I started writing on inflation earlier in times of pandemic (previous posts 1, 2, 3). The summary of the situation in past 4 years is the following.
1. Strong demand along with weak supply due to supply chain disruptions were significant contributor to inflation. Supply chain disruptions were first due to pandemic lockdowns and later due to Ukraine war. The demand was strong due to income support and welfare programs which were part of pandemic relief package in America. Discombobulation of labor markets due to pandemic shock and also in early days of reopening. With income support (government paychecks), many people chose to stay away from employment as pandemic raged. This drove up wages in certain sectors of economy. Similarly, when economy opened up, there was a rush to hire back workers. All these factors pushed wages upwards.
2. Altering of spending habits. More spending on consumer goods and less spending on services because a lot of services were shut in lockdown (hospitality, restaurants, travel etc). And supply of goods was getting constrained due to supply chain disruptions.
3. The above factors also gave opportunity for companies to drive up profit margins collectively.
4. The factors that caused inflation were also pretty much a global phenomenon because the supply side constraints impacted nations around the world to a varying degree. The energy price shocks were more prominent in Europe due to Ukraine war.
The US Labor market was peculiar during pandemic disruptions but the mainstream economists generalized the current situation to that of 1970s and wage price spiral - a gross mischaracterization of the situation. The mainstream pundits preached austerity, rate hikes and a recession to fight what otherwise will be a decade of high inflation. On other side, some economists recognized that the pandemic situation is “transitory” which will be resolved sooner and economy will return to normalcy. The camps were formed. On one side was ‘team persistent’ - group of pundits who forecasted long term inflation (Larry Summers, Jason Furman etc). On other side was ‘team transitory’ - a group of pundits who predicted that inflation is temporary and economy will normalize in future (Claudia Sahm, Paul Krugman, MMT econs etc).
Now we have a 20/20 hindsight of what really happened. The Fed did aggressive rate hikes. But the economy did not go into recession. On the contrary, the growth surged and US was outperformer among other developed nations. The inflation came down without triggering of a recession. The Labor markets normalized (or recombobulated) and US had a good period of near full employment (best labor markets in last 5 decades). Now we move to present times.
Policy of Trump regime
While the real wages kept up with prices and US also had a strong productivity growth, the people were more averse to cumulative level of elevated prices. Trump is an expert reality TV showman and he exploited this resentment of people masterfully. Trump is expert in exploiting, amplifying and capitalizing on grievances and anger of people. Trump said that economy’s success story is a mirage, people can’t put food on the table while America has become a laughing stock of the world. Trump promised to bring prices down.
Trump’s Press conference in 2024 about prices of groceries.
While prices may fluctuate in short term, in long term the price level is like a one way street. It’s not feasible to go back to price level of 2020 or 2015. Best policy on prices is stabilization of inflation rate at a modest level. Trying to reduce prices to go back to price level of say 5 or 10 years in past is a meaningless exercise. Even otherwise, government doesn’t have any precise tools to manage inflation. Monetary policy is a blunt and shamanistic instrument for managing inflation. But all that doesn’t matter to Trump because Trump never intended to bring down prices of groceries. All these promises were only for the purpose to get votes and win elections.
Now when Trump has won the elections, you can keep aside useless promises and rhetoric of Trump. Trump has now embarked upon an odyssey of things which are greatly destructive and harmful to economy. The worst part is that Trump doesn’t care about the consequences. He doesn’t seem to care if the markets go down. He doesn’t seem to care if relationship with America’s allies get severed. Trump could’ve let economy run its existing course and stayed out of adventurous policies, and things would’ve been fine. But Trump demands economic sacrifices from American people in return of a Panacea in future. For what purpose?
Here i strenuously state that one should not try to search for any meaningful and rational motives for Trump’s policy. Because there simply isn’t. Do not attribute neo-mercantilism or nationalism to Trump’s policy. Trump is not playing any 3D or 4D chess to achieve some grand objectives. America didn’t elect a President, it elected a pathology. A person who is deeply disturbed, malignant and dangerous psychologically. He’s also the most incompetent person in real life who’s not even fit to be a janitor. Yet, he was put in the highest office of the nation.
