Hey Joe

Four years ago I watched the inauguration of Donald Trump as US President with a sense of trepidation. As I noted at the time there was a lot to be fearful about as he played the America first card, particularly with regard to the economics. Today the great Trump experiment came to an end and liberals around the world breathed a sigh of relief. There was almost unanimous support at the liberal end of the social media spectrum for Joe Biden, and although he is not known for being a great orator, his calls for unity and the sanctity of truth in his acceptance speech were widely praised.

Although Trump vowed in his departure speech that he will be "back in some form", it is unlikely to be in the role of President. His age may not necessarily count against him – he will be 78 at the time of the next election which is the same age as Biden today – but a bigger problem is that many Republican donors are unlikely to want to renew their association in the wake of Trump’s role in inciting the storming of the Capitol two weeks ago. Although Trump is the only President to have twice been impeached, he is still the figurehead for a movement which has huge support in US politics. He may yet play a pivotal role in endorsing a credible nationalist candidate who will make a successful run for the White House in 2024. That, however, is a topic for another day.

As Biden settles into his new role he has his work cut out. As he acknowledged in today’s speech he takes office at a time of unprecedented disunity and the divisions which have plagued American society are not about to suddenly disappear, partly driven as they are by deep-seated economic issues that will take years to resolve. That said Biden is more likely to pour oil on the waters than oil on the flames and the absence of inflammatory messages from the White House which did so much to foment anger in US society will hopefully go some way towards lowering the temperature.

Short-term issue: Stabilising the economy

Social divisions are not the only problem facing the US. In the short-term, the Biden Administration will have to deal with the economic fallout from the pandemic which has now claimed the lives of 400,000 citizens (for the record, this is roughly equivalent to the population of Tulsa). His nomination of Janet Yellen as Treasury Secretary suggests he means business. Yellen is a heavyweight economist who knows her way around Washington and assuming she is accepted by Congress, Yellen will be responsible for implementing the $1.9 trillion fiscal package unveiled last week which will provide support to an economy battered by Covid.

In particular the Administration seeks to provide labour market support, including sending out cheques for $1,400 per person for those under certain income thresholds; extending emergency unemployment insurance programmes through the end of September and a plan to raise the minimum wage to $15 per hour. In her Congressional confirmation hearing yesterday, Yellen responded to concerns about raising the minimum wage by citing the economic literature indicating that it would have only have minimal effects on job losses. Against that estimates produced by the Congressional Budget Office in 2019 suggested that such an increase would reduce employment by 0.8% which is not exactly trivial.

Longer-term issues: China and the climate

In addition to the short-term challenges posed by the Covid crisis, some of the issues that the new Administration will face are more pressing than they were four years ago. China has loomed large in US thinking for a number of years. Trump’s solution to the problem was to confront China head-on and although Yellen called China America's "most important strategic competitor" and said the Biden administration was prepared to use a "full array of tools" to address its "abusive, illegal and unfair practices" it is an even more formidable economic power than four years ago. In simple USD terms, the US economy is now only 40% larger than China compared to 66% four years ago and measured in PPP terms is now around 14% smaller versus broad parity in 2016. Trump’s view that “trade wars are good, and easy to win” was wrong in 2018. Every year that passes disproves this assertion.

Although Chinese GDP measured in dollar terms is unlikely to exceed that of the US in the next four years, it will continue to close the gap. According to the IMF’s latest projections, the US economy may only be 12% larger than China by 2025 which could well nudge ahead before the end of the 2020s. Although it may be toppled from the number one spot before the decade is out, the US has enormous soft power that ought to allow it to continue wielding considerable influence for decades to come. The extent to which it will be able to do so depends on how it manages relationships with its allies. Biden is likely to pursue a considerably different approach to Trump who adopted the old Lord Palmerston maxim that there are no such things as permanent friends, only permanent interests. With Biden expected to signal that the US will rejoin the Paris climate accord and halt its withdrawal from the World Health Organization, this will act as an indication that the US intends to reassert its position as a constructive player on the world stage which will burnish its credentials in the years to come.

