Since publishing my series on Trumponomics last summer, I have received a few questions for clarification. At the heart of the discussion is the Aggregate Demand (AD) and Aggregate Supply model, AD-AS. The model is represented in the Figure below:
AD = C + I + G + X
C = Consumption, which is dependent on disposable income, that is income after taxes
I = Investment, mostly plant, factory, buildings
G = Government spending
X = Net exports, exports minus imports, which is usually negligible
AS is determined in shape and size by labor (employed and unemployed), land (raw materials, iron, water, oil), capital (factories, compressors, pipes, buildings, pumps), and technology (advanced mental know how). This is called the short-run AS curve because at least one thing is held constant, like capital; but in this case we are focusing on employment, particularly full employment.
What Is Trumponomics?
Investopedia defines Trumponomics as,
Trumponomics describes the economic policies of U.S. President Donald Trump, who won the November 8, 2016 presidential election on the back of bold economic promises to cut personal and corporate taxes, restructure trade deals and introduce large fiscal stimulus measures focused on infrastructure and defense.
This is not what I am focusing on. My point addresses the tremendous rhetoric surrounding the economy last summer: low inflation coupled with ultra high employment. Traditional economics says that this cannot happen.
Fiscal policy is typically within the sphere of the president and Congress – mostly taxation and government spending. Referring to the AD-AS model, point 1 represents idle resources, like plant, natural resources, machinery; but mostly labor (people are unemployed). The government can put these resources to use (mostly workers) by increasing government spending or cutting taxes.
This can continue until point 2 is reached. Here resources are all employed (essentially the economy is at full employment, otherwise known as the natural rate of unemployment – the terms are synonymous). If you go past point 2, (employment that goes above full employment) the economy cannot actually produce more goods because resources are all used up, so all the extra money dumped into the system will only result in higher prices. Inflation must result. An alternative way to explain this is a theory called the Phillips Curve.
Last summer the news channels were talking about the world entering a new age of economics where you can have high employment and no inflation. The natural rate of unemployment is about 5% but the government was saying that unemployment was below 4%. Impossible!
They were hinting that Trumponomics is somehow the new economic theory of relativity. Einstein’s theory says that the laws of physics are different when traveling near the speed of light. Objects loose considerable mass as their kinetic energy increases (mass and energy must be conserved) and all reference frames do not see events at the same time (time dilation).
Nonsense. Last time I looked no one on earth is going the speed of light, thus the old economic principles cannot be broken. The government simply is not giving the public the whole picture.
Did the Fed’s Monetary Policy Help The Economy Before Trump Was Elected?
The short answer is, “Not Really”. Let us see why.
Monetary policy is pretty much the domain of the Federal Reserve. It is essentially the flip side of fiscal policy. This is how the theory goes. If the Fed sells treasuries, money is taken out of the economy and placed in the Fed’s vault. If the Fed buys securities, money is injected into the economy. Looking again at the AD-AS model, if money is injected into the economy, then AD can shift to the right via an increase in consumption.
The Fed has bought back a lot of securities but in my opinion consumption is not affected as strongly as investment. What really gets people hired and working is investment in plant, equipment, compressors, pumps, piping, office buildings, oil production, etc.
Buying securities is the flip side of fiscal policy because when money is injected into the economy, the equilibrium point for the supply and demand of money shifts to a point of lower interest rates. Loans are taken from the money supply and the price tag for loans is interest. A liquidity injection into the economy increases the supply of money and that shifts the money supply curve to the right; thus lower interests. If interest rates are lower, then businesses are more likely to borrow.
In my opinion, these efforts did not help the economy. The Obama economy was torpedoed by the Subprime Mortgage Crisis, which secretly started in early 2007 – I saw the crisis coming because I saw the news reports on PBS. Bottom line is that banks were shot down because there was simply too much bad debt on their balance sheet. To make things worse, subprime mortgages were sliced into stock for investors and placed into hedge funds, 401Ks, retirement accounts, etc. Everyone went down for the count when home owners could not pay their mortgages due to variable and rising mortgage rates.
The TARP program extended billions of dollars to banks in the form of government loans; but I do not believed this really helped. My understanding is that the Too Big To Fails were given loans at zero percent interest. then turned around and made loans to the public for a profit. No help there.
The key reason that Trump inherited a good economy from Obama is because enough time had passed so that banks could write off the bad home loans as bad debt on their tax returns. With the debt gone, the balance sheet is healthy. A healthy balance sheet means banks can make more loans – and loans and investment, in my opinion, are what really drive jobs and a good economy. My understanding is that this takes somewhere between 5 to 7 years.
As you can see from the figure above, lending was revived in 2012. With time, the subprime loans are written off the books and lending has continued to recover.
In my opinion, all the money sloshing around in the economy does not mean a thing; because the US treasury is being raided by the special interest groups. Our politicians have opened the doors to our bank vaults and have let the robber barons in. I will name a few examples:
- Dick Cheney giving no bid contracts to Halliburton and KBR
- Contractors in Iraq serving meals to the military and washing their laundry for something like $80 a pop.
- The military using “contract interrogators”
- Jails and prisons run by corporations
- NASA cataloguing the genomes of all bacteria – something that is constantly mutating
- Billions of dollars given to defense contractors for such things as the “Star Wars” Strategic Defense Initiative – a plan that was not feasible from the start.
- The Clinton administration taking off all the “W”s from every key board and typewriter in the White House before leaving – what arrogance, privilege, and waste.
- The endless special prosecutors investigating Watergate, Iran/Contra, Lewinsky Gate, Russian Probe, etc. In the end, all they yield are perjury lying to Congress charges, presidential pardons, and a slap on the wrist with a short jail sentence.
The government has to fund its over spending with government debt. Our deficit is getting larger and larger because the money is simply wasted. It is going to special interest, private equity, and ultimately offshore tax free shelters. A border wall should help, however. A wall should curb the flow of money going to illegals and other immigrants who come to the US just for the entitlements. And lastly, jobs will go to natural born Americans, and not to those who will mail US dollars to relatives in foreign countries – remember if the money supply is cut, then interest rates go up, investment drops, and that means the AD curve shifts to the left.