Joseph Y. Calhoun: Pump It Up

She’s been a bad girl.
She’s like a chemical.
Though you try to stop it,
she’s like a narcotic.
You wanna torture her.
You wanna talk to her.
All the things you bought for her,
putting up your temp’rature.
Pump it up until you can feel it.
Pump it up when you don’t really need it.

Elvis Costello
Having behind us the producing masses of this nation and the world, supported by the commercial interests, the laboring interests, and the toilers everywhere, we will answer their demand for a gold standard by saying to them: “You shall not press down upon the brow of labor this crown of thorns; you shall not crucify mankind upon a cross of gold.”

William Jennings Bryan
Our companies can’t compete… because our currency is too strong. And it’s killing us.

Donald Trump

I put the Elvis Costello quote at the top because I’m reading his autobiography right now and I think he may have a better grasp of economics than either of the other two quoted. Here’s another quote from his autobiography:

History suggests that underestimating the crude appeal of bigots is usually a mistake.

That was written a couple of years before our recent election, a reference to the rise of the National Front in the UK in the 1970s when Costello was first starting to enjoy some success. The National Front of the 1970s sprouted from the UK economic malaise that would raise Margaret Thatcher to power later in the decade. It was an overtly racist political party that played on commoner fears of immigrants and foreigners. They promoted economic nationalism and the rejection of free trade. They railed against companies putting their interests before the nation’s and it’s workers. They promoted “repatriation” of foreigners and strict control over the ethnic makeup of the UK population. They also wanted state control over banking and financial services to provide interest free loans for municipal housing. And of course they were Euroskeptics, against greater integration with Europe. One can’t help but make comparisons to today’s UKIP party of Brexit fame.

William Jennings Bryan was not the first “populist” politician but he is certainly the most famous (infamous?) one in the US. He was a Democrat but that is hardly relevant today as many of the positions of the two parties have switched over the years. He was, for instance, a creationist, acting as the prosecution in the trial of John Thomas Scopes (the Scopes Monkey trial). As a midwesterner – Nebraskan – he was also an advocate of free trade. But Bryan’s popularity, like that of the National Front in Britain seven decades later. sprang from the same working class economic anxiety. His prescription was one of currency devaluation, the gold/silver debate of the late 1800s. And like so many others in times of economic distress he blamed a lot of the problems on Wall Street:

And who can suffer injury by just taxation, impartial laws and the application of the Jeffersonian doctrine of equal rights to all and special privileges to none? Only those whose accumulations are stained with dishonesty and whose immoral methods have given them a distorted view of business, society and government. Accumulating by conscious frauds more money than they can use upon themselves, wisely distribute or safely leave to their children, these denounce as public enemies all who question their methods or throw a light upon their crimes.

Bryan was not – to put it as nicely as one might – overburdened by intelligence. H. L. Mencken had this to say in his obituary:

Bryan was a vulgar and common man, a cad undiluted. He was ignorant, bigoted, self-seeking, blatant and dishonest. His career brought him into contact with the first men of his time; he preferred the company of rustic ignoramuses…Imagine a gentleman, and you have imagined everything that he was not.

But he knew the right buttons to push to get a crowd going and was the Democratic nominee three different times (1896,1900,1908).

Donald Trump, our new President, has a lot in common with Bryan although I don’t think anyone would ever call Trump a great orator. Nor would anyone ever dare to call him the “Great Commoner” as they did Bryan. But their campaigns sprang from similar economic conditions and share some common characteristics. Middle class or working class uprisings – whether the 1890s, the 1970s or 2016 – all cite similar causes and solutions. Immigrants taking jobs, Wall Street preying on Main Street and the rich getting more than their fair share are common themes. Anti-immigration policies, economic nationalism and currency devaluation are the common cures. From “No Irish Need Apply” and the nativist movements of the late 1800s to the repatriation of immigrants advocated by the National Front in 1970s Britain to Donald Trump’s Mexican wall and executive orders, immigrants and foreigners are always the bad guys stealing our jobs.