There are several converging factors that can cause inflation upsurge in near future. The mindless tariffs and trade wars, not just against China but against Canada, Mexico and EU as well. The economic uncertainty created by foolish policies, on-again-off-again-on-again tariff flip flops and gutting of critical financial regulatory institutions. Mindless deportation policy that will create anxiety among business owners.
Trump’s “reciprocal” tariffs announced on April 2. The formula of tariffs is probably devised by a 4th grader.
American economy under Trump’s mindless trade war will become a hotbed of black marketing, smuggling and organized crime. The organized crime groups will act as a countervailing force to bypass official trade barriers and taxes while consumers will look to buy the goods at lower prices. This black marketing will be worse than prohibition era.
No matter how much Trump claims that China & foreign nations will pay for tariffs, the fact is that tariff costs will be borne by consumers. The consumers will soon find this out. There was a thing called ‘de-risking’ of economy from reliance on China’s supply chains. This was a big thing back in times of pandemic and also due to concerns on high tech defense manufacturing. One way to achieve de-risking is creating closer alliances with friendly countries. This was already happening with creation of free trade zone with Canada and Mexico. The auto industry of America is spread throughout three nations and billions of trade cross borders without any problem. But all this will be disrupted with mindless tariffs and trade wars.
The worse part in this trade war is that nobody knows the extent of damages and risks in this environment of great uncertainty. The uncertainty will be reflected in prices. The companies will also hold back investment decisions and Capital expenditure because of lack of clarity on trade policy. This will break the momentum of strong growth that America possessed since last couple of years. Foreign workers are employed in construction, low wage services and agriculture sector. But raids by ICE and vigilantism against foreigners will create an atmosphere of fear.
The MAGA argument is that Americans should take back the jobs which foreigners occupied. Also if tariffs raises prices of goods, than Americans should start manufacturing them here. That means bringing back low wage low tech production like Clothing, Toys, Shoes, Soaps etc back to America. Americans can manufacture these goods but the cost of making them in America will be higher. A more critical point is that America sits high in global value added chain and there’s a reason that these low wage low tech menial production went overseas. Americans are meant to do innovation stuff and high wage high tech meaningful work in terms of manufacturing. The mass production is globalized and happens around the world (think of production process of iPhone). There is high tech manufacturing that for strategic and national security reasons is planned to be done domestically. This was addressed in things like CHIPS and Science act which now Trump plans to kill.
When thinking of manufacturing, people think that mass production is done by millions of unionized factory workers like in old Fordist economy. But manufacturing is now largely a mechanized process with Robotics, AI and advanced assembly lines, and its value added chains are globalized. The labor contribution to manufacturing is continuously shrinking due to technical progress that is inherent feature of capitalism. US, like other developed nations, is largely a services economy with most of the labor force employed in service sector.
Trump regime’s policy are meaningless jumble which are obviously riddled with internal contradictions. For example, Trump takes pride in ‘strong dollar’, demands that dollar’s status should not be challenged. And Trump also complains about size of trade deficits. Trump complains that nations that are running trade surpluses are taking advantage of America. He doesn’t know that those surpluses return to America as foreign investment. Capital account is other side of current account - a basic identity. The Wall Street recycles trade surpluses earned by foreign nations by providing them with investment opportunities in American economy. The deep financial markets of US absorbs trade surplus of the world. Such has been the role of US in global economy. Nobody is exploiting America.
But what’s the worst that can happen in Trumpian chaos? The worst case scenario is - what will happen to dollar’s status as a reserve currency? If US turns into a rogue state which attacks its own allies, becomes an unreliable & unstable international actor, and cannot be trusted to uphold bilateral/international treaty or agreements. Will foreign nations be willing to hold large currency reserves of dollars in such circumstances? Obviously countries will look for alternate ways of doing transactions. What impact will it have on US economy and living standards of Americans? And what will be the impact of all this on prices of things Americans are so used to pay?
Musical coda
Overheard (2009) Soundtrack