The American economic expansion, heading into its tenth year, still has room to run. So say some of the best regarded pundits. The Federal Reserve Bank of Atlanta estimates that in the second quarter the economy has grown at an annual rate of 3.8 percent. Too gloomy a guess for forecasters at Macroeconomic Advisers. They are advising clients that the economy grew at annual rate of 4.8 percent this past quarter, higher than 34 of the 35 quarters since the recession ended.
Not every forecaster takes such a rosy view. Ellen Zentner, Morgan Stanley’s chief U.S. economist, expects growth to end up at 2.9 percent this year, and slow to 2.2 percent next year. Looking further ahead, the crew at Guggenheim Investments (managers of $246 billion in assets) is predicting that come February 2020 we will see the start of the next recession.
These forecasts, of course, were made before the U.S. and China slapped 25 percent tariffs on $34 billion of each other’s exports, but they have long been priced into the market. The tariffs primarily hit farmers in America and vehicle, industrial machinery and medical products industries in China. Trump is promising to raise levies on $16 billion more in Chinese imports in a fortnight. Then, if China continues to retaliate, he says he will extend tariffs to $500 billion of Chinese goods, just about all the stuff America imports from the People’s Republic. Only when Trump has the November congressional elections behind him will he be willing to negotiate.
Meanwhile, he is banking on the strong U.S. economy to mitigate the effect of the Chinese tariffs, and the weakness of the over-indebted Chinese economy to magnify the effect of a cut in its export markets. Not for him concern about tit-for-tat trade wars, or as Tevye put it in Fiddler on the Roof, that if we adopt a policy of an eye for an eye, and a tooth for a tooth, “That way the whole will be blind and toothless.”
Trump is also gambling that hard-hit farmers will remain loyal, a gamble he seems to be winning. Don Moore, chairman of the American Soybean Association, represents the farm sector that is hardest hit by Chinese retaliation: China buys most of the $14 billion in U.S. soybeans exports. Moore says that despite large losses, “Rural America is supporting Trump.” He wishes the president had resorted to the World Trade Organization procedures, but “We understand the president’s goals to make sure that China becomes a better and more fair trading partner. We understand that they have not treated American business fairly. We admire the president for trying to make sure that is being corrected.”
Optimists are shrugging off the tariff war, and focussing instead on Friday’s “goldilocks” report that the economy added 213,000 jobs in June-neither so hot as to portend inflation, nor so cold as to hint at an economic slowdown. The unemployment rate ticked up from 3.8 percent to 4.0 percent, reflecting the fact that more workers, mostly black and Hispanic women, decided to give up the couch for a job hunt because jobs are now easier to find. After all, there are more job openings in America than there are workers looking for jobs.
These optimists reject the argument that because this expansion is one year short of being ten years old-when it would become the longest period of growth in America’s history-it is staring into its grave. Glen Rudebusch, chief researcher at the San Francisco Fed, contends that earlier growth stretches did not “become progressively more fragile with age,” supporting the view of former Fed chair Janet Yellen who says, “I think it’s a myth that expansions die of old age.” Rather than dying of old age, these expansions were the murder victims of a Fed policy error-premature tightening.
But when it comes to monetary policy, past is not necessarily prologue. Faster tightening can at times be needed. And Trump has given the Fed three reasons for worrying that prices are about to take off. He added to inflationary pressures by cutting taxes and funding the cuts by adding to the nation’s deficit-in effect, printing money. And his tariffs are likely to raise prices on thousands of goods, just when rising oil and gas prices are creating pressure on transport and other costs.
And you can add another reason for the Fed to stick with its current plan of moderate interest rate increases, one that has nothing to do with economics. Call it political pressure. The president’s main weapon in the trade wars, not to mention in the November congressional elections, is a robust economy. So Larry Kudlow, director of Trump’s National Economic Council, abandoned the long custom of respecting the independence of the central bank and took to television to suggest to the Fed what he, and presumably his boss, would like to see happen. “My hope is that the Fed, under its new management, understands that more people working and faster economic growth do not cause inflation . . . and will move very slowly. . . . Just let it [the economy] rip, for heaven’s sake.” Translation: Forget the Fed’s mandate to promote stable prices as well as full employment. The president doesn’t want the Fed to slow growth by raising interest rates.
If the Fed stays its hand, or at least fails to rush to push rates up faster, the sigh of relief will echo (if sighs can echo) around the developing world. Higher interest rates mean a stronger dollar, which in turn means that developing countries will have to pay more in their own currencies to buy dollars, which they need to purchase oil and other commodities. It also means that investors, who bought the relatively risky securities of developing countries in a hunt for yield, can now earn more on dollar assets than in the days of almost-zero interest rates. So they will dump those riskier assets and switch to dollar assets, driving up interest rates and slowing growth in those poorer countries.
My guess is that the Fed will make only minor adjustments in its current course of moderate increases in rates, waiting until the effects of the tit-for-tat trade war are clearer. It will remain unperturbed after a long period of below-target inflation if the inflation rate exceeds that 2 percent target for a while and “runs a little hot,” as the industry jargon puts it. Fed chairman Jay Powell, a Trump appointee, is more investment banker than economist. He will be looking primarily to markets, less to Fed economist-forecasters (whose forecasting record is not unblemished), and not at all to the White House for guidance.