Crashed

by Adam Tooze

  The rate of inflation over the previous 4 quarters;

  One-half of the difference between the real GDP and an estimate of potential GDP;

  One-half of the difference between the rate of inflation over the previous 4 quarters and 2 percent;

  and an assumed real interest rate of 2 percent.

  It was a mechanical formula that required interest rates to be adjusted upward if inflation was high and unemployment low, or downward if the reverse was the case. If the Fed preferred a different rule, the CHOICE Act stipulated that it must spell out its own formula in similarly mechanical terms and demonstrate econometrically that its rule was preferable to the Taylor model.

  As the authors of the bill were well aware, enshrining this formula in law implied an entire alternate history of American monetary policy back to the crisis and before. Taylor and his disciples blamed the crash on the fact that in the early 2000s, under Greenspan, rates had been too low.92 During the crisis, on the other hand, if one applied the Taylor formula, interest rates should have been pushed into negative territory. A strict application of the Taylor rule in the autumn of 2008 would have called for rates of below zero, effectively a tax on savings deposits. It was because he judged that impracticable that Bernanke had adopted quantitative easing. The CHOICE Act would ban any such improvisation. Once the acute crisis had passed, instead of QE2 and QE3, Taylor’s formula would have called for rate increases. There would have been no worrying about taper tantrums, whether at home or abroad. Indeed, no regard would be paid to conditions anywhere in the world other than the United States, unless, of course, the Fed dared to include its wider global concerns as a variable in its own interest rate equation.

  Actual Fed Funds Rate and Taylor Rule Prescription

  Source: Atlanta Fed.

  The CHOICE Act was first and foremost a political gesture. Promising to curb the discretion of the Fed played well on the Republican side. But on the substance of policy there was, in fact, no disagreement. Taylor rule or not, 2017 was clearly a time to tighten, to raise rates and to start, tentatively, unwinding the gigantic balance sheet built up during the era of QE.93 After ending security purchases under QE3 in October 2014, the Fed had made the first move to raise rates in December 2015. It had then paused before inching them up again in December 2016, March 2017 and June 2017. The FOMC ended 2017 by laying a path of at least three further increases in 2018.

  As always, a subtle game was played out between the FOMC and the markets. Janet Yellen proved herself a master of this game, managing to socialize the idea of rate increase without triggering panic. But there was never much chance of her tenure being extended into the Trump presidency.94 There was talk that John B. Taylor himself might be in line to take Yellen’s place. Trump liked the look of Kevin Warsh, an underqualified New York princeling who had been parachuted onto the Fed board by the Bush White House in 2006. But in the end he settled on Jerome Powell. It was a strikingly conventional choice. Powell was a Republican investment banker in the Mitt Romney–Hank Paulson vein. He had earned the trust of the Obama administration by campaigning within the Republican Party against the shutdown of 2011.95 That had led to his nomination to the Fed board in December 2011, where he had distinguished himself by his loyalty to both Bernanke and Yellen. He was also thought to be supportive of the Dodd-Frank framework.96 But what recommended Powell to Trump were most likely his personal attributes. He was not an academic economist. He was a rich businessman. With a personal net worth estimated in excess of $100 million Powell was by far the wealthiest person to take the position of Fed chair since the 1930s. Unlike Professor Taylor, Powell was nondoctrinaire when it came to policy. Under his stewardship the White House would not have to fear unduly painful increases in interest rates.

  V

  Building a new administration and setting a domestic policy agenda was a protracted and complex business, for which Trump and his coterie were ill prepared. All the more forceful was their approach to foreign relations, where the White House and the executive branch had far more leeway. Within forty-eight hours of his inauguration on Friday, January 20, 2017, Trump announced his intention to renegotiate NAFTA. The next day, Monday, January 23, he withdrew the United States from the Trans-Pacific Partnership. TTIP, the object of years of laborious negotiation with the EU, was also left for dead.

