Tuesday, August 8, 2017

Restricting Immigration to the US could hurt Economic Growth in the USA


Now that US President Donald Trump has been in office for six months, we can more confidently assess the prospects for the US economy and economic policy making under his administration. And, like Trump’s presidency more generally, paradoxes abound.

The main puzzle is the disconnect between the performance of financial markets and the real. While stock markets continue to reach new highs, the US economy grew at an average rate of just 2% in the first half of 2017 – slower growth than under President Barack Obama – and is not expected to perform much better for the rest of the year.

Stock-market investors continue to hold out hope that Trump can push through policies to stimulate growth and increase corporate profits. Moreover, sluggish wage growth implies that inflation is not reaching the US Federal Reserve’s target rate, which means that the Fed will have to normalize interest rates more slowly than expected.

Lower long-term interest rates and a weaker dollar are good news for US stock markets, and Trump’s pro-business agenda is still good for individual stocks in principle, even if the air has been let out of the so-called Trump reflation trade. And there is now less reason to worry that a massive fiscal-stimulus program will push up the dollar and force the Fed to raise rates. In view of the Trump administration’s political ineffectiveness, it is safe to assume that if there is any stimulus at all, it will be smaller than expected.

The administration’s inability to execute on the economic-policy front is unlikely to change. Congressional Republicans’ attempts to replace the Affordable Care Act (Obamacare) have failed, not least because moderate Republicans refused to vote for a bill that would deprive some 20 million Americans of their health insurance.

The Trump administration is now moving on to tax reform, which will be just as hard, if not harder, to enact. Earlier tax-reform proposals had anticipated savings from the repeal of Obamacare, and from a proposed “border adjustment tax” that has since been abandoned.

That leaves congressional Republicans with little room for maneuver. Because the US Senate’s budget-reconciliation rules require all tax cuts to be revenue-neutral after ten years, Republicans will either have to cut tax rates by far less than they had originally intended, or settle for temporary and limited tax cuts that aren’t paid for.

To benefit American workers and spur economic growth, tax reforms need to increase the burden on the rich, and provide relief to workers and the middle class. But Trump’s proposals would do the opposite: depending on which plan you look at, 80-90% of the benefits would go to the top 10% of the income distribution.

More to the point, US corporations aren’t hoarding trillions of dollars in cash and refusing to make capital investments because the tax rate is too high, as Trump and congressional Republicans claim. Rather, firms are less inclined to invest because slow wage growth is depressing consumption, and thus overall economic growth.

Beyond tax reform, Trump’s plan to stimulate short-term growth through $1 trillion in infrastructure spending is still not on the horizon. And, instead of direct government investment of that amount, the administration wants to provide modest tax incentives for the private sector to spearhead various projects. Unfortunately, it will take more than tax breaks to bring large infrastructure projects from start to finish, and “shovel-ready” projects are few and far between.

On trade, there is good news and bad news. The good news is that the administration has not pursued radically protectionist policies, such as branding countries as currency manipulators, introducing across-the-board tariffs, or pushing for the border adjustment tax.

The bad news is that Trump is sticking to his “buy American, hire American” credo, and his protectionist gestures will hurt growth more than they save jobs. He has already abandoned the Trans-Pacific Partnership and negotiations for the Transatlantic Trade and Investment Partnership with the European Union. He is renegotiating the North American Free Trade Agreement, and he may try to renegotiate other free-trade agreements, such as the bilateral deal with South Korea. And he could still start a trade war with China by introducing tariffs on steel and other products – especially now that China has been uncooperative in responding to North Korea’s escalating nuclear threat.

Trump could also limit the US’s growth potential by restricting immigration. In addition to barring visitors from six predominantly Muslim countries, the administration is intent on restricting migration for high-skill workers, and is ramping up deportations of undocumented immigrants. This, along with the much-ballyhooed border wall, will cut future labor supply, and thus economic growth, especially as the American population continues to age and drop out of the labor force.

Lastly, Trump’s deregulation agenda will not boost economic growth, and may actually weaken it over time. If financial regulations are loosened too much, the result could be another asset and credit bubble, and even another financial crisis and recession.

Meanwhile, Trump’s decision to withdraw from the Paris climate agreement, combined with a rollback of environmental regulations, will lead to ecological degradation and slower growth in green-economy industries such as solar power. And weaker labor protections will further reduce workers’ bargaining power, thus holding down wage growth and overall consumption.

It is little wonder that actual and potential growth is stuck at around 2%. Yes, inflation is low, and corporate profits and stock markets are soaring. But the gap between Wall Street and Main Street is widening. High market valuations that are fueled by liquidity and irrational exuberance do not reflect fundamental economic realities. An eventual market correction is inevitable. The only question is whom Trump will blame when it happens.

