July 31, 2018 Patrick Oliver-Kelley

The US added 213,000 jobs in June, significantly more than the expected growth in the labor force, suggesting the country’s economy is continuing to boom, despite the prospect of a looming trade war. But the buoyant labor market, coupled with higher oil prices, may stoke fears of inflation. There is also a warning: Other recent peaks in merger activity have been followed by a recession. Potential trade wars, regulatory uncertainty and rising interest rates could mean this boom will end the same way.

In the escalating global conflict over trade, a useful maxim is “be careful what you wish for.” Measures designed to punish an adversary over unfair practices could come back to bite workers in your own country, or those in some other place that’s not directly targeted. When the United States slaps penalties on imports from China, Taiwan faces collateral damage because of its role as a parts supplier. And if China’s retaliation hits US car shipments, German automaker BMW would be pummeled, along with US workers, since that company exports heavily from a South Carolina plant. President Trump hopes that a reset in global trade will bring jobs back to the US. Some of that may happen, but the process could take years. And it is very possible that a trade war would cost more jobs than it creates. It is a sign of how reliant the world has become on cross-border global supply chains.

Mainstream economic theory states that governments should tighten fiscal policy as the economy begins to overheat in order to accumulate a war chest for the next inevitable downturn. The Trump administration is doing the exact opposite. The budget deficit is set to widen to 4.6% of GDP next year on the back of massive tax cuts and big increases in government spending.

Meanwhile, the threat of escalation in Donald Trump’s trade war with China looms. More tariffs would push up prices even if the economy slows. Despite all this, a sudden surge in inflation is unlikely. The effect of pricier petrol should eventually drop out of the figures, too. The Fed has been gradually raising interest rates to cool the economy. But fiscal policy is pushing in the other direction, owing to tax cuts and spending increases under Trump. Such a truth is that there may be little that China can do to fend off a trade war. Protectionism is popular among American voters, especially among Trump’s base. He ran on a protectionist platform, and he is now trying to deliver on his promise of a smaller trade deficit.

Whether he succeeds is another story. Trump’s macroeconomic policies are completely at odds with his trade agenda. Fiscal stimulus will boost aggregate demand, which will suck in imports. An overheated economy will prompt the Fed to raise rates more aggressively than it otherwise would, leading to a stronger dollar. All of this will result in a wider trade deficit.

What will Trump tell voters two years from now when he is campaigning in Michigan and Ohio about why the trade deficit has widened under his watch? Will he blame himself or America’s trading partners? No trophy for getting that answer right.

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