  It was a spectacular overturning of a centerpiece of Obama-era foreign economic policy. TPP was a showpiece of American grand strategy in a multipolar age. It was a shock to America’s allies. Committing to TPP had cost many Asian countries, most notably Japan, serious political capital. And it begged the question: If there was no grand regional alliance, where did that leave Obama and Clinton’s pivot to Asia and the de facto policy of containing China? Indeed, abandoning TPP and TTIP was not just a break with the Obama era, it was a reversal of America’s sponsorship of multilateral trade policy dating back to the 1940s.97 At the first G20 meeting attended by Treasury Secretary Mnuchin in Baden-Baden in March 2008, it was impossible to reach agreement even on a simple pledge “to resist all forms of protectionism.”98 As Wolfgang Schäuble noted in his usual uncompromising fashion, the meeting had reached an “impasse.”99 All Mnuchin had to offer by way of clarification was that the new administration had a “different view on trade.” Philip Hammond, the UK chancellor, advised his colleagues that it was better to give the Trump administration more time: “If we demand a hard answer now, I’m pretty sure we won’t like the answer we get.”100

  Meanwhile, in Washington a battle was raging over NAFTA. As far as Trump was concerned it was “one of the worst deals ever.”101 As he told journalists after three months in office, he “was really ready and psyched to terminate” it.102 The relish was obvious. Bannon and economic adviser Peter Navarro, a nationalist trade economist, urged him to follow his instincts. For the announcement they had earmarked a rally in Harrisburg, Pennsylvania, on April 29, 2017, to celebrate his first hundred days in office. For Mexico and Canada it would have been a brutal blow. Realizing the seriousness of the situation, they rapidly coordinated their positions. Desperate to prevent a precipitate break, hundreds of American business leaders lobbied the White House. The secretary for agriculture, the commerce secretary and the secretary of state all pleaded for a stay of execution. In the end the decisive argument appears to have been a map showing quite how much of “Trump country” would be hurt by withdrawal. Did the president really want to put Texas in play? The map “shows that I do have a very big farmer base, which is good,” Trump later told journalists. “They like Trump, but I like them, and I’m going to help them.”103 That meant not canceling NAFTA. Instead, Washington would renegotiate. But it would do so from a weakened position. The Obama administration had spent years haggling for improved access to Canadian agricultural markets, cross-border licensing of financial services and improved labor standards with Mexico. To do so it had used not raw threats but the lure of the even bigger trade deal, TPP, a project into which the United States had inveigled Mexico and Canada at the Los Cabos G20 summit in 2012. With TPP gone, all the concessions on NAFTA already agreed were consigned to the dustbin of history.104 Trump’s renegotiation would start from scratch with little but threats to offer.

  NAFTA, TPP, TTIP were regional treaties. The truly global forum for trade policy was the WTO. It was an original creation of the founding moment of American globalism in the 1940s.105 The United States had long been its most powerful backer. President Trump did not attend the party to celebrate the seventieth anniversary of its founding in November 2017 at the Ronald Reagan building in Washington, DC, but he sent his ill wishes by way of Fox News. “The WTO was set up for the benefit [of] everybody but us. . . . They have taken advantage of this country like you wouldn’t believe,” he told the news channel.106 As his trade representative, Trump appointed the veteran trade warrior Robert Lighthizer, who in the 1980s had been responsible for extracting the agreements by America’
s major competitors to voluntarily restrain their steel exports to the United States. Lighthizer blasted the WTO with a broadside. He objected to the judicial activism of the WTO’s trade arbitration panel, its pandering to the special pleading of large developing countries like India, its failure to address areas of chronic industrial overcapacity such as steel and above all its inability to get to grips with the unprecedented challenge to economic liberalism posed by the rise of Chinese state capitalism.107 In Washington’s view, the WTO should confine itself to providing a forum for bargaining between the major trading powers. The United States should throw off any restraint on its ability to retaliate against economies that it considered to be discriminating against it. But rather than translating this vision into positive proposals for the WTO, the Trump administration adopted the tactics the Republicans had used to such effect in Congress. The United States refused to permit the appointment of new arbitrators to WTO panels, threatening to hollow out the institution, making it increasingly dysfunctional and illegitimate. If there was no actual éclat at the WTO meeting in December 2017, the lack of progress on any area of trade liberalization was dismal.108 Lighthizer did not even deign to stay until the end of the conference.

