Donald Trump, the U.S. president, is back. On Jan. 20 (local time), Trump rolled out a series of America-first economic policies called 'Ma-ganomics' immediately upon re-entering the White House. He is not sparing allies either. He threatened Canada and Mexico with high tariffs and eyed Greenland, a Danish territory, drawing backlash from traditional allies in Europe. The Atlantic, a U.S. political journal, evaluated that "Trump is using Richard Nixon's 'madman strategy'." This strategy aims to make adversaries perceive oneself as a madman to lead negotiations favorably. Nixon had created fear of nuclear war to draw out negotiations to end the Vietnam War. It was also Nixon who enacted a 10 percent universal tariff. The problem lies in uncertainty. As the world’s largest economy, America, is led by Trump, who is unpredictable, the global economy has entered uncharted territory. This is why 'Economy Chosun' set up a special interview with global economic commentator Martin Wolf, chief economics commentator at the Financial Times (FT), and Kwon Hyo-sung, a former policy analysis team leader at the Bank of Korea, who is now an economist at Bloomberg Economics, to evaluate the prospects and direction of the U.S. economy.
Wolf noted, "The U.S. economy is expected to grow around 2 percent this year, but the inflationary pressures triggered by Trump and the public liability crisis are potential risks." He further stated, "If Trump intends to dismantle the existing allied order and even overthrow systems like the World Trade Organization (WTO), the global economy and cooperative system will face serious chaos."
Economist Kwon also pointed out, "The universal tariffs Trump is pursuing to resolve the trade deficit are a factor leading to dollar strength, yet Trump prefers a weak dollar; hence, his policies are somewhat contradictory."
The discussion was conducted via Zoom with the United Kingdom on Jan. 13, a week before Trump’s inauguration. Kwon posed the questions, and Wolf provided the answers. Below is a Q&A.
The U.S. economy successfully achieved a soft landing in 2024, as you anticipated. How much growth do you forecast for this year?
Wolf said, "In fact, the U.S. economy is unpredictable. Nevertheless, I expect stable and balanced growth this year. America has a closed economic structure with low export dependency, meaning that most demand is generated domestically, and the possibility of inflation skyrocketing is small. Future large-scale investments in artificial intelligence (AI) and data centers will drive the U.S. economy, and tax cuts along with reduced expenditures from the Department of Government Efficiency led by Elon Musk will positively contribute, making a growth rate around 2 percent likely this year."
Even so, what risks will the U.S. economy face?
Wolf expressed, "Two concerns arise. First, the crisis in public liability in the U.S. is worrisome. The annual budget deficit exceeds 6 percent of gross domestic product (GDP). Of course, because the U.S. is the most preferred debtor country in the world, the likelihood of sudden capital outflow is low, but the issue is that this situation is unsustainable. The second concern is inflation. Trump has stated that he will expel many illegal immigrants, which may trigger wage inflation. The Federal Reserve would be forced to tighten its policy, leading to conflicts with Trump that could shake the stability of the U.S. economy itself. In the long term, if a macroeconomic unsustainability situation combines with shocks resulting from Trump, the U.S. economy could face much more severe shocks. However, the likelihood of such a scenario occurring is less than 50 percent."
Global funds are flowing into the United States. In Korea, individual investors have concentrated their investments in U.S. stocks, including Tesla. Over the past few years, funds equivalent to about 5 percent of Korea's GDP have flowed into the U.S. stock market.
Wolf noted, "That is indeed a vast amount. Other countries likely face similar situations. With a robust U.S. stock market and a seemingly solid U.S. economy, funds are concentrating there. However, there is a potential for corrections in the U.S. stock market. This could be related to public liability issues or inflation, and even political turmoil within the U.S. could impact this."
In recent months, the dollar index has shown an upward trajectory. The issue is that for a small open economy like Korea, the dollar is crucial. Will the strong dollar trend continue?
Wolf responded, "That is a very difficult question. I would like to quote Professor Rudiger Dornbusch, a prominent international economist at the Massachusetts Institute of Technology (MIT). He said that 'the unsustainable situation can persist for much longer than we imagine, and then change much faster than we assume.'"
Could you explain in more detail?
Wolf replied, "The current situation is similar to the early Reagan administration in the early 1980s. At that time, the U.S. saw Federal Reserve Chairman Paul Volcker implement the 'Volcker Shock,' raising interest rates up to 20%. The sharp increase in interest rates combined with large-scale tax cuts kept real interest rates persistently high, and the dollar's value literally soared high. However, this resulted in a rapidly deteriorating external position for the U.S. economy. For instance, during that time, the U.S. was wary of the flood of Japanese exports, leading to a rise in protectionist tendencies. This exemplifies how significant political and economic repercussions occur as exchange rates fluctuate significantly.
