Steve Mnuchin desperately needs an economics lesson

Judging by Steven Mnuchin’s performance in his first year in office, one has to wonder whether an Economics 101 course should not be a prerequisite for being Treasury secretary of the world’s largest economy. Maybe then the U.S. and world economies would be spared from the long-run economic damage from ill-advised U.S. economic policy decisions.

Among the more egregious policy decisions to which Mnuchin has given his wholehearted support was the recent unfunded Trump tax cut. According to estimates from the nonpartisan Congressional Budget Office, this tax cut must be expected to increase the budget deficit and to add around $1.5 trillion to the country’s public debt over the next decade.

{mosads}Never mind that a U.S. economy operating at close to full employment and already growing at a healthy clip does not need policy stimulus.

Never mind also that the economy is already receiving a big boost from still abnormally low interest rates and from both a 25-percent increase in equity prices and a 10-percent dollar depreciation since the start of the Trump administration.

Had Mnuchin been versed in economic history, he would have been familiar with the many countries that have got themselves into economic trouble by a lack of budget discipline and by an excessive debt build-up. He would also have learned that even the most diehard of Keynesian economists would not be promoting budget stimulus at a time of cyclical economic strength.

Rather, they too would subscribe to the erstwhile Republican idea that in the good times, the budget deficit and public debt level should be reduced so as to make room for budget stimulus, if and only if needed, when the economy moves into recession.

Had Mnuchin taken a course in monetary economics, he would have understood the extraordinarily difficult position in which he has put the Federal Reserve.

The last thing that the Federal Reserve now needs is to have the economy receive a sizeable fiscal stimulus at a time that it was already close to full employment and at a time that it was already receiving strong stimulus from a combination of still very low interest rates, buoyant equity prices and a slumping U.S. dollar.

Unless the laws of economics have changed since Mnuchin took office, an overheated economy is bound to lead to higher inflation. That in turn will either force the Federal Reserve to move to a higher interest rate path or else to have it risk incurring the wrath of the bond market vigilantes once the first signs of inflation emerge.

In either event, Mnuchin’s budget recklessness could very well have advanced the date at which today’s global asset market price bubbles burst. 

If there can be any doubt about Mnuchin’s lack of grasp of monetary and public finance economics, his recent Davos pronouncements on the U.S. dollar can leave little doubt about his illiteracy on international economics.

This would seem to be the only way to describe his decision to talk down the U.S. dollar and to break from the decades’ long mantra of successive U.S. Treasury secretaries about the country’s interest in having a strong dollar.

There are two basic points that Mnuchin does not seem to grasp about international economics: The first is that the U.S. derives considerable benefit from having the dollar be the world’s major international reserve currency and that the dollar has earned that status by virtue of being a strong currency.

Talking down the dollar puts that predominant status at risk. That explains why previous Treasury secretaries have been very careful not to stray from a strong dollar policy.

The second and more important point that he misses is that the U.S. trade balance is determined not by the level of a country’s exchange rate. Rather, it is determined by the difference between the country’s saving and investment levels.

If a country saves less than it invests, as is the case in the United States, it will run a trade deficit irrespective of the level of its currency.

Had Mnuchin understood this basic point of economics, he would not now be wasting his time promoting a weak dollar. Rather, he would be making every effort to increase the country’s savings rate.

Needless to say, he certainly would not have supported an unfunded tax cut that will almost certainly weaken the country’s public savings level and lead to a widening of the trade deficit.

If past is prologue to the future, in the year ahead, Mnuchin is almost certain to get a costly economic tutorial from the untoward consequences of his policies. The pity for the American public is that he did not get that tutorial at a cheaper price while he was still in college.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.