July 28, 2019
The Trade War Is Slowing Our Economy
The Federal Reserve Open Market Committee meets this week to consider whether to ease the money supply. The most obvious mechanism for doing this is by reducing the interest rates they charge member banks. This change will filter quickly to bank loans on cars, on homes and eventually on credit cards. More money leads to lower borrowing rates for consumers and businesses.
The timing of the Fed’s action is subject to real criticism, and two members of the committee have spoken publicly against a rate increase. At the same time, a Fed nominee has argued in favor of a large cut. Both of these actions are unusual. Fed members usually do not air their disagreements in this way, and Fed nominees are usually tight-lipped about policy choices before the Fed. We live in interesting times.
The global economy is clearly slowing. China is likely in a recession, though their publicly available data is hard to believe. There was even evidence last week of a liquidity crisis emerging between their banks. China is hardly a democracy that must suffer the ignominy of publicly available economic data, so it is hard to be sure what is happening.
Several European economies are on the edge of recession, and the United Kingdom is still trying to extricate itself from the European Union. So, interest rates around much of the world are now lower than in the U.S. It may be that we are opting to lower rates to prevent capital inflows, but we won’t really know the reasoning for a few weeks.
Domestically, economic performance continues to slow. Industrial production is now down for the year. Retail spending had a very poor performance last month and labor markets appear to be cooling. Incomes growth slowed last month, though it was a modest decline. Still, all four major recession indicators are either negative or slowing.
Labor market revisions have trended downwards over the past six months. This is unusual, but recent data suggests employment growth in smaller businesses has declined. We survey small businesses less heavily than big ones, so the downward revisions may indicate a softening labor market that only becomes apparent in the administrative data.
Manufacturing intensive places are also seeing slower growth. Indiana is now in its fifth month of manufacturing employment declines. The sustained factory job growth that buoyed us from the end of the recession is now over.
Declining factory employment is especially obvious in places like Elkhart, Ind., the home of the American RV industry. Labor markets are still tight, but the unemployment rate has risen since last year. RV sales were down modestly in 2018, falling about 4.1 percent from the record year of 2017. As of the end of May, sales were down 22 percent from 2018. Broad layoffs in that sector and its suppliers seem imminent.
The timing of the Fed decision on Monday actually causes me to be more, rather than less, concerned about the business cycle. I still predict only a slowing economy, rather than a full-out recession. However, if the majority of Fed members believe a rate cut is needed; their models must be signaling the start of a recession.
One reason to be optimistic is that this recession has policy-induced roots in the growing trade war. The tariffs themselves are enough to modestly slow the economy, but not enough to cause a recession. Retaliatory tariffs worsen the effects, but as the trade war has expanded in geography, scope and uncertainty, firms respond through a very costly process of moving their supply chains. These small frictions contribute to a slowdown. A trade war can cause a recession, and at the very least make one far worse than it might have otherwise been.
Any belief that a trade war would bring factory jobs back to the U.S. was always spurious nonsense. So, if we are looking for silver linings to a downturn, it is in relearning some of the lessons of the last trade war. Hopefully, they won’t be as costly as they were back in 1930.
About the Author
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