If Donald Trump is calculating that lower interest rates will offset any damage triggered by higher tariffs and keep the U.S. economy motoring through the 2020 election year, he may have bet wrong.BRYAN WOOLSTON/Reuters
If Donald Trump’s rage-fuelled tweet machine had one theme in the past year, it was the endless attacks on the U.S. Federal Reserve and its chairman, Jerome Powell. How inconvenient that the Fed was independent, and didn’t bow to the President’s demands to cut interest rates and goose the economy. Didn’t he know an election was coming?
On Wednesday, Mr. Trump got his wish – sort of. The Fed reduced rates by a quarter point, citing “the implications of global developments for the economic outlook,” that is, the trade war that Mr. Trump himself instigated against allies (Canada, European Union, Mexico) and adversaries (China) alike.
Mr. Trump wasn’t satisfied with the cut – “As usual, Powell let us down,” he tweeted – because he wanted one double the size, with assurances of more to come. The very next day, he announced he would hit China with another round of tariffs, this time 10 per cent on an additional US$300-billion of imports, starting in September. Mr. Trump was no doubt thinking: What better way than creating global trade tension to get Fed boy to keep cutting?
Yes, Mr. Trump may really be that conniving. The timing is certainly curious because all signs had pointed to a tariff truce with China. At the Group of 20 summit in June in Osaka, Mr. Trump backed down on his old threat to slap 25 per cent tariffs on an additional US$250-billion of Chinese exports to the United States. It appeared he feared that more tariffs would backfire, that they would push the U.S. economy toward recession, all the more so if China were to retaliate with punitive tariffs on American imports or by devaluing the renminbi. Indeed, the European Union, where manufacturing is in severe slowdown, already seemed to be heading into the tank.
If he is calculating that lower interest rates will offset any damage triggered by higher tariffs and keep the U.S. economy motoring through the 2020 election year, he may have bet wrong. Friday saw another market sell-off: Germany’s Dax index, home to some of the world’s biggest exporters, fell 3.1 per cent. Most of the other big indexes, including Tokyo’s Topix, were down by hefty amounts, too. The yields on U.S. 10-year Treasuries and German bonds sank, with the latter plunging ever deeper into negative territory, meaning investors face a guaranteed loss if they buy them and hold them to maturity. Such is the price of safety in an ever riskier Trumpian market.
The sell-off could prove relentless if China makes good on its fresh threat to retaliate. “If America does pass these tariffs, then China will have to take the necessary countermeasures to protect the country’s core and fundamental interests,” a Chinese foreign ministry spokeswoman said.
The R-word – recession – has been burbling from the lips of economists and market strategists for some time, but always with considerable hesitancy, as if the chances of negative growth were extremely low. Now, “recession” is being upgraded to somewhere between possible and likely, all the more so since the United States and Europe were showing signs of economic weakness well before Mr. Trump’s latest tariff tantrum. If the United States next month does implement Mr. Trump’s new China-bashing tariffs, “that is fodder for recessions,” Mark Zandi, chief economist of Moody’s Analytics, told CNBC.
The EU is already flirting with recession. Italy, the eurozone’s third biggest economy, has been slipping in and out of negative growth for almost a year, and could enter another full-blown recession if the trade wars intensify and the populist government continues to prove itself inept at economic management.
Germany is not immune to the weakness among the Mediterranean countries and is especially vulnerable to the tariffs popping up everywhere. The Ifo Institute’s manufacturing business climate index is plunging in Germany, reporting its worst showing in July in nine years. The Purchasing Managers’ Index (PMI) is also solidly in contraction territory and Deutsche Bank, the main lender to Germany’s export champions, is in perennial crisis. The rising chances of a hard Brexit at the end of October do not help. Any form of Brexit – one with a trade deal with the EU or one without – will hurt the EU, even if it will hurt Britain more.
Viewed from Europe, the United States under Mr. Trump’s presidency looks like the land of milk and honey. On Friday, the U.S. Department of Labor reported that the economy added 164,000 jobs in July, holding unemployment steady at 3.7 per cent, near a 50-year low.
Still, the manufacturing sector is striking – it fell 1.9 per cent in the first quarter and 2.2 per cent in the second. Overall industrial production has also shrunk in the past two quarters. New tariffs might well push those numbers further into negative territory. The U.S. economy is not as robust as advertised by Mr. Trump and the yield curve, which reflects the difference between three-month and 10-year Treasury bonds, is now inverted, meaning the long-term bonds have a lower yield that the shorties. Historically, inverted yield curves have been reliable predictors of recession.
While manufacturing in the U.S. is not as important as it used to be, any sustained fall is bad news since the sector accounts for 11 per cent of gross domestic product and 8 per cent of employment. If consumer spending falls along with manufacturing output and employment - note the softening car sales in July - watch out. Low corporate spending only makes the economy more fragile. Companies are obsessed with share buybacks, not investing in the labour markets or innovation.
Mr. Trump is taking a huge gamble that already seems to be going against him. Trading tariff increases for rate cuts seems more likely to accelerate the arrival of a recession than delay it. The market reaction on Friday said as much. The Democrats can only hope that Mr. Trump’s economic miracle evaporates in the next year. They would be wise to heed Napoleon’s dictum: Never interrupt your enemy when he is making a mistake.
Eric Reguly