The threat of Trump flation and a Fed war

BERKELEY — Inflation in the United States is lower than it was a year ago, and substantial economic weakness elsewhere is driving other central banks toward interest-rate cuts. With little empirical basis to believe that US monetary policy is not restrictive, I continue to believe that in 18 months, the US Federal Reserve (Fed) will have wished that it had started cutting rates in January 2024.

If I am right, the US is not headed for a soft-landing path; it is already on the runway, albeit with a monetary-policy rudder steering sharply toward contraction, rather than being held in a straight-ahead neutral position. Yet many commentators and Fed officials continue to believe that interest rates should remain at their relatively high levels, because they are fixated on the 1977-79 period, when a near-stabilised inflation rate spiraled out of control.

Back then, the Carter administration’s nominal GDP forecast had been dead-on, real growth came in two percentage points low, and inflation came in 2 percentage points high. Then came the Iranian Revolution and the second major oil-price spike of the decade, leading ultimately to the “neoliberal turn”, the Volcker disinflation (when the Fed hiked rates to 20 per cent), and Latin America’s “lost decade”. To those who worry that history will rhyme, keeping interest rates too high for too long is a risk worth taking.

But even if you are an inflation hawk, why would you worry most about a premature lowering of rates? Is a recurrence of 1977-82 really the scenario that should keep you up at night? With Donald Trump seeking to return to the White House, surely there is a much bigger risk on the horizon. Among other things, Trump has promised to impose significantly higher tariffs than Biden has. And while Biden at least has national-security and industrial-policy rationales for his trade policies, Trump would pursue random, chaotic, corruption-ridden interventions that are almost certain to be substantially inflationary.

Moreover, Trump is keen to remove Fed Chair Jerome Powell through untested legal means, so that he can either install a loyal crony or at least set off a fight with Congress in which he can appear to be challenging the “establishment”. He is also itching to mobilise social-media mobs, if not real-world insurrectionist terrorists, against Fed governors and bank presidents who refuse to lower interest rates at his command.

Far from hyperbole, this threat of political violence is a familiar issue in Washington today. As journalist McKay Coppins writes in his recent book on Mitt Romney: “One Republican congressman confided to Romney that he wanted to vote for impeachment, but declined out of fear for his family’s safety. The congressman reasoned that Trump would be impeached by House Democrats with or without him, why put his wife and children at risk if it would not change the outcome?”

This would be a MAGA rerun of Andrew Jackson’s Bank War in the 1830s, when the president ultimately succeeded in killing off the Second Bank of the United States, arguing that it benefitted a wealthy elite at the expense of the American people. In fact, the Bank War ultimately brought financial disruption, commercial bankruptcies and deflation, thus destroying some share of national wealth and shifting the rest from entrepreneurial debtors to already-rich creditors.

True, later historians argued that Jackson’s battle against the oligarchy of Philadelphia bankers led by the Second Bank’s president, Nicholas Biddle, prefigured Franklin D. Roosevelt’s battle against “economic royalists” a century later during the New Deal. And yet, nothing is better for already-rich heirs and heiresses than general deflation. Should Trump return to the White House and launch a Fed War, the effect would be as economically damaging as Jackson’s Bank War. But, like the Bank War, the effort would probably be popular with his base.

Is this all overblown? Bill Dudley, the former president of the Fed Bank of New York, recently downplayed the risk that Trump would pose to Fed operations, arguing that the next president will appoint only two of the Federal Open Market Committee’s (FOMC’s) 12 voting members. I am less sanguine. Fed governors and bank presidents who do not feel like spending $5,000 a day on security might be induced to resign. And while the Fed chair can be dismissed only “for cause” (inefficiency, neglect of duty, or malfeasance), the conservative majority on the Supreme Court has demonstrated that its commitment to precedent, original intent, or the black-letter meaning of statutes cannot be taken seriously.

Moreover, Dudley himself recognises that another Trump presidency would be damaging enough, regardless of what he manages to get away with:

“The dollar has become the world’s reserve currency and a stable store of value thanks to prudent economic management, a strong rule of law, deep and liquid capital market, and free movement of capital. If efforts to control the Fed threatened these key attributes, the dollar would likely weaken, stock markets would decline and risk premia on US fixed income assets would increase, impairing the country’s economic health.”

For now, Powell and the FOMC are doing their best to make marginal adjustments to interest rates and financial conditions to keep the economy in its soft-landing, slowing-on-the-runway groove. The biggest threats to monetary and economic stability right now have nothing to do with what they decide at their next meeting. If inflation hawks are serious about price stability and the long-term economic outlook, they should be much more worried about the return of Trumpism.

J. Bradford DeLong, professor of Economics at the University of California, Berkeley, is a research associate at the National Bureau of Economic Research and the author of “Slouching Towards Utopia: An Economic History of the Twentieth Century” (Basic Books, 2022). He was deputy assistant US treasury secretary during the Clinton administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies and cemented his stature as a leading voice in economic-policy debates. Project Syandicate.