During his campaign, Donald Trump warned that stocks were in a bubble that was going to pop. While it wasn’t a theme he repeated often, his tune has changed somewhat since winning the election.
No president wants to issue dire warnings of a recession or stock market collapse. But if a major downturn is going to occur in the next 4 years, from Trump’s point of view it would be better if it happened sooner rather than later.
The question is: If Trump is actually successful in implementing an agenda of reduced taxes and reduced regulations, would that be enough to avoid a possible recession?
Frank Shostak recently wrote an article for the Mises Institute titled “Tightening the Money Supply will Inevitably Lead to a Bust”. Shostak’s article focuses on the Fed, and more specifically following the Taylor rule.
Shostak states in his article the following: “Unfortunately, a gradual tightening cannot prevent a subsequent economic bust. Economic busts are simply the inevitable removal of various activities that emerge on the back of loose monetary policy.”
As followers of Austrian school economics and the Austrian Business Cycle Theory understand, the bust phase is not the problem. It is a problem only in the sense that it is the time that people feel the most pain. But the damage was done during the artificial boom phase. This is when resources are misallocated. The bust phase is trying to correct the previous misallocations.
The Fed had an extremely loose monetary policy from 2008 to 2014. Although the Fed has only hiked its target federal funds rate twice since that time, it has kept a tight monetary policy since October 2014 when it ended QE3.
While the lack of bank lending helped to limit some of the damage, we cannot pretend that there was no damage done. The Fed nearly quintupled its balance sheet in this six-year period. There have been misallocations.
Given that the damage has already been done, is there anything that Trump can do to stop it?
The answer is “no”, but he can certainly do things to alleviate the pain. Cutting taxes, including corporate taxes, would certainly help. Repealing burdensome regulations would help, which would include Obamacare.
The one area where libertarians focus more is on overall government spending. Unfortunately, it does not seem that Trump or the Republican Congress is going to do anything in the near term to cut federal spending in any significant way.
We need huge spending cuts in order to leave more capital in the private sector. When the government spends money – whether that money is obtained through taxes, debt, or inflation – it is misallocating resources. It is being spent on things that are not in accordance with consumer demand.
If Trump were to accomplish significant cuts in spending (unlikely), along with reducing regulations and taxes (slightly more likely), then it could go a long way to lessening the severity of a recession.
Still, the misallocations need to correct at some point. They corrected in the oil industry to a large degree a few years ago. Many companies went into too much debt and invested too much in drilling for oil that was only worth it at a higher oil price. When the oil price went down, it was quickly discovered that some of the investment was actually malinvestment.
If there are minor misallocations due to central bank policy, it is possible for technology and productivity to offset the reallocation (bust phase).
Think of it this way. If the Fed were to inflate the money supply 1% higher, it is still a misallocation of resources. But it is small enough in comparison to the entire economy that growth would likely offset that in the future. You could still have a small bust in some sectors, but overall growth could still be positive despite the corrections.
The problem we are facing here is that the misallocations are likely much larger. Again, the Fed went on a digital money printing spree from 2008 to 2014. While oil has corrected, there is a lot that hasn’t corrected, including U.S. stocks.
I don’t think it is possible for Trump to avoid a recession at this point. If the Fed decides to start inflating again (unlikely at the moment), this could delay a recession. Even a massive increase in government spending could temporarily delay a recession. But these actions only delay the inevitable, and they also ultimately would make the recession worse when it does come.
Trump is better off getting a major recession over with now. Reagan survived the recession years of 1981 and 1982 and won re-election by a landslide in 1984. If there is a recession after 2018, Trump will not have much chance of being re-elected.
If Trump can repeal some significant regulations and actually cut government spending, this is going to ultimately help the economy. If a recession happens within the next year, maybe things will be looking up in time for the next presidential election.
But if the government keeps spending more money, we are not going to see any strong growth that is sustainable. The middle class people (who elected Trump) are struggling. They are struggling because so much of their money is flowing to Washington D.C. where the elites live well.
I don’t think Trump can avoid a recession at this point, and I also don’t think he should try. We have to get the painful adjustment over with. He can help make it a little less painful by removing Washington’s boot on our throats. This would not just lessen the pain of a recession, but also help set the stage for some actual sustainable growth in the future.