Climate change is an area where the US voice has been missing on the world stage in recent years. The Trump Administration took the view that regulations were all cost and no benefit. Yet climate change is increasingly viewed as a national security issue and was recognised by the Obama Administration as a major problem. A report issued almost a year ago by the National Security, Military and Intelligence Panel on Climate Change highlighted the damage that rising temperatures could inflict on the US economy. Efforts to combat climate change require global cooperation and without US support it would be almost impossible to make any headway. A more responsible approach by the Biden Administration would be most welcome.

The future is yet to be written

There are conflicting schools of thought as to what the departure of Donald Trump from the White House will mean for the future of the US. Optimists such as Max Hastings argue that just as America was able to put the turmoil of the 1960s behind it and reinvent itself to become the world’s undisputed superpower, so it will similarly be able to overcome the unrest of recent years to become the confident, outward-looking power that we have grown up with. More pessimistic commentators, such as the prominent conservative Andrew Sullivan, believe that the fissures opened up by the Trump era represent a permanent shift in the US political scene as America adjusts to a new world order. We can only wait for events to unfold.

Twenty years ago it was inconceivable that a populist such as Donald Trump would ever have got near the White House. The classic TV drama, The West Wing, portrayed the US as it liked to see itself – a benevolent superpower acting as a force for good, led by an exceptionally smart president with a positive view of what it could achieve (if you haven’t seen it, it is worth watching and viewers in the UK can catch it here). As the fictional President Bartlet once said “We will do what is hard. We will achieve what is great. This is a time for American heroes and we reach for the stars.” Joe Biden is no Jed Bartlet but if he can put the US back on an even keel he will be hailed – perhaps at home but certainly abroad – as the man who rescued the US from itself.

It's over, yet it isn't

At the time of writing we still do not know who has won the 2020 US Presidential election. Whilst it matters profoundly who gets the keys to the White House, many of the issues raised during the election campaign will remain unresolved. Above all else the election reminded us just how split the US is along cultural lines. It is not my intention to get into the details of how Trump might react if he were to narrowly lose the election or the actions Biden might take if he were pipped at the post. Such issues are well covered in the press (here for example). I wish to focus instead on what the election tells us about the nature of the economic and political system in the US (and maybe also the UK) and what the next four years are likely to bring.

We should start by pointing out that the US is not the only country going through some sort of existential political crisis. I have been highlighting such issues in the UK on this blog for quite some time, but the splits on the other side of the Atlantic have existed for longer and are more entrenched. Indeed almost 15 years ago – long before most people had ever heard of Obama – the academics Mark Brewer and Jeffrey Stonecash argued that the cultural split on social and religious lines is only half the story. Division is also fuelled by differences in income and economic opportunity, as I pointed out a few weeks ago.

With the benefit of hindsight I am not sure whether Obama’s message of hope in 2008 would carry the same resonance today, even though many of the problems remain the same. Perhaps what the US election makes clear is that we are not about to return to a world of consensus anytime soon. Trump is not an outlier representing a deviation from the norm. He is the embodiment of a large slice of the electorate that wishes to overturn the status quo because it has not worked for them. I have made the point repeatedly in recent years that governments promised a quick return to the good times following the GFC in 2008 but have on the whole been unable, or unwilling, to deliver. This was partly a consequence of deliberate actions, with the likes of the UK introducing a policy of fiscal austerity which made such a major contribution to the Brexit vote. In the euro zone it was more by accident than design but simmering tensions between southern Europe and their northern neighbours remains a fault line at the heart of monetary union.

