Worst-case scenarios and endgames for the Trump economy

And why Trump's attack on the Fed makes them more likely.

Photo by Glenn Francis via Wikimedia Commons

After Trump was elected, I wrote a post outlining what I thought was the best-case scenario for his second term. I made it clear that I didn’t think this scenario was very likely, but it was at least plausible.

Unfortunately, it didn’t pan out that way. In fact, in some ways, Trump 2.0 has proven to be not only worse than his first term in office, but worse than almost anyone expected during his campaign. The tariffs he has already announced, for example, have been far higher than the (already substantial) numbers he promised as a candidate, and more focused on Mexico and Canada. The policy uncertainty created by his on-again, off-again tariff announcements, and by the divisions within his administration, have also exceeded even the level of incompetence most of his detractors could predict.

It’s now time to talk about worst-case scenarios.

When we think about the worst-case scenario for Trump’s economy,¹ we shouldn’t just think about the worst possible effects of his current policies; we need to think about how much damage he could plausibly do with additional bad moves. We need to skate to where the proverbial puck is headed.

Don’t get me wrong — Trump’s tariffs are already very bad, and will cause grinding deindustrialization, a macroeconomic slowdown, and possibly higher inflation. They may even cause continued capital flight, which would raise U.S. borrowing costs, hurt the economy even more, and make the national debt less sustainable. We’re already on the path to some bad economic outcomes, and it’s not clear how bad they’ll get, even if we don’t make any big additional mistakes.

But that’s a very big “if”. In my post about capital flight, I outlined two nightmare scenarios for the endgame of Trumpian economics: a sovereign default and spiraling inflation. Let me just quote my own post a bit:

I suspect Trump will do something more like what he used to do as a businessman when his debt went bad — look for a cheap bailout, and if one doesn’t emerge, declare bankruptcy…

If foreigners are headed for the exits, there’s only one entity with the ability to bail out the U.S. government, and that’s the Fed. If the Fed printed a bunch of money…it would bring long-term interest rates back down…So Trump could try to exert pressure on the Fed to do this…But there’s one big problem with that strategy: inflation…If Trump were to try printing money…it would likely just cause even more capital to flee the country, requiring even more Fed money-printing to push yields back down. It’s hard to see how that wouldn’t result in spiraling inflation.

The other thing Trump could do is to declare bankruptcy — i.e., to have the U.S. default on its sovereign debt….Trump declared bankruptcy quite frequently back in his days as a businessman — it does seem to be his natural instinct…[Interest] costs [on the national debt] are already soaring, so further increases due to capital flight might cause Trump and his people to conclude that there’s no way the U.S. can ever pay down its debt.

Just a few days after I wrote that post, it’s already looking like Trump might be even worse than what I predicted. I suggested Trump might replace Fed Chair Jerome Powell when Powell’s term is up next year. Instead, Trump has suddenly begun talking about firing Powell immediately. Bloomberg reports:

Donald Trump is studying whether he’s able to fire Federal Reserve Chairman Jerome Powell, his top economist said Friday, a day after the president publicly criticized the head of the central bank for not moving fast enough to slash interest rates…Hassett went on to suggest that the Fed under Powell, who was appointed by Trump during his first term, had acted politically to benefit Democrats.

Trump wants to get rid of Powell because Trump wants to cut interest rates, and Powell is refusing to do so. Here’s Bloomberg again:

President Donald Trump said he could force out Federal Reserve Chair Jerome Powell, rebuking the notion that the US central bank is independent, and vented frustration that monetary policymakers had not recently cut interest rates…“If I ask him to, he’ll be out of there,” Trump told reporters in the Oval Office Thursday when asked about an earlier social media post blasting the Fed chair as being too slow to lower rates…

Powell said in a speech at the Economic Club of Chicago Wednesday that the Fed must ensure tariffs don’t trigger a more persistent rise in inflation, and indicated the central bank would “wait for greater clarity before considering any adjustments to our policy stance.”

Those remarks squelched hopes for now that the Fed would jump in with a rate cut that could help stem a weeks-long stock market rout triggered by Trump’s tariff rollout.

Firing Powell in order to appoint a more pliant Fed chair who will lower interest rates at the President’s behest would spell the end of central bank independence in the United States. That would be in keeping with Trump’s strategy of trying to dominate, degrade, and overpower any institution in America that doesn’t bow to his will.

But it would also be extraordinarily dangerous for the economy. Why? Because central bank independence is one of the key institutions that America and other rich nations have set up in order to prevent the kind of catastrophic economic collapses that tend to bedevil developing countries in places like Latin America.

As I wrote in my earlier post, there are basically two truly nightmarish economic scenarios here: 1) Hyperinflation, and 2) Sovereign debt default. They’re not mutually exclusive, of course — you can have both, one can lead to the other and vice versa, and the economic pressures that lead to the two are often similar.

It’s important to understand the chain of events that could lead from the end of the Fed’s independence — in combination with Trump’s tariffs — to hyperinflation and/or sovereign default. All too often, commentators just sort of wave their hands and tell us that if we mess with the Fed and the dollar and the other pillars of the U.S. financial system, we could get those nightmare outcomes. The commentators aren’t wrong. But it’s actually not too hard to understand why these things could happen if Trump keeps pushing in the direction he’s been pushing.

So far, I still consider these extreme scenarios to be pretty unlikely, given all the people in the U.S. who would stand to lose catastrophically if either were to occur. But they’re looking a bit less unlikely than they were a week ago when I wrote my post about capital flight. And they’re probably less unlikely than the rosy best-case scenario I wrote when Trump first got elected.

So let’s go through the two worst-case outcomes, and think about how and why Trump might bring each one about.

Nightmare scenario #1: Hyperinflation