Warning signs are flashing brightly, suggesting that a downturn in the U.S. economy is likely in the next year. If it comes, President Trump has certainly earned his share of the blame — though not for the reasons many suggest. His tariffs are not the core problem. Instead, chaos and lack of commitment to clear, stated economic priorities pose a much bigger challenge.
There are indeed trouble signs. Consumers have been carrying the economy lately, with consumer purchasing responsible for essentially all GDP growth in the second quarter of 2019. Yes, there was a small increase in government spending. But it was more than offset by problems in the other two major components of GDP — private investment (which declined) and the U.S. goods trade deficit (which keeps rising).
Notably, consumer sentiment plunged in August, recording its largest monthly decline since December 2012. Some attribute these challenges to the Trump tariffs — and “rising tariffs” were indeed cited by one-third of participants in a recent economic survey.
But economist Paul Krugman has noted that “protectionism” gets an “excessively bad rap.” Krugman explains that even high tariffs don’t always cause unemployment since they can be offset by gains in import-competing industries.
It’s important to note the implication of what Krugman is saying here. Yes, tariffs can make the economy slightly less efficient. But overall employment may be largely unaffected. It’s also true that farmers have been hurt by retaliatory tariffs. But they’ve been suffering from falling grain prices for several years. Soybean prices have fallen 40 percent since 2014, for example. Much of that has been driven by a U.S. dollar that is now continually increasing in value. As the dollar rises, U.S. grain prices must fall for soybeans and other commodities to remain competitive with overseas producers, and much of that damage happened before Trump was elected.
To offset this currency problem and rebuild America’s agricultural and manufacturing sectors, the U.S. dollar must move to a more competitive level. But that’s a battle the president continues to overlook as he focuses primarily on tariffs.
If there are larger problems from the Trump tariffs, they stem from the uncertainty and confusion with which they’ve been applied. In recent months, new tariffs have been announced, then postponed, then announced again at even higher levels. The president even suggested ordering U.S. companies out of China. And at the G7 summit, he told reporters he was having “second thoughts.” But last week, his administration announced a new round of trade negotiations with Beijing — and Wall Street celebrated.
All this uncertainty is bad for business. And business investment declined sharply in the second quarter, with overall GDP growth declining to 2.0 percent. That’s down from 3.0 percent in the first quarter. Estimates of current, third quarter growth from the Federal Reserve Banks in Atlanta and New York have fallen to 1.5 percent, and the New York Fed estimates that growth in the fourth quarter will fall to 1.1 percent.
Contributing to this decline is the August ISM manufacturing report, which showed that new orders, production and employment are all contracting. And employment growth fell below expectations in August, with average monthly job creation dropping by nearly a third — from 208,000 last year to 143,000 in 2019.
A real cause for concern is the so-called yield curve “inversion.” Short-term interest rates on government securities are now well above those for longer term Treasuries. This is noteworthy since the bond market has “predicted six of the last six recessions.”
Last month, the New York Federal Reserve’s estimate for the probability of a recession reached its highest level since 2007. They suggest a 37.3 percent chance of recession in the next 12 months. That’s troubling since their model has exceeded 30 percent before every recession since 1960. And the previous peak in their index came in March 2007, nine months before the onset of the Great Recession.
Contributing to all of this was the premature decision by the Federal Reserve Board of Governors to raise short-term interest rates a full 2.5 percent over the past two years. Their decision came despite any signs of excessive inflation or overheating in the economy.
Another problem is that Trump has failed to shrink the U.S. trade deficit. And his freewheeling approach has made things worse by discouraging investment while also distressing consumers. And even with his tariffs, the U.S. trade deficit has continued to rise over the past two years. This shouldn’t be a surprise, however. As noted above, the U.S. dollar has risen 20 percent in real value over the past five years. That has made imports artificially cheap, and U.S. exports more expensive in world markets.
A rising dollar matters greatly in the current mix, and Senators Tammy Baldwin (D-WI) and Josh Hawley (R-MO) have introduced legislation that would impose a tax on foreign capital inflows to help lower the value of the dollar. That could increase U.S. export competitiveness — which would finally start shrinking America’s massive trade deficit.
There are other opportunities, though. More than $2 trillion of investment is needed for America’s crumbling infrastructure. Given today’s low interest rates, the timing is right — and this could be extended to launching a needed transition into renewable energy programs.
All of these efforts can be put in place today to help rebuild the U.S. economy, and manufacturing in particular. Commonsense efforts are sorely needed right now to avoid a recession that is looking more likely.
Robert E. Scott is a senior economist with the Economic Policy Institute Policy Center.