There is some truth in all these complaints or they wouldn’t work so well for the politicians with the gall to exploit them. Middle class incomes have stagnated today, capital gaining a larger portion of national income from labor. The late 1800s period known as the Long Depression was marked by deflation as the US returned to the gold standard following the Civil War. Incomes in the midwest were especially hard hit as commodity prices deflated. Deflation – a contraction of the money supply (gold) – made debts harder to pay. And farmers especially depended on debt to run their operations. That period was also known as the Gilded Age as inequality widened dramatically during the second industrial revolution. Rapid immigration meant high GDP growth but it also held down wages and fueled a backlash against the new immigrants. Today, the targets are more foreigners than immigrants as US companies outsource labor to foreigners willing to work for less. But the backlash by voters is the same.

Wall Street is always an easy target after a financial crisis and there were six between the Civil War and 1900. J.P. Morgan – the man not the bank – was at the center of many of the bailouts and also led the way by financing the industrialists of the time. Indeed, Morgan was at the forefront, involved in the formation of GE, International Harvester and US Steel. The man became so powerful that he loaned the US government gold in 1895. He was Wall Street and an easy guy to dislike. Today’s bankers have gotten off easy compared to the treatment of Morgan and his company in the early 20th century.

There is also plenty of blame for the monetary systems of each period. The Sherman Silver Act and adherence to the gold standard led directly to the Panic of 1895 and the rise of Bryan. The Cross of Gold speech was a direct response to the Eastern elite who wanted desperately to maintain the status quo that had been so good to them. The inflation of the 1970s hit the middle class globally but especially hard in the UK where the state had come to dominate the economy by that time. Trump’s rise too has been driven by the 2008 crisis and the lack of robust recovery since, something we at Alhambra have maintained for a number of years is primarily a monetary failure.

One could even go so far as to say the US over the last few years has, like the period of the late 1800s, experienced deflation. The rapid rise of the dollar since mid-2014 is a deflationary event even if quite a bit milder than the Long Depression of the Gilded Age. The rapidly changing value of the dollar is a challenge for everyone but especially the poor among us. They are buffeted by forces of which they are unaware and over which they have no control. Low interest rates and the contraction of global trade are symptoms not causes of our economic troubles. It isn’t secular stagnation – we have not run out of ideas – but monetary malpractice that should be the focus of economic research.

Another common feature of the periods prior to populist phases is rapid technological change. The benefits of free trade, low inflation (or mild deflation) and relatively free markets may not be evenly distributed but they are hard to deny. Increasing inequality may be unavoidable as scarce capital is ascendant at such times, returns to first movers enormous. And capital cares little of borders and national interests, just returns. The dislocations caused by rapid technological development are also hard to deny and when we do, we get William Jennings Bryan – and Donald Trump.

The difference, of course, is that Bryan never made it to the Oval Office so we never followed his inflationary prescription. The UK rejected the National Front in favor of Margaret Thatcher. In the US, we have had populist Presidents, Andrew Jackson the most obvious candidate. His feud with the 2nd Bank of the US is classic populism, pitting the privileged rich customers of the bank against the common man. Although known as a hard money advocate it is interesting that Jackson’s policies led to a classic inflation followed by a deflationary collapse – the Crisis of 1837. From his veto of the bill authorizing a recharter of the SBUS:

It is to be regretted that the rich and powerful too often bend the acts of government to their selfish purposes. Distinctions in society will always exist under every just government. Equality of talents, of education, or of wealth can not be produced by human institutions. In the full enjoyment of the gifts of Heaven and the fruits of superior industry, economy, and virtue, every man is equally entitled to protection by law; but when the laws undertake to add to these natural and just advantages artificial distinctions, to grant titles, gratuities, and exclusive privileges, to make the rich richer and the potent more powerful, the humble members of society-the farmers, mechanics, and laborers-who have neither the time nor the means of securing like favors to themselves, have a right to complain of the injustice of their Government. There are no necessary evils in government. Its evils exist only in its abuses. If it would confine itself to equal protection, and, as Heaven does its rains, shower its favors alike on the high and the low, the rich and the poor, it would be an unqualified blessing. In the act before me there seems to be a wide and unnecessary departure from these just principles.

