If your car has a flat tire, boosting the horsepower of the engine won't necessarily increase its speed.
That is the challenge facing policy makers at the Federal Reserve and within the Trump administration as they look to counter a likely economic slowdown caused, at least in part, by the escalating trade war between the U.S. and China.
While increased government spending or lower interest rates would be expected to lift domestic demand and spur investment, it does not address the fundamental uncertainty that the current U.S. trade conflicts pose for businesses and investors. Also, the effectiveness of a stimulus package of increased spending or tax cuts could be limited in an economy where U.S. consumers are already driving growth.
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"It's possibly getting too close to avert a technical recession through fiscal or monetary policy given that somewhat limited firepower in both directions," Chris Williamson, chief business economist at IHS Markit, said in an interview. "If the trade war escalation continues, then those traditional stimulus measures will have increasingly reduced impact."
Sapping confidence
Businesses are identifying U.S.-China trade tensions as a significant issue in confidence surveys, along with supply chain adjustments stemming from moving manufacturing from China, according to the July edition of the Institute for Supply Management's Report on Business. The purchasing managers' index, an indicator of manufacturing output, showed growth tapering, with a 51.2% reading in July, the lowest level since August 2016. A reading over 50% shows growth.
U.S. GDP growth slowed to a 2.0% annual pace in the second quarter after accelerating past 3% in the previous quarter. Nearly three out of four economists in the National Association for Business Economics' August 2019 survey believe the U.S. economy will enter a recession in either 2020 or 2021, with 38% saying it will happen next year and 34% pointing further out.
The consumer sector of the U.S. economy has largely been a bright spot as global demand growth slowed. The U.S. economy added 164,000 jobs in July, beating consensus expectations and supporting the notion that U.S. domestic economic conditions remain solid.
That suggests consumer stimulus may not prove helpful in the event of a downturn, according to Jennifer Lee, senior economist at BMO Capital Markets.
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"It's already a very low interest rate environment and heading even lower, so consumer spending is still actually driving economic growth already," she said in an interview. "I don't know if I would be even going down that path if it's going to be a consumer-led recession."
Forced technology transfer
If averting recession was President Donald Trump's priority, ending, or at least, scaling back, the conflict with China is probably his best bet. However, he seems more focused on his long-term goal of rebalancing trade with the world's second-largest economy and ending practices, such as forced technology transfer, that have allowed Chinese companies to rapidly gain on their American rivals.
Political motives will likely keep both the U.S. and China engaged in talks to strike a deal, but it could easily stretch past a year into the future, former U.S. trade official William Reinsch said in an interview.
"Nobody believes this, but [the Chinese are] saying they're defenders of the trading system, they're the defenders of free trade, and it's Trump that is the great disrupter," said Reinsch, a researcher with the Center for Strategic and International Studies who served as undersecretary of commerce for exports under President Bill Clinton. "Trump does not at this point want to pull out of the talks, because that would be failure."
If anything, the conflict is intensifying after a rapid series of tit-for-tat actions in August. On the first day of the month, the Trump administration announced that it would impose long-threatened 10% tariffs on $300 billion of Chinese goods, starting Sept. 1. There was a change of heart Aug. 13, when the U.S. said it was delaying tariffs on some of those products to Dec. 15 to allow U.S. shoppers to buy Christmas gifts before prices went up.
That was met 10 days later with retaliatory measures from China, which set levies of 5% to 10% on $75 billion of U.S. goods, and reimposed tariffs of 25% on U.S. autos and 5% on auto parts that it suspended earlier in 2019. The same day, Trump tweeted that the tax on $300 billion of Chinese imports would be increased to 15% and called Chinese President Xi Jinping an "enemy" of the United States.
'Bigger enemy'?
Trump has been pushing the Federal Reserve to cut interest rates faster to help support the U.S. in its trade war with China. In response to a speech by Fed Chair Jerome Powell at Jackson Hole on Aug. 23, in which he declined to hint at further stimulus, Trump tweeted: “who is our bigger enemy, Jay Powell or Chairman Xi?”
Markets believe that the Federal Reserve will reduce its key rate by a further 50 basis points this year after cutting by 25 basis points at its last meeting, but Trump clearly wants more.
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The White House had been considering a payroll tax cut as an option to address earlier in August, with Trump initially telling reporters Aug. 20 he had been thinking about a reduction in payroll taxes for a long time. He later ditched that idea after saying the next day the U.S. economy is "the strongest in the world by far."
Former President Barack Obama reduced payroll taxes in 2011 and extended those cuts through 2012, but when that cut expired, it left workers feeling like they had been hit with a higher tax bill, The Washington Post reported in November 2014.
Pushing a payroll tax cut to encourage consumer spending may backfire if workers see the extra money as temporary and opt to save it instead. Plus, if a downturn does cost people their jobs, there would be fewer people collecting paychecks and reaping the benefit of lower taxes, Sarah House, senior economist at Wells Fargo Securities, said in an interview.
"If you have a lot of people losing jobs, an extra percent or two isn't necessarily going to offset that in terms of the aggregate in the job losses," she said.



