Nobody respectable thinks the Trump administration will be able to get U.S. growth up to its goal of 4 percent. Of course, nobody respectable thought Trump would be elected president either. The respectables were wrong before. And they’re wrong now.
Still, conservative economist Douglas Holtz-Eakin told the Wall Street Journal there’s “no way to get to 4 percent without more people.” (Immigration policy during the Trump era appears decidedly anti-“more people.”) Economists at Goldman Sachs continue to think the “speed limit” for U.S. economic growth will be around 1.75 percent over the coming years. The Congressional Budget Office expects growth to be around 2 percent annually for the next decade. Liberal economist Jared Bernstein, who worked in the Obama administration, stopped short of calling the goal impossible but said the 4 percent goal is “as close to that as I’m comfortable asserting.” When asked recently if he thought 4 percent growth was possible, Warren Buffett simply said, “That’s very high.”
U.S. economic growth has been relatively slow in the aftermath of the financial crisis and Great Recession, with the U.S economy expanding at about 2 percent a year. Trump has vowed to double that pace. Now, as his economic policy team settles in, the outlines of a key part of his plan to supercharge growth are emerging as a risky attempt to reinvigorate a financial sector that led the U.S. into the banking disaster of 2008. And his plan might just work.
The recipe economists have long used to think about economic growth — developed in the 1950s by a Nobel Prize–winning economist named Robert Solow — calls for three big ingredients. The first is people, in the form of a growing labor force. The second is capital, the money businesses need to invest in stuff like machinery that helps them make a profit. Add a dash of the mystery ingredient known as productivity, and presto! — economic growth.
All the experts who think 4 percent is unattainable note that in the U.S. economic pantry, supplies of some of those ingredients are fairly low. The U.S. labor force growth is slowing fast as the demographic wave of baby boomers breaks toward retirement. And other than a productivity boom in the 1990s tied to adoption of computers and other information technology, U.S. economic productivity growth has been stagnant for more than four decades, with few indications it will rise.
But there’s another ingredient that we potentially have a ton of: capital, alternately known as finance. The U.S. has a lot of finance. And the Trump administration could temporarily pump up U.S. economic growth by letting banks and financial markets go crazy and lend money to, frankly, anyone with a pulse.
When Solow came up with his model for how the economy grows, economists thought of banks and other financial institutions, like stock and bond markets, as well-paid remoras attached to the side of the shark that is the real economy. The remoras — while providing some benefits to the shark — are basically just along for the ride.
In the same way, banks and financial institutions were thought to be a side effect of the economy, not a driver of it. They collected fees for lending or otherwise arranging the financing that companies needed to make profitable investments. But banks weren’t thought to lead economic growth; industry was. “Where enterprise leads, finance follows,” as Cambridge economist Joan Robinson summarized in the early 1950s.
This, too, is dead wrong. We know the financial sector can drive the economy, at least for a while, because the financial sector drove the U.S. economy off a cliff back in 2008. Then, the financial crisis plopped America into the vast, foul soup of the Great Recession.
Only economists could manage to miss such an obvious feature of the economy. It’s rare to find an economic boom that isn’t accompanied by supercharged financial booms — binges of betting and borrowing in banks and stock and bond markets. The U.S. railroad-building boom of the late 19th century. The stock market boom of the late 1920s. The 1980s savings and loan lending boom driven by Reagan-era deregulation. The tech stock boom of the 1990s.
And it’s equally rare to find a financial boom that doesn’t end badly. These busts aren’t always disastrous for the economy. (The tech stock bust of 2001 generated only a mild recession.) But as we saw in 2008, they can be really bad.
The years before 2008 were great times for banks and Wall Street. Deregulated under Bill Clinton, banks transformed themselves into machines that fueled the housing boom. They took billions of dollars worth of risky home loans and processed them into supposedly safe mortgage bonds that banks then sold to investors and kept for themselves. Everybody was making a lot of money. At the peak of that boom in 2006, the financial sector accounted for roughly 8 percent of a U.S. economy that — while not hitting a Trumpian 4 percent — was growing at about 3 percent a year. Good times.
Of course, those times didn’t last. High gas prices ate into the finances of overstretched American families. They started missing mortgage payments, and those supposedly safe mortgage bonds Wall Street created turned out to be toxic. As a result, the financial system collapsed and had to bailed out by Jane Q. Taxpayer. And because the banks basically went bust, the economy cratered and millions lost jobs. In response, the government imposed a whole load of rules that have made the banking system less risky — and less profitable — in the hopes of avoiding a rerun of the crisis.
But wait, some people made out like bandits during the mortgage bond boom and bust and even the Great Recession — people like, say, highly remunerated Wall Street executives, mortgage traders, and hedge fund managers; people like, maybe, former Goldman Sachs President Gary Cohn and former Goldman Sachs mortgage bond trader and later hedge fund manager Steven Mnuchin, the two men now running economic policy in the Trump administration.
Just so you know, the idea of former bankers in the Trump administration easing regulations on banks isn’t some sort of conspiracy theory. It’s a matter of public record.
President Trump signed executive orders on Feb. 3 directing the the Treasury Department and other financial regulators to find ways to revise the Dodd-Frank financial regulatory overhaul of 2010. Those regulations put in place a range of rules aimed at making banks safer in the aftermath of the banking bust of 2008.
The first high-profile policy pronouncement from Cohn, now president Trump’s chief economic adviser, was directly focused on cutting off the restraints put on Wall Street after the financial crisis. “We’re not going to burden the banks with literally hundreds of billions of dollars of regulatory costs every year,” Cohn told the Wall Street Journal.
In other words, the writing is on the wall. Trump is about to turn the banks loose again, and everybody knows it. Just look at bank shares, which have been leading U.S. stock markets sharply higher since Trump’s election. Investors expect that banks will be able to take bigger risks and make bigger profits — at least for a while.
But the question remains: Could a banking system — one that regulators allow to make tons of loans to people with little chance of paying the money back — help get growth up to the 4 percent target Trump has repeatedly mentioned?
We could get closer than many expect. After all, in 2004 the U.S. economy reached 3.8 percent annual growth, driven by a surge of consumer spending and residential real estate investment. And at one point that year, the growth rate was high at 6.9 percent, more than high enough for Trump to declare victory. Heck, during the first and last quarters of 2006, the economy grew faster than 4 percent, thanks to a bit of help from the financial sector.
And in coming years, more people will likely be looking to borrow. That’s because a big bunch of millennials, America’s largest generation, are finally going to have that relationship conversation, move out of their parents’ homes, get hitched, and settle down — since they waited longer to do it than everyone else.
That should bring on a boomlet of spending and borrowing that a freshly unfettered financial sector will gladly help move along. Throw in a bunch of Trump government spending on infrastructure financed by big deficits, and 4 percent growth is a distinct possibility.
But I’ll also bet that overly fast growth driven by a borrowing boom won’t last. And if it’s driven by excessive lending at banks or borrowing in the bond markets, it could lead to a nasty bust and slow growth hangover. We’ve seen this movie before.
Frankly, 4 percent growth isn’t worth the risk. After all, faster growth doesn’t necessarily have any impact on how well-off regular people are. (A more quickly growing GDP makes the economic pie bigger but doesn’t necessarily change the size of the slice that workers are getting. And it makes the economy a helluva lot more vulnerable to the big, volatile swings that can be incredibly painful for workers.
On the other hand, some people — fast-moving, sophisticated economic opportunists who buy low and sell high — like volatility. For these people, big swings open up large windows for making money. These people have a name. They’re called traders. And in Trump’s White House, they’re the ones running the economy.