If the fiscal situation of the U.S. deteriorates again, causing inflationary pressures to rise, and if the Fed feels pressured to raise interest rates, the combination of 'tax cuts, increased fiscal deficits, and high-interest rates' from the Reagan era could be replicated under the Trump administration.
The universal tariffs Trump is pursuing to resolve the trade deficit are a factor leading to dollar strength, yet Trump prefers a weak dollar. There are also accusations that his policies are somewhat contradictory.
Kwon affirmed, "Indeed. If Trump raises tariffs in the current poor financial situation, the strengthening of the dollar is likely to worsen the trade deficit. In the Reagan administration, it took 4-5 years to resolve currency issues through the Plaza Accord and the Louvre Accord. Trump will likely go through a similar process. Even if he appoints a new Federal Reserve chair who attempts to maintain a weak dollar without raising interest rates, the issues will surface if inflation worsens. If the dollar value increases excessively, the export industry will be impacted, ultimately negatively affecting Trump's core support base."
Recently, there are predictions on Wall Street that the U.S. will slow down its pace of interest rate cuts corresponding with Trump's inauguration. As employment and service sector indicators in the U.S. continue to unexpectedly perform well, Trump's high tariffs and immigration policies could elevate inflationary pressures. Wolf also remarked, "Since inflationary pressures remain high, the Fed is likely not to reduce interest rates, meaning a strong dollar could be maintained for the time being."
What do you foresee for the Fed's monetary policy this year? Recently, the yield on 10-year U.S. government bonds has approached 5 percent, which analysts attribute to expectations that U.S. policy rates will rise further. Some observers suggest that the interest rate cutting cycle in the U.S. has now concluded.
Wolf stated, "The Fed is unlikely to continue lowering interest rates. Chairman Powell does not want to go down as 'the Arthur Burns of this century.' Even if he were to lose his position due to being dismissed by Trump or not being reappointed, it is likely he wouldn't unduly lower interest rates. Current inflationary pressures are still high. Particularly within the service sector, inflation remains persistently strong. The extension of Trump's tax cut policies and the reduction in labor force due to the expulsion of illegal immigrants combined with rising prices of alternative goods due to tariffs will exacerbate inflationary pressures. The Fed is unlikely to take this lightly and will probably maintain current interest rates. Given that long-term rates have significantly increased, lowering rates could destabilize the bond market and the economy. The Fed is expected not to take on such risks, although political pressure could be a variable. However, Powell is likely to endure it well."
Some economists, including former Fed Chairman Ben Bernanke, believe that Trump's tariff policy will have a limited impact on inflation. Bloomberg Economics also suggests that if Trump imposes tariffs on intermediate and capital goods rather than final consumer goods, the price impact will be minimal.
Kwon added, "Tariffs raise the costs of intermediate and capital goods, which can reduce corporate profits and lead to decreased production. This relates to the 'Effective Protection Rate' problem wherein chaotic policies can increase inefficiency and cost burdens on the economy as a whole. Ultimately, how much of the tariff increases are passed onto consumers determines the impact on prices. However, if tariffs continue to rise, trade structures may become tangled, making it difficult to foresee who benefits or suffers. Personally, I believe direct causes of inflation are decreasing labor force within the U.S., excess demand, expanded fiscal spending, and the delayed response from the Fed. While tariffs certainly lead to inefficiencies, they are not the decisive cause of inflation."
I would like to ask about the independence of the Fed. Trump has criticized the Fed for raising interest rates during his first term. How do you see Trump's return affecting the Fed's independence and policy decisions?
Kwon replied, "That is a very important question. The last time the Fed was significantly undermined by presidential interference was during the Nixon administration. It took over a decade for the Fed to regain trust afterward. This was due to the emergence of Fed Chairman Paul Volcker in 1979, and the support he received from Reagan who took office in 1981. The issue is that Trump could potentially pose a greater threat than Nixon. Fortunately, while it’s not possible to be entirely reassured, the likelihood of Trump fundamentally undermining the Fed’s independence seems low because Wall Street, the populace, and Congress will push back significantly. Additionally, the Fed's Board changes very slowly structurally. Even if Powell stepped down as Chair, he could remain as Board Member. Regional Fed Presidents are also institutionally protected. Trump's ability to replace the Chair might be limited if Congress does not approve the new candidate. In the past, Trump tried to appoint his allies to the Fed Board but did not get past Congress. Thankfully this time, someone reasonable like U.S. Treasury Secretary Scott Bansen could act as a moderating influence."
The Bank of Korea finds itself in a dilemma. There are downside risks to the economy from Trump's trade and foreign policies, and simultaneously, a political crisis from the state of emergency declared at the end of 2024 has undermined the confidence of domestic consumers and corporations. From the Bank of Korea's perspective, it is unclear whether to lower interest rates or hold them steady to prevent the depreciation of the won. What should be done?