Donald Trump, on the other hand, has been duly elected and is in the process of trying to enact his agenda. Economically, that means the classic populist prescription of cheap money, protectionism and bashing of immigrants. Yes, there are also plans for tax and regulatory reform but the holy trinity of populist economics may make them moot points. The first thing to note is that two of the planks are seemingly contradictory. A cheaper dollar and protectionism, according to orthodox economic theory would seem impossible to combine. Theoretically, if the US enacts protectionist tariffs – of whatever form – the dollar should adjust to offset the tariff. That would mean a higher dollar to reduce the cost of imports and raise the cost of our exports. Theoretically, it should have no impact on the trade deficit over the long term.

That’s theory though and one thing that should be clear from the last couple of decades is that economic theory rarely survives contact with the real world. Ceteris is definitely not paribus. In this case, pursuit of a trade surplus – a white whale if ever there was one – seems more likely to produce a weaker currency. Maybe not in the short term but almost certainly in the long term. The world already faces a dollar shortage, something our Jeffrey Snider has written about repeatedly over the last few years. The Eurodollar system that is the de facto global dollar standard is contracting. Call it international bank balance sheet contraction or whatever else you want but the fact is that the supply of dollars globally has been and continues to shrink. If you doubt that, look no further than the nearest foreign exchange web site. The price of a dollar has risen dramatically since 2014, an indication that dollar supply has not kept up with dollar demand.

If the Trump administration were able to achieve their goal of a trade/current account surplus – something that has only been accomplished in recent decades through recession – it would just further reduce the global supply of dollars, accelerating the collapse of the Eurodollar system. With that as the predicted outcome though, it seems highly unlikely that the rest of the world will just sit around and do nothing in the face of hostile US trade policy. Not with trillions in US dollar reserves at their disposal.

It may be that Trump is bluffing on tariffs and will eventually just settle for a weak dollar as the easy path so he can say he’s addressing the trade issue. A cheap currency has never produced anything other than inflation but that hasn’t stopped others from trying the same thing. If that is the outcome, it would be ironic indeed as foreigners with dollar debts would be the most obvious beneficiaries, not the working class voters who put Mr. Trump in office. If he is bluffing he better hope no one calls him on it though. Imposing tariffs may get him that trade surplus he thinks he wants but it would probably come in a global recession wrapper. Or something worse. It almost assures that the de facto dollar standard on which the world has functioned since the 1960s is over. And with it the exorbitant privileges that come with the title of World’s Reserve Currency.

I don’t know how all this will come out over the next few months. I do feel that stock markets are discounting a level of global growth that seems unlikely and is, by the way, wildly incompatible with the picture being drawn by bond and currency markets. The dollar has slumped since the beginning of the year as the reality of making policy replaces the fantasy of the campaign trail. Bonds have also rallied but I think it is noteworthy that TIPS have rallied more than nominal bonds, inflation expectations continuing to rise as real growth expectations pull back. I can’t say – yet – that the dollar has peaked and that the weak dollar scenario is the one that will play out. Maybe the market is just hopeful that will be the outcome.

As I said above, economic theory rarely survives contact with the real world. The idea that the dollar and the world will just smoothly adjust to the tariffs is one that I find absurd. There are a lot of assumptions in that model of the world but maybe the most ridiculous is that the Federal Reserve would not respond to that kind of shock. And that’s the real reason I included that Elvis Costello quote. If Mr. Trump is a true believer in tariffs and follows through, I suspect he’ll be soon be calling the Fed Chair – whoever that might be – and screaming:

Pump it up until you can feel it.