Tariffs could unwittingly act as an antidote to US economic overheating, says Chief Economist Léon Cornelissen.
President Donald Trump has flown in the face of traditional economic theory by pushing through tax cuts and higher spending when the US economy is already strong. This has prompted new Federal Reserve (Fed) Chairman Jerome Powell to be cautious about future rates policy.
However, the potential effects of tariffs on imports into the US, and particularly a trade war with China could end up reversing any extra growth from the stimulus, Cornelissen warns. The outcome means more uncertainty for investors, he says.
“The policy mix chosen by US policy makers is not exactly what the doctor would order for an economy running at or close to full employment,” says Cornelissen. “Expansive fiscal policy, a combination of tax cuts and higher spending could of course drive the unemployment rate even lower. But the chances are high that it will mostly precipitate in higher inflation, demanding more aggressive monetary tightening.”
“According to the Fed median forecast, unemployment will fall to 3.6% in the next two years – the lowest level since the late 1960s – and almost 1% lower that the Fed’s own estimate of the longer-term jobless rate. However, these worries about the composition of the macroeconomic policy mix are not incorporated in the official views of the Fed.”
“Although policy makers sound increasingly upbeat about the US economy in the near term, raising their median forecast for economic growth in 2018 to 2.7% from 2.5%, and for 2019 to 2.4% from 2.1%, these forecasts remain well below 3%. Longer term, they have kept their forecast unchanged at 1.8%. This doesn’t display much optimism about the longer-term effects of the recent tax legislation.”
This concern has already been reflected in the inaugural remarks of the new Fed chairman, Jerome Powell, who replaced Janet Yellen in February. “He conceded in his first press conference after the March Federal Open Market Committee (FOMC) meeting that elements in the tax legislation could lift investment, and with that productivity, as well as labor force participation,” says Cornelissen.
“But he also said US central bankers held a wide range of views on the size of the effects of the tax cuts. These remarks are illustrative of the general caution expressed by the new Fed chairman, who took the opportunity to play down the importance of the central bank’s higher median interest rate forecasts (inevitably given its rosier economic forecasts), and to stress the uncertainties surrounding the economic outlook.”
“Logically, the Fed is still projecting only three rate rises this year, although three instead of four has become a close call on the basis of the famous ‘dot plot’. ‘It is too early’ is the mantra preferred by the cautious Powell, who is keeping his cards close to his chest and tends towards continued dovishness, implicitly accepting an inflation target overshoot. This policy is probably much to the liking of the one who has appointed him (Trump) to replace an equally dovish Janet Yellen.”
“I would argue that US growth and inflation will turn out to be higher than the Fed is currently predicting, necessitating a much tighter monetary policy – but there is one important caveat. And that is the possibility of the break-out of a damaging worldwide trade war which could dampen world GDP growth significantly and easily extinguish any overheating fears.”
Cornelissen says the initial tariffs on steel and aluminum were a hastily announced improvisation, and possibly a last-minute attempt to influence the March Congressional election in Pennsylvania in favor of the Republican candidate, a move that turned out to be in vain as the Democrat won. “These tariffs are also too small to have any macroeconomic significance,” he says.
“More serious are the measures targeted solely on China. The US firstly announced a 25% tariff on at least USD 50 billion-worth of imports from China in aerospace, information communication technology and machinery. Secondly, Trump initiated a World Trade Organization (WTO) case against Chinese technology licensing practices, which is odd in the light of concurrent US attempts to hollow out the WTO by vetoing the appointment of judges to its Appellate Body, in effect the supreme court of world trade. Thirdly, the US is imposing new restrictions on Chinese investment in the US in sensitive technology sectors.”
“What is most likely to lie behind the tariffs is what analysts consider to be a broader objective from the White House to disrupt a high-level Chinese strategy called ‘Made in China 2025’. In other words, the current US administration wants to slow down the inevitable ascent of China, and that makes it unlikely that the unpredictable US president – who has very broad powers on trade policy – will back down in some kind of face-saving deal. A tit-for-tat trade war between the US and China will damage global GDP in many unpredictable ways.”