This time may be different
The USD has been the weakest developed country currency through 2017. The DXY, a measure of the US effective exchange rate, has fallen by about 10% from 103 in January to 93 today. There are a few reasons for this, including a more gradual start to the normalisation process. But a key factor is political risk.
Indeed, there is a striking correlation between the declining path of President Trump’s approval ratings (currently 36%) and the depreciating USD since January 20. There are concerns about the ability of the Administration to pass a coherent legislative agenda (tax, infrastructure), to manage domestic issues (from the debt ceiling to Charlottesville), to respond appropriately to geopolitical issues (such as North Korea), and to strengthen the US in the global economy (TPP, NAFTA). There are economic challenges confronting the US, but political issues are the main concern.
Of course, this is not all new. Twenty years ago this month, I arrived in Boston to start graduate studies at Harvard. Congress was bitterly divided, and there had been government shutdowns. President Clinton was being investigated, leading to an impeachment process. And a few years later, the Supreme Court had to decide on the 2000 Presidential Election after the chaos of voting in Florida, awarding the election to President George W. Bush.
But despite these domestic political challenges, the US continued to grow strongly and to generate innovative firms and services. This resilience is a core part of the orthodoxy on the US. For example, Warren Buffet argued in his 2016 shareholder letter, ‘For 240 years it's been a terrible mistake to bet against America, and now is no time to start’.
Indeed, during this period the US was probably close to the apex of its global dominance. The US was the sole remaining superpower, was growing strongly, had booming asset markets, and set the terms of the global policy debate – including being the central actor in responding to various financial crises (a famous Time Magazine cover featured Alan Greenspan, Bob Rubin, and Larry Summers as the ‘Committee to save the world’). The US has continued to function and prosper despite various political challenges. Over the past several decades, the US rebounded from the political troubles of the 1970s (including President Nixon’s resignation), was on the winning side of the Cold War, saw off Japan for global economic supremacy in the 1980s, and so on.
But is this time different? Can we expect ongoing resilience of the US? I have noted previously that, at some point, the costs from these various macro dysfunctions are likely to overtake the advantages of the bottom-up innovation and dynamism that is produced in the US. There are several fundamental challenges facing the US – and developed Western economies more broadly. Globalisation and technology are having increasingly disruptive effects on economies, notably on labour markets; productivity growth remains lacklustre; and the geopolitical balance is shifting. So far, the US has not responded effectively.
There is significant variation in how resilient countries have been to economic and political challenges over the past few centuries. In recent analysis, I show that several small advanced economies have been resilient to regime change in the global economic and political system, remaining close to the income frontier over the past century (and more), by continuously adapting to a changed economic and political environment. The quality of their political and social institutions has been a key factor in this resilience. This is true for large countries as well.
There have been several pieces of good commentary over the past weeks arguing for determined responses to current challenges: Simon Johnson and Daron Acemoglu argue that ‘The United States has teetered on the brink of catastrophe before, and rebuilt itself by rethinking its institutions. It's time to do so again’; the FT’s Martin Sandbu laments the absence of big ideas after the crisis as we have seen in previous periods, and offers some creative suggestion; and scholar diplomat Philip Zelikow claims the US needs to develop a new approach to avoid the world ‘slouching towards a grave systemic crisis’. As in previous periods of disruptive change, like the 1930s and the 1970s, new policy approaches will be required.
But this is demanding of political leadership and public sector capacity. Indeed, my view on the outlook for the US – and other Western countries – rests heavily on my assessment of the ability of the political system to deliver such change. And there are real questions regarding the extent of this leadership in the US.
At the Shangri La Dialogue in Singapore in June, Defence Secretary Mattis responded to a question on US commitment to Asia by referring to the famous Winston Churchill observation that ‘You can always count on Americans to do the right thing - once they’ve exhausted all the alternatives’. This response was met with nervous laughter by the audience, who were not entirely reassured.
It is much too early to write the US off, and I am not persuaded by the market hyperbole of ‘the US as emerging market’. But significant structural reform will be required. For the moment, the distribution of possible outcomes from the US – both at home and in terms of its global engagement – is much wider than for some time. And my sense is that these political challenges will increasingly weigh on the US economy. This time may be different.