In the US the widening gap between the haves and the have-nots is the result of benign neglect. Trickle-down economics, a corner stone of Ronald Reagan’s policies in the 1980s, has never been repealed but it increasingly appears to be leading to adverse outcomes. Research into US wealth and income equality conducted by the Pew Research Center throws some light onto why people are so dissatisfied. Average household incomes in real terms have basically stagnated over the past 20 years, growing at a miserable 0.25% per annum. In the preceding 30 years they grew at an average rate of 1.2% per year. To put it another way, real incomes are more than 20% lower than they would be had the trend over the period 1970 to 2000 been sustained. Moreover the data also show that households at the upper end of the earnings scale have continued to outperform those lower down the scale.

A similar story holds for wealth where growth in the wealth holdings of upper income families has outstripped that of lower income families. Indeed the disparity has widened in recent years, with the real value of wealth holdings for upper income families having risen since the turn of the century whilst those lower down the scale have seen the real value of their wealth holdings decline (chart). The Pew Center makes the point that high income households are less dependent on the value of their homes to generate wealth and are more likely to hold financial assets whose value has been boosted in the low interest rate environment. It does therefore seem to be the case that policies to boost the stock market really do benefit the already-rich at the expense of the less well off.

It seems obvious that the widening disparity between the rich and the less well-off is a key reason why people continue to vote for Trump. Whatever people may think of him, his electioneering is touched by genius – a multi-millionaire pretends to be on the side of the little guy, promising them they will be better off under his presidency whilst the policies he espouses, such as tax cuts, benefit Trump and his ilk. Throw in the smokescreen of blaming foreigners (in this case the Chinese) for US economic woes and he has it made. However, Trump has done nothing to make life better for his core voters. The way to alleviate some of their problems is to apply a redistributive fiscal policy but that is not going to fly in a country which sees such options as heretical socialism. Indeed, the Republicans hate Obama’s signal policy on healthcare reform because it seems so un-American.

Whoever is the next President is unlikely to redress the balance by raising taxes on higher earners. Bernie Sanders tried to popularise such a policy and look where it got him. However, under a Democratic President there might be a move towards increasing spending. Modern Monetary Theory (MMT) is popular on the left wing of the Democratic Party and may make small steps towards the mainstream. This policy (which I looked at here) in effect suggests that because governments are the monopoly supplier of money they can provide unlimited quantities of liquidity without creating inflation. There is a lot wrong with the economics of MMT – it’s the Democratic equivalent of trickle-down – but it might spark a bigger debate about how to boost public spending to benefit those left behind. The Republicans do not appear to have any new economic ideas other than more of the same. However, this will not help the left-behind and will likely lead to greater stridency as both sides continue to shout at each other across the divide.

There is little doubt that the US, like the UK, needs a radical economic and political overhaul. This is simply not going to happen. As the neoconservative commentator Bill Kristol noted in an article today, the day after the election can be characterised as a mixture of the good, the bad and the ugly. In his view, the good news is that Joe Biden is more likely to be president than Donald Trump – and this from a leading light of the neocon movement. The bad is that the election will leave both the Republicans and the Democrats worse off than before, since the fairly even showing of both parties does not suggest any incentive to rethink their strategy. The ugly is that “after four years of seeing Donald Trump govern … the American people rewarded President Trump with an increased share of the overall vote. To some very real degree … We have met the enemy and he is us.” Whoever occupies the White House in January will continue to face a restive electorate.

The last days of empire?

Most of us are not privileged to witness major historical events at close hand. Even if we did, we would be unlikely to fully understand their significance. Imagine being present at the signing of the Magna Carta in 1215, little knowing that it would represent one of the first attempts to codify individual freedoms that would echo down the centuries. Nor would many people have seen the Ninety-five Theses supposedly pinned to the door of All Saints' Church in Wittenberg by Martin Luther in 1517, but we are all familiar with the resultant splits within the Catholic Church which were arguably a first step on the road to the Age of Enlightenment.

