"The deep 2018 tax cuts, without comparable cuts to spending, mean U.S. federal fiscal deficits are once again rapidly growing."
The American economy is adrift, like a huge sailing ship. When tides are high and winds are favourable, it can be headed in the right direction. But when conditions darken, the U.S. economy will have no mooring or anchor to rely upon. It could even end up crashing on the rocks once again as it did in 2008.
The U.S. economy is now a decade into a sustained growth cycle, and it is essentially back to its potential growth path. Near-term economic conditions are generally positive, notwithstanding the trade war with China and the recent meltdown in share prices for many profitable and well-performing companies. U.S. economic growth was robust in 2018, fuelled by a tax cut that advantaged firms and higher-income individuals, and the consensus is for solid performance again in 2019 with output growth projected at 2.5 per cent or higher. Job creation has been solid and measured unemployment is below 4 per cent.
Current performance is no doubt important, but a focus on the short term deflects attention away from the underlying macroeconomic and structural weaknesses of the U.S. economy.
Weakness can be seen in four macroeconomic fundamentals. First, the United States' fiscal anchor has been lost at sea. Large fiscal deficits and mounting U.S. public debt are not a recent phenomenon to be blamed solely on the Donald Trump administration and the previous Congress. A pattern of large deficits and a steady run-up in U.S. public debt stretches back to the early stages of the G.W. Bush administration, made much worse by the 2008-09 global financial crisis and the exceptional fiscal stimulus used to rekindle growth and help restore confidence in the U.S economy.
But the deep 2018 tax cuts, without comparable cuts to spending, mean U.S. federal fiscal deficits are once again rapidly growing; the Congressional Budget Office projects a fiscal deficit over US$1-trillion in 2020. The growth boost from tax cuts was short-lived and has largely evaporated. Public debt is increasing and is projected to exceed 90 per cent of GDP by 2020 – triple the share of GDP when Bill Clinton left office almost 20 years ago.
Debt-service costs will inevitably absorb a larger share of the national budget. Moreover, the U.S. fiscal framework is burdened by massive unfunded social security liabilities, and the sustainability of Medicare and Medicaid are at risk. Congress has so far been unwilling to consider how to fund these program commitments to the American public.
Second, U.S. monetary policy is still not fully re-anchored. The United States and many other parts of the global economy have been medicated for a decade with truly exceptional monetary stimulus, or what we termed “monetary morphine” in a past Globe and Mail commentary. Reducing the dependency on easy money and restoring more traditional monetary conditions was never going to be easy or straightforward.
The U.S. Federal Reserve saw signs two years ago of more normal U.S. output and employment growth ahead and its benchmark short-term interest rate has been steadily increased in small increments. However, the recent sharp downward adjustment in equity prices, coupled with a decline in long-term interest rates, confirm that the U.S. economy has not completed its withdrawal from monetary morphine. Trade and other policy turmoil simply provided an added shock. The Fed will have to proceed carefully on its journey back to more normal interest rates if it is to avoid destabilizing confidence in the recovery.
Third, as Canadians know all too well, the Trump administration has made chaotic attempts to strengthen the U.S. trade bargaining position, but without an overarching trade strategy and with no consideration of the collateral damage. Mr. Trump boxed himself in on the North American free-trade agreement and the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP), and American exporters now seem sure to lose market share in CPTPP signatory countries. A new trade agreement with Canada and Mexico has been negotiated, but tariffs remain in place on Canadian and Mexican steel and aluminum – which makes little economic sense. And the new United States-Mexico-Canada Agreement still has to run the gauntlet of confirmation by a divided Congress.
Trade talks with China are now the headline story, and where they are headed is unknown. To reduce economic uncertainty and be able to roll back the punitive tariffs being paid by American consumers on Chinese goods, Mr. Trump may eventually have to declare victory in the China trade negotiations, even if there is limited underlying positive change to justify this declaration.
And fourth, climate change is the ultimate existential threat facing the United States and the world in the years ahead. Despite the overwhelming scientific and physical evidence, and mounting costs and risks, Washington has moved backward by announcing its withdrawal from the Paris Accord. Some climate policy action is being taken by other levels of U.S. government, but the absence of federal leadership and co-ordination will inevitably put the United States years behind others in terms of climate-change mitigation, adaptation and seizing low-carbon growth opportunities.
It is hard for Canada to protect itself from an American economy adrift, due to deep economic integration and myriad business, social and personal networks. The least we can do is to identify and understand the many risks and implement our own strong macroeconomic, trade and climate change policies. That may not entirely prevent the malaise from spreading – but it could make Canada better equipped to deal with the consequences.
Glen Hodgson is a senior fellow at the C.D. Howe Institute.