November 10, 2016
A disaster for Merkel, the EU, and the economics profession
We noted yesterday that the election of Trump was Brexit all over again, and this is true on so many levels. Our coverage today will mainly focus on this one subject because of its huge reverberations for Europe. We think that the Trump presidency is a disaster for the EU - though not for economic reasons. The disaster is political. It hits the EU at a time when it is most divided.
The EU leadership is also hopelessly unprepared for what is happening. One group of people who got it wrong is the German establishment, including virtually everyone to the left of the AfD and, most importantly, Angela Merkel. Tagesspiegel called the election result the largest conceivable disaster for German foreign policy. It writes that German government officials acknowledge that they do not have a single contact in the Trump team. The defence minister Ursula von der Leyen told them that she does not even know whom to call in Washington.
Most peculiar was Angela Merkel's reaction yesterday when she talked about Trump in the same way she talks about Vladimir Putin or Racep Tayyip Erdogan: that she is willing to co-operate with him only as long as he respects shared values. She might be in for a surprise. Die Welt reported that Merkel would be particularly sore if Trump cancelled the international climate agreement, which she regarded as her personal triumph.
It looks as though Merkel is trying to forge a distinct, anti-Trumpian European response, which we think is doomed to fail not least because of Germany's own behaviour during the eurozone crisis. If Merkel had agreed to functioning crisis-resolution mechanisms during 2008-2012, the EU would now be well on its way towards a political union, and would be in a position to forge an effective foreign and security policy rather than the working-paper diplomacy it now has. Merkel herself chose the intergovernmental approach because it suited her and her party for domestic political reasons. The strategy has had multiple costs: ongoing crises, uncertainty about the future of the euro itself, and a lack of political union when you need it the most.
We very much agree with Mark Leonard who writes that the EU has about two months to get itself a coherent foreign and security policy, which of course it won't. A divided EU has little to offer as we saw during the Iraq war in the previous decade. He says the EU needs to invest more into its own security, and should form alliances with other powers that also have an interest in reining in Trump's revisionism, China being the obvious candidate here.
We would like to add that there is no way the EU can do this as EU-28 or EU-27. This will have to happen within a meaningful subgroup - and that group should include the UK. There is no way the EU is in a position to build an effective foreign and security policy without the UK. That alone would be a reason to offer the UK something other than a hard Brexit. It is more likely is that the EU will not act, and disintegrate further.
We agree with Paul Krugman, who wrote yesterday that the Trump presidency is a disaster in its own right but is not necessarily bad for the economy. Trump is a political calamity for the US and the world, but his promised infrastructure spending programme is likely to have positive impact on US growth. We assume that fiscal multipliers must be very high after years of austerity. That was also borne out by yesterday's market reaction. The US stock market rallied, with the S&P up 1.1%, close to its all-time high. Remember all the ludicrous forecasts about market crashes and an immediate global recession, both ahead of the US elections and the Brexit referendum? Forecasts like these make us underestimate the true threat.
In both cases the economics profession warned of impending disaster, the most recent example being the 370 US economists who wrote a joint letter warning against Trump. When disaster failed to arrive in the UK, some doubled down to say that the disaster would happen later, or pretended to ignore what is happening, like Simon Johnson who wrote only last week "of the sharp slowdown [to come in the US], much like the British are experiencing." If the world does not behave according to the model, then surely something is wrong with the world that needs to fixed.
We also noted a story in FT this morning, according to which Trump's economic advisers reiterate what they said during the campaign: that they are seeking to replace Janet Yellen when her terms end in early 2018, criticising her and the Fed for having created "a false economy". The principle of central bank independence that has strengthened the power of central bankers is also disappearing. We are not surprised by this development. Society has lost the consensus about what monetary policy should do, and consensus has been the political foundation for central bank independence.
One important recurring question is: why does the establishment persistently underestimate the populists? You can't blame the polls alone. They showed a 3-4 point Clinton lead ahead of the elections, which was wrong, but not that wrong in view of the final results (which had Clinton ahead by a whisker in the popular vote). The problem is how we interpret the polls. The only logical conclusion one can draw from this - and also the pre-Brexit polls - is that the result was too close to call. And if a result is too close to call, then none of the outcomes should really come as a surprise. But this is not what's happening. The policy establishment - and the media in particular - is completely incapable of separating what they want from what they think is going to happen. And they are incapable of learning. They do this every time. You could build a viable trading strategy on this mismatch alone. We will have plenty of occasions to witness this mismatch in the numerous elections next year.