National Interest

by Desmond Lachman

    In multiple respects, President Trump is rushing the US economy into short-term and long-term trouble.

    During the dark days of the 1979 Iranian revolution, a gallows-humor joke circulated in Tehran. When people asked one another how they were doing, they replied that they were doing badly, but not as badly as tomorrow. Six months into the second Trump administration, we must wonder whether, with all its economic policy mistakes, something similar could be said about the US economic outlook.

    Start with the chaotic and aggressive way in which Trump has been implementing US trade policy. Seemingly oblivious to the unfortunate experience with the 1930 Smoot-Hawley Tariff Act, Trump has chosen to raise US import tariffs to their highest level in the past hundred years. From an average of around 2 percent at the start of the year, Trump has now increased the average US import tariff to 18.3 percent.

    According to the most recent estimates from the Yale Budget Lab, those tariff increases will raise US consumer prices by 1.8 percent and subtract .5 percentage points from economic growth. They will also reduce the average US household’s income by $2,400 a year. Worse yet, from a long-term perspective, those tariffs are likely to reduce the competitiveness of the American economy and limit the benefits the country derives from international trade.

    If Trump’s trade policy has been a major economic policy blunder, it has been overshadowed by his signature legislative package: the One Big Beautiful Bill Act. The Congressional Budget Office estimates that between 2025 and 2034, the bill’s tax cuts will add $3.4 trillion to the budget deficit. That will keep the US budget deficit above 6.5 percent of GDP for as far as the eye can see and raise the country’s debt-to-GDP ratio to a Hellenic 126 percent by 2034.

    A fundamental weakness of the US economy is that it relies on the kindness of strangers to finance its twin budget and trade deficits. Indeed, of the $29 trillion in outstanding U.S. Treasury bonds, foreigners own over $8 trillion. This makes it of paramount importance that the United States maintains investor confidence that it will not try to inflate or tax its way out from under its debt mountain. If it fails to maintain that confidence, the country could face a crisis in the bond or dollar markets.

    Another economic policy mistake is that Trump seems to be going out of his way to undermine foreign investor confidence. One way he does this is by putting enormous pressure on the Federal Reserve to cut interest rates aggressively, even at a time when inflation is running above the Fed’s 2 percent inflation target. Another way he is doing so is by raising questions about the reliability of the country’s economic data by firing the head of the Bureau of Labor Statistics.

    Yet another way he is raising questions about the country’s commitment to honor its debt servicing obligation is by having his administration periodically muse about the desirability of a 20 percent tax on interest payments to foreigners and about the merits of a forced conversion of foreign Treasury bond holdings into 100-year zero-coupon bonds.

    Just to make sure that the country will not grow its way out of its debt problem, Trump is pursuing an aggressive policy of deporting illegal immigrants. Until recently, these immigrants had been a significant factor in low inflation and steady economic growth. Deporting large numbers of immigrants is likely to create production problems and cost pressures, particularly in the agricultural and construction sectors of the economy.

    All of these policy mistakes are likely to end in economic tears in the run-up to next year’s midterm elections. Of one thing, one can be sure. If the US economy goes pear-shaped next year, Trump will not assume responsibility for his policy errors. Instead, he will point an accusing finger at Federal Reserve Chair Jerome Powell for having pursued too tight a monetary policy.