Wolf answered, "From the perspective of a central bank, it is truly difficult to face simultaneous political and economic shocks. Standard macroeconomic shocks or inflation can be somewhat predictable, allowing for impactful responses, but if a massive political challenge leads to a crisis of trust, the narrative shifts. The Bank of Korea might not be entirely sure how to respond. However, it can’t be asserted that a political crisis will necessarily impose severe structural damage to the economy. Rather, based on the system's trust in Korea and its citizens, consistently implementing policies centered on standard macroeconomic indicators like inflation, interest rates, and growth rates could be a rational choice. It may be preferable to maintain the existing financial and monetary policy framework instead of excessively lowering interest rates and allowing exchange rates to soar abruptly."
The possibility of accelerated depreciation of the won is currently a significant risk for the Korean economy.
"If not handled correctly, it could lead to large-scale capital outflows and result in serious foreign exchange and financial crises. Therefore, the Bank of Korea should maintain communication with the market to uphold confidence, and when necessary, consider adjusting interest rates or implementing measures to stabilize the foreign exchange market. Additionally, they should closely cooperate with the government to prevent political turmoil from directly causing structural changes in the economy. In other words, rather than abruptly shaking the policy framework, it is more realistic to secure market confidence and, if needed, gradually implement exchange rate and interest rate policies."
Trump is reshaping even traditional alliances. He has claimed the renaming of the Gulf of Mexico, the merger of Canada, and control over the Panama Canal and Greenland, creating tensions with many allied countries. While there are no eternal enemies or friends, Trump argues that allied nations must also succumb to U.S. interests.
Geopolitical risks are increasingly influencing the world economy. In Korea's case, there is significant concern regarding the conflict between the U.S. and China.
Wolf emphasized, "The U.S.-China conflict is the geopolitical risk I am most concerned about. It is hard to predict how aggressively Trump will act, but it is likely he will seek to encircle China primarily around trade conflicts. The new Secretary of State, Marco Rubio, is a hardliner, which contrasts sharply with Trump's personal admiration for Xi Jinping. The U.S. will aim to encircle China and pressure as many nations as possible to sever their economic ties with China. In turn, China will not remain passive, and the tension could possibly escalate into war."
The problem is that the partnership between the U.S. and Europe, which has collaborated in areas such as security and economics, is also being shaken. For instance, the U.S. has suggested the possibility of using military force to seize Greenland, a Danish territory.
Wolf remarked, "Indeed. The fate of the Western Alliance is a very important issue. As an old-school Westerner, I believe that I share the core values of this alliance, but Trump does not share these values. Just a month ago, I could not have imagined that the Greenland issue would become such a heated topic. Trump views alliances merely as tools. Consequently, the future relationships between the U.S. and Europe, the United Kingdom, Japan, and Korea will inevitably become uncertain."
If international cooperation weakens in this manner, what concerns arise?
Wolf responded, "A great deal of chaos is expected. The U.S. has been a key nation that created the international order after World War II, and Trump's return signals a willingness to destroy that order. The Paris Climate Agreement represents this. Climate change is an existential challenge threatening the world, and if the U.S. withdraws, the global response will become significantly more challenging (Trump signed an executive order withdrawing from the Paris Climate Agreement on Jan. 20, his first day in office). Additionally, if existing trade frameworks and the dollar system are destabilized, small open economies like Korea will suffer heavily. Organizations such as the World Trade Organization (WTO), International Monetary Fund (IMF), and World Bank are not just economic systems but are also interconnected with political stability. If the U.S. seeks to destroy these, the global economy and cooperative systems will descend into chaos."
Plus Point
Martin Wolf, who experienced the emergency martial law in Korea in 1972, remarked, "Both parties must recognize each other's legitimacy... U.S. democracy is endangered by Trump."
Economic commentator Martin Wolf is a highly influential figure who has been named one of the '100 Leading Thinkers in Foreign Policy' for three consecutive years since 2009. In April 2024, he translated and published 'The Crisis of Democratic Capitalism' in Korea, sharply pointing out the conflict between capitalism and democracy. He also has deep connections with Korea. While working at the World Bank in 1972, he briefly stayed in Korea, witnessing the emergency martial law declared by President Park Chung-hee as he announced the Yushin Constitution.
Wolf diagnosed that in an America under Trump's potential re-election, liberal democracy is also facing a serious crisis. After Trump consolidates power over key government institutions, there is a substantial risk that he may retaliate against political opponents and even resort to irrational measures, such as deploying the military to expel illegal immigrants en masse. Wolf expressed concern that "a coup-like situation could occur." In reality, Trump declared a 'national emergency' at the southern border via an executive order immediately after taking office on Jan. 20, deploying troops to the southern border while announcing strict measures to block illegal immigrants, stating that those without proper documentation would not be allowed to remain in the U.S. Wolf warned that "The U.S., which has been the backbone of democracy since World War II, stands at a crucial juncture for significant change due to Trump, and this has become a tangible threat rather than just an abstract concept."