulus. That tightening only had a significant impact in early 2019, just as the trade war got nasty. While the Fed swiftly cut rates again, its actions were too little and too late. Meanwhile the Republican Congress, alarmed at the rising budget deficit, had used the opportunity to attack entitlement programmes, cutting welfare benefits and spending across the board to shrink the state. Unemployed Americans started to set up shanty sites, nicknamed “Trump towns” in memory of the “Hoovervilles” of the 1930s. Right-wing media claimed all those people living rough were actors paid for by George Soros.
All this might have led the Democrats to sweep to power in the mid-term elections. But with his popularity in decline, President Trump, in search of an easy foreign-policy win, launched a pre-emptive strike on North Korea in the autumn of 2018. The resulting war cost 2m lives, disrupted Asian trade and added to the economic downturn. But it allowed the Republicans to paint themselves as the patriotic party, and they expanded their majority in Congress.
So the American economy was hit by a triple whammy: the lingering effects of tighter monetary policy; a fiscal policy that hit demand by transferring money from the poor to the rich; and a slump in global trade. The trade war also damaged growth in China. So the world’s two biggest economies pulled the rest of the world into a slump. Global supply chains were disrupted as many of the efficiency gains of the previous 20 years dissipated.
Economists berated the Trump administration for their actions. But just like the 1,028 economists who signed a petition against the Smoot-Hawley tariff, they were ignored. “The public have had enough of experts,” the President proclaimed. His philosophy of “never retreat” prevented him from changing course; in China, nationalist pressure insisted that President Xi stand up to the Americans; while the EU was too preoccupied with Brexit to make a difference. Britain emerged from the EU in 2021 to pursue free trade policies in the middle of a tariff war.
It might not have happened just as the Great Depression might have been averted with the right combination of fiscal and monetary policies. That downturn also came out of a blue sky when the economy was doing well and the stockmarket was at a high. But the political elite of the world were too preoccupied with headline-grabbing measures to head off the disaster.
* This piece came to us via a hole in the space-time continuum
Japan still has great influence on global financial markets
IT IS the summer of 1979 and Harry “Rabbit” Angstrom, the everyman-hero of John Updike’s series of novels, is running a car showroom in Brewer, Pennsylvania. There is a pervasive mood of decline. Local textile mills have closed. Gas prices are soaring. No one wants the traded-in, Detroit-made cars clogging the lot. Yet Rabbit is serene. His is a Toyota franchise. So his cars have the best mileage and lowest servicing costs. When you buy one, he tells his customers, you are turning your dollars into yen.
“Rabbit is Rich” evokes the time when America was first unnerved by the rise of a rival economic power. Japan had taken leadership from America in a succession of industries, including textiles, consumer electronics and steel. It was threatening to topple the car industry, too. Today Japan’s economic position is much reduced. It has lost its place as the world’s second-largest economy (and primary target of American trade hawks) to China. Yet in one regard, its sway still holds.
This week the board of the Bank of Japan (BoJ) voted to leave its monetary policy broadly unchanged. But leading up to its policy meeting, rumours that it might make a substantial change caused a few jitters in global bond markets. The anxiety was justified. A sudden change of tack by the BoJ would be felt far beyond Japan’s shores.
One reason is that Japan’s influence on global asset markets has kept growing as decades of the country’s surplus savings have piled up. Japan’s net foreign assets—what its residents own abroad minus what they owe to foreigners—have risen to around $3trn, or 60% of the country’s annual GDP (see top chart).
But it is also a consequence of very loose monetary policy. The BoJ has deployed an arsenal of special measures to battle Japan’s persistently low inflation. Its benchmark interest rate is negative (-0.1%). It is committed to purchasing ¥80trn ($715bn) of government bonds each year with the aim of keeping Japan’s ten-year bond yield around zero. And it is buying baskets of Japan’s leading stocks to the tune of ¥6trn a year.
Tokyo storm warning
These measures, once unorthodox but now familiar, have pushed Japan’s banks, insurance firms and ordinary savers into buying foreign stocks and bonds that offer better returns than they can get at home. Indeed, Japanese investors have loaded up on short-term foreign debt to enable them to buy even more. Holdings of foreign assets in Japan rose from 111% of GDP in 2010 to 185% in 2017 (see bottom chart). The impact of capital outflows is evident in currency markets. The yen is cheap. On The Economist’s Big Mac index, a gauge based on burger prices, it is the most undervalued of any major currency.
Investors from Japan have also kept a lid on bond yields in the rich world. They own almost a tenth of the sovereign bonds issued by France, for instance, and more than 15% of those issued by Australia and Sweden, according to analysts at J.P. Morgan. Japanese insurance companies own lots of corporate bonds in America, although this year the rising cost of hedging dollars has caused a switch into European corporate bonds. The value of Japan’s holdings of foreign equities has tripled since 2012. They now make up almost a fifth of its overseas assets.
What happens in Japan thus matters a great deal to an array of global asset prices. A meaningful shift in monetary policy would probably have a dramatic effect. It is not natural for Japan to be the cheapest place to buy a Big Mac, a latté or an iPad, says Kit Juckes of Société Générale. The yen would surge. A retreat from special measures by the BoJ would be a signal that the era of quantitative easing was truly ending. Broader market turbulence would be likely. Yet a corollary is that as long as the BoJ maintains its current policies—and it seems minded to do so for a while—it will continue to be a prop to global asset prices.
Rabbit’s sales patter seemed to have a similar foundation. Anyone sceptical of his mileage figures would be referred to the April issue of Consumer Reports. Yet one part of his spiel proved suspect. The dollar, which he thought was decaying in 1979, was actually about to revive. This recovery owed a lot to a big increase in interest rates by the Federal Reserve. It was also, in part, made in Japan. In 1980 Japan liberalised its capital account. Its investors began selling yen to buy dollars. The shopping spree for foreign assets that started then has yet to cease.
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