Monday, July 24, 2017

Why QE and other Unconventional Monetary Policies will be used again

Financial markets are starting to get rattled by the winding down of unconventional monetary policies in many advanced economies. Soon enough, the Bank of Japan(BOJ) and the Swiss National Bank(SNB) will be the only central banks still maintaining unconventional monetary policies for the long term.

The US Federal Reserve started phasing out its asset-purchase programme (quantitative easing, or QE) in 2014, and began normalising interest rates in late 2015. And the European Central Bank is now pondering just how fast to taper its own QE policy in 2018, and when to start phasing out negative interest rates, too.

Similarly, the Bank of England (BoE) has finished its latest round of QE — which it launched after the Brexit referendum last June — and is considering hiking interest rates. And the Bank of Canada (BOC) and the Reserve Bank of Australia (RBA) have both signalled that interest-rate hikes will be forthcoming.
Still, all of these central banks will have to reintroduce unconventional monetary policies if another recession or financial crisis occurs. Consider the Fed, which is in a stronger position than any other central bank to depart from unconventional monetary policies. Even if its normalisation policy is successful in bringing interest rates back to an equilibrium level, that level will be no higher than 3 per cent.

It is worth remembering that in the Fed’s previous two tightening cycles, the equilibrium rate was 6.5 per cent and 5.25 per cent, respectively. When the global financial crisis and ensuing recession hit in 2007-09, the Fed cut its policy rate from 5.25 per cent to 0 per cent. When that still did not boost the economy, the Fed began to pursue unconventional monetary policies, by launching QE for the first time.


As the last few monetary-policy cycles have shown, even if the Fed can get the equilibrium rate back to 3 per cent before the next recession hits, it still will not have enough room to manoeuvre effectively. Interest-rate cuts will run into the zero lower bound before they can have a meaningful impact on the economy. And when that happens, the Fed and other major central banks will be left with just four options, each with its own costs and benefits.
First, central banks could restore quantitative- or credit-easing policies, by purchasing long-term government bonds or private assets to increase liquidity and encourage lending. But by vastly expanding central banks’ balance-sheets, QE is hardly costless or risk-free.

Second, central banks could return to negative policy rates, as the ECB, BOJ, SNB, and some other central banks have done, in addition to quantitative and credit easing, in recent years. But negative interest rates impose costs on savers and banks, which are then passed on to customers.

Third, central banks could change their target rate of inflation from 2 per cent to, say, 4 per cent. The Fed and other central banks are informally exploring this option now, because it could increase the equilibrium interest rate to 5-6 per cent, and reduce the risk of hitting the zero lower bound in another recession.
Yet this option is controversial for a few reasons. Central banks are already struggling to achieve a 2 per cent inflation rate. To reach a target of 4 per cent inflation, they might have to implement even more unconventional monetary policies over an even longer period of time.

Moreover, central banks should not assume that revising inflation expectations from 2 per cent to 4 per cent would go smoothly. When inflation was allowed to drift from 2 per cent to 4 per cent in the 1970's, inflation expectations became unanchored altogether, and price growth far exceeded 4 per cent.

The last option for central banks is to lower the inflation target from 2 per cent to, say, 0 per cent, as the Bank for International Settlements has advised. A lower inflation target would alleviate the need for unconventional policies when rates are close to 0 per cent and inflation is still below 2 per cent.
But most central banks have their reasons for not pursuing such a strategy. For starters, zero inflation and persistent periods of deflation — when the target is 0 per cent and inflation is below target — may lead to debt deflation. If the real (inflation-adjusted) value of nominal debts increases, more debtors could fall into bankruptcy.

Moreover, in small, open economies, a 0 per cent target could strengthen the currency, and raise production and wage costs for domestic exporters and import-competing sectors.

Ultimately, when the next recession strikes, central banks in advanced economies will have no choice but to plumb the zero lower bound once again while they choose among four unappealing options. The choices they make will depend on how they weigh the risks of bloating their balance-sheets, imposing costs on banks and consumers, pursuing possibly unattainable inflation targets, and hurting debtors and producers at home.

In other words, central banks will have to confront the same policy dilemmas that attended the global financial crisis, including the “choice” of whether to pursue unconventional monetary policies. Given that financial push is bound to come to economic shove once again, unconventional monetary policies, it would seem, are here to stay.


via projectsyndicate

Tuesday, July 11, 2017

What the Central Banks will do in the next Recession

Financial markets are starting to get rattled by the winding down of unconventional monetary policies in many advanced economies. Soon enough, the Bank of Japan (BOJ) and the Swiss National Bank (SNB) will be the only central banks still maintaining unconventional monetary policies for the long term.

The US Federal Reserve started phasing out its asset-purchase program (quantitative easing, or QE) in 2014, and began normalizing interest rates in late 2015. And the European Central Bank is now pondering just how fast to taper its own QE policy in 2018, and when to start phasing out negative interest rates, too.

