Now that the establishment financial media is discussing the yield curve and the possibility of recession, there is going to be a lot of discussion on the causes. The anti Trump forces will blame Trump, but I don’t know what the pro Trump crowd will blame.
During Trump’s campaign in 2015/ 2016, he was critical of the Federal Reserve. He also pointed out that there were bubbles in the economy. He was right. The problem is that his position has changed since becoming president. He has taken credit for the boom in stocks and the overall economy, so it will be hard for him to not accept the blame.
Trump has been critical of the Fed lately, but it is because the Fed has been tightening and increasing its target federal funds rate. Trump doesn’t want the Fed to burst the bubbles because it will take place on his watch.
If there is a recession on Trump’s watch, then I think the pro Trump crowd will blame the Fed. That will be their go-to excuse. They will be correct in blaming the Fed, but not for the reasons stated. The Fed isn’t at fault because of its recent tightening. The Fed is to blame for its extremely loose monetary policy from 2008 to 2014.
I think there will be a lot of discussion about Trump’s policies on taxes, tariffs, and regulations. Some will say that his tariffs brought on the recession. Ironically, some of this may come from the left.
From a libertarian standpoint, it is good that Trump lowered corporate tax rates and some other taxes (although there are some libertarians who disagree on this point). It is also good that he has actually reduced regulations in some areas.
On the bad side, Trump has enacted tariffs, which are taxes on imports and exports. This causes consumers to pay more for products than they otherwise would have. Also on the bad, side, massive government spending has continued on Trump’s watch, and it has even gotten worse. The deficit has exploded again. You know it is bad when we are looking at trillion-dollar annual deficits even if the economy stays out of recession.
I don’t want to say that all of these things have no impact on the business cycle. They do have an impact. Tax reductions can provide a temporary boost, even if it means bigger deficits. Tariffs can certainly slow things down. Massive overall spending by government is bad economically because it misallocates resources.
But none of these things are the primary cause of the artificial booms and busts that we see.
It’s the Monetary Policy
The main driver of the boom/ bust cycle is the Federal Reserve. Its primary tools are the money supply and controlling of the interest rates. These two things are related. When the financial crisis hit in 2008, the Fed responded with unprecedented monetary inflation and near-zero interest rates. The Fed continued its balance sheet expansion (monetary base inflation) until late 2014.
This is a classic case of the Austrian Business Cycle Theory, as taught by Ludwig von Mises. The artificially low interest rates and easy money cause resources to be misallocated and causes unsustainable booms. The low interest rates send a false signal that there is more savings than what actually exists.
When the Fed stops inflating and suppressing interest rates, then the misallocations (malinvestments) are exposed. The investors in the bubble sectors realize that it is unsustainable, and the bubble pops. This can happen eventually even if the central bank just slows down its pace of inflation.
If the central bank keeps inflating at ever-expanding rates, then eventually we will have what Mises referred to as the crack-up boom. This is hyperinflation, which leads to far greater poverty than any recession or depression.
In other words, the recession that we will eventually get is baked into the cake. It is unavoidable at this point. The damage was already done. It is just a question of how severe it will be and whether the government and the Fed allow it to run its course.
If we hit a recession soon, it won’t really be Trump’s fault. But it was stupid of him to take credit for the so-called booming economy of the last two years. We could certainly be much better off if he hadn’t enacted new tariffs. We could be better off if he had gotten Congress to cut spending instead of increasing it. But no matter what, he can’t prevent a recession that was already in the cards. The most he could do is to slightly speed it up or slow it down.
I think the mistake that many Austrian school economists have made is predicting a recession too early. Maybe it is a mistake in predicting anything, since the Austrian school teaches that we can’t predict human action with certainty, which is the driver of the economy.
The problem is that timing is almost impossible. Even though the Fed stopped its balance sheet expansion 4 years ago, it takes time for all of this to process through the economy. Interest rates have crept up, but are still historically very low. Bubbles can often last longer than what seems possible. They can also blow up bigger than what seems possible.
As I have said, we actually need a recession for the benefit of the middle class. It will be painful, but the current misallocations of the bubble economy are also painful. Life has become quite expensive. We need a recession, which will hopefully lead to a reduction in government. One can always hope.