I raise these points because it is impossible to know whether what we are experiencing today reflects a fundamental shift in the way our societies and economies will operate in future or whether it is minor diversion on a path we have been following for the past 75 years. One of the motivating factors for thinking about this was an excellent article on the Mother Jones website by the historian Patrick Wyman who looked at the decline of empire. As Wyman put it, “the fall of an empire …looks more like a cascading series of minor, individually unimportant failures than a dramatic ending that appears out of the blue.” He also makes the point that whilst all societies face challenges and setbacks, what determines the survival of the status quo is the quality of the institutions which are able to define a response. At issue in large parts of the west today is whether the institutional framework is sufficiently robust to face up to the challenges of the 21^st century.

Just weeks away from the US election the world looks on to see whether the Donald Trump experiment will be brought to a halt or whether the process of institutional erosion will be given free rein to continue. In Wyman’s view, the future popular narrative of the relative demise of the US will pin the blame on Trump, “but it’s far more likely that the real meat of the issue will be found in a tax code full of sweetheart deals for the ultra-wealthy, the slashed budgets of county public health offices, the lead-contaminated water supplies. And that’s to say nothing of the decades of pointless, self-perpetuating, and almost undiscussed imperial wars that produce no victories but plenty of expenditures in blood and treasure, and a great deal of justified ill will.” This may not be the version of the US that you recognise or accept. But the wider point is that a country as institutionally strong as the US does not suddenly go from being the only superpower to sharing the stage with others in just four years. Other factors are at play. 

Why the economics matters 

The Nobel Prize winning economist Joseph Stiglitz points to “the growing concentration of market power, which allows dominant firms to exploit their customers and squeeze their employees.” This in turn has allowed shareholders and company managers to expropriate a bigger slice of the pie, leading to widening inequality and further fuelling the sense of resentment which led to Trump being elected in the first place. In Stiglitz’s view a small number of firms dominate key sectors of the US economy, which has allowed them to attain disproportionate political influence “and as the system has become more rigged in business’s favor, it has become much harder for ordinary citizens to seek redress for mistreatment or abuse.” 

To compound these problems, evidence compiled by the World Economic Forum suggests that US social mobility has slowed and maybe even gone into reverse. For generations, workers tended to earn more than their parents. However, the evidence suggests that those born in the 1980s whose parents were in the middle of the income distribution only have a 45% chance of earning more than their parents compared to 59% for those born in the 1970s and 95% for those born in the 1940s (chart below). This is not what the American Dream is made of.

One of the factors underpinning this result is the sluggish pace of wage growth. Real hourly earnings, for example, have increased by only 11.7% since the mid-1960s despite a significant increase in productivity. Moreover there has been particularly rapid growth in the price of services such as health and education. Consumers thus have to devote a much higher slice of their disposable income to educate themselves and maintain their health than they did 50 years ago. The income distribution has also become increasingly skewed in favour of the well-off. According to data from the Pew Research Center households towards the upper end of the income distribution have increased their share of wage income over the past 50 years, from 28% to 48%, at the expense of those in the middle, whose share fell from 62% in 1970 to 43% by 2018 (chart below).

This matters because it is this sense of dissatisfaction that Trump tapped into in 2016. But what is driving it? It may partly be due to the decline in trade union membership since the 1980s which has prevented organised labour from acting as a counterweight to rent seeking company owners. The application of new technology further adds to the pressure by pushing down on the wages of the less well educated segment of the labour force. Of course, these issues are not merely confined to the US – this sense of dissatisfaction was a driving force behind the Brexit referendum result in the UK – but they are more extreme on the other side of the Atlantic. The extent to which politicians are willing to tackle these problems will play a big role in determining how Anglo Saxon society and its economy will look in future and whether it will still be held an example for others to follow. 