Similarly, the Bank of England (BoE) has finished its latest round of QE – which it launched after the Brexit referendum last June – and is considering hiking interest rates. And the Bank of Canada (BOC) and the Reserve Bank of Australia (RBA) have both signaled that interest-rate hikes will be forthcoming.

Still, all of these central banks will have to reintroduce unconventional monetary policies if another recession or financial crisis occurs. Consider the Fed, which is in a stronger position than any other central bank to depart from unconventional monetary policies. Even if its normalization policy is successful in bringing interest rates back to an equilibrium level, that level will be no higher than 3%.

It is worth remembering that in the Fed’s previous two tightening cycles, the equilibrium rate was 6.5% and 5.25%, respectively. When the global financial crisis and ensuing recession hit in 2007-2009, the Fed cut its policy rate from 5.25% to 0%. When that still did not boost the economy, the Fed began to pursue unconventional monetary policies, by launching QE for the first time.

As the last few monetary-policy cycles have shown, even if the Fed can get the equilibrium rate back to 3% before the next recession hits, it still will not have enough room to maneuver effectively. 

Interest-rate cuts will run into the zero lower bound before they can have a meaningful impact on the economy. And when that happens, the Fed and other major central banks will be left with just four options, each with its own costs and benefits.

First, central banks could restore quantitative- or credit-easing policies, by purchasing long-term government bonds or private assets to increase liquidity and encourage lending. But by vastly expanding central banks’ balance sheets, QE is hardly costless or risk-free.

Second, central banks could return to negative policy rates, as the ECB, BOJ, SNB, and some other central banks have done, in addition to quantitative and credit easing, in recent years. But negative interest rates impose costs on savers and banks, which are then passed on to customers.

Third, central banks could change their target rate of inflation from 2% to, say, 4%. The Fed and other central banks are informally exploring this option now, because it could increase the equilibrium interest rate to 5-6%, and reduce the risk of hitting the zero lower bound in another recession.

Yet this option is controversial for a few reasons. Central banks are already struggling to achieve a 2% inflation rate. To reach a target of 4% inflation, they might have to implement even more unconventional monetary policies over an even longer period of time. Moreover, central banks should not assume that revising inflation expectations from 2% to 4% would go smoothly. When inflation was allowed to drift from 2% to 4% in the 1970s, inflation expectations became unanchored altogether, and price growth far exceeded 4%.

The last option for central banks is to lower the inflation target from 2% to, say, 0%, as the Bank for International Settlements has advised. A lower inflation target would alleviate the need for unconventional policies when rates are close to 0% and inflation is still below 2%.

But most central banks have their reasons for not pursuing such a strategy. For starters, zero inflation and persistent periods of deflation – when the target is 0% and inflation is below target – may lead to debt deflation. If the real (inflation-adjusted) value of nominal debts increases, more debtors could fall into bankruptcy. Moreover, in small, open economies, a 0% target could strengthen the currency, and raise production and wage costs for domestic exporters and import-competing sectors.

Ultimately, when the next recession strikes, central banks in advanced economies will have no choice but to plumb the zero lower bound once again while they choose among four unappealing options. The choices they make will depend on how they weigh the risks of bloating their balance sheets, imposing costs on banks and consumers, pursuing possibly unattainable inflation targets, and hurting debtors and producers at home.

In other words, central banks will have to confront the same policy dilemmas that attended the global financial crisis, including the “choice” of whether to pursue unconventional monetary policies. Given that financial push is bound to come to economic shove once again, unconventional monetary policies, it would seem, are here to stay.

Wednesday, May 17, 2017

Could Jeff Sessions be on the FBI ?


With purge of Comey the cover-up of Russia investigation will be complete as they will choose a stooge like Sessions for FBI job. Stinks!


Monday, May 8, 2017

Some risks are hard to calculate


With Emmanuel Macron’s defeat of the right-wing populist Marine Le Pen in the French presidential election, the European Union and the euro have dodged a bullet. But geopolitical risks are continuing to proliferate. The populist backlash against globalization in the West will not be stilled by Macron’s victory, and could still lead to protectionism, trade wars, and sharp restrictions to migration. If the forces of disintegration take hold, the United Kingdom’s withdrawal from the EU could eventually lead to a breakup of the EU – Macron or no Macron.

At the same time, Russia has maintained its aggressive behavior in the Baltics, the Balkans, Ukraine, and Syria. The Middle East still contains multiple near-failed states, such as Iraq, Yemen, Libya, and Lebanon. And the Sunni-Shia proxy wars between Saudi Arabia and Iran show no sign of ending.

