The ‘stable genius’ has the world economy on a knife edge

Economists are reaching into history books to explain the turmoil unleashed by US President Donald Trump and his war on trade.

Terms such as stagflation, comparisons with the Great Depression, biographies of Reed Smoot and Willis Hawley – all have featured as analysts seek to explain the economic fallout from Trump’s tariff agenda.

Donald Trump waves goodbye to trillions of dollars in the wake of his tariff war.Credit: AP

That real fallout is evident everywhere. From the hit to superannuation balances to the 10 per cent drop in consumer confidence, as tracked by the closely watched Westpac-Melbourne Institute measure of consumer sentiment, the effect of Trump’s plan is unavoidable.

Most concerning is what is playing out in the United States.

The Atlanta Federal Reserve produces a “nowcast” of America’s GDP – an approximation of how the economy is performing in real time. As national accounts can take months to be fully compiled by statistical agencies, a short, sharp analysis is very useful to central bankers.

According to the Atlanta Fed, the US economy contracted by 2.8 per cent through the first three months of this year. A month ago, it was expecting growth of close to 3 per cent.

That’s before the full extent of Trump’s tariffs were known, before the bloodbath on global equity markets, before China said it would impose its own 34 per cent tariff on American imports and before Trump said he would hit China with an extra 50 per cent tariff.

The US Conference Board measure of consumer confidence fell by 7.2 per cent late last month, its fourth consecutive fall.

Its measure of consumer expectations dropped an alarming 12.8 per cent to its lowest level in a dozen years. It is at the level associated with an American recession.

All of this was measured before Trump declared war on Australian penguins and Norwegian reindeer.

One of the world’s best economic modellers, Warwick McKibbin, produced the model used by the Australian Treasury to determine the hit caused by Trump’s tariffs. At a 0.2-percentage point permanent reduction in Australian economic growth, it’s measurable but not end-of-the-world levels.

It’s certainly not associated with a recession as some have suggested. The economy continues to grow, albeit a little more slowly. It’s one of the reasons financial markets are pricing in interest rate cuts from next month as the Reserve Bank steps in to stabilise the economy.

But McKibbin’s modelling paints a bleak picture of what Trump’s tariffs will do to Americans.

Demand for labour in durable-goods manufacturing – products made to be used for a long time such as cars and washing machines – falls by 7.5 per cent over the next 12 months. This is the sector he is ostensibly trying to save, but the reality of pushing up the price of key inputs is that businesses will lay off staff.

Prices for US agricultural goods are expected to rise, while employment in the sector is tipped to fall, because of Trump’s tariffs.Credit: Bloomberg

Mining (down 4.5 per cent), agriculture (down 4.3 per cent) and non-durable manufacturing, which includes clothes and shoes (down 2 per cent), will all need fewer workers. The only part of the US economy that adds workers is the services sector, which is America’s greatest economic strength.

The reduction in jobs is due to sectors producing less. Durable manufacturing output is modelled to fall by 8 per cent alone.

And then there’s the inflation impact. Prices for durable manufactured goods are likely to rise by 3.4 per cent in the next 12 months. Prices for every other part of the economy are tipped to climb.

McKibbin says these results highlight the problem facing Trump, who wants to end any trade deficit America runs with any country.

“The goal of eliminating the US trade deficit one bilateral trade balance at a time cannot work without severe strain on the US economy,” he said.

“The US runs trade deficits because it spends more than its income (or has sufficient savings to match investment). This can be eliminated by earning more or spending less or saving more or investing less. Spending less is the likely outcome of a trade war.”

It’s this combination of slower growth and higher prices in the US that has prompted the resurrection of the term stagflation – a word last used in the 1970s to describe that decade’s terrible rolling recessions and soaring inflation.

The last time the Federal Reserve faced stagflation, it drove America into a deep recession to kill inflation.

Fortunately for Australians, with both the government and Coalition resisting the urge to slap retaliatory tariffs on American imports, which would drive up the prices of things such as planes, trucks and computers, the chances of stagflation here are remote.

That’s about the only upside to a global trade war with America and China at its centre.

Some analysts believe that if Trump steps back from his tariffs, normality will return to the global economy and equity markets.

Peter Berezin, chief global strategist at BCA Research who late last year put the chance of a recession this year at 75 per cent because of Trump’s tariff agenda, is not convinced.

“I do think that at this point, we might have passed the event horizon, meaning that even if Trump backs off from the tariffs, there’s been enough damage done to the US economy, to the global economy, to investor confidence, consumer confidence, that we’re probably going to see a recession regardless of what happens,” he told the New York Times on Tuesday.

All of this is being driven by the self-described “stable genius”, Donald Trump.

People gather across from the New York Stock Exchange in October 1929 as the stock market crash that would precipitate the Great Depression gets under way.Credit: AP

In his seminal book, The Great Crash, 1929, acclaimed economist John Kenneth Galbraith had this to say about the geniuses behind the financial mistakes that helped cause the Great Depression.

“If one has been a financial genius, faith in one’s genius does not dissolve at once,” he wrote.

Trump has shown no signs yet that he has lost faith in his tariff plan despite all evidence to the contrary that he should.

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