And why the response of politicians matters even more 

According to Stiglitz “US corporate executives made sure that the vast majority of the benefits from the [2017] tax cut went into dividends and stock buybacks, which exceeded a record-breaking $1.1 trillion in 2018.” This reinforces the sense that Trump’s economic policies have benefited the rich at the expense of those who voted for him. Yet there is a good reason why this should be the case: Presidential hopefuls require a big war chest, to which big business is more likely to contribute if their interests will be served by the candidate. As the experience of Bernie Sanders illustrates, politicians who are prepared to tackle the redistribution question are unable to generate sufficient buy-in to be elected. Nor is the business capture problem confined to the US. Michel Cames and Eckard Helmers argue (here) that “the European oil industry co-initiated the shift to diesel cars in the 1980s and 1990s in order to find outlets for middle distillates [diesel]” and they did so in tandem with the European Commission by selling it as a way to meet CO₂ reduction targets. Never mind the fact that it raised nitrous oxide levels, with all the attendant health consequences.

The danger in all this is that rising economic inequality and the capture of the political decision making process by big business threatens to further raise the degree of anger at the status quo. This could be used by future generations of nationalist politicians to pursue an agenda which makes that of Trump seem tame. The long-term health of the Anglo Saxon economy and the society which underpins it depends on it being seen to serve the interests of voters. After a decade of uncertainty in the wake of the financial crisis of 2008, and even more so at a time of the unprecedented Covid pandemic, the US and UK are crying out for someone to deliver genuine leadership and make voters believe that the economic system works for them. Failure to act before it is too late risks condemning the Anglo Saxon model to irrelevance. We may not understand the slow process of erosion as we live through it but it will surely be clear to future generations of historians.

Two Angry Men

Those of you unfortunate enough to have watched the US Presidential (so-called) debate were witness to an event which gives democracy a bad name. Chinese officials wanting to demonstrate the superiority of their system could do worse than force the Chinese population to watch the debate in its entirety. It was devoid of form and content and was characterised instead by name calling and fractiousness. Whilst it always matters who wins the US election, this time feels even more important than usual. Moreover, it matters how the aftermath of the election plays out. If, as many fear, Trump loses the election but does not agree to a peaceful transfer of power this would take the US down a dark road from which it might be very difficult to return. However, whilst this is a risk, we should perhaps refrain from getting too far ahead of ourselves. Instead let us confine ourselves to looking at some of the many economic issues that did not get an airing.

Four years on

Four years ago, in what we thought was the most unedifying campaign in history, we were at least able to pick out some discernible economic policies. Both Donald Trump and Hillary Clinton set out a clearly defined tax policy, for example, and Trump gave fair warning of his protectionist trade stance. The economics is less clear cut this time around although that is because tackling the Covid-induced economic collapse and the resulting rise in unemployment are – or should be – priorities for Messrs Trump and Biden. Trump has raised the use of Twitter to an art form and has spent the last four years tweeting about the strength of the stock market as a barometer of the economy’s strength. Although the economy suffered a dramatic plunge in output in the second quarter, with the result that employment levels are back at early-2015 levels, the equity market is broadly back where it was prior to the March collapse. However, it is likely that voters will use the evidence of their labour market experience as a barometer of how strong the economy is rather than rely on the elevated level of the equity market.

It's the economy, stupid

One-term presidents are rare these days and in the last 100 years only Herbert Hoover (1932), Jimmy Carter (1980) and George H. W. Bush (1992) have served a full presidential term only to lose at the second attempt. In all three cases the weakness of the economy was the factor which undermined their efforts to win a second term. The economic position facing Trump less than five weeks ahead of the 2020 election is at least as bad as that facing his predecessors. The role of government in providing support is proving to be one of the more contentious economic policy issues. The Coronavirus Aid, Relief and Economy Security Act (“CARES Act”)  has provided support equivalent to an estimated $2.3 trillion (11% of GDP), whilst the Paycheck Protection Program and Health Care Enhancement Act chipped in another $483billion. Talks on further support are stalled in Congress and time is running out to reach agreement before the election, with the Republicans keen on business support measures whilst the Democrats are looking for more support for individuals (e.g. increased unemployment benefits).

Pressure on the Fed ...