In Asia, US or North Korean brinkmanship could precipitate a military conflict on the Korean Peninsula. And China is continuing to engage in – and in some cases escalating – its territorial disputes with regional neighbors.

Despite these geopolitical risks, global financial markets have reached new heights. So it is worth asking if investors are underestimating the potential for one or more of these conflicts to trigger a more serious crisis, and what it would take to shock them out of their complacency if they are.

There are many explanations for why markets may be ignoring geopolitical risks. For starters, even with much of the Middle East burning, there have been no oil-supply shocks or embargos, and the shale-gas revolution in the United States has increased the supply of low-cost energy. During previous Middle East conflicts – such as the 1973 Yom Kippur War, Iran’s Islamic Revolution in 1979, and Iraq’s invasion of Kuwait in 1990 – oil-supply shocks caused global stagflation and sharp stock-market corrections.

A second explanation is that investors are extrapolating from previous shocks, such as the attacks of September 11, 2001, when policymakers saved the day by backstopping the economy and financial markets with strong monetary and fiscal policy easing. These policies turned post-shock market corrections into buying opportunities, because the fall in asset prices was reversed in a matter of days or weeks.

Third, the countries that actually have experienced localized asset-market shocks – such as Russia and Ukraine after Russia’s annexation of Crimea and incursion into Eastern Ukraine in 2014 – are not large enough economically to affect US or global financial markets. Similarly, even as the UK pursues a “hard Brexit,” it still only accounts for around 2% of global GDP.

A fourth explanation is that the world has so far been spared from the tail risks associated with today’s geopolitical conflagrations. There has not yet been a direct military conflict between any major powers, nor have the EU or eurozone collapsed. US President Donald Trump’s more radical, populist policies have been partly contained. And China’s economy has not yet suffered from a hard landing, which would create sociopolitical instability.

Moreover, markets have trouble pricing such “black swan” events: “unknown unknowns” that are unlikely, but extremely costly. For example, the market couldn’t have predicted 9/11. And even if investors think that another major terrorist attack will come, they cannot know when.



A confrontation between the US and North Korea could also turn into a black swan event, but this is a possibility that markets have happily ignored. One reason is that, notwithstanding Trump’s bluster, the US has very few realistic military options: North Korea could use conventional weapons to wipe out Seoul and its surroundings, where almost half of South Korea’s population lives, were the US to strike. Investors may be assuming that even if a limited military exchange occurred, it would not escalate into a full-fledged war, and policy loosening could soften the blow on the economy and financial markets. In this scenario, as with 9/11, the initial market correction would end up being a buying opportunity.

But there are other possible scenarios, some of which could turn out to be black swans. Given the risks associated with direct military action, the US is now alleged to be using cyber weapons to eliminate the North Korean nuclear threat against the US mainland. This may explain why so many of North Korea’s missile tests have failed in recent months. But how will North Korea react to being militarily decapitated?


One answer is that it could launch a cyber attack of its own. North Korea’s cyber-warfare capabilities are considered to be just a notch below those of Russia and China, and the world got an early glimpse of them in 2014 when it hacked into Sony Pictures. A major North Korean cyber attack could disable or destroy parts of the US’s critical infrastructure, and cause massive economic and financial damage. That remains a risk even if the US can sabotage North Korea’s entire industrial system and infrastructure.

Or, faced with disruption of its missile program and regime, North Korea could go low-tech, by sending a ship with a dirty bomb into the ports of Los Angeles or New York. An attack of this kind would most likely be very hard to monitor or stop.

So, while investors may be right to discount the risk of a conventional military conflict between the US and North Korea, they also may be underestimating the threat of a true black swan event, such as a disruptive cyberwar between the two countries or a dirty bomb attack against the US.

Would an escalation on the Korean Peninsula be an opportunity to “buy the dip,” or would it mark the beginning of a massive market meltdown? It is well known that markets can price the “risks” associated with a normal distribution of events that can be statistically estimated and measured. But they have more trouble grappling with “Knightian uncertainty”: risk that cannot be calculated in probabilistic terms. 

via projectsyndicate

Wednesday, April 12, 2017

Border Adjustment Tax in USA will not happen



The decision to strike Syria has a bit of 'Wag the Dog' element according to Dr Nouriel Roubini. 

For the US to say NATO is obsolete is not constructive. The US is treating its allies in Europe and Asia less well. That's destabilizing Europe.

Watch the video above for full interview

Tuesday, April 11, 2017

Republicans think supply-side trickle down policies are great


US President Donald Trump’s first major legislative goal – to “repeal and replace” the 2010 Affordable Care Act (“Obamacare”) – has already imploded, owing to Trump and congressional Republicans’ naiveté about the complexities of health-care reform. Their attempt to replace an imperfect but popular law with a pseudo-reform that would deprive more than 24 million Americans of basic health care was bound to fail – or sink Republican members of Congress in the 2018 mid-term elections if it had passed.