  The shock delivered by the new administration to global economic institutions was severe. There had been nothing like this since the 1930s and nowhere was this felt more acutely than in Europe. In the early days it was unclear whether the Trump team actually acknowledged the EU as a counterparty or understood that the United States no longer maintained bilateral trade relations with individual European countries. In an interview given just days before he took office, Trump dismissed the EU as a “vehicle for Germany.” According to inside sources, members of his entourage were placing phone calls to European leaders to ascertain which countries might be “leaving next.”109 Trump’s people believed the Brexit hype. There was a fear in Europe that Trumpery would spread. London was about to trigger Article 50 and formal exit proceedings. The Austrian, Dutch and French elections were all in play. There were forces in the White House that openly supported not only Brexit but Marine Le Pen and the Front.110

  Once the initial shock wore off, international forces began to concert themselves. Mexico and Canada worked together closely to do what was possible to save NAFTA. The other parties to TPP decided to go ahead without the United States. By late May, when Trump made his first visit to Europe, the “populist” spook had passed. Macron was in the saddle in Paris. When the American president refused publicly to underline America’s commitment to Article 5 of the NATO treaty and gave notice of his intention to withdraw from the Paris climate change agreement, Merkel had seen enough. Germany was in general election mode and the spectacular swing in European public opinion against Trump gave Merkel every reason to act. On May 28, 2017, the day after Trump’s departure, speaking to an enthusiastic crowd in Munich, the German chancellor announced that Europe had to adjust to a new reality.111 After Trump and Brexit, it was clear that Europe could no longer rely completely on its long-standing American and British allies. “The times in which we can fully count on others are somewhat over, as I have experienced in the past few days. We Europeans must really take our destiny in our own hands. Of course we need to have friendly relations with the US and with the UK and with other neighbours, including Russia. But we have to fight for our own future ourselves.”112

  It was no doubt a remarkable moment. As Richard Haass, president of the Council on Foreign Relations, tweeted: “Merkel saying Europe cannot rely on others & needs to take matters into its own hands is a watershed—& what US has sought to avoid since WW2.”113 But what did it actually amount to? Europe’s own process of consolidation in the wake of the crisis seemed stalled. President Macron of France offered a bold vision of Europe’s future in a major speech at the Sorbonne.114 But who was it addressed to? After the inconclusive elections in Germany in September 2017, there was only a caretaker government in Berlin. Italy was creaking under the weight of years of recession. Spain was thrown into chaos by Catalonia’s bid for independence. Furthermore, any moves toward further integration and self-determination for the Continent were bound to arouse resistance. If Britain was leaving, the difficult Eastern Europeans remained. In July 2017, on his second trip to Europe for the G20 meeting in Hamburg, Trump made a point of stopping in Poland. In front of a crowd of supporters of the Law and Justice government, Trump found a European audience that loved him. The flags waved as he proclaimed America’s commitment to NATO as a bulwark of civilization and a bastion for the people of the West who “still cry out ‘We want God.’”115 Trump had segued from “America first” to a “clash of civilizations,” but neither one nor the other would go down well with the multicultural crowd that was awaiting America at the G20 meeting. As Hammond, the British chancellor, had pointed out, sometimes it was better not to push the Trump administration too hard for a clarification of its position. There was reason to fear that one might not like the answer.