The role of the Federal Reserve could also come under scrutiny after the election. Trump has frequently excoriated Jay Powell (whom Trump nominated) for not doing enough to support the economy even before Covid in a series of messages which are reminiscent of the way Turkish President Erdogan treats the Central Bank of Turkey. We can be certain that if Trump were to win in November the Fed will come under even greater pressure to bow to the demands of the White House. Trump has nominated Judy Shelton to the FOMC – a nominee who believes in returning to the gold standard and has in the past been extremely critical of the Fed. It is uncertain whether she would receive Congressional approval even if Trump were to win. It is pretty certain that she will not get the nod under a Biden presidency. But analogous to the way nominations to the Supreme Court have become another front in the culture war, so the Fed has become another unwilling participant in the war between the various political factions in the US.

... and China 

Whatever else happens, relations with China will dominate the next four years. Trump has made it clear that he is willing to do whatever it takes to ensure the US remains the top dog and the view from China is that he is trying to suppress China’s rise come what may. Just as matters seemed to be cooling earlier this year, events have since heated up again. Trump has demanded that Chinese firm Bytedance, owner of the app TikTok, sell its US operations; he has banned the sale of electronics components to telecom firm Huawei, and has threatened to delist Chinese companies from US stock exchanges. Although under a Biden presidency the China bashing may be less aggressive, the Democrats are not about to re-pivot towards Obama’s pro-Asia stance. Biden's proposed trade plan will confront China in cooperation with allies rather than acting unilaterally on trade, and he plans to tighten rules against corporate inversions to discourage companies from moving overseas.

Health and taxes

One of Trump’s signature polices was the 2017 Tax Cuts and Jobs Act which consisted of a large, permanent tax cut for corporations and temporary cuts to individual taxes that will expire in 2025. One consequence of the Act was that investors used the tax cuts to repatriate funds back to the US and channelled it into share repurchases and dividends, rather than wage increases or investment. Biden’s tax plans point to a swing in the other direction with tax hikes for wealthy individuals and a plan to raise the taxes on long term capital gains to the same rate as normal income. To the extent that the Trump tax plan supported the equity market, Biden’s plans are likely to be a lot less equity supportive.

Healthcare is another major economic issue particularly in the wake of the huge spike in Covid-related deaths. Having failed to repeal Obamacare the Republicans may be treading on thin ice on this issue. Obamacare is generally popular and the House rejected a serious effort to overturn it in 2017 on the grounds it would be a vote loser. We hear far less these days about the negatives of the policy although this does not preclude the Republicans from making another attempt to repeal it in the next four years. But such an attempt would never be passed by a President Biden. Healthcare will thus be one of those issues that the two sides of the political spectrum will fight over when there are less pressing things to worry about.

May the man with the best pitch win

Of course we heard none of this last night. But when it comes down to it the candidates have to realise that attacking each other is pointless – the man who wins on 3 November will be the one who makes the best pitch to restore the living standards of voters. It is hard to make a proper judgement from this side of the Atlantic but if the debate was anything go by, that person is not Donald Trump.

Trump, tariffs and beyond

As the world now knows, Donald Trump followed through on last weekend’s tweet promising to raise tariff rates on USD200 bn of Chinese imports from 10% to 25%. The fact that some of the heat appeared to go out of the tariff wars towards the end of last year suggested that both sides realised there was nothing to be gained from continually ramping up the rhetoric. After all, nobody ever won a tariff war. But once again Trump has upended conventional wisdom and those who continue to underestimate him should now be fully aware that he means to push forward with his ‘America First’ agenda, irrespective of how damaging it might appear at first sight.

We need to view Trump’s actions in a domestic context. Simply put, they can be seen as the opening shot in his 2020 re-election campaign and his strong-arm tactics are broadly popular at home. The US also has a point about technological expropriation and the requirement for the Chinese to open up their domestic markets in a reciprocal manner, in line with their WTO commitments. But we also have to view this from the Chinese perspective which sees itself as reasserting its rightful place on the world stage after two centuries of political and economic humiliation by the west. Finding a resolution that accommodates both sides will not be easy.