Now, Trump and congressional Republicans are pursuing tax reform – starting with corporate taxes and then moving on to personal income taxes – as if this will be any easier. It won’t be, not least because the Republicans’ initial proposals would add trillions of dollars to budget deficits, and funnel over 99% of the benefits to the top 1% of the income distribution.

A plan offered by Republicans in the US House of Representatives to reduce the corporate-tax rate from 35% to 15%, and to make up for the lost revenues with a border adjustment tax, is dead on arrival. The BAT does not have enough support even among Republicans, and it would violate World Trade Organization rules. The Republicans’ proposed tax cuts would create a $2 trillion revenue shortfall over the next decade, and they cannot plug that hole with revenue savings from their health-care reform plan or with the $1.2 trillion that could have been expected from a BAT.

The Republicans must now choose between passing their tax cuts (and adding $2 trillion to the public debt) and pursuing a much more modest reform. The first scenario is unlikely for three reasons. First, fiscally conservative congressional Republicans will object to a reckless increase in the public debt. Second, congressional budget rules require any tax cut that is not fully financed by other revenues or spending cuts to expire within ten years, so the Republicans’ plan would have only a limited positive impact on the economy.

And, third, if tax cuts and increased military and infrastructure spending push up deficits and the public debt, interest rates will have to rise. This would hinder interest-sensitive spending, such as on housing, and lead to a surge in the US dollar, which could destroy millions of jobs, hitting Trump’s key constituency – white working-class voters – the hardest.

Moreover, if Republicans blow up the debt, markets’ response could crash the US economy. Owing to this risk, Republicans will have to finance any tax cuts with new revenues, rather than with debt. As a result, their roaring tax-reform lion will most likely be reduced to a squeaking mouse.

Even cutting the corporate tax rate from 35% to 30% would be difficult. Republicans would have to broaden the tax base by forcing entire sectors – such as pharmaceuticals and technology – that currently pay little in taxes to start paying more. And to get the corporate-tax rate below 30%, Republicans would have to impose a large minimum tax on these firms’ foreign profits. This would mark a departure from the current system, in which trillions of dollars in foreign profits remain untaxed unless they are repatriated.

During the presidential campaign, Trump proposed a one-time 10% repatriation-tax “holiday” to encourage American companies to bring their foreign profits back to the United States. But this would deliver only $150-200 billion in new revenues – less than 10% of the $2 trillion fiscal shortfall implied by the Republicans’ plan. In any case, revenues from a repatriation tax should be used to finance infrastructure spending or the creation of an infrastructure bank.
Some congressional Republicans who already know that the BAT is a non-starter are now proposing that the corporate income tax be replaced with a value-added tax that is legal under WTO rules. But this option isn’t likely to go anywhere, either. Republicans themselves have always strongly opposed a VAT, and there is even an anti-VAT Republican caucus in Congress.

The traditional Republican view holds that such an “efficient” tax would be too easy to increase over time, making it harder to “starve the beast” of “wasteful” government spending. Republicans point to Europe and other parts of the world where a VAT rate started low and gradually increased to double-digit levels, exceeding 20% in many countries.

Democrats, too, have historically opposed a VAT, because it is a highly regressive form of taxation. And while it could be made less regressive by excluding or discounting food and other basic goods, that would only make it less appealing to Republicans. Given this bipartisan opposition, the VAT – like the BAT – is already dead in the water.

It will be even harder to reform personal income taxes. Initial proposals by Trump and the Republican leadership would have cost $5-9 trillion over the next decade, and 75% of the benefits would have gone to the top 1% – a politically suicidal idea. Now, after abandoning their initial plan, Republicans claim they want a revenue-neutral tax cut that includes no reductions for the top 1% of earners.

But that, too, looks like mission impossible. Implementing revenue-neutral tax cuts for almost all income brackets means that Republicans would have to phase out many exemptions and broaden the tax base in ways that are politically untenable. For example, if Republicans eliminated the mortgage-interest deduction for homeowners, the US housing market would crash.

Ultimately, the only sensible way to provide tax relief to middle- and lower-income workers is to raise taxes on the rich. This is a socially progressive populist idea that a pseudo-populist plutocrat like Trump will never accept. So, it looks like Republicans will continue to delude themselves that supply-side, trickle-down tax policies work, in spite of the overwhelming weight of evidence to the contrary.

Monday, March 27, 2017

Donald Trump Border Adjustment Tax

The United States may be about to implement a border adjustment tax. The Republican Party, now in control of the legislative and executive branches, views a BAT – which would effectively subsidize US exporters, by giving them tax breaks, while penalizing US companies that import goods – as an important element of corporate-tax reform. They claim that it would improve the US trade balance, while boosting domestic production, investment, and employment. They are wrong.

