The American Populist Reckoning

The most likely outcome of Donald Trump's presidency will be slower growth, further increases in inequality, and erosion of public services. And America’s ability to out-innovate others, including China, will take another blow.

Simon Johnson

WASHINGTON, DC – Populism is an approach to government that relies on lavish promises that ultimately cannot be met. The most prominent historical cases since 1945 were, for a long while, mostly found in Latin America. There are always apologists who claim that a new source of economic miracle has been discovered. But the ending is always the same: some form of crisis and disaster. Populism today is again in the ascendancy, but now one of the most virulent forms is in the United States – and with the credibility of the central bank very much on the line.

Argentina under Juan Perón (1946-1955 and 1973-1974) and his successors is often held out as the canonical example of populist misrule. Each iteration of populism has its special features, but the general pattern is this: unsustainable wage increases, an overvalued exchange rate, and massive foreign borrowing (enabled by local recklessness and foreign short-sightedness). Critics are persecuted, experts disparaged, and ridicule piled onto anyone with any kind of reasonable concern. Central banks and other independent governmental bodies, such as courts, are always subverted through personnel changes and other pressures.

Then the reckoning comes, with some combination of inflation, significant exchange-rate devaluation, and a deep recession (or worse). All too often, the cycle then starts again with another round of promises that cannot possibly be met. The central bank’s credibility, once dismantled, does not easily return.

Looking around the world today, Venezuela is an obvious Latin American example that experienced a recent version of populism (though sustained by oil revenues for longer than usual). With Venezuela now experiencing a classic populist collapse, who else is displaying obvious symptoms today?

The United Kingdom is one prominent potential case. It is entirely possible that Britain can still avoid the disaster of leaving the European Union in a way that avoids a massive disruption of trade. The worry, of course, is that the path to a soft landing remains unclear – and it is very late in the day, relative to the politically established deadlines (for the EU and for the UK).

Some British political leaders, mostly on the right, continue to play the populist card to a disconcerting degree. It remains to be seen whether they need to cause a collapse before the hollowness of their promises becomes self-evident.

The good news is that key UK institutions, including the Bank of England, remain strong and reasonably independent. Let’s hope that this remains the case, regardless of what happens within the Conservative Party and to Prime Minister Theresa May’s government.

A much bigger problem looms in the US, where President Donald Trump has combined disregard for the fiscal impact of tax cuts with an apparent desire to start trade wars. Now comes his most dangerous move to date: increased pressure on the Federal Reserve to stimulate the economy.

The pressure on the Fed is understandable in political terms, because the temporary sugar high of the tax cuts enacted at the end of 2017 is wearing off, and there is insufficient congressional support to cut taxes further. Expanding deficits already stretch as far as the eye can see. Although US economic growth is satisfactory, it is naturally slowing as the country reaches full employment. As a true populist, Trump has promised growth rates that are unattainable except through extraordinary and unsustainable measures – such as significant easing of monetary policy.

The Fed is weak politically today because it has had a bad 15 years. First, it not only oversaw but actually cheered on the breakdown in consumer protection that made rapacious real-estate lending possible in the run up to 2008. Then the Fed completely failed to understand how the structure of derivatives could amplify risks, so that what should have been a mild downward correction in house prices became a system-wide (and global disaster). Subsequently, the Fed attempted to make amends by easing credit to an unprecedented degree. Unfortunately, “cleaning up” in this fashion proved difficult and the damage to millions of lives remains all too tangible.

The defense mounted by Fed leaders at the time was that crises happen and nothing can be done about it. That view is entirely wrong. The US avoided serious financial crises from the 1940s to the early 2000s because good enough regulation remained in place.

Leading congressional Republicans spent a decade aiming their rhetorical fire at the wrong target within the Fed’s sphere of activities, claiming that its post-crisis policies were “too loose” and would cause inflation. The Republican critique proved entirely without merit: inflation remained low. But the political damage was done, and now Trump’s pressure for much looser monetary policy is being supported by members of Congress who previously argued for the exact opposite.

Now the Fed is weak, and Trump is clutching at straws, desperate to jack up growth by any means until the 2020 presidential election. He is packing the Fed’s Board of Governors with people who want to say yes to him and will mobilize his base against Fed staff and regional bank presidents if they resist easing monetary conditions.

Could pumping up the economy in this fashion clear Trump’s path to reelection? Trump has been lucky before, and the global economy looks relatively benign (unless Brexit brings bad surprises). And while all of Trump’s macroeconomic promises will prove as ephemeral and fleeting as those of Perón, populism always lasts longer than most people think possible.

The reckoning, when it comes, will likely be different from that in Argentina or Venezuela. The US has a stronger, more diversified underlying economy with a better track record over the past century. And the dollar is used widely around the world, as reserves for central banks, as a private-sector store of value, and to invoice most international trade. The most likely outcome will be slower growth, further increases in inequality, and erosion of public services. And America’s ability to out-innovate others, including China, will absorb another blow.

Trump will leave the scene soon enough. Will his legacy be even more populism, made possible by the destruction of the Fed’s political legitimacy? Such an outcome looks entirely posible.

Simon Johnson, a former chief economist of the IMF, is a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-founder of a leading economics blog, The Baseline Scenario. He is the co-author, with Jonathan Gruber of Jump-Starting America: How Breakthrough Science Can Revive the Economic Growth and the American Dream.

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