Market reaction to Trump’s actions has been somewhat muted. Admittedly, US equities fell 2.2% during the course of last week but that is not a huge decline and only puts the S&P500 back where it was a month ago. One interpretation is that markets are clinging to the belief that a resolution to the tariff war will somehow materialise within the next couple of weeks. After all, only goods leaving China after the Thursday midnight deadline will be subject to the new tariffs – those currently in transit will not – so if a deal can be brokered within the two weeks it takes for goods to make the journey by sea, the impact of the latest tariff spat will be limited.

That may be a very complacent view. Indeed, recent events might just prove to be another shot in the long war against globalisation from which there are no economic winners. Consider first the tariffs themselves. They are in effect a tax on imports and the one thing we do know about product taxes is that they are borne by the end-consumer. Companies that import certain items from China will now have to pay 25% more for them (although the impact so far has been partially offset by dollar appreciation). Households consuming those Chinese goods on the list will face a similar problem. But as this paper by Pablo Fajgelbaum and his co-authors point out, the direct impacts of last year’s tariff hikes cost the US economy just USD69 billion (0.3% of GDP). And once we account for the substitution away from Chinese imports towards domestic alternatives and the gains from higher prices received by US producers, the total impact is a mere USD7.8bn, or 0.04% of GDP.

But this is to underestimate the longer-term damage that an escalation of tariff wars could inflict on the global economy. Unfortunately, the recent actions might encourage the Trump administration to believe that tariff wars are indeed “good and easy to win” as the President said in March 2018 which (a) reduces the chances that the US will offer any concessions to the Chinese in the current dispute and (b) encourage the US to target European exporters, where German auto manufacturers are widely concerned that they will be the next in the line of fire.

With regard to point (a), we do not know how the Chinese will respond. Given that the US imports more from China than it exports, China’s direct ability to engage in a tit-for-tat tariff escalation is limited. It could, of course, levy additional duties on US agricultural products. But more damagingly it could target the US tech sector. China is less dependent than the rest of the world on Amazon, Apple and Google given the local dominance of Tencent, Huawei, Baidu and Alibaba. The Chinese companies start from the advantage of a bigger domestic market and are already formidable competitors in third markets. In a phrase reminiscent of the thinking during the Brexit referendum campaign, the likes of Apple need China more than the Chinese need them.

Also we should not overlook the fact China is the biggest buyer of US Treasury debt. Whilst it is unlikely to sell its current holdings, a buyers strike may push up US interest rates and thus have the opposite effect to what Trump wants (he has, after all, called for the Fed to lower interest rates). However, it is widely believed that the Chinese have no incentive to exacerbate the trade dispute in the short-term – particularly since the Communist Party wants to sell a rosy view ahead of the 70^th anniversary of the People’s Republic in October and the party’s centenary in 2021. But if there is no quick fix or if they are forced to make too many concessions, the Chinese will not easily forgive or forget.

With regard to point (b) there is a relatively easy fix. The EU could adopt a policy of pre-emptive tariff equalisation by reducing the tariffs on auto imports from the US from the current 10% to the rate of 2.5% which the US levies on EU imports. But the wider concern is that the US will become a less reliable ally than has been the case over the past 80 years. Europe and the US have common international interests and cooperation has led to better outcomes for both sides. This would be put at risk in the event of policy divergence. For example, one of the biggest issues rising up the policy agenda are environmental concerns which require international cooperation – no single economy can fix things on its own.

The current environment is increasingly one of mutual suspicion which does not bode well for finding global solutions to global problems. There is also a risk that local issues could become flashpoints for bigger problems, as we experienced during the Cold War. For example, China regards the region bordering the South China Sea as its own sphere of influence and is increasingly less tolerant of US interference in the region. The US does not see it the same way. But having dominated the geopolitical arena since 1945, the US may be forced to cede some control and the manner in which it does so will have a great bearing on the history of the 21^st century. The tariff wars could turn out to be a Gavrilo Princip moment. Or they may simply be a Cuban missile experience. Either way, there is a lot more at stake than import taxes.