The truth is that the Republicans’ plan is highly problematic. Along with other proposed reforms, the BAT would turn the US corporate income tax into a tax on corporate cash flow (with border adjustment), implying far-reaching consequences for US companies’ competitiveness and profitability.

Some sectors or firms – especially those that rely heavily on imports, such as US retailers – would face sharp increases in their tax liabilities; in some cases, these increases would be even greater than their pre-tax profits. Meanwhile, sectors or firms that export, like those in manufacturing, would enjoy significant reductions in their tax burden. This divergence seems both unwarranted and unfair.

The BAT would have other distributional implications, too. Studies indicate that it may hit consumers among the bottom 10% of income earners hardest. Yet it has been promoted as a way to offset the corporate-tax cuts that Republicans are also pushing – cuts that would ultimately benefit those at the top of the income distribution.

Making matters worse, the BAT would not actually protect US firms from foreign competition. Economic theory suggests that, in principle, a BAT could push up the value of the dollar by as much as the tax, thereby nullifying its effects on the relative competitiveness of imports and exports.

Moreover, the balance-sheet effects of dollar appreciation would be large. Because most foreign assets held by US investors are denominated in a foreign currency, the value of those assets could be reduced by several trillion dollars, in total. Meanwhile, the highly indebted emerging economies would face ballooning dollar liabilities, which could cause financial distress and even crises.

Even if the US dollar appreciated less than the BAT, the pass-through from the tax on imports to domestic prices would imply a temporary but persistent rise in the inflation rate. Some studies suggest that, in the BAT’s first year, the new tax could push up US inflation by 1%, or even more. The US Federal Reserve may respond to such an increase by hiking its policy rate, a move that would ultimately lead to a rise in long-term interest rates and place further upward pressure on the dollar’s exchange rate.

Yet another problem with the BAT is that it would create massive disruptions in the global supply chains that the US corporate sector has built over the last few decades. By undermining companies’ capacity to maximize the efficiency of labor and capital allocation – the driving motivation behind offshoring – the BAT would produce large welfare costs for the US and the global economy.

The final major problem with the BAT is that it violates World Trade Organization rules, which allow border adjustment only on indirect taxation, such as value-added tax, not on direct taxes, like those levied on corporate income. Given this, the WTO would probably rule the BAT illegal. In that case, the US could face retaliatory measures worth up to $400 billion per year if it didn’t repeal the tax. That would deal a serious blow to US and global GDP growth.

So how likely is the US to enact the BAT? The proposal has the support of the Republican majority in the House of Representatives, but a number of Senate Republicans are likely to vote against it. Democrats in both houses of Congress are likely to vote against the entire proposed corporate-tax reform, including the BAT.

The executive branch is also split on the issue, with President Donald Trump’s more protectionist advisers supporting it and his more internationalist counselors opposing it. Trump himself has sent mixed signals.

Disagreement over the BAT extends to business as well, with firms that export more than they import supporting it, and vice versa. As for the general public, low- and middle-income households should oppose the BAT, which would drive up prices of the now-cheap imported goods that these groups currently consume, though Trump’s blue-collar constituents, particularly those who work in manufacturing, may support the measure.

Ultimately, the case for the BAT is relatively weak – far weaker than the case against it. While this may be enough to ensure that it doesn’t pass, there are strong protectionist forces in the US government pushing hard for it and similar policies. Even if the BAT is rejected, the risk of a damaging global trade war triggered by the Trump administration will continue to loom large. 

Tuesday, March 21, 2017

Fed tightening will affect the markets and growth


Markets are overestimating the positives of the US-Trump policies. Infrastructure, stimulus, deregulation, tax cuts: I think Trump will achieve much less on those dimensions. And they're underestimating the risk that the U.S. protectionist policies are going to lead to trade wars, that the restrictions on immigration are going to slow down labor supply, and that micromanaging the corporate sector is going to be negative.

Over the next six to 12 months, maybe the positives are going to dominate because you have animal spirits, a build-up in consumer and business confidence, you'll have some policy action. The economy is growing and hopefully those positives are going to stay for a while.

But the more there's going to be trade friction, the more there will be restriction of migration, the more this stimulus is going to be excessive, forcing the Fed in a full-employment economy to tighten more and faster, the more some of these negatives start to effect markets and economic growth over time.

China's credit-fueled fixed investment

That means more bad debts, more bad assets, more leverage, and more overcapacity. So you are kicking the can down the road, you are stabilizing growth in the short run. Of course, this is the year of stability given the political transition in China, but then you might be creating more financial vulnerability over the medium term that you're not addressing.

Reforms so far are stalled, restructuring is so far stalled, especially of [state-owned enterprises] of the financial system, and that's a danger that is building up for the future.

