TradePost USA: President Trump has been saying that the economy is strong, but seems to be getting ready to blame the Federal Reserve and increases in interest rates in the event that there is a recession. Are interest rates the biggest threat to the economy or is it more likely that our trade policy will tip us into recession?
John Dunham: Neither. The only Federal Reserve policy that will have any impact on the real economy is what they are calling QT or Quantitative Tightening. This is the Bank’s program to reduce the bonds it holds on its balance sheet. This is supposed to end in September, and will in an of itself lead to a slight reduction in longer-term rates. Even so, this is not a real drag or stimulus to the economy, and for the most part, monetary policy does not have much of an effect anymore.
The trade policy question is more pertinent. The Administration’s innate desire to put tariffs on virtually everything are no more than a tax on American producers and consumers. This tariff tax has already wiped out most of the tax savings from the recent tax reform (although the structural changes in the code will still have a positive effect). Since higher taxes lead to slower economic growth, the increase in tariffs is problematic; however, to date they are not large enough to drive the economy into recession.
The biggest problem facing the economy in the near term is the level of debt that has been accrued by government, consumers and corporations. There is a lot of zombie debt out there on the corporate side, with many below investment grade bond (and for that matter many investment grade instruments) propping up companies that do not turn a profit. In addition, there are huge equity investments in companies like Amazon and Uber that are light on profits. A collapse of this debt market bubble similar to the collapse of housing debt, is most likely the match that will light the recessionary fuse.
TPUSA: American farmers are losing overseas sales to other agricultural countries, such as Brazil. Is this impact enough to drive the entire economy into recession? Will farmers be able to regain those sales if we reach a trade deal with China?
John Dunham: No and no. First, agriculture is a very small part of the overall economy, and agricultural exports represent just 7-tenths of a percent of GDP, so while farm exports are important to certain regions, they definitely do not drive the economy. Countries like Brazil, Australia, and Canada are increasing their exports not because of the trade issues with China, but because they are productive. Brazil and Argentina also have very weak currencies which make their products inexpensive relative to other exporters like the United States.
TPUSA: Will the recent trade/immigration conflict with Mexico make other countries reluctant to trade with the U.S. for fear that America will use tariffs as a weapon to address other issues that are unrelated to trade, such as getting NATO countries to increase defense spending or forcing European countries to impose sanctions on Iran?
John Dunham: There really are no trade and immigration conflicts with Mexico. The USCMA agreement is not a major detour from NAFTA, and Mexico has and will have continued access to US markets. In addition, the immigration issues stem not from Mexicans crossing the border, but from nationals from other countries crossing what is generally a porous land border with Mexico. On the other hand, the use of the American financial system (for example access to the SWIFT network) as a weapon will have an impact on trade and international relations.
TPUSA: Will the uncertainty caused by the on-again/off-again trade policies – close the Mexican border/don’t close the Mexican border, impose tariffs on Mexico/don’t impose tariffs on Mexico – impact U.S. companies and their global supply chain arrangements enough to impact the economy in general?
John Dunham: Yes – it seems trite, but it is true that business likes consistency and predictability. The Administration seems to succumb to knee-jerk reactions and tends to announce policies that never come to pass. Now, the tariffs on China are on hold. While it is understandable that the President sees this as a means of negotiation (and it is potentially a successful strategy), it is sometimes difficult to read the tea leaves and understand what is true and what is a feint. Businesses and industries that maintain good government affairs operations are the most likely to succeed in this type of environment.
TPUSA: The U.S. is a leading energy producer, which is usually considered to be a good thing. If the rest of the world slips into an economic slowdown, even if the U.S. initially does not, could such a downturn and consequent decline in energy demand create adverse economic ripple events in the U.S. energy industry and consequently for the rest of the economy?
John Dunham: Yes and no. Energy has been a key economic driver during the last couple of years, and is an important part of the economy in many states, so a reduction in demand for oil and natural gas (or for that matter a big jump in interest rates which will shut down marginal operations) can be problematic.
That said, the US is still a very minor exporter of energy. The spread between the domestic price (WTI) and the international price (Brent) demonstrates that the US is still not part of the world market for supply of energy commodities.
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