The US: As good as it gets?

For all the recent concerns about the global economic slowdown a lot of the data released in the last couple of weeks supports the view that the world economy is, for the most part, enjoying a decent run. Despite the government shutdown around the turn of the year and concerns over the ongoing trade dispute with China, the US posted an annualised GDP growth rate of 3.2% in Q1. Whilst inventories contributed almost 0.7 percentage points to this figure, the GDP outcome was still significantly better than expected at the start of the year. As Mohamed El-Erian pointed out in a Tweet, “the 2s-10s US yield curve has steepened quite a bit in the last two and a half weeks” which has received far less attention than the flattening which preceded it, which was viewed in many quarters as a harbinger of recession (chart).  

Just to show that the good news is not confined purely to the US, the Q1 euro zone GDP data out this morning pointed to a rise of 0.4% q-o-q (around 1.6% on an annualised basis). Whilst this was considerably slower than US growth rates, it was again rather stronger than might have been anticipated a few weeks ago. Next week’s Q1 UK figures are also likely to come in at 0.4% q-o-q with the possibility of an upside surprise on the back of pre-Brexit inventory accumulation.

With the US economy continuing to look solid, and no sign that the cycle is about to turn down as it is set to become the longest cyclical upswing on record, equity markets continue to power ahead. That said, Q1 earnings have been rather disappointing on the whole and earnings per share on the S&P500 are currently running around 6.5% lower than Q4 levels and 9.5% below the Q3 2018 peak. Based on consensus estimates, it thus looks likely that barring a miraculous surge US earnings in 2019 may only register a small positive gain of around 2.5% following a hefty 23.7% last year (the biggest gain since 2010). Naturally, this reflects the fact that the 2018 numbers were flattered by corporate tax cuts, and some weakness was always likely given that last year’s one-off boost could not be repeated.

Doubtless you will read newspaper headlines from equity bulls suggesting that around 80% of S&P500 companies have beaten earnings expectations of late. But we should not place so much emphasis on a metric which companies use to game the system in order to flatter their earnings profile. The simple truth is that despite the strength of the economy, corporate USA is unlikely to repeat last year’s stellar numbers. That is not necessarily a bad thing: If the market consensus proves to be right, US earnings growth over the period 2018-19 will still cumulate to 27% which translates into 12.6% per annum versus an annual average of 7.4% since the turn of the millennium.

But there are some indications that the dynamic that has driven the US market over the past couple of years may be fraying at the edges. First quarter earnings at Alphabet (the company formerly known as Google) undershot relative to expectations thanks to weak revenues whilst Netflix’s forecasts for subscriber numbers also trailed estimates during Q1. Admittedly Netflix has aggressive targets for the remainder of the year and a track record of delivering, so as a result the price has held up pretty well since the start of the year. But such has been the strength of the FAANG (Facebook, Apple, Amazon, Netflix and Google) sector that any downside surprises may catch the market unawares.

The Fed, which meets tomorrow, is likely to keep rates firmly on hold for a long time to come and reiterate that it is in wait-and-see mode. Whilst this has helped drive markets higher, I can’t help wondering whether the decision in March to announce a pause may have been a tad premature particularly given the strength of activity in Q1. Call me old-fashioned but it is not the job of central banks to support the markets, which after all have had a great run over the past decade. And given the extent to which equity markets and economic fundamentals have been running out of line, a further modest monetary tightening – or at least the impression that the Fed might do so – may be enough to take some of froth out of the markets without unduly derailing the economy.

Nonetheless, the macro data are probably as good as we are going to get – this is the ultimate Goldilocks scenario, with the US economy neither too hot nor too cold. The labour market data suggests that the job machine is running smoothly and consumer confidence has recently spiked to near all-time highs. Donald Trump’s recent exhortations to the Fed to cut interest rates and engage in more QE is thus completely the wrong advice right now. But if past experience is any guide, we should enjoy the current conjuncture while we can. It may not last.