Tuesday, February 14, 2017

Dollar rise under Trump could hurt US manufacturers

When Donald Trump was elected President of the United States, stock markets rallied impressively. Investors were initially giddy about Trump’s promises of fiscal stimulus, deregulation of energy, health care, and financial services, and steep cuts in corporate, personal, estate, and capital-gains taxes. But will the reality of Trumponomics sustain a continued rise in equity prices?

It is little wonder that corporations and investors have been happy. This traditional Republican embrace of trickle-down supply-side economics will mostly favor corporations and wealthy individuals, while doing almost nothing to create jobs or raise blue-collar workers’ incomes. According to the nonpartisan Tax Policy Center, almost half of the benefits from Trump’s proposed tax cuts would go to the top 1% of income earners.

Yet the corporate sector’s animal spirits may soon give way to primal fear: the market rally is already running out of steam, and Trump’s honeymoon with investors might be coming to an end. There are several reasons for this.

For starters, the anticipation of fiscal stimulus may have pushed stock prices up, but it also led to higher long-term interest rates, which hurts capital spending and interest-sensitive sectors such as real estate. Meanwhile, the strengthening dollar will destroy more of the jobs typically held by Trump’s blue-collar base. The president may have “saved” 1,000 jobs in Indiana by bullying and cajoling the air-conditioner manufacturer Carrier; but the US dollar’s appreciation since the election could destroy almost 400,000 manufacturing jobs over time.

Moreover, Trump’s fiscal-stimulus package might end up being much larger than the market’s current pricing suggests. As Presidents Ronald Reagan and George W. Bush showed, Republicans can rarely resist the temptation to cut corporate, income, and other taxes, even when they have no way to make up for the lost revenue and no desire to cut spending. If this happens again under Trump, fiscal deficits will push up interest rates and the dollar even further, and hurt the economy in the long term.

A second reason for investors to curb their enthusiasm is the specter of inflation. With the US economy already close to full employment, Trump’s fiscal stimulus will fuel inflation more than it does growth. Inflation will then force even Janet Yellen’s dovish Federal Reserve to hike up interest rates sooner and faster than it otherwise would have done, which will drive up long-term interest rates and the value of the dollar still more.

Third, this undesirable policy mix of excessively loose fiscal policy and tight monetary policy will tighten financial conditions, hurting blue-collar workers’ incomes and employment prospects. An already protectionist Trump administration will then have to pursue additional protectionist measures to maintain these workers’ support, thereby further hampering economic growth and diminishing corporate profits.

If Trump takes his protectionism too far, he will undoubtedly spark trade wars. America’s trading partners will have little choice but to respond to US import restrictions by imposing their own tariffs on US exports. The ensuing tit-for-tat will hinder global economic growth, and damage economies and markets everywhere. It is worth remembering how America’s 1930 Smoot-Hawley Tariff Act triggered global trade wars that exacerbated the Great Depression.

Fourth, Trump’s actions suggest that his administration’s economic interventionism will go beyond traditional protectionism. Trump has already shown his willingness to target firms’ foreign operations with the threat of import levies, public accusations of price gouging, and immigration restrictions (which make it harder to attract talent).

The Nobel laureate economist Edmund S. Phelps has described Trump’s direct interference in the corporate sector as reminiscent of corporatist Nazi Germany and Fascist Italy. Indeed, if former President Barack Obama had treated the corporate sector in the way that Trump has, he would have been smeared as a communist; but for some reason when Trump does it, corporate America puts its tail between its legs.

Fifth, Trump is questioning US alliances, cozying up to American rivals such as Russia, and antagonizing important global powers such as China. His erratic foreign policies are spooking world leaders, multinational corporations, and global markets generally.

Finally, Trump may pursue damage-control methods that only make matters worse. For example, he and his advisers have already made verbal pronouncements intended to weaken the dollar. But talk is cheap, and open-mouth operations have only a temporary effect on the currency.

This means that Trump might take a more radical and heterodox approach. During the campaign, he bashed the Fed for being too dovish, and creating a “false economy.” And yet he may now be tempted to appoint new members to the Fed Board who are even more dovish, and less independent, than Yellen, in order to boost credit to the private sector.
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If that fails, Trump could unilaterally intervene to weaken the dollar, or impose capital controls to limit dollar-strengthening capital inflows. Markets are already becoming wary; full-blown panic is likely if protectionism and reckless, politicized monetary policy precipitate trade, currency, and capital-control wars.

To be sure, expectations of stimulus, lower taxes, and deregulation could still boost the economy and the market’s performance in the short term. But, as the vacillation in financial markets since Trump’s inauguration indicates, the president’s inconsistent, erratic, and destructive policies will take their toll on domestic and global economic growth in the long run. 