  Clearly, Merkel’s vision of a united Europe fighting for its own future would have to tackle deep internal divisions. Nor was the rise of right-wing nationalism Europe’s only point of difference. Trump’s protectionism was directed not just against Asian competitors. Germany too was in the crosshairs. As ever, Finance Minister Schäuble was quick to respond. He would no more take criticism from Trump and Mnuchin than he had from Obama, Geithner, the IMF or fellow Europeans.116 In the German view a trade surplus was first and foremost a reward for export competitiveness. But the kind of gigantic deficit run by the United States also pointed to deeper macroeconomic imbalances. It was hardly surprising that given Germany’s budget surplus and America’s large and growing government deficit there should be a difference in their trade accounts. This was the familiar repertoire of arguments about transatlantic trade. But this time Schäuble added a twist. It was true, he admitted, that German exports enjoyed a competitive advantage. The euro was undervalued. But it was not Germany that set interest rates or the value of the euro. It was the ECB. To the horror of German savers, Mario Draghi’s expansive policy of QE was driving European bond yields into negative territory and depressing the value of the euro. Visiting Washington in April 2017 Schäuble told American audiences that he had warned Draghi about the tendency of the ECB’s expansive monetary policy to inflate Germany’s trade surplus.117 That it was causing tension with the United States was predictable. The ECB stood firm, and the IMF backed the continuation of QE in Europe. But Schäuble had served notice of how Trump’s attacks might be instrumentalized in the long-running argument over eurozone economic policy. The furor around Trump should not cause one to forget how bitterly Europeans and Americans had squabbled over economic policy in the “good” Obama years.

  The ECB’s belated monetary expansion at a time of Fed tightening was a real source of transatlantic imbalance and it was a reminder of the disharmony over monetary policy that had marked the world economy since the onset of the crisis, a disharmony to which conservative voices in Germany had contributed as much as anyone.118 Nor were the chronic surpluses of Germany, the Netherlands and China figments of the Trumpian imagination. They pointed to real and persistent imbalances in the world economy. In global trade policy as in so many other areas, the outrage caused by the uncouth belligerence of the Trump administration too easily obscured the reality of the problems it was gesturing toward. At the G20, the atmosphere was self-congratulatory. The WTO earned applause for seeing the world economy through the financial crisis of 2008 far better than it had fared during the Great Depression of the 1930s. There had been no catastrophic lurch toward high tariffs and protectionism.119 There had been no repeat of the Smoot-Hawley tariff of 1930. The twenty-first-century system of global governance might not be popular, but it had worked, or so the story went. Ten years on from the crisis, it was, therefore, the height of populist irresponsibility to indulge in backbiting economic nationalism. For the defenders of the status quo, Trump made a perfect caricature ene
my against whom to reassert the nostrums of liberalism. But this deflected attention from a more complex and ambiguous reality. The idea that Trump constituted a sudden and shocking break with a prevailing liberal success story depends on an unduly sanguine view of the global backdrop. This was as true with regard to trade as it was with regard to monetary policy. In fact, the last major effort to negotiate a global trade deal, the Doha round, had come to a crashing halt in the summer of 2008. World trade had recovered from the disaster of 2008–2009. But since 2010 trade volumes had stagnated. In 2015 they had declined.120 This was driven in part by the business cycle. The taper tantrum and the setback to commodity prices had rocked the emerging markets. But it also reflected a wave of protectionist measures adopted by countries across the world, concentrated not on tariffs but on a variety of nontariff barriers.121 No one imagined that Trump’s personal views on trade reflected arcane knowledge of new types of protectionism. He was regurgitating opinions first formed in the 1970s and 1980s. But if the expert staff around Lighthizer was looking for ammunition to demonstrate the reality of discrimination against US exports, it was ready to hand. Through tax breaks, subsidies and export credit systems, not to mention China’s state capitalism, world trade was increasingly shaped not only by corporate value chains, but also by state intervention. A large part of America’s huge trade deficit was accounted for not only by Chinese trade discrimination, but also by lost export earnings siphoned through offshore tax havens, located not only in the Caribbean but also in the EU.122 In this respect too the once-robust assumption that globalization was an inevitable, natural process was losing its power to convince. Trump’s trade hawks did not advocate a return to the 1930s, but neither were they willing to continue the pretense that the naïve triumphalism of 1989 with its easy assumptions about the inevitable victory of democratic capitalism any longer “jived with the facts.” As the national security strategy issued in December 2017 darkly declared: “There is no arc of history that ensures that America’s free political and economic system will automatically prevail.”123