Thursday, January 12, 2017

Monday, January 9, 2017

Protectionism and Nationalist policies could lead to more conflict around the world

Donald Trump’s election as president of the United States does not just represent a mounting populist backlash against globalization. It may also portend the end of Pax Americana — the international order of free exchange and shared security the U.S. and its allies built after World War II.

That U.S.-led global order has enabled 70 years of prosperity. It rests on market-oriented regimes of trade liberalization, increased capital mobility, and appropriate social-welfare policies; backed by American security guarantees in Europe, the Middle East, and Asia, through NATO and various other alliances.

Trump, however, may pursue populist, anti-globalization, and protectionist policies that hinder trade and restrict the movement of labor and capital. And he has cast doubt on existing U.S. security guarantees by suggesting he will force America’s allies to pay for more of their own defense. If Trump is serious about putting “America first,” his administration will shift U.S. geopolitical strategy toward isolationism and unilateralism, pursuing only the national interests of the homeland.

When the U.S. pursued similar policies in the 1920s and 1930s, it helped sow the seeds of World War II. Protectionism, starting with the Smoot-Hawley Tariff, which affected thousands of imported goods, triggered retaliatory trade and currency wars that worsened the Great Depression. More important, American isolationism — based on a false belief that the U.S. was safely protected by two oceans — allowed Nazi Germany and Imperial Japan to wage aggressive war and threaten the entire world. With the attack on Pearl Harbor in December 1941, the U.S. was finally forced to take its head out of the sand.

Today, too, a U.S. turn to isolationism and the pursuit of strictly U.S. national interests may eventually lead to a global conflict. Even without the prospect of American disengagement from Europe, the European Union and the eurozone already appear to be disintegrating, particularly in the wake of the United Kingdom’s June Brexit vote and Italy’s failed referendum on constitutional reforms in December. Moreover, in 2017, extreme anti-Europe left- or right-wing populist parties could come to power in France and Italy, and possibly in other parts of Europe.

Without active U.S. engagement in Europe, an aggressively revanchist Russia will step in. Russia is already challenging the U.S. and the EU in Ukraine, Syria, the Baltics, and the Balkans, and it may capitalize on the EU’s looming collapse by reasserting its influence in the former Soviet bloc countries, and supporting pro-Russia movements within Europe. If Europe gradually loses its U.S. security umbrella, no one stands to benefit more than Russian President Vladimir Putin.

Trump’s proposals also threaten to exacerbate the situation in the Middle East. He has said that he will make America energy independent, which entails abandoning U.S. interests in the region and becoming more reliant on domestically produced greenhouse-gas-emitting fossil fuels. And he has maintained his position that Islam itself, rather than just radical militant Islam, is dangerous. This view, shared by Trump’s incoming national security adviser, General Michael Flynn, plays directly into Islamist militants’ own narrative of a clash of civilizations.

Meanwhile, an “America first” approach under Trump will likely worsen the longstanding Sunni-Shia proxy wars between Saudi Arabia and Iran. And if the U.S. no longer guarantees its Sunni allies’ security, all regional powers — including Iran, Saudi Arabia, Turkey, and Egypt — might decide that they can defend themselves only by acquiring nuclear weapons, and even more deadly conflict will ensue.

In Asia, U.S. economic and military primacy has provided decades of stability; but a rising China is now challenging the status quo. U.S. President Barack Obama’s strategic “pivot” to Asia depended primarily on enacting the 12-country Trans-Pacific Partnership, which Trump has promised to scrap on his first day in office. Meanwhile, China is quickly strengthening its own economic ties in Asia, the Pacific, and Latin America through its “one belt, one road” policy, the Asian Infrastructure Investment Bank, the New Development Bank (formerly known as the BRICS bank), and its own regional free-trade proposal to rival the TPP.

If the U.S. gives up on its Asian allies such as the Philippines, South Korea, and Taiwan, those countries may have no choice but to prostrate themselves before China; and other U.S. allies, such as Japan and India, may be forced to militarize and challenge China openly. Thus, an American withdrawal from the region could very well eventually precipitate a military conflict there.

As in the 1930s, when protectionist and isolationist U.S. policies hampered global economic growth and trade, and created the conditions for rising revisionist powers to start a world war, similar policy impulses could set the stage for new powers to challenge and undermine the American-led international order. An isolationist Trump administration may see the wide oceans to its east and west, and think that increasingly ambitious powers such as Russia, China, and Iran pose no direct threat to the homeland.

But the U.S. is still a global economic and financial power in a deeply interconnected world. If left unchecked, these countries will eventually be able to threaten core U.S. economic and security interests — at home and abroad — especially if they expand their nuclear and cyber-warfare capacities. The historical record is clear: protectionism, isolationism, and “America first” policies are a recipe for economic and military disaster.